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State regulators encourage brokerages to use insurance to fund arbitration losses

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NASAA says step would help address problem of unpaid arbitration awards

State securities regulators encouraged brokerages Wednesday to use insurance to fund arbitration payouts to customers who win disputes, saying it would help reduce the number of unpaid awards.

The North American Securities Administrators Association released a survey of 64 firms that showed that 77% of them carried errors & omissions insurance, while 23% did not carry insurance. Of the firms participating in the survey, 23% reported paying at least one E&O claim over the past year, and 17% reported that an arbitration claim was paid by insurance.

Most of the firms in the study were small, according to NASAA. The survey showed that at least 28 insurance carriers offered E&O policies.

State regulators see insurance coverage as part of the answer to the growing problem of unpaid arbitration awards. From 2012 through 2016, the amount of unpaid arbitration awards has ranged from a high of $75 million in 2013 to a low of $14 million in 2016, according to Financial Industry Regulatory Authority Inc. statistics. Finra runs the arbitration system for brokers.

“The survey results reveal that the majority of the responding firms had E&O insurance and that their policies have paid claims,” the NASAA report states. “Further, the results of the survey contradict the blanket assertion that E&O insurance is too expensive or too difficult for smaller firms to obtain.”

The NASAA report acknowledged that E&O insurance often excludes claims that are made in arbitration cases, such as fraud, sales of alternative products and selling away by a registered representative. It also said E&O doesn’t solve some major causes of unpaid arbitration.

“Because E&O insurance may not necessarily address awards against inactive firms or claims involving fraud or other excluded conduct, it is not a complete solution to the problem of unpaid arbitration awards,” the report states.

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In 2018, Finra released a report outlining several steps that could be taken to address unpaid arbitration, including legislation or regulations requiring firms to carry insurance to cover unpaid arbitration awards. The report said unpaid arbitration is a problem requiring a response from Congress and several regulators.

“We look forward to reading NASAA’s report,” Finra spokeswoman Michelle Ong wrote in an email.

One critic of the Finra arbitration system praised NASAA for holding Finra’s feet to the fire.

“Finra was hoping the unpaid arbitration issue would blow over and disappear,” said Andrew Stoltmann, a Chicago securities attorney and a board member of the Public Investors Arbitration Bar Association. “But to NASAA’s credit, it remains a critical issue for the organization.”

State regulators are trying to spur action on unpaid arbitration awards.

“We appreciate that this issue is complicated and are pleased that Finra and others are studying it,” Christopher Gerold, chief of the New Jersey Securities Bureau and NASAA president said in a statement. “But this problem is not fixing itself.”

Mr. Stoltmann said the NASAA insurance suggestion is helpful.

“It’s an important step, and one that will cure part of the unpaid arbitration problem,” Mr. Stoltmann said. “The best solution remains an industry funded unpaid arbitration pot.”