EFTA01126601.pdf

Family Offices: An Overview of the New Dodd-Frank Exemption Panel Discussion Moderated by Thomas McGraw (IP. Morgan Private Bank) With Participants Miles Padgett (Kozusko Harris Duncan) Leor Landa (Davis Polk & Wardwell LLP) Jeffrey Schwartz (Davis Polk & Wardwell LLP) John Duncan (Kozusko Harris Duncan) January 10, 2012 Although information contained herein has been obtained from sources believed to be reliable. the views expressed are those of the speakers and may differ from the views of J.P. Morgan and its affiliates. Neither J.P. Morgan nor any of its affiliates guarantee its accuracy or completeness and accept no liability for any direct or consequential bsses arising from its use. J.P. Morgan's role is limited to moderating this panel discussion. by providing speakers who are well versed on this topic. Similady. although the speakers have collaborated in preparing ponions of the information contained herein. they may also have views that differ trom those expressed in a particular portion. are not guaranteeing the accuracy or completeness of the information contained herein and accept no liability for any direct or consequential losses arising from its use. EFTA01126601 Topics for Discussion • Overview of Family Offices Exemption ■ Illustrative Case Studies • Q&A EFTA01126602 Section 1 —Overview of Family Offices Exemption EFTA01126603 Family Office Exemption Background Dodd-Frank Act revoked the "less than 15 client exemption" effective July 21, 2011 Pre-existing family offices have until March 30, 2012 to be either qualified for an exemption or register with the SEC Extension period is only available for advisers that qualified for the private adviser exemption on July 20. 2011 EFTA01126604 Family Office Exemption (cont) Qualifying for Family Office Exemption • The family office can provide investment advice only to "family clients" • Only "family clients" can own the family office • Only "family members" and "family entities" can exercise control of the family office The family office cannot hold itself out to the public as an investment adviser EFTA01126605 Permissible Family Clients (Family clients are also the only permissible owners of the family office) Descendants of Common Within 10 generations Family Members Ancestor (and their pouses No in-laws Estates) r ep, Foster, Adopted hildren & Certain Wards Former family members retain status (but not for control) Revocable Trusts Grantor must be a permissible family client Family clients are only current beneficiaries; outside Family Trusts, Irrevocable Trusts charities can be current beneficiaries if funding solely from family clients Entities Charities & Non Profits Funding only from family clients Business Entities Owned by & operated only for family clients Execs, Directors, Affiliated family office can be the employer Trustees, & GPs of Family Former employees limited to prior "assets" Key Employees Office (and their Substantive Investment 12 months experience required for investment Estates) Employees employees (either at family office or another company) Trustee must be a Key Employee and the Key Employee Key Employee Trusts must be sole contributor 5 EFTA01126606 Control is More Limited "Controlling influence" over management or policies other than as an officer Descendants of on Within 10 generations Family Members Ancestor (and their Estates) Spouses No in-laws Step, Foster, Adopted Former family members are not permitted to Children & Certain Wards exercise control Revocable Trusts I• Grantor must be a permissible family client Family clients are only current beneficiaries; outside Family Trusts & Irrevocable Trusts charities can be current beneficiaries if funding solely from family clients Entities Charities & Non Profits Funding only from family clients Business Entities Owned by & operated only for family clients Key Employees Neither current nor former Key Employees. (and their Estates) nor their trusts are permitted to exercise control EFTA01126607 Family Office Exemption (cont.) Miscellaneous • Common Ancestor • Selection is highly flexible and can change • Involuntary Transfers • Grace period of one year from change of title ■ Applies for purposes of permitted clients and owners, but likely not control ■ Family charities accepting outside donations ■ No longer permitted ■ Have until December 31, 2013 to distribute outside contributions ■ Favorable worst-in-first-out presumption EFTA01126608 Section 2 — Illustrative Case Studies EFTA01126609 Example 1 — Internal Family Office Facts: A founder of an investment adviser that manages several large hedge funds ("HF Adviser") wants to create a family office to manage the founder's family assets. The family office would utilize the personnel and resources of HF Adviser to manage the family assets. HF Adviser is not a registered investment adviser (in reliance on the SEC's extension of the private adviser exemption). The investors in HF Adviser's hedge funds include third-party investors that are not members of the founder's family or key employees of HF Adviser. Issues: Can HF Adviser qualify for the family office exemption? EFTA01126610 Example 1 — Internal Family Office (cont.) Answer: Will depend on the circumstances, but generally will be difficult for the HF Adviser to operate under the family office exemption while managing the assets of its hedge funds. Analysis: The family office exemption requires, among other things, that a family office must have no clients other than "family clients" ' Assuming the hedge funds managed by HF Adviser are not owned by and operated for the sole benefit of "family clients," the hedge funds (which are clients of HF Adviser) will likely not be "family clients" thus rendering the exemption unavailable for HF Adviser. 