The Perils of Group Sponsored BD E&O Programs
By Bayard Bigelow III MBA CPA
Many broker / dealers enter into contractual arrangements with a property / casualty insurer to provide insurance protection against their negligence or that of their registered representatives. Our experience has been, however, that neither the broker / dealer itself nor its registered representatives understand the implications of the insurance decisions made by the broker / dealer. The purpose of this article is to explore those ramifications more fully.
The relationship between the broker / dealer and its registered representatives is that of principal and agent. Accordingly, it is widely held that the principal may be called upon and be held legally responsible for the acts of its agent(s). The insurance mechanism by which the principal obtains insurance for the negligent acts of its agent, however, is quite different for broker / dealers than it is for almost any of the professions. It differs in the sense that the broker / dealer will sponsor a “group” insurance program, typically requiring that all of its registered representatives purchase insurance as a condition of appointment. In many other professional arrangements of this nature including property / casualty insurers and their agents, hospitals and doctors as well as other principal / agent relationships, the principal only requires that insurance be in place, but does not require that the “agent”, broadly defined, participate in an insurance program bearing the approval of and endorsement by of the principal.
The motivation of the broker dealer to sponsor a group errors and omissions (“E&O”) insurance program is completely understandable – the broker / dealer needs assurance that its registered representatives can demonstrate financial responsibility if their mutual client presents a claim. What is typically less clear to the broker / dealer, however, is that through the act of sponsorship of the insurance program, the broker / dealer may in essence be assuming the role of the insurer of last resort if the program turns out to be inadequate to meet the needs of its registered representatives – in essence, the broker / dealer may be implicitly warranting that its sponsored insurance program is adequate.
The mechanism by which these programs are marketed only compounds the problem – the insurance broker will typically inform the insured registered representatives through an insurance brochure which, at a minimum, cannot be thought of as full disclosure; and, may turn out to be quite misleading to the registered representative.
It is typically clearly stated in the insurance contract that the broker / dealer is the “First Named Insured”. As such, the broker / dealer is responsible for payment of premium, receipt of various notices under the policy and negotiation of the very terms of the contract itself. In essence, the very wording of the contract itself as well as the relationships defined within the contract will assign responsibilities to the broker / dealer which it may well be ill equipped to satisfy.
The very design of the insurance program itself may turn out to be inadequate, principally because of the relationship between the broker / dealer and its registered representatives. Let’s examine some of these structural problems.
- “Marketing” to the registered representatives
- Scope of coverage
- Prior acts and tail coverage
- Aggregate limits
- Conflicts of interest
“MARKETING” TO THE REGISTERED REPRESENTATIVES
The annual renewal of the group policy is typically marked by the mailing of an announcement to the registered representatives of the features of the current program. The mailing may include a letter identifying how inexpensive this year’s program is, together with a summary of its salient features. While these mailings are made by the insurance broker, they prominently feature the tacit and implicit approval of, and the endorsement by, the broker / dealer. Further, the registered representative will typically receive no further explanatory information, although he or she may receive a certificate of insurance.
Apart from leaving the registered representative with no choice, such documents fall far short of representing complete disclosure – they are analogous to the registered representative supplying only a summary, rather than the full prospectus, to an investor interested in a particular security.
In the brochure itself it is typically stated that the brochure does not represent all of the relevant terms and conditions of the policy; and that the terms and conditions and the policy shall govern in determining the extent of coverage. Those who ignore this or similar warnings do so at their peril.
From time to time, the registered representative may wish to obtain additional information about the terms and conditions of the insurance program under which he or she is provided with coverage. Quite logically, the registered representative will turn to the compliance department of the broker / dealer. A registered representative making such an inquiry may find that the compliance department suddenly becomes uncooperative, or perhaps even hostile, apparently assuming that the mere act of inquiry masks some tip-of-the-iceberg like potential claim.