Does Your Securities Broker or Investment Advisor have Errors and Omissions Insurance?

When shopping for an investment firm, or during your next meeting with your financial professional, ask whether the firm carries errors and omissions insurance. This type of insurance, also known and “E&O coverage,” insures against claims made by customers against their investment professionals.

Unpaid arbitration awards remain a significant focus of regulators, legislators, and investor advocates. According to data published by the Financial Industry Regulatory Authority (“FINRA”), the organization that regulates broker-dealers and their registered representatives, between a quarter and a third of all arbitration awards go unpaid. A large portion of unpaid awards were made against firms that were out of business at the time the arbitration claim was initiated. In the years 2013 through 2017, the total unpaid awards exceeded $160 million.

Investors who receive an award in arbitration should be able to collect the award. When a firm is not able to pay an award and has no insurance coverage, the investor has limited options. Only one state (Oregon) requires financial professionals to carry E&O insurance. A few states (Vermont, Indiana, and Montana) have established restitution funds that in some instances provide for recovery if an arbitration award is unpaid.

To try to understand why many broker-dealer firms lack E&O coverage, the North American Securities Administrators Association (“NASAA”) surveyed firms to determine the economic feasibility of E&O coverage for FINRA members. NASAA was particularly concerned about claims that E&O insurance was too expensive and too difficult for members to obtain. NASAA’s report on its survey was released on December 11, 2019. See NASAA Broker-Dealer Sectoin E&O Insurance Survey Report (December 2019).

The majority of the 64 broker-dealer firms surveyed by NASAA were small firms as FINRA data indicated that most unpaid arbitration awards were made against small firms. See Discussion Paper – FINRA Perspectives on Customer Recovery (February 2018). The NASAA study found that 23% of the 64 surveyed firms did not carry E&O Coverage. Firms that lacked coverage gave many reasons for not purchasing the insurance. Interestingly, it did not appear that the cost of coverage was the predominant factor. Only 4% of the surveyed broker-dealers that lacked coverage cited the cost of premiums as the reason, and only 9% of the firms that had coverage responded that the coverage was expensive. NASAA concluded that E&O coverage could be obtained at a “manageable cost.” Nor did access to the market present a significant obstacle. NASAA found coverage spread evenly among 28 different carriers, which indicates that the market for E&O coverage is competitive and robust.

A cautionary note in NASAA’s report is that most E&O policies contain significant exclusions. Common exclusions include fraudulent activity, annuities, Regulation D offerings, private securities transactions, alternative investment products, and selling-away claims. While mandating E&O insurance may not provide a source of funds to pay awards against inactive firms or where the claims involve fraud or excluded investment products, NASAA’s study led it to conclude that mandating E&O insurance may provide a source of recovery for some investors who successfully obtain a monetary award against a brokerage firm. NASAA also suggested that requiring broker-dealers to disclose whether they have E&O insurance may incentivize firms to obtain such coverage and allow investors to make more informed decisions when selecting a firm with whom to do business.