10 EFTA01126611 Example 1 — Internal Family Office (cont.) What about an internal family office contained within a privately-owned operating company? ' A privately owned operating company (e.g., a manufacturing company) could have an internal qualifying family office provided that the requirements of the exemption were met. • The operating company can provide investment advice only to "family clients" • Only "family clients" can own the operating company (no JV partners or minority interest holders) • Only "family members" and "family entities" can exercise control of the operating company • The operating company must not hold itself out to the public as an investment adviser EFTA01126612 Example 2 — Multijurisdictional Family Office Facts: A family office with a principal place of business in Zurich, Switzerland has branch offices located in London and New York ("Global Family Office"). Global Family Office manages the assets of a single family. The members of the family are scattered throughout the world and include U.S. residents, non- U.S. residents, U.S. citizens and non-U.S. citizens. Issues: Is Global Family Office subject to U.S. jurisdiction such that the U.S. Investment Advisers Act could apply? • Can Global Family Office qualify for the family office exemption? 12 EFTA01126613 Example 2 — Multijurisdictional Family Office (cont) Answer: n U.S. Jurisdiction - Global Family Office would likely be subject to the U.S. Investment Advisers Act because it uses U.S. jurisdictional means in the course of its investment advisory business. • New York City office • Likely uses U.S. jurisdictional means (phone calls, mailings) with respect to family members that are located in the United States. • Family Office Exemption — Global Family Office could satisfy the family office exemption if it (i) has no clients other than family clients, (ii) is wholly owned by family clients and controlled by one or more family members (or family entities) and (iii) does not hold itself out to the public as an investment adviser. • It would likely not be able to utilize the exemption if it has any clients other than "family clients" 13 EFTA01126614 Example 3 — Individual Trustee Facts: G' An individual acts as a co-trustee of several trusts established by a wealthy friend for members of that friend's family. Those trusts hold $99 million of assets. The individual is also a co-trustee of a $2 million trust established for members of his own his family. As a co-trustee of each trust, the individual shares fiduciary responsibility for selecting, monitoring and replacing third- party investment managers and receives some form of compensation. Issues: • Assuming the individual trustee could be viewed as an investment adviser with respect to the friend's trusts, may the trustee qualify for the family office exemption? • If not, what is the basis for concluding that the trustee is not required to register and comply with the Advisers Act with respect to the friend's trusts? 14 EFTA01126615 Example 3 — Individual Trustee (cont.) To qualify for the family office exemption with respect to the friend's trusts, the individual may need to: Disregard the trust for the benefit of his own family (because the family office exemption generally does not extend to those serving multiple families) " Qualify as a Family Office • SEC rule specifies that a family office is a "company" (so the SEC may view a "family office" only as an advisory firm or company, not as an individual) What is the impact of disregarding the $2 million? What about the private funds adviser exemption? 