Welcome to Financial Advisor IQ


Make Sure You're Covered if a Client Sues

August 31, 2017

Providing expert advice is the hallmark of a successful financial services professional. It’s also an advisor’s biggest risk.

While advisors are careful not to make mistakes, that doesn’t prohibit a third party or disgruntled client whose investment went sour from suing for their losses. Clients, business partners, federal regulators like the SEC, vendors, creditors and shareholders all pose a risk to the RIA and BD, even when the broker or advisor is doing everything right. That’s because even erroneous claims must be defended or settled out of court to preserve resources and the advisor’s hard-earned reputation.

Lawsuits against an RIA or BD come in many flavors and sizes. In addition to the known regulatory liability, some of the most common allegations of professional liability for investment professionals include claims of poor advice when an investment doesn’t pan out, improper due diligence, failure to adjust investments in due time, and poor investment management.

Unfortunately, these lawsuits can drag on, requiring the advisor to fight it out in court, which is costly, time-consuming and can take a serious toll on a small, independent business.

Many service professionals make the mistake of assuming their General Liability Insurance policy covers their professional service exposures. This couldn’t be further from the truth. A GL policy is limited in scope and covers only personal or bodily injury and property damage. If a client falls and breaks their hip while walking up an investment advisor’s office steps, the advisor’s GL policy will respond. But if the same client sues the advisor after his investment advice led to a major loss, a Professional Liability policy is the only coverage that can back them.

Professional Liability Insurance protects businesses against charges of negligence or harm, based on the professional service or advice offered. Otherwise known as Errors and Omissions (E&O) Insurance, a PL policy covers defense costs, judgements, settlements and in some circumstances can also cover fines or penalties resulting from the allegations of misrepresentation, breach of professional services, wrongful business practices, misleading advice and conflicts of interest.

There’s no such thing as a one-size-fits-all PL policy. Without standardized policy language a PL policy is uniquely designed based on the business’ size, location, risk base and desired coverage limits, written specifically for the advisor’s risk. For this reason, having an insurance broker that understands the market and individual risk for each investment firm will be critical to procuring the right policy and coverage limits.

Without standardized policy language, RIAs and BDs will need to work with their broker to ensure they procure the right PL policy, including claim limits and coverages. Here are five things to consider when procuring a PL policy:

Find a broker who specializes in financial services. Be wary of those who don’t complete a thorough analysis of your business’ services, risks and potential exposures prior to quoting policy limits. Generalists who cannot explain the difference between the various investment products you are advising are far less likely to be of true assistance when there is a complex claim.

Make sure the policy includes all the financial services offered. Make sure the policy’s definition of professional services includes everything you advise on. Otherwise, exclusions could possibly lead to coverage denials in areas not explicitly mentioned.

Look out for broad exclusions. Broad exclusions could overlap with a firm’s greatest exposures — make sure core business functions are all included in the policy. For example, many investment management PL policies exclude coverage for investment banking services.

Consider the firm’s entire suite of professional coverages and how they line up together. Ideally, when all a business’ professional policies work in tandem, coverage gaps are minimized, if not eliminated. Your insurance contract should be part of your overall risk management framework, and an experienced insurance broker can advise you on how these risks are typically managed.

Working with an insurance broker who is knowledgeable about financial services is a must and will bring a greater return on investment long after the policy has been written, and is of the most value when a claim surfaces.