In the wake of the outcry from the Great Recession directed at Wall Street, the federal government has taken both legislative and regulatory measures that many fear will miss the mark. Rather than making investors more confident and making business more efficient, there is a possibility that new laws and accompanying regulations will hamper decision-making and divert attention from core business activities. While most of the new regulations target large public companies, there are some implications for family businesses and family offices that are important to note.
As usual, the concern after this round of new legislation is what the actual consequences of these rules will be once implemented. These concerns are compounded today by two rather unique factors. The first is the structural nature of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which has left it to the Securities and Exchange Commission and other regulators to clarify how the law is implemented in many cases. Second, it is the latest set of elections that have changed the balance of power in Washington and effectively raised more questions about what will ultimately be the law of the country.
Prudent business practices tell us to prepare for both the expected and unexpected consequences of government action. So, in that spirit, it may be worthwhile to take a closer look at some of the implications of the Dodd-Frank Wall Street Reform and Consumer Protection Act that was signed into law on July 21, 2010. While, as its name suggests, the law addresses major consumer protection reforms, And the commercial restrictions of major banks, regulation of financial products, it also contains important new requirements for corporate governance that may directly affect family businesses.
Consequences, intended or not
As an example of how these decisions affected family-owned businesses under Dodd-Frank, in clarifying reporting requirements for family offices, the Securities and Exchange Commission (SEC) drew a clear line between a single-family office and those serving multiple families. As a result, family offices that have been opened for other families to share their services and the costs of offering them to the public as investment advisors may be excluded. If the Securities and Exchange Commission (SEC) determines—based on its October 12, 2010 definition—that the family office is in fact providing investment advice to the public, it will be required to register with the Securities and Exchange Commission under the provisions of the Advisors Act of 1940. In the past, advisors who They have less than 15 clients from the provisions of this law. However, the new legislation overturned the exemption, with the likely result that only single-family offices would be able to avoid registration and reporting. Apparently, hedge funds, not family offices, were the intended targets of these changes, but the result still prompted the Securities and Exchange Commission to develop a definition of family office that seemed more restrictive.
Unintended consequences like this – and the results of attempts to clarify or reform laws and regulations – can often cause the most difficulties, precisely because no one saw the problem in advance. While some of them may have a direct impact on family businesses, such as in family offices, others may have a more systemic impact. For example, after Sarbanes-Oxley passed, public companies were required to disclose more information and significantly expand their filings with the SEC. So much of this paperwork has become so prevalent that it has affected what banks and other financial institutions require of all their customers, thus complicating the process of securing other lines of credit and borrowing for private businesses as well.
One of Dodd-Frank’s most widely discussed and potentially far-reaching provisions deals with proxy access. Soon after the law was passed, the Securities and Exchange Commission approved new rules allowing shareholders to have access to a public company agent to add their nominees, at the company’s expense, for election to the board of directors. Although there are restrictions on the number of nominees that can be placed on proxy by shareholders over those selected by the corporation’s nominating committee, this change sends shock waves through corporations. An investor or group of investors needs to own only 3 percent of the company’s voting stock to exercise this judgment and to place candidates for up to 25 percent of board seats on an agent. This is a relatively low threshold for many pension funds, labor unions and other active shareholder groups that have their own agendas. This small percentage can represent a crippling force for family businesses that have sold even a small portion of their stock in a public offering.
This is sure to discourage many family businesses from turning to the public markets for funds to grow their businesses and effectively cuts off an important source of investment capital. Any family business considering a future public offering should carefully consider opening its board of directors to opposition groups with agendas set by minority owners outside the family. Proxy access will also give new ammunition to those who want to challenge stock categorization in ways that enable families to retain control of voting. The New York Times and Barnes and Noble newspapers have had these types of attacks in the recent past.
Even small businesses, defined as those selling less than $75 million in stock in the public markets, will be subject to this new agent rule. However, the SEC has suspended enforcement for small businesses for three years to allow time for the rule to be applied to larger companies to be considered. It is therefore crucial for family businesses that fall within this definition of a small business to begin planning their strategy for controlling this new threat within the short period for which they have to prepare. Possible strategies may include stock buyback plans and other ways to reduce exposure before the three years are up.
Compensation and say pay
Although not an immediate threat to control, saying over wages presents potential interference and disruption to the governance of a publicly traded company, even if the controlling stake is family owned. This part of the regulation requires that shareholders at least every six years (which can often be by shareholder vote) have a non-binding vote on executive compensation. Although a non-binding vote would not directly affect an executive’s actual compensation, it could potentially give an additional voice to dissident groups that do not understand or care about the competitive environment in which the company operates. This process will undoubtedly be another reason why family businesses may want to avoid raising capital through public offerings of their shares as so many have done in the past.
Impact on family businesses
Given the issues raised above, an unintended consequence of the Dodd-Frank Rules and the resulting rules the SEC implements them may be shutting down an important source of growth capital for family-owned businesses. Families have always had to carefully consider the pros and cons of selling some of their stock in the public markets for privacy reasons. Now there is a real threat of control, even if a minority of shares are put up, and many may choose not to go down that path, even if it means slower growth and lost jobs.
Also, it is important to remember that even family businesses that do not sell any shares on public exchanges are likely to be affected by the continued development of new regulations as a result of the Dodd-Frank Act. As with Sarbanes-Oxley, banks and financial institutions will adjust their operations and practices to comply with new regulations for public companies. This will undoubtedly mean that family businesses will need to respond to issues designed for public companies simply because they have become part of the way financial institutions do business. It is important that these companies begin to anticipate these changes and work with bankers, accountants, and lawyers to be ready.
Of course, not all of the effects of these changes are bad. The goals of the Securities and Exchange Commission are to develop new regulations to comply with Dodd-Frank’s intent to promote effective communication and accountability among shareholders, owners, directors, and executives of the company. These are also important goals that any family that owns a business should pursue. Trust and harmony between the family is built and emphasized through transparency between the owners and intended owners of the family business. Much of what Dodd-Frank seeks to impose on public companies in terms of compensation practices and shareholder access can be used to preserve the patient capital on which family businesses depend.