Five things that can go wrong at the family office

We asked leaders to point out pitfalls that can harm the client relationship. Depending too much on specific individuals, either within the family or the family office, is one thing that can cause disruption if that individual dies or retires. 

Kathy Kerr  •  Canadian Family Offices

What happens when things go wrong at the family office?

Poor performance, mistakes and government audits are among the risks any wealth management firm might face. Especially at family offices, they can cripple the trust between advisor and client.

Prevention, of course, is the ideal solution. Here are a few possible risks and how they can be mitigated.

Fraud or incompetence

Family offices need to have protective frameworks in place to anticipate the possibilities of fraud and incompetence, advisors say.

“It doesn’t matter what a family office may do, there will always be a snake that gets into the system,” says Enzo Calamo, CEO of Vancouver-based Lugen Family Office and Medici Family Office. “When I’m building out my model, I look for checks and balances along the way, because that’s the only way you can protect from something bad or incompetent.”

Family offices can also bring in strategic partners or third-party consultants to offer independent second opinions on courses of action.

“The more you have independence in the checks and balances, the more effective and honest the system,” says Calamo. “As soon as you have collusion in the model – it’s all in-house or the strategic partner does whatever you tell them to do – that’s when risk starts to evolve.”

Investment losses

Poor portfolio performance can be a source of conflict in the family office and/or family relationship. Sometimes a portfolio manager isn’t up to snuff, but it can also be a misalignment of expectations.

Patricia Saputo, co-founder of Crysalia, a learning and development office for enterprising families in Montreal, says a family will indicate during the discovery phase of the family office relationship what its risk tolerance is.

“A client [might] say, ‘Oh, don’t worry, if the markets go down 25 or 30 per cent, I’ll be fine. And then the markets do go down 25 or 30 per cent, and they’re on the phone freaking out. Then you have to have a conversation with your client saying, ‘We’re going to make sure we have a strategy limiting your risk.’”

Saputo adds that if the family stated that it wanted a conservative strategy, and then the portfolio goes down 25 per cent, that could be grounds to end the contract with the family office. But if the portfolio bounces right back up, it could be an opportunity to say, “I shouldn’t have had that in my portfolio, so let’s adjust and move on.”

Tasso Lagios, managing partner at Richter Family Office in Montreal, says investment managers should build diversification into the portfolio to prevent a losing investment strategy from having a major impact.

“That’s why a lot of families are picking a diverse number of strategies and a diverse number of managers within that strategy,” he says.

The loss of key talent

Depending too much on specific individuals, either within the family or the family office, risks major disruption if that individual dies or retires.

When Calamo was diagnosed with leukemia in 2013, he realized he needed to restructure his family offices. He says he built a team and pulled in partner resources that could outlast his tenure.

“Too much is based on individuals. There’s a lot of talent in individuals both in the family and the family office. When you start taking those individuals out, that’s why family wealth gets destroyed,” says Calamo.

“You need to bring in the resources to protect the family knowledge.”

Clients, he says, need to create a sort of “family university” that captures family values and equips members with the tools they need should a key family member suddenly leave the picture.

Tax audits

Tax audits can result in confusion and strife for families, Lagios says. “Many times the family doesn’t understand the impact. You need the right person to both defend the situation” – the family office should be able to explain the tax strategy it utilized.

The family office also needs to keep the family informed throughout the process, he says.

Quillan Quarrington, family office leader for PwC Canada, says the family’s reaction to an audit depends on what style of taxpayer they are.

“Some might feel that if they aren’t being audited every year, maybe they aren’t being aggressive enough and they’re paying too much tax,” he says. “Some would rather take a more conservative path.

“When we’re coming to tax planning we’re always talking about the risks associated with any plan,” says Quarrington.

Cyber attacks

Family privacy and digital security are constant concerns these days. “We’ve moved from human theft, which we’ve learned to manage, to cyber-attacks, which are coming through a different door,” says Lagios.

Family offices need the right people in place before a problem happens, he says, possibly a third-party expert from the cyber-perspective and internal controls from the non-cyber-perspective. Richter includes cyber-safety in its educational program for families so they can be vigilant as well.

If an attack happens, the family office should act quickly.

“Usually the first line of defence is to get a specialist to come in who has experience retrieving the data or retrieving the funds,” says Lagios. “Sometimes it may be too late and you look to insurers.”

Saputo says client families dealing with a multi-family office might consider hiring a third-party IT firm themselves to ensure their information stays safe and private in the family office.

Even so, attacks can still happen, she suggests.

“When you do an update there’s a vulnerability in the system that leaves the door open,” she says. “If the hacker … sees that open door and comes in, you’re compromised. It’s not because you purposely left that door open, it just so happens there’s a vulnerability.”