The Ins and Outs of RIA Insurance | #itsecurity | #infosec


For registered investment advisors, a lot can go wrong, including a bad trade on a client’s behalf, accidentally sending money to a bad actor instead of a client, or having computer systems get hacked. That’s when good insurance can provide important protection.

With social engineering attacks like business email compromise on the rise, custodians are cracking down. Last year, for example,

Charles Schwab

 started requiring all RIA firms that work with it to carry an aggregate minimum of $1 million of insurance. This includes errors and omissions liability coverage to help protect the firm against claims alleging business-related mistakes. Schwab also requires coverage for social engineering, theft by hackers, and theft by employees, as applicable.

Another large custodian, Fidelity Institutional, recently announced a $1 million minimum insurance requirement, with its own specifications and time frame for adoption. 

But even if your custodian doesn’t have strict insurance requirements, it can make good business sense to have appropriate coverage. Here are five tips to help you determine what types of coverage may be right for your practice.

Understand the business case. Firms should go through a thorough analysis of whether insurance is needed, and, if so, what kind, according to Brian Hamburger, founder and managing member of the Hamburger Law Firm, which focuses on the investment advisory space. Your coverage levels should also be reviewed as policies come up for renewal to make sure nothing has changed.

Your insurance needs will be dictated by factors such as your business mix, what professional services you provide, how you provide them, and what requirements, if any, your custodian imposes. Keep in mind that even if a custodian requires a certain minimum, that level of protection may not be enough for your business needs.

While Hamburger generally recommends RIAs have some kind of liability insurance, there’s no one-size-fits-all answer. A fee-only practice that charges a relatively modest fee based on AUM, uses mainstream investments, and has rigid investment processes likely will have far less exposure than a firm that’s engaged in more risky business practices. A firm with an especially low risk might even opt to self-insure by setting aside resources to handle one or two claims a year on its own, Hamburger says.

“Insurance is a tool and a very effective tool, but there are all sorts of insurance products out there,” he says. “There’s insurance that quite frankly isn’t worth the paper it’s printed on, and there’s insurance that does a great job of limiting a firm’s exposure.”

Seek out a specialist. Because it’s such a nuanced area, it’s advisable to pick an insurance broker who specializes in coverage for RIA, says Richard Chen, a New York-based attorney who advises investment professionals on regulatory and compliance matters. Also be sure to compare multiple policy options. 

One place to start is with your custodian. Both Schwab and Fidelity have lists of possible insurance brokers to call, and while you don’t have to use someone on those lists, they can be good starting points.

Specialists can help you determine what your needs may be, based on specifics of your business. The reason a specialist is so important is because RIA insurance is complicated and the details in policies make all the difference, Chen says. “Insurance brokers know all the nuances and specifics that make these policies more or less valuable,” he says.

Understand your policy options. Every policy is different in terms of what it covers and what it doesn’t, says Brian Francetich, director of the RIA team at Golsan Scruggs in Lake Oswego, Ore., which helps RIAs find appropriate insurance. 

“This is the Wild West of insurance,” he says. “Each insurance company is going to do it in its own way.” 

It’s possible to cobble together the various policies you may need, which could include E&O, a financial institution bond policy, and some type of cyber insurance coverage. You might also be able to buy a base E&O policy and add endorsements to include coverage such as employee theft, social engineering, and theft by hacker. Cyber insurance is an up-and-coming area, as well, but not all policies are packaged the same. Some RIAs are buying cyber insurance thinking they will be protected against all sorts of attacks, but some policies may not satisfy a custodian’s requirements or offer the best level of protection, Francetich says.

The bottom line. Cost can vary widely. Some firms could pay thousands of dollars, while others could expect to pay tens of thousands, depending on factors such as a firm’s assets under management, its asset mix, business style, previous claim history, and type of coverage desired. Don’t try to skimp in an attempt to save a few dollars; it may end up costing you multiples more to not have appropriate levels of protection.

“You can always find something cheaper, but on some level you get what you pay for, and details matter,” Francetich says.

The devil is in the details. Although there are multiple policies and carriers who offer insurance to RIAs, understanding different policy restrictions can help you discern between a policy that provides good coverage for your firm and one that doesn’t. Some policies, for example, don’t cover suits related to private placements or hedge funds, while others won’t cover discretionary investment activity. There may also be restrictions related to when coverage begins and what types of occurrences are covered. 

Whatever policy you are looking at, it’s important to read the language carefully, says Michael Cermak, vice president at Chicago-based insurance broker Thompson Flanagan. Be sure to understand specifics of how the policy triggers, what restrictions exist, and what’s required for the policy to pay out.  

Hamburger also recommends advisors understand the level of control they retain under the policy. Some policies limit advisors’ rights to defend a suit versus settle it. Other policies may restrict advisors’ ability to choose their own legal counsel. 

“Unless the advisor gets high-quality insurance that has the provisions they need to retain control, the advisor is left in a vulnerable situation where the advisor thought the coverage they paid for isn’t worth nearly as much as they thought,” Hamburger says.

Write to advisor.editors@barrons.com



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