Regulatory threats to family offices in the US stemming from the political reaction to the Archegos Capital Management saga are not going away. The family offices sector must engage now with policymakers, global law firm Dentons argues. This story may also have international implications.
(An earlier version of this article appeared on Family Wealth Report, sister news service to this one. We are repeating it here because, as readers know, when regulatory developments take place in the US, they are often followed in the rest of the world. The Archegos Capital Management story has produced a lot of fallout.)
Family offices must start talking to policymakers on any proposed legislative moves to tighten controls on what they do, lawyers at Dentons argue, following recent calls to crack down on the sector because of the Archegos saga.
The implosion of New York-based Archegos Capital Management, which was a hedge fund structured as a family office, has prompted legislators and regulators to demand more controls on what family offices do. The calls have led to pushback from wealth management sector figures who say such controls will miss their mark and hurt family offices as a whole. (A recent conference run by the UHNW Institute, in partnership with Family Wealth Report, also touched on the Archegos/family offices regulation issue.)
New York Congresswoman Alexandria Ocasio-Cortez, a member of the House Financial Services Committee, recently introduced HR 4620, the Family Office Regulation Act of 2021. The act would limit how family offices are exempt from the definition of “investment advisor” under the Investment Advisers Act of 1940.
A raft of hedge fund groups, such as those of famed investment tycoon George Soros, morphed into family offices and ceased taking in third-party money in order to avoid coming under regulatory oversight after the Dodd-Frank Act was passed a decade ago.
“Significant changes to current regulations could materially restrict the availability of the exemption for many family offices, thereby resulting in both a substantial invasion of their privacy and an impairment of their ability to fund start-ups and promote innovation. Given the importance of the current exemptions to family offices, we believe it is critical for family offices to begin a dialogue now with the regulators on any proposed changes to existing rules and exemptions,” lawyers at Dentons said in a recent note.
Dentons’ note said that the bill would also repeal a grandfathering clause in section 409 of the Dodd-Frank Act which permitted family offices whose clients include persons that are not members of the family to qualify for the family office exclusion. Finally, the bill would authorise the SEC to further define a “covered family office” to exclude family offices that are below the $750 million threshold if they are highly leveraged or engage in high-risk activities.
Dentons said the bill will probably pass the House if it reaches the floor but predicts that its chances of passing the Senate are “currently very slim”.
“That said, even if HR 4620 never becomes law, the positions taken by the bill’s supporters in the Financial Services Committee could significantly impact the way that the regulators at the SEC and CFTC choose to address regulation of family office issues,” Dentons continued.
Under the spotlight
The Archegos saga has put single-family offices under a political spotlight that also coincides with commentary about wealth inequality and the allegedly unfairly light tax treatment of the ultra-wealthy. (That criticism has also elicited responses that such comments are seriously off-base.)
Six large banks, such as Credit Suisse and Nomura, lost billions of dollars when Archegos defaulted on a margin call in March this year. The use of equity total return swaps allowed Archegos to receive economic exposure to the relevant stocks without directly owning them, thus avoiding direct-ownership-based disclosure requirements
“It appears that the equity total return swaps used by Archegos were not reported because, under the current rules, total return swaps are exempt from many reporting requirements under the federal securities and commodities laws, regardless of whether Archegos was an exempt family office or a registered investment advisor,” Dentons said.
“Nonetheless, because Archegos has said that it operated as a single-family office, both Democratic legislators and federal regulators at the CFTC and the SEC have raised questions about whether Archegos properly qualified for the family office exclusion and whether the scope of the family office exclusion under the Dodd-Frank Act should be narrowed or repealed altogether. They make this case even though family offices are investment firms that solely manage the wealth of family clients or the manager’s own money.
The Dentons note pointed out that the Securities and Exchange Commission has identified "Amendments to the Family Office Rule" as one of its key regulatory priorities for 2021. So far, the SEC has yet to implement any new disclosure requirements for total return swaps or modified any rules with respect to family offices.
Dentons added: “Any large loss to banks from a single investment firm always provokes thoughtful debate around the adequacy of existing prudential and financial market regulations and the efficacy of market participants’ risk-management programmes. Given the lack of systemic impact from the Archegos losses, the misalignment of family office structures with the rationale for investment firm regulation, and the swaps oversight regimes currently in place or being brought online by market regulators, absent additional information, the Archegos case does not justify new regulation for family offices.”