A version of this article first appeared in CNBC’s Inside Wealth newsletter with Robert Frank, a weekly guide for wealthy investors and consumers. Register to receive future editions, straight to your inbox.
Kevin Warsh can credit more than $100 million of his vast fortune to a lucrative regulatory exclusion that favors family office executives and investment professionals, family office lawyers told Inside Wealth.
While single-family offices are generally considered to only manage the assets of family members, a little-known exception allows certain employees to invest with the ultra-wealthy families they work for.
Warsh’s recent financial disclosures highlight the exclusion.
The candidate for Federal Reserve chairman owns two stakes worth at least $50 million each in a vehicle called the Juggernaut Fund, according to filings. The fund is managed by Duquesne Family Office, the personal investment company of billionaire hedge fund manager Stanley Druckenmiller.
Warsh joined Duquesne as a partner and advisor after leaving the Fed in 2011 and has ownership interests in dozens of other Duquesne entities. The Juggernaut Fund’s underlying assets are not detailed, citing Warsh’s “pre-existing confidentiality agreements” with the company.
A lawyer who has advised family offices for 30 years told CNBC that it is increasingly common for family offices to structure compensation for their key employees in the same way as private equity firms. This could include incentive fees for investments or capital co-investment opportunities, said the lawyer, who spoke on condition of anonymity in order to speak freely.
Family offices often lend money to these employees in order to fund their capital commitments and write them off over time or apply future bonuses to the debt, the attorney explained.
Single-family offices can allow employees to co-invest through a family office rule published by the Securities and Exchange Commission in 2011. Under the rule, family offices are not required to register as investment advisers as long as they only advise or manage the assets of family clients, a category that includes key employees as well as family members of the company founder.
To qualify, key employees must hold a leadership position such as a director or executive or be involved in the company’s investment activities, according to the SEC. Investment professionals must have served in these roles within the family office or other business for at least 12 months, according to the SEC.
“I think the SEC staff at the time was sensitive to the family office community’s concerns about making investment opportunities and in-house investment staff as robust as possible,” said a lawyer at a New York firm, who asked to remain anonymous to speak on the matter. “They recognized that to attract and retain this type of talent, you had to offer executives this level of compensation.”
Lawyers told Inside Wealth that Warsh likely fell within the key employee exception. Duquesne and a representative for Warsh did not respond to requests for comment.
Evan Hall, a partner in the investment management group at Haynes Boone, said the “key employee” category is somewhat flexible, however.
“If you are an employee of the company who participates in investment decisions, that doesn’t have to be everything.” investment decisions for the family office,” Hall said. “People can play a little. Can a consultant meet the definition of a key employee? It seems really blurry, but it’s a line we see a lot. »
Warsh has promised to divest his Duquesne-affiliated investments if confirmed to lead the Fed, but he has not revealed how he would do it.
Lawyers who spoke with Inside Wealth said Warsh would have to sell them to the Druckenmiller family or another family client for Duquesne to comply with the family office rule.
“I will say that if he doesn’t have friendly partners willing to buy him out, getting out of the underlying investments tends to be very difficult,” said another New York lawyer, who also asked to remain anonymous to speak candidly. “Otherwise it is very difficult to withdraw from private investments.”
At the Senate Banking Committee confirmation hearing Tuesday, Sen. Elizabeth Warren, D.-Mass., asked Warsh if he would sell those interests back to Druckenmiller.
“Will you disclose how you’re divesting these assets? Or are you just going to take a $100 million check from someone whose entire business is betting on what the Fed will do?” » Warren said.
Warsh said he had reached an agreement with the Office of Government Ethics, but did not give specific details about it.
Although Warsh’s appointment and wealth have drawn attention to how family offices compensate their employees, attorney Michael Schwamm, a partner at Duane Morris, said it was unlikely to call for regulatory scrutiny over how key employees are defined or how many people can co-invest.
He said the SEC would likely only act if an investment goes bad and an employee loses all of their savings and publicly attacks the company.
“I wouldn’t be surprised if family officials triggered the finish line, but is this something the SEC will actively pursue?” he said. “Not until something happens.”