Although families and single-family offices certainly need to be aware of their risks—and how to mitigate them—the firm-wide risks of multi-family offices may be even more complex. In some ways risks for multi-family offices are more akin to those of RIA wealth managers because of their multi-client base. But there are ways to recognize and manage these risks, as well.
It begins with the most fundamental building blocks of any firm: employees and partners. Amelia Renkert-Thomas, a partner in the New Haven law office of Withers Bergman LLP, counsels her multi-family office clients to think about employment-related risk—to hire carefully and document employment agreements—and equally important, update those agreements when necessary. “There’s always that tension between hiring at will, which certainly is the goal of most firms, and then making sure that there’s still the necessary level of documentation…At a minimum, multi-family offices need to have confidentiality agreements, protected information agreements, non-solicitation and non-competition agreements in place—particularly with their key employees, but really with anyone, because multi-family offices are really holding in trust tremendously valuable information for their clients, and they need to be aware of confidentiality and privacy.”
In addition, Renkert-Thomas adds, “Any deal between a multi-family office and a key employee needs to be documented very carefully.” After the initial agreement, it is all too easy for firms to trip themselves up if something about the initial deal changes, such as the actual outcome versus how the deal was spelled out in the original document. “Whatever deal there is needs to be documented really fastidiously and then needs to be honored in accordance with its terms,” she says. If things change, as can happen, especially at a small firm, and there’s “a handshake deal...and no one ever goes back and updates things,” it could become a problem.
Another area that requires vigilance at multi-family offices is technology, according to Renkert-Thomas. Multi-family offices retain a trove of confidential—and potentially devastating—data that, in the wrong hands, could create all sorts of difficulties, she points out. They need “firewalls between their various clients…[they] need to have state-of-the art technology.”
Not only do family offices have to watch clients’ liability coverages, but a multi-family office “needs to watch its own liability coverage, needs to structure itself fairly defensively,” says Renkert-Thomas. Partners in a large-scale multi-family office “may wish to structure [it] as a holding company with a group of LLCs that perform specific functions [so] that you can basically put risk in separate silos,” she adds. This way, a problem in one area doesn’t infect the whole firm. “Certainly,” she advises, “I would keep investments separate from administrative back-office functions.”
There are more subtle risks in play here as well. Multi-family office and RIA wealth managers need to think about the “relationships among various providers to the family” notes Renkert-Thomas. “The question is: What role does the multi-family office play in monitoring other providers?” This is much more than a liability risk; reputation is also at stake. What happens, she asks, when a new client “brings with them investment managers from a prior relationship? Is the new multi-family office responsible for saying these guys are going to steer you wrong? Are they responsible for making sure that those investment advisors and managers are actually reporting truthfully? Where does their responsibility begin and end?”
Firms need to think this through thoroughly because, she explains, “the deal between the family and the multi-family office needs to be documented very carefully and reviewed regularly, probably at least annually.” Not only that, but firms need to be “very careful to specify which responsibilities a multi-family office takes on and which ones it doesn’t…We’ve been thinking a lot about what level of [fiduciary] duty a multi-family office owes to a family as opposed to, say, a private bank.” There’s no case law yet, Renkert-Thomas adds, but, “to the extent that a multi-family office holds out as providing a very high level of service, it may well be held to a higher level of fiduciary duty than another investment service provider.”
A Case in Point
For example, let’s say the creator of a family’s wealth has died, leaving a spouse who was not very fiscally involved, and has young children. The spouse “read the brochure that says: ‘We’re with you all the way, we’ll handle your investments, we’ll pay your bills, we will develop cash flows and budgets’—fairly standard soup-to-nuts multi-family office offerings,” says Renkert-Thomas. Then they discover “down the line that ‘there’s been a margin call and no one notified me; key bills have gone unpaid—all sorts of things that I relied on them to do based on this’—whether reasonably or not,” she adds. Such a client might have grounds to bring an action against the firm—and might actually win it. “I just think multi-family offices have to think defensively and be very careful about documenting exactly what they’re responsible for and exactly what the client is responsible for,” Renkert-Thomas warns.
Is it possible that the liability for fiduciary duty rises with the level of client dependency? If so, notes Renkert-Thomas, multi-family offices really need “to think on a granular level about what the multi-family office is going to be doing for the client and specify that very clearly. It’s not so much detail as clarity that’s important, because the client needs to be able to understand what they’re signing, too—and 27 pages of disclaimers aren’t going to help.”
Complicating matters further is the fact that there are many permutations of family offices and how they differ from other advisory firms. “Lots of people call themselves family offices, some you’d probably agree are, and some you’d say aren’t, that they’ve just adopted the name—there’s very little clarity on what is or isn’t a family office—it’s sort of the buzzword of the decade in wealth management circles,” says Renkert-Thomas.
Not only that, but the way multifamily offices are structured, what they will and will not do for client families and how they are run varies widely according to the founder’s philosophy. This makes it all the more critical that what is going to be done and not done by a firm be documented.
If that surviving spouse does bring an action against the firm, she concludes, “you don’t just have reputational risk as a result of your own actions…you have, probably, allied service providers, outside investment managers and their reputational risk colors you as well—so you need to be careful of who’s playing in your sandbox.”
Kate McBride is editor in chief of Wealth Manager.