Archegos implosion could lead to family-office regulation

When Archegos Capital Management recently stepped on a derivatives landmine, it may have set off an explosion that will have repercussions for advisory firms that manage wealthy families’ finances.

In late March, Archegos defaulted on margin calls involving swaps transactions that forced the sale of approximately $20 billion in underlying securities. The conflagration, which caused major investment banks to lose nearly $10 billion, is likely to draw regulatory scrutiny of family offices, a category that includes Archegos.

Family offices don’t have to register with the Securities and Exchange Commission, which makes it difficult for the regulator to monitor the inner workings of the vehicles.

“There’s little to no insight on that side of the industry,” said Amy Lynch, president of FrontLine Compliance.

But that may be about to change. The SEC had targeted family office oversight for review this year even before the Archegos blowup.

“We should not be surprised if this leads to a re-evaluation of where family offices fit within the regulatory structure,” said Marlon Paz, a partner at the law firm Mayer Brown.

Securities regulators are investigating the Archegos situation, and it’s also drawing attention from Capitol Hill. Sen. Sherrod Brown, D-Ohio and chairman of the Senate Banking Committee, on Thursday sent a letter to Credit Suisse Securities, Nomura Holding America, Goldman Sachs and Morgan Stanley asking the investment banks to explain their role in the Archegos meltdown.

The Archegos collapse raises “several questions regarding … the treatment of so-called ‘family offices,’” among other issues, Brown wrote.

But assessing the murky family-office world presents challenges, such as sorting out the different kinds of family offices. One is the traditional manager of a family’s legacy assets. Another is an investment fund that doesn’t have third-party investors and just manages its own money. Hedge funds can avoid the SEC registration required by the Dodd Frank financial reform law if they’re family offices.

“They would have to regulate with a scalpel,” said Todd Cipperman, principal at Cipperman Compliance Services. “How do you distinguish between those two [kinds of] family offices?”

The Archegos blow up didn’t occur because of lack of oversight of family offices, said David Guin, a partner at Withers Bergman. It had to do with regulation of derivatives trading.

“The issue was that there is no required reporting of swaps positions,” said Guin, who has family-office clients. “Fixing this situation would require swaps reporting, not regulating family offices. It’s possible the SEC will change course and say family offices ought to be regulated, but it seems unlikely to me.”

Instead of requiring family-office registration, the SEC might strengthen its ability to assess the use of risky derivatives. “It could lead to much more examination of hedge funds that engage in these kinds of activities,” Cipperman said.  

Archegos owner Sung Kook (Bill) Hwang has previously run into regulatory trouble. His former hedge fund, Tiger Asia Management, paid $60 million to settle SEC charges of insider trading in 2012. The regulator prohibited him from managing clients’ money, so he started Archegos.

For the most part, family offices concentrate on family wealth and aren’t particularly big, Lynch said. “We’re talking millions, not billions, in assets,” she said. “Having those small entities exempt from SEC registration makes sense to me.”

Even if family offices avoid SEC registration, there are still questions about whether they’re institutional or retail clients for financial advisers and whether Regulation Best Interest, the broker advice standard, should apply to them.

It’s a “gray area of the law,” Paz said. “I suspect the lack of clarity is going to prompt some regulatory clarification. The SEC will look at it through an investor-protection lens. It’s a topic that’s been a long-time coming.”

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