Private View Blog: Don’t blame family offices for sins of the individual

Family offices are, in essence, simply extensions of private individuals, and blaming these institutions for the investment activities of their founders is missing the point, argue Boston Private’s William Woodson and Richard Perez

The collapse of Archegos Capital Management has led to huge losses incurred by financial services firms that extended them credit, coupled with market disruption from panic selling to meet margin calls. Amid this chaos, a debate about whether family offices should be more strictly regulated has resurfaced.
This concern was made clear in recent public comments made by commissioner Dan Berkovitz of the US Commodity Futures Trading Commission (CTFC). The failure of Archegos and “the billions of dollars in losses to investors and other market participants,” states Mr Berkovitz, “is a vivid demonstration of the havoc that errant large investment vehicles called ‘family offices’ can wreak on our financial markets."

His comments relate to the CTFC's 2019 decision to exempt family offices from having to register as commodity pool operators (CPOs) or provide annual notice to this effect. This decision was similar to that of the Securities and Exchange Commission (SEC), which in 2011 exempted family offices from having to register as investment advisers under the Investment Advisers Act of 1940. Both regulatory agencies grant this exemption when family offices invest money solely for the benefit of family members or senior executives, rather than third parties.

Family offices were exempted from registration as investment advisers, following the Dodd-Frank Wall Street Reform and Consumer Protection Act, which followed the 2008 financial crisis, for the same reason.

Force for good?

We believe the concerns expressed by Commissioner Berkovitz – while understandable in that they convey shared disbelief and outrage that this happened – do not accurately depict family offices, the role they play in capital markets, the merits of the regulatory exemptions granted to them, or their importance to wealthy families and, by extension, society as whole.

The benefits of family offices, as vehicles of choice through which wealthy families manage personal and financial affairs, cannot be overstated. A select few families now control a disproportionate amount of wealth globally. This wealth, and how it is managed and used, has significant societal implications.

Family offices, given the professional wealth-managerial function they play, have an important responsibility and unique opportunity to assist families in channelling this wealth for good, whether through prudent investment management, helping children become responsible stewards of their wealth, investing in game-changing technology, or engaging in meaningful philanthropy and impact investing.

Individual accountability

Two key questions were recently raised by Howard Fisher, former senior trial counsel with the US Securities and Exchange Commission. Was the fact that Archegos was a family office a factor in the collapse? And, should the SEC regulate family offices based on the grounds that they impose a systematic risk?

Archegos’ status as a family office appears irrelevant when considering whether the investing activities of its founder, hedge fund trader Bill Hwang, should be more closely scrutinised and regulated. Family offices are, at the end of the day, simply extensions of private individuals. In this case, the office played a ‘conduit managerial function’ for a private individual over his own money.

To focus on family offices, as a distinct form of investing enterprise aside from the private individuals who use them is, using Mr Fisher's words, "to miss the forest for the trees". Mr Hwang could just as easily have made the large bets in his own name, rather than through his wholly-owned family office management company. In this case, should not the outcry be against the individual, instead of the entity through which he conducted his activities?

If so, the focus should shift to the systematic risk these large, individual or family, investors impose on others in the securities markets and banking system. The question, then, should be how much risk private individuals should be allowed to take with their own money. Or, which mechanisms can monitor these exposures, as they pertain to public companies.

There are already a number of regulatory programmes in place to monitor these bets, to help investors and financial services firms avoid or mitigate any systematic risks which a large investor might pose. These include SEC Schedule 13D, which must be filed once an investor acquires 5 per cent or more of a public company, and SEC Section 16, requiring additional disclosures from officers, directors and 10 per cent shareholders of public companies.

One must also consider the role of leverage and the risk management policies of the prime brokers with which Archegos traded. These, large financial services firms, already heavily regulated, including with respect to swap reporting and exposures, extended an enormous amount of credit to Mr Hwang. They did so while believing that they had: (1) adequate collateral, (2) appropriate risk management policies in place, and (3) sufficiently liquid positions to orderly sell shares, as needed, to meet margin calls. This, obviously, turned out not to be the case.

Regulators are certain to focus on the actors in this tragedy, including Mr Hwang and the prime brokers (who, according to public reporting, failed to accurately assess the total amount of leverage associated with these positions). The swap mechanisms used to obtain high levels of credit should also come under scrutiny. However, the culprits in this tragedy are the actors themselves, not the family office entity through which their actions were conducted.

William Woodson is executive vice president at Boston Private, leading the firm’s Family Enterprise Services Group. Richard Perez is chief strategist at Boston Private.