With last year's passage of the Dodd-Frank Act, regulatory exemptions many family offices and wealth managers have long enjoyed are being lifted. Enterprises that advise more than one linear family—or aspire to in the near future—are at a crossroads. Important decisions lie ahead. 

As the SEC puts the final polish on its definition of "Family Office," many, for the first time, must choose: Should they register as an investment advisor with the SEC, or alter the corporate structure and convert to a trust company to continue working for multiple families?

Your first instinct may be to avoid the administrative burdens and disclosures that come with SEC registration, especially given the paramount importance many families place on privacy. But public trusts will also face additional regulation at the state or federal level. Trust companies are generally subject to minimal capital requirements and more stringent financial reporting standards. Registering as a trust company may also require a certain amount of public disclosure of both client financial data and information on office operations.

New terrain
Post-Dodd-Frank, it seems all roads lead to increased transparency and regulation. Regulators viewing their mission as serving the public good will continue to allow certain exemptions that would not appear to pose risk to the public at large. (For example, an exemption will still be allowed for those that qualify as a “Family Office” under the new SEC legislation or that operate within the limitations of the state exemptions afforded to private trust companies serving one family or a limited number of clients. However, given the increased costs associated with serving the needs of wealthy families, many offices have taken on new clients to share costs. Their broadened client base will preclude many from taking advantage of historical exemptions. 

What can go wrong
When a family office provides a vast array of services, it invites the potential for claims. Allegations of equitable relief (demands for books and records or dissolution of trusts), monetary damages (breach of fiduciary duties, negligence or outright fraud) or criminal actions (fraud or insider trading) can be levied by regulators, stakeholders in the organization, employees and clients. Further, it is important to remember that a claim need not have merit to be asserted; even baseless allegations must be contested and can require the defendant to incur legal fees.

Historically, the risk of regulatory related claims was perceived to be limited due to the office’s exempt status, as well as the close relationships advisors generally forged with their clients. These days, however, regulatory exemptions are disappearing.  Offices may be taking on additional clients—or beginning to deal with the family's "next generation,” with whom they do not share a longstanding relationship and who might have new ideas about how assets should be handled. Accordingly, family offices now face very real risks on a daily basis.

For example, in the past few years trustees and investment advisors have faced claims:

• By the grandson of a first generation family office member alleging conspiracy to deprive him of his inheritance. The conspiracy, he alleged, was motivated in part by a desire to conceal breaches of fiduciary duties in investment activities.
• By a family after the office's investment strategy resulted in losses. The suit alleged breaches in multiple capacities, from failings in fiduciary duty, tax advice, and trust agreements, to unsuitability of investments under state securities laws. 
• By a family who alleged negligence after an investment advisor failed to secure breakpoint fees (discounts provided when multiple family members invest in the same fund).
• By a former employee for wrongful termination and interference with business relations.
• By clients of a family office after the outside investment advisor they retained diverted millions of dollars from their accounts. This underscores the fact that outsourcing will not necessarily protect a family office from claims; it can still face claims of failure to exercise due diligence in retaining the outside vendor or failure to properly oversee the activities of the outside vendor.

As difficult as these types of claims would be in the abstract, when claims involve family members, financial losses and employer/employee relationships there is often an emotional component that makes claims more difficult and costly to resolve.

Seeking shelter
It is a new day, and many family offices that never before considered professional liability and directors and officers liability insurance are now taking a close look. When they do, they are relieved to find that policies are available to comprehensively cover their multi-faceted risks. Moreover, while a veil of privacy previously kept many from pursuing coverage, the industry's heightened transparency means that many more offices in the future will have audited financials, overcoming an historical hurdle to coverage. 

Typical policies are menu-driven and highly customizable to accommodate the needs and structures of individual offices. Along with D&O, E&O, and fiduciary liability insurance, a dedicated Investment Management Insurance policy is an important consideration, particularly for larger entities serving as RIAs.

Staying focused on a single family may seem like an easy and less risky option in the wake of Dodd-Frank. However, the competitive climate will make it increasingly difficult to bypass the efficiencies and economies of scale that come with managing more families. Fortunately, with the insurance available now, family offices and wealth managers will have more options than ever to mitigate their risks and can go forward with confidence...wherever their business strategies take them. 

Mary McIvor is Vice President of Financial Institutions Claims at Chartis.

Coverage provided by a member company of Chartis Inc. The descriptions contained herein are summaries only. Please see actual policy for full terms, conditions and exclusions. All submissions are subject to underwriting guidelines. Coverage may not be available in all jurisdictions.