The head of the CFTC, one of the main US regulators, has criticized how family offices that are essentially investment organizations but don't take in outside money are exempt from certain rules. They are often large enough for their actions to affect markets, he said.

A top US regulator has called for controls over family offices, criticizing how they are exempt from certain market rules and worrying that the multi-billion dollar demise of Archegos highlights potential systemic risks. 

“The Archegos failure highlights the importance of strengthening the CFTC’s oversight of these large funds and preventing bad actors from trading in our markets,” Dan M Berkovitz, commissioner, at Commodity Futures Trading Commission, said in a statement late last week.

The Archegos entity operates as a family office for former New York hedge fund executive Bill Hwang. Its demise has caused multi-billion losses for Credit Suisse, Nomura and a number of other banks including Goldman Sachs, Morgan Stanley, Citigroup, BNP Paribas, Deutsche Bank and UBS. 

There has been a trend over the past 10 years of hedge fund firms morphing into family offices by ceasing to manage third-party funds - George Soros is an example. As a result, these entities aren’t covered by the Securities and Exchange Commission, as would otherwise have been the case following the Dodd-Frank legislation enacted after the 2008 financial crash.

“The collapse of Archegos Capital Management and the billions of dollars in losses to investors and other market participants is a vivid demonstration of the havoc that errant large investment vehicles called `family offices’ can wreak on our financial markets. Family offices can be active in both securities and commodities markets,” Berkovitz said in a statement on the regulator’s website.   

“Unfortunately, in the last two years the CFTC has loosened its oversight of family offices. In 2019, and again in 2020, the Commodity Futures Trading Commission (CFTC) approved rules that exempted family offices from some of our most basic requirements,” he continued. 

“I objected to these exemptions at the time, warning in 2019 that `[t]he approval of [these rules] without any checks and balances on exempt family office CPOs [commodity pool operators] will increase risks to our markets and market participants’,” Berkovitz said.   

Berkovitz said the term “family office” has “nothing to do with ordinary families.”

“Rather, it is an investment vehicle used by centi-millionaires and billionaires to grow their wealth, reduce their taxes, and plan their estates. According to a 2019 report, the average wealth of family offices surveyed in North America was $1.3 billion, with $852 million in assets under management. As we have just seen, the failure of a large family office can cause significant harm to our financial markets,” he said. 

“Because family offices do not solicit investments from the public, they are generally exempt from certain CFTC regulations that relate to investor protection. But the CFTC strayed far beyond this rationale when it also exempted multimillionaire and billionaire family offices from basic requirements related to market protection and integrity,” he said. 
 

Exempt
The regulator said that in November 2019, it exempted family offices operating in CFTC-regulated markets from providing notice that they were exempt from CFTC registration requirements.  

“All other entities claiming similar exemptions must provide notice. The information required would fit on a post-it note, and the CFTC estimated the annual cost of the filing to be merely $28.50,” Berkovitz said.  

“There is no rational justification for exempting large family offices with billions of dollars under management from minimal notice requirements with relatively trivial costs. Without a notice filing, the Commission remains generally unaware of the very existence of these large commodity pools, is hampered in its ability to oversee their activities, and does not even know whom to contact should issues arise,” it said. 

In July 2020, the CTFC exempted persons in family offices from a new CFTC rule designed to foreclose “bad actors” from acting as CPOs if they are subject to statutory disqualification, he said.

“In other words, even if a family office operator or one of its principals has been barred from CFTC markets, committed a felony involving commodity or securities laws, or has been found to have violated specified statutes involving embezzlement, theft, extortion, forgery, and fraud, they can remain exempt from CFTC registration. Thus, convicted felons, market manipulators, and other financial market miscreants can operate freely within the confines of a family office, unbeknownst to the CFTC. In my view, there is no reasonable justification for such a policy,” he said.

“To protect the integrity of the commodity markets, the Commission must be aware of and [be] able to monitor the activities of large family offices. In order to do this, the Commission should have basic information about family offices that are operating commodity pools. The qualifications of persons operating family offices should be no less than for persons operating other exempt and non-exempt pools. I urge the Commission to revisit these issues soon,” he said. 

Hedge funds that morph into family offices are not typical family offices, which tend to be far less heavily leveraged than appears to be the case with Archegos.

In July last year, John Paulson, who earned billions of dollars by correctly anticipating the sub-prime mortgage wreck of a decade ago, exited the business and converted his operation to a family office.

Others taking the route are Leon Cooperman, Steven A Cohen, Eric Mindich and Jonathon Jacobson, although for different reasons. Another example is Clifton Robbins' switch at his Blue Harbour Group business.

Firms change to a family office structure for different reasons, such as a desire to wind up a firm and retire, or because of lackluster performance, or to avoid certain regulatory oversight and costs.