E&O protection: Advisor, know thyself

By Kate McCaffery | August 19 2013 03:25PM

Almost by definition, professional advisors are, or should be, product suitability specialists. It might come as a surprise then, to know this: It’s not uncommon for the same specialists to skip over the suitability analysis of their own needs when purchasing professional liability coverage.

It’s one of several weak points in the chain of circumstance that can result in an advisor finding himself or herself exposed to an errors and omissions (E&O) claim, with significant personal, professional, and business repercussions.

In examining how advisors can protect themselves against E&O claims, an effort to adopt professional ‘best practices’ is still the most advisable way to go. Advice imploring professionals to ‘document, document, document,’ is a common pervasive theme when discussing these best practices in general, and E&O claims in particular. Still, the message is slow to penetrate in some circles.

Part of the problem could stem from the fact that E&O insurance still isn’t mandatory for professionals in all jurisdictions. According to Advocis, The Financial Advisors Association of Canada, those working in Prince Edward Island, Nova Scotia, Newfoundland, New Brunswick, and the territories are not obligated by legislation to carry E&O insurance. However, it’s assumed the majority likely should have coverage, by virtue of their relationships with most companies, and agencies that require it.

Still, when taking out an E&O policy, many simply choose the minimum amount they can buy, without understanding the policies, or their limitations.

Pause for a moment now, and feel the chill: It’s estimated by Advocis that two per cent of business done in Canada results in a claim of some sort. Bad markets drive claims, suitability drives a very significant number of claims, and clerical errors are also a source of claims activity.

Moreover, along with coverage limitations, advisors aren’t terribly knowledgeable about how their actions can invalidate their policies, or affect future coverage.

Protect yourself

It’s an old story, but “it’s also the current story,” today: Documentation, or lack thereof, is what will make or break a claim against you.

Whether people appreciate this message or not, is still the subject of some debate. Advocis president and CEO Greg Pollock says advisors are getting the message, but says it takes time for such a wholesale change of business practice to take hold across the industry.

Hugh Fardy, senior vice president at the CG&B Group Inc. also says the message is slow to get across. “Computer systems put everybody in the mode where everything is fast, quick, short, and bang, it’s done. Documentation made in the computer system is sometimes not as good as it should be, or as good as it was when things were handwritten,” he says.

Even today, he adds, “documentation is still the biggest issue. Often it’s not that an advisor did something wrong, it’s that they can’t prove they didn’t.”

Best practices, beyond effective documentation of your interaction with clients, includes documentation of your policies and procedures themselves. It’s also necessary to retain these documents for future use, without their being shredded or lost. Up-to-date know-your-client forms also need to be maintained so a client’s significant life changes (birth, death, divorce, retirement) do not escape notice, and financial plans are amended or reconsidered accordingly.

Education is a significant way to avoid E&O claims, as well. Roberta Tasson, vice president of corporate risk at The Magnes Group Inc., says simply attending workshops or sessions provided by a product manufacturer is not enough. Before selling any product, she says advisors must understand how the product works, it’s benefits, and any associated risk, in detail. This effort, she says, needs to include a thorough review of any prospectus or offering memorandum for every financial product that might be recommended.

“A main driver of claims is negligence, the suitability of investments that were recommended, or the suitability of the overall financial plan.” She adds that “external variables, such as market conditions, cannot be controlled by the financial advisor, and do not usually result in E&O claims.” That said, she adds that high profile cases in recent years, those which involved leveraged investment strategies, could potentially result in multi-million dollar awards. The industry has also seen its first class action lawsuit brought against an advisor recently. “This is alarming for the insurance industry,” she adds.

This basic message about best practices, meanwhile, is only the start of what advisors need to consider. Almost every industry and business is subject to evolution at some point, and financial service is no exception. E&O policies did not always cover many roles that exist today. The availability of coverage for exempt market dealers is one example. Referrals are another.

Pollock says the APA (Advocis Protective Association) program, for example, includes a referral clause today, to protect against litigation if a third-party relationship you recommended, goes awry, and the client’s lawyer decides to include you in the proceedings.

Limits and limitations

Assuming this coverage is automatic, however, can be detrimental if you find yourself caught up in the one or two per cent of cases that result in a claim.

One of the most effective ways to protect yourself in the event of a claim, is to actually embrace and understand your own professional liability coverage – ahead of time.

“More and more people are providing services that are outside of what’s governed by their license; your E&O coverage is there to cover you for things that are governed by your license,” Fardy says. Advisors “doing all kinds of little ‘bells and whistles’ services for their clients, (services) that are not covered by their license, may not be covered by their E&O policy.”
In some cases, he says dually-licensed advisors will even require two separate policies. “If I go and do something outside of my license, technically the policy doesn’t respond to those. As times change, things that used to be rare become the norm.” He points to the shift where insurance brokers have started taking deposits as an example. “Insurance policies expand to pick those things up. But that takes time, and it’s not a guaranteed thing.”

As for liability limits, he says a significant number of people underestimate how much coverage they should buy. Liability limits, he says, should instead be based on the type of work an advisor does, not on the volume or quantity being transacted each year.

An advisor dealing in smaller mutual fund accounts, or term life policies (or both) will have a significantly different exposure, relative to those who sell or manage group or corporate accounts, or higher net worth clients, for example. In a property and casualty example, he points out that a small home and auto broker in one part of the country has a significantly different amount of exposure to potential claims than the same broker operating in a border town, where clients visit neighbouring states to buy gas every third day.

Other factors to consider include extensions – for regulatory defense, fines and penalties, referrals, and for retirement. He says those who wind down their limits in anticipation of retirement, are often the same people who buy limits for the wrong reason. “It’s not the size of your business or the amount of work you’re doing that determines your limit, it’s the kind of work you’re doing.”

Today, it’s possible that a new risk is emerging too – those who wind down their policy limits are only able to obtain coverage in retirement, for the amount their last policy was worth, despite how much business exposure they’ve built up over the years. Tasson says, too, that a lot of advisors aren’t purchasing retirement coverage, at all.

“I think,” Fardy says, “all buyers need to have a clearer understanding of what they bought, how it applies to the services they provide, and the limitations.”