Unsophisticated investors could pose problem in downturn
Even though liability coverage for securities firms is widely available, industry observers say only 20% to 25% of those who should buy the coverage actually do so.
They note that many brokerages don’t see a need for errors and omissions insurance because few investors are suffering in the long-running bull market.
But securities brokers are still in a risky business, and they should take advantage of the soft market for insurance coverage just as they have the bull market for stocks, professional liability experts advise.
Though “statistically, it is true that when the market is good, fewer claims are filed against brokers than when the market is bad, I would think that these days, with so many unsophisticated investors in the market, brokers would want to be more protective of themselves and exercise risk management by buying lots of insurance,” says Mark Carlin, a partner in the Washington law firm of Sherman Meehan Curtin & Ain who represents plaintiffs in securities cases.
In fact, he suggests, the volatility of today’s stock market could result in even more claims against brokers than when the market is bearish.
Eric Rush, assistant vice president of Zurich-American Insurance Co. in New York, says that “there has been a slight uptick” in claims against brokerages insured by Steadfast Insurance Co., a Zurich subsidiary.
More investors, more errors?
Claims often increase “with any type of business that takes off,” he says. Indeed, nearly half America’s households are investing in the stock market, according to a joint survey released last month by the Investment Company Institute and the Securities Industry Association.
One of the more likely claims to be filed against brokers is for recommending unsuitable investments. Brokers have a duty to make recommendations that fit an individual investor’s circumstances.
Most claims are submitted for arbitration by the National Association of Securities Dealers.
“The insurance policy is designed to protect them for their errors and omissions. We’re all fallible. The insurance is designed to protect their reputations and their assets,” says John Iannotti, vice president, financial institutions, at American International Specialty Lines Insurance Co. in New York, a unit of American International Group Inc. It underwrites the brokerage professional liability insurance program available to members of the NASD.
Like most insurers that write this coverage for stockbrokers, American International sells it not to individual brokers but to the brokerage entity to cover itself and its registered representatives, Mr. Iannotti explains.
The minimum premium for the NASD program is $2,500. Limits start at $250,000 and can be arranged as high as is necessary, he says.
Mark Freitas, chief operating officer of New York insurance broker Frank Crystal & Co. Inc., explains that most brokers don’t think the price or terms of E&O coverage is attractive.
He says policies could cost as much as $15,000 for a $1 million limit with a $50,000 per-occurrence deductible.
“There’s also a lot of brokers who just don’t know this coverage is available,” Mr. Freitas says.
“Usually, it’s the firms with 750 or more registered reps who buy it,” says Mr. Iannotti.
For example, Charles Schwab Corp., which has been in the discount stock brokerage business for more than a decade and was one of the first to launch an Internet trading site, has E&O coverage for both the company and its brokers, according to Phil Zimmerman, senior vice president, risk and credit, at the broker’s San Francisco headquarters. He declined to identify Schwab’s insurer or provide details of the coverage.
Despite this historic pattern, American International, which writes the NASD program usually purchased by smaller firms, is beginning to see interest among the newest Wall Streeters.
“We get a significant number of requests for online trading companies and day traders,” says Mr. Iannotti, adding, “we haven’t done any day trading firms yet. We have a lot of difficulty in looking to extend coverage to this area. They just don’t have a history.”
That doesn’t mean insurers won’t ever write coverage for such firms. “We’re looking at each risk on an individual basis,” Mr. Iannotti says.
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