E&O Implications Of Possible Broker-Dealer/Adviser Standard Unclear

Concerns about a doomsday scenario for broker-dealers and their agents under a uniform fiduciary standard are premature, according to an underwriter for professional liability insurance.

“A fiduciary standard could look a lot of different ways,” cautions Ross Herlands, an underwriter with Aspen Specialty Insurance in New York. “It could result in guidelines that could demand greater disclosure, or it could be much more intrusive,” he said.

Mr. Herlands was commenting on the Securities and Exchange Commission staff study released late Jan. 20 that recommended a “uniform fiduciary standard of conduct” for broker-dealers and investment advisers when selling retail investment products.

The study was mandated by the Dodd-Frank financial services reform law.

“Any comment is speculative, given that the agency could go in several different directions,” said Mr. Herlands, who has 20 years of experience working for various insurers in the professional liability insurance market. He is a lawyer and has worked in claims as well as underwriting.

This is only a staff study, he pointed out, noting that the SEC has yet to draft a rule and that the industry will be given the opportunity to comment on the rule and perhaps shape it to something it could more easily live with.

Moreover, he cautioned that despite the current economic downturn, seen by some observers as the most severe since the Depression, the market for professional liability has not experienced the hardening that many expected.

“I could see where in this space, given the last 18 months of claims, we would be expecting rates to be hardening,” Mr. Herlands said. “But they have not to the degree expected.”

At the same time, he said the staff study that recommended establishment of a uniform fiduciary standard in the sale of investment products asked the federal financial regulatory agency to look into eliminating mandatory arbitration of securities claims.

“It brings into question whether the SEC is going to curtail the practice of mandatory arbitration in investment agreements,” Mr. Herlands said.  

Would eliminating the ability of companies and agents to require mandatory arbitration in any agreement with clients affect your view on pricing in the marketplace? NU asked.

“Yes,” he said. “It has the potential of increasing the frequency of lawsuits that will be tried to a jury rather than an arbitration panel. Plaintiff lawyers typically would choose to have a case heard by a jury.”

As for insurance carriers, Mr. Herlands said it is just too early to gauge the impact. “With broad experience in dealing with these issues, insurance carriers who insure broker-dealers will deal with this in one way or another,” he said.

“If there is a full-blown fiduciary standard mandated by the SEC, it seems that this might have an upward pressure on rates. While it would be surprising if this caused new entrants to enter the marketplace, it is unclear whether this would change the mix of current carriers,” he said.

The SEC staff study will be presented to the Senate Banking Committee and the House Financial Services Committee, but the provision in the law mandating the study gives the agency full authority to proceed to implement the study's recommendations.

The study said that “when broker-dealers and investment advisers are performing the same or substantially similar functions, the SEC should consider whether to harmonize the regulatory protections applicable to such functions.”

Currently, insurance agents who work for a single insurance carrier, so-called “captive” agents, are subject to a suitability standard, which requires them only to sell products that are “suitable” to the investor.

Officials of the National Association of Insurance and Financial Advisors are concerned about the proposal because they feel it will increase securities lawsuits by investors who sue if there is an economic downturn several years after the product is sold and the value of the investment drops.

They are also concerned that the increased costs of liability insurance will reduce the incentive for agents to sell investment products, and therefore decrease competition as well as the ability of middle income investors to get the services of a professional adviser.

An additional concern is that they are being singled out because they are captive agents who are limited because they market the products of a single company or a group of companies.

Mr. Herlands said he “didn't know” whether this will increase the numbers of carriers in the marketplace.

“This is a very specialized business,” he said. “If this is put in place, there will be an increase in frequency of claims. If you look at it through a lawyer's eyes, a raised standard holds agent or broker to a much higher standard.”

He said it is “entirely possible that costs will rise. It is reasonable to expect, especially in the short term, that there will be an increase in frequency of claims, so-called “Monday morning quarterbacking over whether a product is in the best interests of the client.”

At the same time, there are other facts to consider, he said.

First, he said, “this is only a staff study,” and the SEC must first draft a rule and submit to it to industry comment.

“Therefore, the industry will have input and a chance to craft the rule to something it could live with,” he said.

In general, he said, “We are not expecting a change for the next couple of years.

“There will be industry battles to shape the final regulation and there will be a transition period,” he said. “So looking in the future is difficult.”

For more information on this topic and reaction from the Independent Insurance Agents and Brokers of America to the SEC staff study, see the article titled “IIABA Calls SEC Uniform Standard Recommendations 'Unnecessary” on NU's website, www.propertycasualty360.com.