By ALEC FOEGE
Efforts by the U.S. Securities and Exchange Commission to increase its scrutiny of hedge funds will likely hasten a move by some of those funds to become family offices.
“We’re seeing more of it now than we did five, seven, 10 years ago,” said Thomas Riggs, a tax partner and managing director at PKF O’Connor Davies in New York who has shepherded some prominent hedge funds through the process.
If some of these new regulatory proposals are enacted, Riggs said, “It’s going to accelerate that trend.”
Typically, two pools of hedge fund managers consider converting their firms into family offices, Riggs said. One consists of younger hedge fund managers in their 40s or 50s who have made their money and want to enjoy life a little more, he said. The other is made up of older managers, in their mid-60s or later, who are feeling their mortality and trying to figure out what their legacy will look like. Each group has distinctly different concerns.
What both apparently share is a distaste for the SEC’s recent proposal to expand reporting requirements for hedge funds and private equity firms with more than $500 million in net assets.
“We do a lot of work for some of the very big hedge funds in Greenwich,” said Riggs. “All of my ultrahigh-net-worth and my high-net-worth clients are accredited investors, so of course they don't want and don’t need the SEC to babysit their investing.”
On Aug. 9, the agency approved a proposal to move forward with the new requirements for hedge funds to provide additional information on investment exposure, investment concentration, and borrowing and financial arrangements. A period of public comment will follow the publication of the proposal.
Such initiatives, Riggs said, have prompted more hedge fund managers to consider returning capital to outside investors and transitioning into family offices.
“I don't know if [the proposal] in and of itself would necessarily lead to a major shift,” said Dan Campbell, a director at ACA Group, a regulatory compliance advisory firm in metropolitan Atlanta.
“But looking at the totality of the rule proposals coming out of the FCC over the past eight to nine months, I can see how in certain situations a hedge fund manager, particularly of a firm that has been around for some time and maybe winding down a bit, could potentially contemplate that.”
The SEC, under Chairman Gary Gensler, has argued that the private-fund industry has grown substantially in recent years and thus has become a larger part of the U.S. financial system. The proposed amendments would apply to hedge funds with more than $500 million in net assets.
Information from the amended Form PF won’t be public, but regulators would be able to access it for enforcement purposes and to gauge systemic risk.
Previously, in January, the SEC proposed amendments to Form PF that would compel private funds to file reports within one business day regarding events of significant stress that would harm investors or signal risk to the broader financial system. The added administrative burden alone may entice more large funds to jump into the family-office space.
CONVERSION COMPLEXITIES
ACA Group’s Campbell noted that the transition from hedge fund to family office has its own complexities, not the least of which is redeeming all third-party investors. And while family offices continue to be subject to fewer financial disclosures, new SEC rules around transparency — such as certain Section 13 filings related to the kind of security-based swaps that led to the recent collapse of Archegos Capital Management — mean that family offices could endure more scrutiny than ever.
“I definitely think that the perception is that the SEC is far more interested in getting more information now than they ever have in the past from the registered-investor community,” said Campbell.
There even have been rumblings that family offices, too, may come under greater scrutiny. A recent survey by the family-office recruitment consultancy Agreus Group reported that 54% of family offices anticipate being subject to greater regulation by the end of 2022. This belief may stem in part from a recent Democratic-backed bill (H.R. 4620) that would require family offices with more than $750 million in assets under management to register with the SEC.
“If investors are punished for setting up a family office due to increased regulation, then you’re going to put people off from setting up family offices, which may not necessarily be good for the broader economy,” said Tayyab Mohamed, Agreus’ co-founder and head of its U.S. office in New York.
“Because if you look at some of the seed funding and some of the biggest investments made in all the industries that make an impact in our society today, a lot are done by people from family offices — because of the ease of making investments, the lack of regulation; because it’s their personal money as opposed to external money. [Increased regulation] would change things fundamentally.”
Alec Foege has written for The New York Times, Rolling Stone and Crain's New York Business, among other publications.