Last week the SEC adopted rule amendments to the definition of “accredited investor” under Regulation D (“Reg D”) of the Securities Act of 1933. The rule amendments, the SEC says, are intended to modernize a term that has not changed in nearly 40 years and to “more effectively identify institutional and individual investors that have the knowledge and expertise to participate in” today’s “multifaceted and vast private markets.”

Recently, I have had an opportunity to review many “tokens” that can be transferred over the Ethereum blockchain and used for various “smart contracts.” Depending on their facts and circumstances, certain kinds of tokens being sold in so-called “initial coin offerings” were the subject of a recent SEC Section 21(a) report. I have also seen correspondence from family offices seeking to participate in these token offerings, in some cases before the developer has fully worked out the token. This raises a concern that a family office may wound itself trying to get in on the “cutting edge” of this new way to disseminate technology.

Our previous post discussed how a family office registered as an investment adviser (RIA) under the Investment Advisers Act of 1940 (Advisers Act) might underestimate the scope of its custody of family assets for purposes of Rule 206(4)‑2. The problem is that the rule’s definition of custody extends to all funds and securities an RIA has the power to withdraw, even those not held for investment. This post considers how a family office with sufficient personnel to independently staff its RIA can limit the scope of funds and securities subject to Rule 206(4)‑2.

The staff of the Division of Investment Management (IM) recently issued a flurry of interpretive guidance regarding when advisers are deemed to have custody of their clients’ funds and securities. The guidance covers transfers among a client’s custodial accounts, standing letters of instruction to a custodian, and inadvertent custody under the client’s custodial agreement. The guidance does not affect family offices exempted from the Investment Advisers Act of 1940 (Advisers Act) by Rule 202(a)(11)(G)‑1. The guidance also does not address issues commonly faced by family offices that must register under the Advisers Act.

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.

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.

When the SEC adopted the Family Office Rule to implement Section 409 of the Dodd-Frank Act and exempt a “family office” from the definition of “investment adviser,” it had to provide a definition of “family.” Regrettably, the definition of family member begins with lineal descendants of a common ancestor . That has created unusual problems because, by using that singular reference point, the practical effect is that neither the common ancestor nor the wife of that common ancestor, as well as her parents and her siblings, will be treated as “family members,”

Family Offices frequently acquire interests in private funds as part of the family office asset allocation process. Private funds have to be certain of the validity of their ability to rely on an exclusion from the definition of “investment company.” The Family Office Rule under the Investment Advisers Act has a detailed definition of “family member” for purposes of that exemption.  In general, a person is a “family member” if he is a lineal descendant of a common ancestor, or a spouse or child of a lineal descendant. There is also a definition of “family client” that includes every possible trust, charitable organization, or ownership situation to which the family office could give investment advice. But the Investment Company Act also defines “family,” differently, in the two most commonly used exclusions from the definition of “investment company.”