ETFs and the Definition of Insured Investments

By Brian Francetich
It is not our position to address the viability of various investment vehicles. It is, however, our occupation to advise the RIA community on the issues and implications surrounding this subject as it pertains to fiduciary risk and the trigger-of-coverage available from the E&O insurance contract (defense and/or settlement).

This month’s ia360 Risk Tip focuses on the emergence, evolution, increasing use of Exchange Traded Funds that can appear in many sizes, shapes, forms and colors. In the case of a proposed fiduciary breach, will the Errors & Omissions professional liability underwriter step-up to the plate?

As preached by our office, the scope of covered investments (definition of covered investment classes within the insurance contract) varies from carrier to carrier. Here is an example from one E&O underwriter’s contract language:

“We do not cover claims which arise out of or are in any way related to actual or alleged arbitrage, short sales (except short against the box), trading or failure to trade derivatives, including, without limitation, interest rate swaps, collateralized mortgage obligations, structured notes, commodities, commodities futures contracts or any type of option, or future, or futures option contract or similar investments or investment products…”

The words above in bold our emphasis!

What does “similar investments” mean?! Yikes! Obviously, unacceptable language for our clientele. Where does the scope end? What about ETFs engaging in those practices? Another carrier explicitly excludes leveraged or enhanced ETFs. It is imperative that we tread carefully not only in our selection of investments, but also in the procurement of professional liability insurance. How does your contract of insurance speak to these investment types?

Oddly, as I was preparing this I came across an article in the July 30, Wall Street Journal titled “Warning Signs Up For Leveraged ETFs” by Daisy Maxey (p.C9). The article discusses concerns of custodials, brokerages and regulators regarding these investment vehicles.

Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.