September 28, 2021

Volume XI, Number 271

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September 27, 2021

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Family Offices Receive Increased Regulatory Scrutiny

The recent defaults by Archegos caused several large broker-dealers to incur significant losses. Archegos represented that it operated as a single-family office, which made it exempt from many provisions of the federal securities and commodities laws.1 Questions have arisen about whether Archegos properly qualified for the family office exemption and whether, in any case, the exemption is too broad. For example:

  • On April 7, 2021, Senator Sherrod Brown, the Chairman of the Senate Banking Committee, wrote to several brokers that traded with Archegos asking them to identify the services they provide to family offices and how they review family offices before accepting them as clients.2

  • On May 6, 2021, in testimony before the House Financial Services Committee, SEC Chairman Gensler noted the Archegos situation.3

  • The Securities and Exchange Commission (SEC) has identified "Amendments to the Family Office Rule" as one of its regulatory priorities for 2021.4

  • On May 1, 2021, CFTC Commissioner Berkowitz issued a statement that "[t]he Archegos failure highlights the importance of strengthening the Commodity Futures Trading Commission's (CFTC) oversight of [family offices] . . . ."5

Family offices are investment firms that solely manage the money of a single family and that of the family office's key employees. The Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) granted the SEC broad rule-making authority to exempt family offices from the Investment Advisers Act of 1940. Section 202(a)(11)(G) of the Investment Advisers Act exempts from the definition of an investment adviser, and therefore from all of the requirements of that Act, "any family office, as defined by rule, regulation, or order of the Commission." In June 2011, the SEC adopted Rule 202(a)(11)(G)-1 defining a family office for purposes of this exemption. Under this Rule, a family office is excluded from the investment adviser definition if it: (1) manages the wealth and other affairs of a single family, (2) provides investment advice only to family clients, (3) is wholly-owned by family clients and exclusively controlled by family members and/or certain family entities, and (4) does not hold itself out to the public as an investment adviser. Neither the total assets under management by the family office, nor the nature of those assets (such as the amount of leverage utilized or the exposure of counterparties to its positions), nor the number of family members participating in it are disqualifying factors for the exemption. As noted above, it would appear that the Dodd-Frank Act gives the SEC broad authority to expand or restrict this definition, and the SEC is currently considering doing so.

Effective January 9, 2020, the CFTC adopted rule amendments that codified prior CFTC no-action letters exempting operators and advisors to family offices, as defined in the SEC Rule summarized above, from the obligations to register as commodity pool operators (CPOs) and commodity trading advisors.6 These exemptions are self-effectuating, forgoing the notice filing obligations typically associated with other CPO exemptions. Moreover, family offices are exempted from the condition, which applies to other exempt CPOs (with limited exceptions), that the exempt firm's principals not be subject to certain statutory disqualifications. As noted above, CFTC Commissioner Berkowitz has urged the CFTC to review these exemptions.

Looking Forward at the Family Office Exemption

Review of the family office exemption could be addressed in several ways. First, Congress could repeal or limit the family office exemption. No legislation has been introduced to accomplish this, and it appears that any possible legislative action is not imminent. Rather, it is more likely that the SEC and/or the CFTC will change their regulations to redefine the family office exemption. Existing legislation appears to grant the Commissions broad statutory authority to redefine the family office exemption more restrictively — or even, in the case of the CFTC, to eliminate it completely. Significant changes to current regulations could significantly restrict the availability of the exemption for many family offices.

Although any proposed regulations will afford the public with the opportunity to provide comments, given the importance of current exemptions to family offices, it may be prudent for family offices to begin a dialogue now with the regulators on any proposed changes to existing rules.


1 Rather than trading in individual securities, Archegos allegedly obtained economic exposure to securities by entering into total return swaps with brokers. These positions were allegedly not reported by Archegos because total return swaps are exempt from many reporting requirements. Under current rules, this would be the case regardless of whether Archegos was an exempt family office or a registered investment adviser. On May 6, 2021, in testimony before the House Financial Services Committee, SEC Chairman Gensler noted that: "At the core of that story was Archegos' use of total return swaps based on underlying stocks, and significant exposure that the prime brokers had to the family office. Under Dodd-Frank, Congress gave the SEC rulemaking authority to extend beneficial ownership reporting requirements to total return swaps and other security-based swaps. Among other things, I've asked staff to consider recommendations for the Commission about whether to include total return swaps and other security-based swaps under new disclosure requirements, and if so how."

 

https://www.brown.senate.gov/newsroom/press/release/brown-presses-banks-...

 

https://www.sec.gov/news/testimony/gensler-testimony-20210505

 

https://www.federalregister.gov/documents/2021/03/31/2021-04360/regulato...

 

https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement040121

 

See CFTC Rules 4.13(a)(6) (17 C.F.R. § 4.13(a)(6)) and 4.14(a)(11) (17 C.F.R. § 4.13(a)(6)).


 

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume XI, Number 160
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About this Author

Henry Bregstein, Katten Muchin Law Firm, Financial Institutions Legal Specialist
Partner

Henry Bregstein is the global co-chair of the firm’s Financial Services practice and a member of the firm’s Executive Committee and Board of Directors. In his role as partner in the Financial Services practice, he advises banks, domestic and offshore hedge funds, private equity funds, life insurance companies, family offices, sovereign wealth funds, investment advisers and broker-dealers on regulatory, securities, tax, finance, licensing, corporate and other legal matters.

Henry provides guidance on fund formation and regulatory compliance and advice related to...

212-940-6615
Christian B. Hennion, Finance Attorney, Katten Muchin Law Firm
Associate

Christian B. Hennion concentrates his practice in financial services and asset management matters, including counseling fund managers, registered investment advisers and commodity trading advisors on both transactional and regulatory matters. Chris has advised a wide range of US and international managers, from start-ups to large institutions, regarding a variety of matters, including private fund launches and reorganizations, advisory engagements, Investment Advisers Act and Commodity Exchange Act compliance obligations, Securities and Exchange Commission (SEC) and Commodity Futures...

312-902-5521
Richard D. Marshall, Katten Muchin, SEC Representation Lawyer, Finance Attorney, New York,
Partner

Richard D. Marshall focuses his practice on the representation of financial institutions and employees subjected to investigations by the Securities and Exchange Commission, Department of Justice, Financial Industry Regulatory Authority and state securities regulators. Rick also counsels broker-dealers, investment companies and investment advisers on regulatory issues, particularly relating to SEC and FINRA regulations. He also frequently counsels clients on compliance and risk management issues and the handling of inspections.

Rick provides...

212.940.8765
Allison C. Yacker, Katten Muchin, Corporate regulatory Matters Lawyer, Offshore Hedge Funds Attorney
Partner

Allison Yacker, co-chair of the New York Financial Services group, represents domestic and offshore hedge funds, including fund of funds, private equity funds, commodity pools, investment managers, managed account platforms, banks and broker-dealers on a broad range of corporate, securities, finance and other regulatory matters. She provides structuring, organization and ongoing advice related to hedge funds and private equity funds that employ a broad range of investment strategies and regularly counsels investment managers with respect to state and federal registration...

212.940.6328
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