AICPA Recommendations Incorporated in SEC Rule Defining “Family Office” Exclusion under Investment Advisers Act

June 30, 2011

The U.S. Securities and Exchange Commission adopted a rule June 22 expanding the definition of the “family office” exclusion under the Investment Advisers Act of 1940. The SEC rule incorporated several suggestions made by the American Institute of Certified Public Accountants.

Historically, family offices were not required to register with the SEC because the Investment Advisers Act provided an exemption to investment advisers who had fewer than 15 clients.  The exemption was removed by the Dodd-Frank Wall Street Reform and Consumer Protection Act so the SEC could regulate hedge funds and other private equity fund advisers, but Dodd-Frank mandated that the SEC define family offices so that they would not have to register under the Investment Advisers Act.

The final rule states that a family office is exempt from registration if it provides investment advice only to “family clients,” is wholly owned by family clients and is exclusively controlled by family members and/or family entities, and does not hold itself out to the public as an investment adviser.

As the AICPA and others suggested, the SEC adopted an approach that permits a family to choose a common ancestor (who may be deceased) and define family members by reference to the degree of lineal kinship to the designated relative.  In order to prevent families from choosing an extremely remote ancestor, which could allow commercial advisory businesses to rely on the rule, the SEC is imposing a 10 generation limit between the oldest and youngest generation of family members.  Such a limit would constrain the scope of persons considered family members while accommodating the typical number of generations served by most family offices. 

The SEC adopted another AICPA suggestion regarding the transition period provided for relief for involuntary transfers.  It has been extended from a four month transition period to one year.

A suggestion made by the AICPA and others that the SEC expand who may own the family office from “family members” to “family clients” was agreed to by the SEC.

If family offices do not meet the terms of the exclusion, they will have to register with the SEC or applicable state securities authorities by March 30, 2012. A family office that does not meet the conditions of the rule may petition for an exemptive order from the SEC. Existing exemptive orders will not be rescinded.  The rule allows for a longer transition period (through Dec. 31, 2013) for the termination of relationships with charitable entities or non-profit organizations that are not exclusively funded by the family.

The AICPA’s comment letter, a Journal of Accountancy article summarizing the AICPA’s recommendations and a comparison of the AICPA’s recommendations with the SEC’s final rule are available on the AICPA website.