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.