15 EFTA01126616 Example 3 — Individual Trustee (cont) What is the basis for simply concluding that a trustee is not an investment adviser? o Legal guidance is mixed in this area and the answer heavily depends on the particular facts and circumstances. ' If an individual trustee is providing investment advice and receiving compensation for his services, there is a risk that the arrangements may require compliance with the Investment Advisers Act (or applicable state law). ' Based on guidance, the factors listed on the next slide could be relevant to the determination o It could potentially be helpful if the individual is serving as a co-trustee together with (or delegating investment authority to) a registered investment advisor or a bank exempt from registration 16 EFTA01126617 Example 3 — Individual Trustee (cont) ' Based on guidance, the factors that could be relevant to determining whether a trustee is an investment advisor may include the following: • Whether the arrangement specifically contemplates securities advice that is not merely incidental to a broader, non-investment advisory relationship (e.g., an investment trustee vs. an investment and distribution trustee); • Whether the trust is revocable or irrevocable, and potentially whether the trust is a testamentary or inter-vivos trust and whether the trustee also holds legal title to the trust property or is, for example, directing an "administrative trustee" that holds legal title; • Whether the trustee is engaged in the business of providing such services to multiple parties and may be seen as holding itself out as providing investment advisory services; and • Whether compensation is tied directly to a securities portfolio for which the trustee provides investment services (such as asset-based fees). 17 EFTA01126618 Some Questions to Consider (including how far you want to go without additional SEC guidance) ■ If the family office is not "compensated" for investment services, is that person a "client" for purposes of the family office exemption? ' Changes within the family ■ Descendants of step-children? ■ Widow (non-family) remarries? ' Key Employees: ■ For trusts, does controlling only investment decisions suffice? ■ Practically, must ex-employee assets be paid out ASAP? n Sharing employees with another office is ok? How many? D Can 3rd party control the family office as trustee of a "family entity"? EFTA01126619 Alternatives to Conforming with New Exemption Potential Alternatives ' Conclude individual or office is not subject to Advisers Act ' Find an alternative exemption ■ Private fund advisers w/ less than $150MM in AUM in the United States ■ Foreign private advisers ■ Venture capital fund advisers ' Apply to the SEC for an exemptive order (or, more likely in the case of an individual trustee, a no-action letter) ' Register with the SEC ' Reincorporate as a Private Trust Company (for reasons other than evading the Advisers Act) 19 EFTA01126620 Consequences of SEC registration Impact of SEC Registration o Must appoint a chief compliance officer o Must establish a compliance program and a code of ethics ' Must comply with custody and recordkeeping requirements ' Subject to periodic SEC inspection ' Subject to anti-fraud provisions of the Advisers Act ' Subject to recordkeeping and reporting requirements 20 EFTA01126621 Private Trust Company Considerations o Benefits ■ All family office clientele may be served ■ All family office investment and other services may be provided ■ Full fiduciary powers with good insulation from fiduciary liability ■ May import favorable state trust, trust company and tax environments ■ No SEC-dictated "risk management" ' Issues • Critical mass: sufficient assts to warrant cost of entity • Some low to moderate regulatory burden (including "true" risk management) ■ "Bank exclusion" conditioned on (i) substantial portion of business "exercising fiduciary powers" and (ii) not operated for purposes of evading Advisers Act • Start up costs 21 EFTA01126622 Compliance Options Overview Options Main Strengths Main Weaknesses Qualifying Family Office •:. Full Investment Powers •:. Limited Clientele 4:- Same Single Family Office (SFO) Role •:- No SFO investment role with Non- in Investments as currently Qualifying Family Clients Partially-Qualifying 4:- Full Investment Powers •:- Limited Clientele Family Office .1. Same SFO Role in Investments as •:- No SFO Role with Non-Qualifying Family currently Clients Outsourced Chief Investment •:- Unlimited Clientele C• No SFO Investment Advisory Powers Officer (CIO) •t• No Internal-SFO Investment Expense •:- Almost No Role for SFO in Family Investments with Discretion C• Investment Advisory Fee considerations Outsourced CIO c• Unlimited Clientele C• No SFO Investment Advisory Powers without Discretion C. Coordination/Communication Role of •:- Limited Role of SFO in Family SFO with Investments Investments C. No Internal-SFO Investment Expense •:- Investment Advisory Fee considerations •:- Complexity of each investor (individuals, entities, trusts) making own investment decisions Family Registered Investment •:. Full Investment Powers •:. Cost Adviser •:. Unlimited Clientele •:. Regulatory approach, structure and other burdens Family Private Trust •:. Full Investment Powers •:. Cost Company •:. Unlimited Clientele •:. Fiduciary Structure (or a strength?) •:. Trust Powers •:. Regulatory requirements C. All Other PTC Benefits 22 EFTA01126623 Section 3 Q&A Notice: The presentation Family Offices: An Overview of the New Dodd-Frank Exemption and the materials related thereto are for general information only. They are not full analyses of the matters presented and should not be relied upon as legal advice. EFTA01126624