Consider the following problem: You’re overseeing a family office that manages the trust of a multigenerational family. You have an outside investment advisor holding 50% of the trust’s assets in several financial products. Then it’s discovered that the advisor has taken the money for personal use.

What would happen if the family sues your office—or you—for mismanagement of the trust?

If the family office is found liable for violating fiduciary duties, it may leave you—directors, officers or other executives—personally responsible.

A family office’s fiduciary responsibility to the wide-ranging interests of its beneficiaries is one of the highest legal duties owed by one party to another. The officers and executives of this office are legally bound to manage the assets for the beneficiaries’ sole benefit. If they cross this line, they will be subject to liability for the beneficiaries’ financial losses.

There are other risks, too, ranging from employment discrimination and the violation of trust agreements to professional negligence. These risks are on par with and sometimes exceed those confronting the directors and officers at corporations.

Since such matters tend to be handled privately, there are no precise statistics capturing the volume and costs of litigation filed by family beneficiaries against family office management. However, what is clear is that both the frequency and severity of liability claims have grown over the years, making this a crucial risk management and insurance concern for family office chiefs.

While different types of insurance products are designed to transfer a substantial portion of these risks, many family offices lack structured and recurring processes to identify and manage their exposure.

Insurance policies addressing the unique risks faced by family offices have evolved to include updated coverage terms and conditions. These upgrades are needed to address the inherently more complicated nature of litigation threats resulting from professional services negligence and mismanagement, trustee administration errors and allegations of wrongful employment practices.

Professional Risk
The broad range of services that family offices provide for clients often impose upon them a fiduciary standard of care. This requires, among other things, that investment advisors act solely in their clients’ best interest. Family office executives and professional staff who fail to perform these obligations prudently may incur liability for a breach of fiduciary duty, inadequate or inaccurate advice, or professional errors and omissions.

Think of an alternative asset investment that flounders—perhaps a large allocation to the energy industry during the last two years, amid a precipitous decline in the stock of many publicly traded oil and gas companies.

Another example of professional risk is an executive’s over-reliance on a third-party advisor to whom a large percentage of the family members’ assets are allocated. An example of this would be the regrettable investments made to Bernie Madoff. The disgraced stockbroker’s notorious Ponzi scheme directly affected many wealthy families. If a family office selected Madoff as the sole or predominant third-party advisor to the beneficiaries, its directors, officers and other executives would be liable for the decision.

This problem would be the same for third-party professionals such as accountants, lawyers and tax advisors retained by the family office. If these providers make costly mistakes, the family office staff may get in trouble for the way it delegated its responsibilities.

Disputes among family members about the allocations of their respective investments are a different kind of problem. Younger beneficiaries, for instance, might be interested in assembling a more aggressive investment portfolio, while older ones prefer a more conservative approach, and the family office may be called upon to mediate these conflicts. Any failure to balance diverging expectations could lead to charges by certain family members that their interests were not treated impartially or prudently.

Family office executives might also be accused of negligence in estate and tax planning matters, improper record-keeping (such as a missed stock options exercise date), deviations from a planned investment strategy, the payment of invalid claims against family members and the overcharging of fees.

Trustee Risk
Family offices that also act as trustees owe the highest level of fiduciary duty to the family beneficiaries, including the duties of loyalty, impartiality, prudence, and preservation and protection of property. This significant accountability stems from the fact that trustees are the legal owners of any assets held by a trust for the benefit of family beneficiaries.

By law, a trustee must exercise the care, diligence and skill that a prudent person would in managing the affairs of others. The family office must prudently consider the beneficiaries’ needs in making all decisions about trust assets, such as investment decisions and the distributions that are made to beneficiaries from the assets. Any failure to exercise this duty of care could result in legal actions brought against the family office by beneficiaries alleging violations of the trust agreement.

Consider a trust that has been established principally for tax benefits that instead incurs a significant tax liability or financial burden. The family office trustee can be sued for imprudence in establishing the trust and held personally liable for trust debts.

The same consequences are possible if the family office retained the services of a third-party lawyer or tax professional to establish the trust. As mentioned earlier, the negligent selection and monitoring of outside advisors is a significant liability for a family office. While the prudent investor rule allows a trustee to delegate an investment function to a suitable advisor, it is up to the trustee to carefully select this advisor and explicitly document why this professional was chosen.

Another risk for trustees is that some beneficiaries may allege that their investment interests were not treated with the same impartiality shown other family members.

Trustees must also ensure that assets held by the trust are well understood, properly maintained and protected at all times. Another thing that must be understood is the trust agreement, which establishes the trust’s objectives, borrowing limits, period of activity and the stated beneficiaries. Since trusts are highly complicated instruments, the administrative burdens for a family office can be significant. For instance, in many states, once a beneficiary reaches the age of 25, that family member is authorized to receive a copy of the trust’s financial statements and tax returns. If a trustee fails to provide the documents, it can result in a legal action and alleged violations of the trust agreement.

Trustees furthermore may have to recognize any cybersecurity risks confronting the family office, and take specific actions to reduce and mitigate these threats. For example, an internet scam like phishing may be designed to penetrate the bank account of a family member to make an illegal electronic transfer of funds. The trustee’s duty to preserve and protect such property may open up another avenue of litigation.

In all cases, defending against a breach of trust allegation can be expensive and exhausting, and it could possibly tarnish a defendant’s character.

Employment Practices Risk
Like all employers, family offices are subject to claims brought by employees and others alleging discrimination based on race, color, religion, sex, national origin, disability or age. Claims may also be brought for harassment, wrongful discharge, defamation and a wide variety of other offenses.

Allegations of this nature against family office directors, officers and executives can generate costly litigation. Substantial punitive damages, for instance, may be imposed upon a defendant, resulting in steep financial losses and tattered reputations. Such allegations are on the rise, with nearly 90,000 charges of workplace discrimination filed against employers in 2015, according to the Equal Employment Opportunity Commission.

Insurance Considerations
It’s important for executives to become aware of the unique, fast-evolving professional and management liability exposures they face. To manage these risks, it’s essential to partner with an attorney, agent, broker or another professional and an insurance company that understands the dangers and can turn to special insurance products to help.

The stakes are high for those caught in costly liability lawsuits. The first line of defense is to be prepared for the worst—risk mitigation and insurance can offer the protection that family offices need.