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BD/IA Risk Review – October 2020

Risk & Analytics|Investments

By Brian Cavanaugh , Jack Jennings , Jeremy Sokop and Jacob Camilliere | October 1, 2020

Risk and insurance considerations and approaches

AmTrust exits Broker-Dealer E&O

Through several senior sources at AmTrust, we’ve been made aware that AmTrust is exiting the Broker-Dealer E&O class of business. Rated A- by A.M Best with a “Stable” outlook, AmTrust has been a supporter of the Broker Dealer space in the small to mid-market segment for the past five years.

The senior executive we spoke with mentioned that the class of business exit was driven primarily by loss experience. Beginning in Q3 2020, small to mid-size Broker Dealers will need to look elsewhere for their coverage needs.

Selling away coverage and fidelity bonds

In December of 2018, the U.S. Attorney’s Office for the Southern District of New York announced that a New York Investment Advisor pled guilty to conspiracy to defraud certain investment advisory clients out of more than $11mm. ,

At the time, the USPIS Inspector in charge said, “[t]his case has all the markings of a classic Ponzi Scheme with payments made to investors with other investor money, bogus account statements, etc. [the investment advisor] also used investor money to pay personal and business expenses. His day of reckoning has arrived.”

What made this scenario noteworthy in the context of BD/IA insurance is that nearly all of the defrauded investors were advisory clients. This case has all the markings of a traditional claim scenario referred to on the brokerage side as “Selling Away” and highlights three important issues:

  • How RIAs are not immune from Selling Away exposures;
  • The key differences in coverage between pure RIA E&O and BD E&O policies; and,
  • How Fidelity Bonds - for both BDs and RIAs - might respond to Selling Away scenarios.

Consider how a pure RIA E&O / D&O policy might respond to the above scenario. Certain policy provisions, such as the conduct exclusion, the definitions of Insured Persons and Professional Services might all come in play. However, unlike BD E&O policies, RIA policies are unlikely to contain coverage limitations around Selling Away scenarios. In speaking with several senior executives in the industry, the underwriter’s desire to limit this exposure in BD policies stems from a few considerations including:

  1. The mobility and autonomy of independent contractors in a BD model;
  2. The standard of accountability for BDs (best interest) versus RIAs (fiduciary standard); and,
  3. The type and nature of securities generally traded in the two different models.

The scope and nature of Selling Away coverage in a BD E&O policy can vary greatly including limitations on whom the products are sold to, that the unapproved securities have to be “Securities” as defined by the 33’ and 34’ Act (including Reg. D.) and other limitations around specific classes of securities may also apply elsewhere in the policy.

Despite the differences in coverage between BD E&O and RIA E&O policies, both firms generally purchase some common form of Fidelity Bond coverage - a Form 14 Financial Institutions Bond (BDs are required to be bonded pursuant to FINRA Rule 4360). Fidelity Bond coverage is another avenue of recourse for Selling Away claims; however, differences in coverage and claim philosophy vary significantly from underwriter to underwriter.

Some markets have taken to issuing a separate sub-limit for Selling Away by means of a coverage extension; however, depending upon the terms of the underlying bond, this may not be necessary and may even inhibit or prohibit claim recoveries, e.g., imposing more restrictive covenants than in the underlying Fidelity Bond itself.

Some things to consider when negotiating the placement of your Fidelity Bond will include:

  1. Is the definition of “Employee” in my policy suitable for my exposure?
  2. Does my policy place restrictive covenants around scenarios involving fraud or theft?
  3. How does my historical exposure fit with my existing coverage?
  4. Does my bond address scenarios where a theft is perpetrated by an employee in collusion with other non-employees of my firm?
  5. Does my bond cover claims resulting from a theft after the client funds had been transferred out of their account with my firm?

All these questions go to understanding how your bond will address a “Selling Away” claim. With answers to these questions in mind; it’s important to understand that every claim is different, and with that in mind, no single coverage solution is appropriate for all clients. That’s why you will want to work with a qualified broker and an underwriter that has the flexibility and authority to draft terms that respond to your organization’s unique exposures.

Robinhood Markets Inc. probed by SEC

Willis Towers Watson’s Rob Yellen, recently authored an article on the “Robinhood Effect.” In essence, the effects of the surge in retail investor trading on the public equity markets. It’s an interesting commentary on market volatility and how new technologies and trading platforms are lending to larger and faster swings in volatility. Rob also discusses the potential effects of this volatility on public company insurance programs.

