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.