Insurance protects financial advisers from unplanned costs

The Missouri secretary of state office announced Nov. 15 that the former employer of a Joplin-area investment adviser has to pay more than $1 million in fines and restitution after the adviser, Mark L. Henry, allegedly defrauded customers out of more than $800,000. (See story here.)

The ruling states that Wisconsin-based Investment Centers of America Inc. must pay $788,000 in restitution to investors, as well as nearly $250,000 in fines and court costs.

Nadia Cavner, head of the Nadia Cavner Group at BancorpSouth, and U.S. Bancorp recently jointly dismissed a suit alleging she had violated her confidentiality and nonsolicitation agreements by “improperly attempting to lure away” her former U.S. Bancorp clients.

Both sides of that case declined to discuss whether a settlement had been reached.

Both cases, however, highlight the importance of financial advising firms having the appropriate coverage to protect against both losses and potential legal issues.

Not just fraud

The Financial Industry Regulatory Authority, which regulates all securities firms doing business in the United States, requires firms to maintain a blanket fidelity bond – a bond that protects against losses due to employee dishonesty.

John Piatchek, president of Springfield financial planning firm Piatchek & Associates Inc., said the most typical coverage is a professional liability policy, also known as an errors and omissions policy, which goes beyond covering an employee’s malicious acts.

“It protects (firms and brokers) in the event of lawsuits for wrongful doings or bad transactions,” Piatchek said. “It’s not necessarily about out-and-out fraud; in the normal course of business, things go wrong or there are misunderstandings with clients. It’s simply there to protect us, much like a doctor’s liability coverage, against anything you could get sued for.”

Broker-dealer help

Piatchek said advisers’ coverage is offered almost exclusively by large national companies; broker-dealers negotiate a master contract with the larger company and then offer the coverage to their advisers. There are multiple types of coverage available for advisers, but Cavner is clear on which one she considers most important.

“Errors and omissions is the main policy,” she said. “You can buy additional insurance if you wanted to – it’s up to each individual representative – but errors and omissions is the main one.”

While Cavner declined to speak specifically about her own coverage, the National Association of Insurance and Financial Advisors recommends errors and omissions coverage between $500,000 and $2 million for both financial advisers and insurance agents, covering against errors and omissions as well as legal costs from any litigation brought by unhappy clients.

Springfield financial adviser Eric Peterson said that most broker-dealer companies, which usually oversee the financial advisers’ investing activities on behalf of clients, carry insurance on the advisers they work with “just in case.”

Peterson equated errors and omissions insurance to liability insurance for car owners.

“You want to drive safely, you want to make sure your equipment is in good shape, understand how your car behaves, be aware of the driving conditions, be careful of how you drive and what your expectations are for the vehicle,” he said. “But it’s also required that you have liability coverage on the vehicle, just in case.”

Open communication

But, Peterson added, the best protection for any adviser is transparency with clients.

Advisers, he said, should provide full disclosure of the investments they’re offering, including any compensation the adviser might receive and the risks involved.

The adviser also should be aware of the client’s risk tolerance and investing experience.

All of those steps and an open channel of communication, he said, help prevent the most common reason for litigation: customers unhappy with the results of their investments.

“Both the client and the adviser must understand the working relationship and clearly identify the appropriateness of expectations,” Peterson said.

“Regular communication helps to ensure that clients and advisers are on the same page in regard to the client’s accounts,” he added.