Ask an Expert - Liability Insurance

Not necessarily.  Section 412(a)(2) of ERISA, as added by the PPA of 2006, provides an exemption from the bonding requirement for an entity which is registered as a broker or a dealer  under Section 15(b) of the  Securities Act of 1934, provided the B-D is subject to the fidelity bond requirements of a self-regulatory organization.  This exemption applies to the B-D entity and its officers, directors and employees.  Based on the exemption and home office opinion, many dually registered IARs believe they are exempt from the ERISA Investment Bond requirements, but we do not believe that to be accurate.

In light of the purpose of the bonding requirement, which is to protect plan assets from the dishonesty of a person with discretionary  authority over such assets, we have concluded that the B-D exemption is limited to the employees, officers and  directors of the B-D that have already afforded such protection to the plan through another bond. This has always been a gray area, but unless the IAR is a W-2 employee and uses the B-D's RIA, we do not believe they are exempt from the ERISA Investment Bond requirement.

Plan sponsors are looking for ways to transfer and limit investment related risk.  By acting in a co-fiduciary capacity under 3(21) or 3(38), advisors can add value and sponsors can shed some investment related liability.  Just because a plan sponsor has fiduciary coverage, it doesn't mean the policy limits and coverage are adequate or that it will prevent claims and/or litigation.  Claims, settlements and litigation may also increase the cost of future coverage as well as limit availability.

Keep in mind that most sponsors do not have the background to make informed decisions about diversification, platforms, costs, contract provision and investment options.  A qualified advisor can reduce a sponsor's risk and reserve their fiduciary policy for claims based on errors made by the sponsor, including health & welfare and other non-investment related problems.  The sponsor is, however, responsible for performing due diligence on the RIA and ensuring they have affirmative fiduciary coverage as well as any applicable ERISA bonds.  As insurance standards evolve, some sponsors in the larger plan market are starting to specify the amount of fiduciary liability coverage the RIA should have.   Some have also probed general liability insurance, but that coverage may be limited for professional services.

In a perfect world, the plan sponsor and the RIA would both have fiduciary coverage.  The sponsor would have first party coverage for mistakes by them or others operating in a first party capacity.  The RIA would have third party coverage for professional services rendered to the plan.  To ensure the ability to pay real first party claims and not have their limits impaired, sponsor coverage should not extend to consultants, TPAs or RIAs.  It is also important to note that 50% of the claims against sponsors are in areas outside their 401(k) plan.  

Given that many plan fiduciaries mistakenly believe their fidelity bond provides personal liability protection, advisors have an additional opportunity to provide further insulation by helping the sponsor review and or obtain fiduciary liability insurance coverage.  A fiduciary claim may be unrelated to the advisor's advice, but given an agreed upon fiduciary role, they are likely to be named as co-defendants.  While the advisor agreement may include indemnification, the added coverage is comforting because legal defense is often the primary cost associated with a claim. Based on their expertise and risk management services, the advisor may also be able to secure a carrier discount for the sponsor.

Advisors willing to accept a fiduciary role, offer proof of affirmative coverage, deliver high value services, operate with full disclosure and state in writing what their role is and isn't, clearly provide a valuable service.  They also have a marketing edge that can be used against their competitors, particularly in the small plan market. 

This is a legal matter, but service termination provisions should  be covered in the advisor's agreement.  From an insurance liability standpoint, advisors should be concerned when clients reject their advice and they have problems getting paid.  Client difficulty with other professional relationships is also a red flag.  Regarding ERISA plans, poor recordkeeping, late deferral payments and a history of complaints should be taken very seriously. Resignation aside, advisors operating in a fiduciary capacity have a legal duty to inform the trustees in writing of the issues surrounding any known or suspected breach in fiduciary responsibility.  Resignation does not alleviate this responsibility.

Many advisors fail to realize it, but deductibles can vary considerably.  Smaller policies are in the $5,000 range while larger firms may find $25,000 deductibles common.  Financials are often required for higher deductibles and some carriers, like Chubb, impose higher deductibles for financial advisors.  In some cases with BD policies,  the coverage may not include commissions earned.  In other words, the commissions earned over the claim dispute could be the deductible. 

Fidelity Bonds are designed to provide plan indemnification for the theft of plan assets rather than insurance type coverage. Fidelity Bonds do not cover the cost of corrections resulting from plan thefts nor do they provide plan fiduciaries with defense coverage.