Our previous post illustrated ethical quagmires that can result when a staff attorney of a family office tries to negotiate the potentially conflicting interests of the family’s members. This post explains how a well-crafted engagement letter can help an attorney navigate such quagmires through clarity in who is the intended client and who is not. It also considers using non-client letters to keep things sorted out.

Family offices continue to multiply and the industry professionals who provide services to them have grown. The typical single-family office has president, a chief operations officer, a chief investment officer and a chief financial officer. In many cases, the office may employ one or more lawyers on staff. Those lawyers may serve the needs of a number of persons and entities advised by the family office, including:

  • the family office as a legal organization;
  • members of the family in their personal capacity, as shareholders of an operating company from which wealth was created, or as beneficiaries of a trust;
  • members of the family acting as trustees of trusts;
  • investment entities created by the family, i.e., passive and active investment vehicles such as LLCs and partnerships and private or public foundations; and
  • members of the family acting as trustees or directors for the boards of those investment entities.

The evolving best practice is to treat each of the above five situations as a different “client” for purposes of evaluating potential conflicts of interests, maintaining confidentiality and other ethical issues. This is the first of two blog posts intended to help attorneys employed by a family manage their relationships with their family office clients.

My first post discussed the requirements for the Section 4(c) exemption from broker-dealer registration added by the JOBS Act. This second part will apply Section 4(c) of the Securities Act of 1933 to a number of situations where questions can be raised whether the activities require registration as a broker-dealer.

We have previously discussed the long-running saga regarding whether transaction-based compensation related to non-public sales of securities require registration as a broker-dealer under the Securities and Exchange Act of 1934 (“Exchange Act”). Our discussions have included (i) the tricks and treats of the SEC’s Crowdfunding release last Halloween, (ii) California’s exemption for “finders,” and (iii) a Christmas present for resellers of privately placed securities in last year’s Fixing America’s Surface Transportation (FAST) Act. As a precursor to any of this, Congress added Section 4(b)(1) [now treated as if it had been properly renumbered as Section 4(c) by the FAST Act] to the Securities Act of 1933 (“1933 Act”) describing circumstances in which a person involved in a Rule 506 offering under Regulation D would not have to register as a broker-dealer under Section 15(a)(1) of the Exchange Act.

Late last fall, Congress faced a serious crisis in trying to pass a comprehensive transportation bill, designated as the Fixing America’s Surface Transportation (FAST) Act.  Amendments to various Federal securities and banking laws were added to the FAST Act during the reconciliation process. These amendments had not been the subjects of serious hearings in either house of Congress and were such narrow, rifle-shot changes as to deserve to be considered special pleading. Some commentary has already been published regarding amendments to  the Securities Act of 1933, which included codification in Section 4(a)(7) of what had been previously referred to as the Section 4(1½) exemption: a long-standing interpretation permitting the resale of unregistered securities to sophisticated investors without causing the seller to be an underwriter. Certain Silicon Valley investors apparently considered Section 4(1½) too delimiting, leading to the statutory changes that should facilitate greater liquidity for those investors, hopefully making it easier for early state start-ups to raise additional capital.

The FAST Act also amended two provisions of the Investment Advisers Act of 1940 (“Advisers Act”).  Readers will recall that the Dodd-Frank Act included exemptions from SEC registration for venture capital advisers, family offices and certain hedge fund advisers. The SEC promptly adopted regulations to implement these exemptions. Section 203(l) exempts investment advisers whose only clients were one or more “venture capital funds” as defined in Rule 203(l)-1. Rule 203(m)-1 exempts investment advisers solely to private funds that had assets under management in the United States of less than $150 million.

As of January 1, 2016, a person defined as a “finder” will become exempt from the broker-dealer provisions of the California Securities Law of 1968, as amended. Under that law, the Commissioner of Business Oversight regulates the activities of broker-dealers. Assembly Bill No. 667, Section 25206.1 will exempt a “finder” from registration with the Commissioner as a broker-dealer.

On October 30th, the SEC adopted their Crowdfunding rules and the adopting release became available on October 31st, commonly referred to as Halloween.  There are two interesting regulatory decisions in that 686 page release, both of which could be described with one or the other of the customary child’s cautionary warning when you answer your front door on Halloween evening.

The Family Office Rule states that a family office cannot have any clients other than family clients. The term “family client” is defined in paragraph (d)(4) of the Family Office Rule to include any family member, any key employee, certain non-profit organizations, certain irrevocable and revocable trusts, and certain wholly-owned companies, all as set forth in subparagraphs (i), (iii), (v), and (vii) – (xi) of that paragraph. It was intended that a person who was a “family client” would never cease to be a client of the family office except under unusual circumstances. To that end, there are exceptions in subparagraphs (ii), (iv), and (vi) of that paragraph for former family members, for former key employees, and for the estates of family members, former family members, and former key employees.

My initial post examined the risk of miscalculating regulatory assets under management (“RAUM”) for purposes of registering with the SEC as an investment adviser. This post shows that the SEC is highly motivated to bring reasonably punitive enforcement proceedings against investment advisers that “voluntarily” register with the SEC instead of with the appropriate state.

As a matter of Federalism, Congress cannot require the several states to adopt laws regulating investment advisers, but it can prohibit “small” investment advisers from registering with the SEC unless they have a sufficient amount of RAUM. For the last two decades, Congress has been slowly but continuously removing “small” investment advisers from the SEC’s jurisdiction.