Family office managers and owners have until 30 March 2012 to comply with new family office regulations issued by the SEC. Here, some options are discussed by lawyers specializing in the family-office industry.

In the second of a two-part series on the Securities and Exchange Commission’s rules surrounding family offices, the options that family offices have in complying with the regulations are discussed. Part one discusses the rules and the background surrounding them.

Family office managers and owners have until 30 March 2012 to comply with new family office regulations issued by the SEC. While that date isn’t exactly around the corner, family offices need to decide on a course of action in response to these rules and begin implementation quickly, says David Guin, a partner with the law firm Withers Bergman.

“Most family offices are probably in the implementation stage at this time, but some were waiting for the final rule to come out before they took action,” he notes. “There are still a number of families who have identified where their problems are and are trying to decide between different courses of action.”

Basically, it’s a choice between bad and worse, and whichever way a particular family office decides to go is likely to be expensive, he adds. The major issue for many families is the involvement of non-related parties in family office investments, which isn’t permitted under the new rules.

“If you have to buy out parties who are investing with your family office, you either have to do that out of capital generated within the collective investment vehicle or members need to contribute more to buy the others out,” Guin says.

A “narrowly-drafted” exemption

Steve Thayer, a partner with Handler Thayer in Chicago, agrees, saying, “Many investment structures managed by family offices are complicated with multiple parties. The chances of those types of offices qualifying for this narrowly-drafted family office exemption is pretty slim, meaning they aren’t going to qualify because they have other outside partners in a deal. They might manage private equity and it made sense to bring in outside partners.”

Guin notes that in many cases smaller family offices brought in outside partners to help defray the expenses involved in running the family office and those that are part of complex investments. So even if a particular family office could pay off the partners and go back to a structure involving just family members, it might not make sense from a financial and investing point of view.

Alternatives for family offices

Because the exemption crafted by the SEC applies to a very limited amount of family offices, families and managers of family offices have a couple of choices, according to Thayer. “Families are going to have to do one of two things: either they’re going to have to bite the bullet and pick an entity that is going to have to register with the SEC and subject themselves to increased scrutiny, increased exposure of who they are, what investments they have and what their affiliations are, or they are going to have to affiliate with a multi-family office.”

Thayer believes that most of the smaller family offices which can’t qualify under the new rules will choose to affiliate with a multi-family office that is already registered with the SEC. “It’s a way for those smaller offices to get customized services with a firm that is already registered as a Registered Investment Advisor,” he says. “They can get their investments and investment advice through that multi-family office and have access to the investment that they want – private equity or whatever.”

And there’s likely to be an ultimately beneficial payoff for smaller family offices in affiliating with multi-family offices, Thayer notes. “Frankly, any family office with assets under a couple of hundred million dollars should be using a multi-family office anyway because they will have more access to bigger investments and pay lower fees than if they do it on their own,” he continues. “Because when you are smaller, there are more layers of money managers, fees and platforms that cost more money.”

The separate entity option

The issues can be more complex for smaller family offices who provide investment advice and services to local charities and others in the community and feel they have a responsibility to continue that work because it is part of their mandate, notes Guin. “These family offices aren’t trying to figure out how to get rid of the non-family people and avoid registration,” he adds. They are trying to figure out if they should register or set up an affiliated entity, and are still questioning what they should do, he continued.  

There is a way that smaller family offices who don’t want their private information to be made public can get around this requirement, which is by creating a separate entity to deal with non-family members and register that entity, Guin says. “They have to be careful to create enough ‘separateness’ to meet the SEC guidelines, and the two-entity structure creates a whole different level of cost and complexity that I do think was unintentional on the part of the SEC,” he continues.

Guin finds the major concern among his clients in this space is privacy. They don’t want their private family information and financial data out in the public domain and these are the family offices that will either create a separate entity or affiliate with a larger multi-family office, he said.

For those who want to stay small and operate within the exemption, they will have to get rid of non-family member partners and investors. That can pose a problem because these non-family members are well aware of the issues involving the rule and could hold out for a better deal than they might otherwise get when leaving the family office.

For any family that needs to restructure to meet the exemption, “non-family member investors do have some leverage to get a better deal,” he says. “The alternative to buying people out may be to liquidate the company if they won’t go. But if I’m running the company and I liquidate it at a loss for my personal benefit because I don’t want to register, there is a question of whether I would be breaching my fiduciary duty to these people.”

These are the questions that many family office managers and members, their attorneys and the SEC are considering as the date for implementation moves closer. By 30 March 2012, whatever decision a specific family office makes will have to be implemented in order to comply with the rule, Thayer says.