On September 2, the WSJ reported that Robinhood Markets Inc. is facing an SEC fraud investigation related to its failure to disclose relationships with high-speed trading firms. The WSJ has speculated that Robinhood Markets Inc. may face a $10M fine if they agree to settle with the SEC.

In several prior posts, we’ve discussed the importance of coverage for regulatory claims. For startups and new ventures, the issue of insurance spending is a significant one. Very often new ventures grapple with an asymmetrical insurance market - and an underwriting bias toward more established businesses - electing to take unconventional approaches or forgoing insurance altogether in the most vulnerable areas of their businesses.

A product of these asymmetries - prohibitively high retention structures, disproportionate premiums or punitive coverage terms - may make risk transfer through insurance impractical on a superficial level. However, as demonstrated by the most recent case, firms may want to take a second look at their risk profiles and the cost-benefit of getting a qualitative insurance program in place.

Unfortunately, the risks are not always apparent. On this point, the D&O example illustrated in Rob’s article is a helpful one highlighting that D&Os are particularly vulnerable as far as accountability for regulatory violations (in the case we mentioned above.) At a minimum, startups and growth-stage companies may find value in purchasing D&O (including both personal asset and balance sheet / indemnification protection).

To the extent D&O proposals contain E&O exclusions, firms will also want to look at their E&O risks. In other words, what are the types of services that they’re performing for others and are they covered for them? Could these exposures potentially lead to regulatory risk to the firm, or even to the firm’s relationships with clients that they hadn’t previously considered?

For these reasons, we recommend working with a qualified insurance broker that will help your firm carefully think through these issues.

Perhaps you’ve heard of cyber insurance?

On September 18, Investment News reported a tech outage at a major Broker-Dealer. Reportedly, the tech problems were so severe that they prohibited advisors from contacting clients and accessing account information. Unfortunately, that same company announced earlier in the week that it would lay off 500 non-advisory employees.

The conventional thinking around cyber often stems from the obvious claim scenarios, such as network breaches, the loss or misdirection of personally identifiable information, personal credit card information or personal health information. Often overlooked are the protections afforded by cyber insurance policies for network interruption failure (due to a malicious attack or error).

Business interruption coverages are in principle designed to cover customers for losses of income and restoration expenses that occur as a result of a security breach or system failure. Dependent business interruption coverage is also available for the failure of a third-party network and subsequent loss of income by the customer as a result.

Some considerations when evaluating whether business interruption coverage is appropriate for your firm are:

  • Firms may want to look at the definition of “system failure” to understand the coverage limitations and conditions;
  • Make sure they fully understand their policy retentions and any applicable waiting period. Firms may want to ensure they are sufficiently capitalized to endure any loss of income during the designated waiting period in their policy;
  • The extent of coverage for restoration expenses after a network shutdown; and,
  • The reputational impact to the firm for other cyber claims scenarios, such as a network breach and how a policy might respond.

Per the most recent example in the cited article, understanding the risk of network failure is not as simple and straightforward as it may seem. Not only should firms carefully account for the risks of an outage of the systems supported by their networks, but also networks which they rely on through third-party engagements. Be sure to talk through these scenarios with your broker and understand how they’ve dealt with similar situations in the past and any challenges in the policy language.

FINRA flexes on alleged Anti-Money Laundering violation

On August 10, FINRA reported that it fined a major trading firm $15M for failures in the firm’s anti-money laundering (AML) program. That same day the CFTC announced a penalty of $11.5M and disgorgement of $706,214 against that same firm, resulting in total fines and penalties of $38M.

Jessica Hopper, FINRA Executive Vice President and Head of Enforcement, said, “[t]oday’s action is a reminder that member firms must tailor their AML programs to the firms’ business model and customer base, and also dedicate resources to programs commensurate with their growth and business lines. FINRA will continue to take steps to ensure that firms comply with their obligation to monitor for, detect and report suspicious activity.”

As we discussed above in our article about Robinhood’s current SEC probe, firms must carefully evaluate D&O coverage as a means of risk transfer for defense costs associated with regulatory investigations. Ultimately, directors and officers are accountable for their firms’ policy making and adherence to those policies. Therefore, the liability created by the directors and officers with respect to their own personal assets should be intuitive, but perhaps also so should the risk presented by the consequences of that decision-making power.

To the extent the regulatory investigations arise from services performed for others, E&O policies may come into play as an avenue of risk transfer for regulatory investigation costs. It’s crucially important to maintain some function of E&O coverage, including regulatory investigations coverage, when your D&O policy contains an E&O exclusion.


Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed subsidiaries of Willis North America Inc., including Willis Towers Watson Northeast Inc. (in the United States) and Willis Canada, Inc.

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