Insurance is in the news. Suzanne Barlyn writes in Reuters that our friends at PIABA want insurance to be mandatory. Their solution to the unavailability of insurance? Don’t do the business. My problem with this is that FINRA seems committed to allowing mom and pop small broker/dealers to exist. The major wirehouses are not going into some town where the population is 1500 and it is under 6 feet of snow for 8 months out of the year. But a person who decides that this is the business for them could set up an independent office in this fictional town and serve the town’s needs. If that broker is required to have insurance, the cost may be too high to justify the business. So we are then left with brokerage offices of only large and regional firms because the small firms’ insurance costs drove them out of business.
PIABA says they’re concerned about the unpaid awards for its constituents’ clients. But for the most part, those clients are only seeing between 60% and 67% of the award. The rest goes to the lawyer who may have put $100,000 of time and expenses into a case. So let’s make sure we understand that the clients’ interests are not the only interests at play here.
When I first started in the securities business I had no idea that there was insurance available to cover brokers’ mistakes. I worked a major New York wirehouse, Prudential Securities, which was self-insured (in insurance-speak) as far as I know. In fact, we used to write in our arbitration answers “Prudential Securities is not an insurer against losses.”
So several years later I was surprised to learn about insurance in this business. When I first learned about it, the coverage was very broad. And as insurance companies paid out more money, the coverage narrowed. I’ve represented insureds and claimants against insureds. In my experience, insurance has its good points and its bad.
The good – a broker who makes an honest mistake has a backstop. Just like car insurance, good drivers sometimes get into an accident. That’s what insurance is therefore. Sometimes you screw up.
It would also provide protection for customers doing business with small brokerage firms with little capital. The caveat here is that the coverage may be exhausted before you get to the pot of gold. Most policies use up the liability cap to pay expenses. So a one million dollar policy, after litigation expenses, may only be worth $900,000. Also, insurance companies may decide that a series of customer claims constitute one incident under the policy. So if there is a higher overall limit and a lower per-claim limit, the lower limit would apply. This leaves less money to pay claims from the policy but the broker or firm only has to pay one deductible.
From a claimants’ lawyer’s perspective, insurance is good because insurance companies don’t like risk. So if a case has risk, an insurance company wants out. So even if the case is defensible, the insurance company’s employees and stockholders will sleep better at night knowing that the risk was extinguished.
So that’s some of the good points.
Here’s some of the bad – Insurance companies hate risk. Didn’t I just say this a good point? you may ask. I did. But because they hate risk, sometimes they settle cases for more than a claimant deserves. Further, insurance companies are not interested in the effect of a settlement on a broker’s record. They just want to extinguish the risk. This can cause blowback for the broker in the form of a regulatory inquiry and a ding on his/her CRD report.
The existence of Insurance policies encourages specious claims. I worked for a lawyer who did not have malpractice insurance for the longest time. He said that not having insurance discouraged malpractice claims because he got to pick the fight. Because of the risk-averse nature of insurance companies, a specious claim may still get paid, encouraging lawyers to file claims just to see if they can get a door prize.
Multiple claims could equal multiple deductibles. Some broker-dealer policies have a low deductible, say $5,000, if only the broker is named but a higher deductible, say $25 or $50,000, if the firm is named. But those same firms push the deductible back on the broker. If there are multiple claims naming the firm, and they’re treated as separate incidents, just the deductible alone can crush the broker.
The broker can lose control of the case. Most liability policies, broker-dealer or otherwise, have a cram-down provision. The policy allows the insured some input, but the ultimate decision to settle is with the insurance company. If the insurance company wants to settle and the broker vehemently objects, the insurance company can hand off the defense of the claim to the broker and walk away from any further expense or liability. So the broker is left in a tough spot. She/he either has to put their money where their mouth is and try the case on their own nickel or let the insurance company extinguish the debt.
From a pure dollars and cents perspective, if the premium is reasonable, having insurance makes sense. But in practice, it can wreak havoc with a broker’s license and possibly even attract unwanted claims. Like everything in life, there’s no clearcut answer. But in my humble opinion, FINRA will never require insurance for every firm.
That’s the view of one lawyer from Jupiter, Palm Beach County, Florida. I’m Marc Dobin.