There is a nagging debate regarding the status of Family Offices that precedes the introduction of Regulation Best Interest. Institutional-oriented BDs often take a liberal view when drawing the line between institutional and retail. Regulators, charged with protecting investors, tend to be a little more conservative on that front, while Family Offices often want to be treated as institutions, sometimes against their best interest. Reg BI made a delineation between retail and institutional that clarified which camp most investors were in. That left the remaining ambiguity to be focused on Family Offices.
Family Offices occupy a magical world somewhat beyond regulation of their activities but still within the protection of FINRA. How much protection they should be afforded can be a moving target. How can BDs offer the services Family Offices are requesting and remain compliant with regulatory expectations? The path begins with FINRA Rule 4512. This rule, boiled down, establishes the institutional threshold at total investable assets of at least $50 million. However, with the new retail customer and retail investor definitions implemented as part of Reg BI and Form CRS, a family office with $50 million could still be considered a retail investor/customer. Fortunately, a recent SEC no action letter was issued in which the Staff stated enforcement would not be recommended against broker-dealers that do not recognize “Institutional Family Offices” as retail investors/customers for purposes of Reg BI and Form CRS if the Family Office meets certain conditions.
An “Institutional Family Office” is defined in the letter as a Family Office that has one or more experienced securities or financial services professionals, manages total assets of $50 million or more, does not rely on the broker-dealer for recommendations, and has professionals who are independent representatives of their family clients. See Section III of this letter.
The notice specifically states that, in order to qualify as an institution for the purposes of Regulation BI and Form CRS, the Family Office must acknowledge that:
- it is capable of evaluating investment risks independently, both in general and with regard to all transactions and investment strategies involving a security or securities;
- it will exercise independent judgment in evaluating the recommendations of any broker-dealer or its associated persons;
- it is a sophisticated investor with knowledge of and experience with regard to the securities or investment strategies involving a security or securities it trades or implements with the broker-dealer (if any);
- the family office professionals responsible for investment decisions have not and will not accept any compensation or items of value from the broker-dealer that would cause the professional to act in a manner that is inconsistent with the best interest of the family clients; and
- the family office meets the definition of “family office” under Advisers Act Rule 202(a)(11)(G)-1.
Broker-dealers may believe the Family Offices they work with meet these conditions; however, it is the broker-dealers’ responsibility to maintain the documentation to evidence all requisites are met. Also, as stated in the no action letter, broker-dealers will need a written acknowledgment from the Family Office that they meet all conditions to be treated as an institution.
This is a reasonable compromise by the regulators. It allows BDs to treat Family Offices as institutions, after knowing specifics and documenting that knowledge, while offering Family Offices the opportunity to be treated in the manner that works for them. Family Offices have been granted the unusual power of therianthropy. It is probably best not to question it.