Dodd-Frank: The worst case for family offices

Charles Lowenhaupt of Lowenhaupt Global Advisors is perhaps the most vocal critic of the new regime. In a white paper written in July, he claimed the rules introduced under Dodd-Frank posed the most significant institutional challenges in history to US families of wealth and family offices.

Months on, he says there appears to be a disconnect between those who are advising family offices on compliance and those who understand what family offices actually should be doing for their families. He outlines a number of scenarios to support his view that limiting customers to family members is not as simple as it may sound, including:

• If a family member has debts, which may result in a creditor taking partnerships or investment vehicles managed by the family office, that creditor has substantial leverage over the family because if the creditor is not bought out within a certain time frame the family office will be in violation of the rules

• If a family member funds a business with other shareholders or if the family has a publicly held business of which it is the major shareholder, the office cannot advise the company with respect to investment management. There are similar restrictions if a family member funds a charity, which gets some contribution by those other than family members

• If a family office would like to align an employee’s interest with its own by granting ownership interest in investment vehicles, the employee will not be able to maintain his interest after retirement or pass his interest to his own heirs.

Lowenhaupt suggests that simply failing to register if you are required to is not a solution. Not only does the new rule allow the SEC to impose penalties and sanctions, it also allows any dissatisfied family member to take recourse and recover damages under appropriate circumstances. “Under the securities laws, if a family office should register and does not, a ‘customer’ may be able to recover investment losses and fees.” He points out that a dissident family member could report the violation to authorities.

Private trust companies are an option, continues Lowenhaupt, but in the US these will require a different regulatory oversight. “Other family offices are looking at ‘umbrella companies’, companies running separate single family offices under the same SEC registration that allows for anonymity. There was considerable discussion of outsourced CIOs but those will work only to the extent that the family office itself is removed from any engagement with the CIO and family relating to investments.”

Relocation is also unlikely to work, he says, unless the single family office can divide into different family offices, one for US family members and another for those outside the US. “This is a very difficult and complex proposition if there is a desire to maintain efficiencies of scale.”