E%amp;O Policy Exclusions For Securities Violations On The Rise

To that end, Rybka suggested that producers seek the opinion of the client's outside counsel when dealing with NASD-listed transactions. They should also disclose additional details respecting the proposed sale (e.g., the settlement companies with which the producer has established relationships and the reason for selecting a particular buyer). And they should determine whether their E&O policy covers the transaction.

Life settlements notwithstanding, E&O policies aren't as attractive as they used to be, Rybka said, observing that policies from the four remaining E&O insurers carry lower coverage limits and higher premiums than in years past. Some broker-dealers and producers, he noted, are unable to get coverage. The policies also entail new exclusions.

For example, they won't pay for "fines or penalties imposed by law or regulation or self-regulatory agencies," such as the NASD and SEC. Nor will the policies cover "sums that are deemed uninsurable under state law," such as penalties and punitive damages.

Additionally excluded from policies, Rybka observed, are claims "arising from or contributed to by activities through which the insured gained any profit or advantage" to which he or she wasn't legally entitled. These activities include paying or receiving commissions without a license, insurance fraud, bid-rigging, 'wet ink transactions' and rebating.

The last may encompass non-recourse premium financing, an arrangement through which a bank finances a client's premium payments for two years, after which the client can retain, transfer or sell the policy. Rybka said the arrangement's key attractions for the client–the offer of free insurance for two years and the prospect of securing a portion of the cash value upon the sale of the policy to a settlement company–may constitute rebating.

Also now excluded from E&O policies are claims involving the use of confidential information not authorized by the insured. Rybka cited the example of a producer who learned about a client's income through an accountant who failed to first get the client's approval for the disclosure.

Likewise, producers may be without coverage if they fail to disclose to the client how they're compensated or if they don't make clear in what capacity they're serving the client, be it as agent, broker or registered investment advisor.

Also in the fine print, exclusions: for actual or alleged price-fixing, price discrimination, unfair trade or anti-competitive conduct; claims arising from alleged tax advice, except where such advice is accompanied by a written disclaimer advising the client to seek counsel from a tax professional; and claims arising from placement of coverage with a multiple employer welfare benefit plan, such as a 419 plan.

How can advisors best deal with all the new pitfalls? The first course of action, said Rybka, should be obvious, if not altogether exciting.

"It's boring, but it's important that advisors carefully read through their E&O policy exclusions–all 10 or 15 pages worth. Their livelihood may depend on it. Also, they've got to review with clients their expectations, particularly as they relate to brochures, websites and letters.

"I also advise drafting an engagement agreement for every client," he added. "Producers and brokers also need to carefully coordinate–in writing–with their broker-dealer on offerings."