Broker-dealers lack E&O savvy

At a time when litigation has threatened the financial viability of several securities firms, executives at independent broker-dealers, as well as the more than 110,000 or so independent-contractor registered reps, often are woefully underinformed about their errors-and-omissions insurance, according to industry observers.

“The advisers have no clue” about their coverage, said Brian Kovack, president of Kovack Securities Inc., a broker-dealer with $3.2 billion in assets under management. Smaller firms, because of thin staffs and lack of expertise, are particularly at risk, he said.

“They [should] pay for an insurance expert, and often don’t,” Mr. Kovack said.

E&O insurance protects against unintentional mistakes in serving clients. Many times, advisers and their reps don’t understand the extent or limits of their coverage until it is too late. In some recent cases, broker-dealers have been in the middle of investor litigation when they’ve become embroiled in disputes with their insurance carriers over the amount of coverage they have to satisfy legal claims.

The failure to comprehend insurance coverage can have dire consequences.

QA3 Financial Corp. was in the middle of a dispute with its carrier, Catlin Specialty Insurance Co., when it closed its doors in February and went into bankruptcy. QA3 claimed in a lawsuit that it had $7.5 million in coverage for legal claims stemming from the sale of bad investments. Catlin claimed that the firm had $1 million.

REPS AT RISK

A lack of understanding when it comes to E&O insurance can prove particularly damaging to reps and advisers who affiliate with a firm, executives said. While some QA3 reps had begun to make exit plans before the firm shut down, many were surprised when QA3 said it was closing.

“Advisers are rarely aware that unless they take the appropriate action when they move to a new broker-dealer, they typically will no longer be covered for business transacted at their former firm,” said Jodie Papike, executive vice president of Cross-Search, a recruiting firm. “The result is typically damaging and expensive.”

Three other independent broker-dealers — Next Financial Group Inc., Berthel Fisher & Co. Financial Services Inc. and Brecek & Young Advisors Inc. — are also at odds with their insurance carriers, claiming in lawsuits that the carriers have failed to cover investor claims.

A SECOND LOOK

Those lawsuits potentially could prompt broker-dealers to take another look at their policies, one insurance broker said.

“Broker-dealers are definitely aware of these cases — that’s for sure,” said John McKenna, an insurance broker with ARC Excess and Surplus LLC. “It could be an impetus for them to look at their policies more closely, if they hadn’t already.”

Meanwhile, one of those lawsuits recently expanded in scope. In February, Berthel Fisher filed an amended lawsuit in federal court in Cedar Rapids, Iowa, to include its insurance broker, CalSurance Associates Inc.

Previously, Berthel Fisher had sued its carrier, Arch Specialty Insurance Co., claiming it had $7 million in aggregate coverage. Arch claims that the firm has a $1 million limit to all related claims. In February, its amended lawsuit alleged that the firm would sue CalSurance for “negligence and breach of fiduciary duty” if Arch prevailed in the dispute.

Tom Berthel, chief executive of Berthel Fisher, in the past has declined to comment specifically on the lawsuit. He has said, however, that he hopes it can be resolved.

A spokeswoman for CalSurance, Cathy Webb, declined to comment.

LACK OF INFORMATION

Typically, firms send advisers a one-page document detailing the total coverage of the firm, and that’s the extent of information firms give to reps, Mr. Kovack said. Errors-and-omissions insurance “is supposed to protect them, but on the whole, they’re completely in the dark” about their coverage, he said.

“When evaluating a plan, most advisers assume that plans with similar costs will have similar coverage,” Ms. Papike said.

“Most advisers look at price as the determining factor in quality of coverage, when in fact, cost is far from an indication of the quality or extent of coverage,” she said. “In reality, even plans from the same company with similar costs can have notably different coverage.”

One way broker-dealers can help calm reps’ fears over insurance coverage is to spend time covering the topic with them at firm gatherings, executives and insurance brokers said.

For example, Kovack Securities brings in its insurance carrier and broker to answer questions at its annual meeting, Mr. Kovack said.

The effort is particularly important, as insurance carriers are “jacking up costs and increasing exclusions,” he said, noting that broker-dealers must pay attention to policy details.

“It’s the fine print that oftentimes will make or break coverage,” he said.

E-mail Bruce Kelly at [email protected].