Schwab, others urge purchase of liability insurance

With investment returns down and clients’ dander up, lawyers are turning their guns on independent financial advisers like never before, according to lawyers, insurance executives and companies that keep custody of adviser assets.

Law firms are advertising in newspapers from The Wall Street Journal to the San Francisco Chronicle, soliciting investors who have lost money in the market.

“We’re seeing increased exposure and increased concerns,” says Lori Nugent, a partner at law firm Cozen & O’Connor in Chicago. “Lawyers are aggressively encouraging their clients to seek deep pockets in an attempt to recoup their losses.”

In past down markets, investors sued stockbrokers and executives of the companies whose stock they bought. But independent, fee-based advisers largely slipped beneath the radar.

The advisory industry is taking the new threat seriously.

Charles Schwab Corp. of San Francisco has quietly negotiated favorable terms for an errors-and-omissions policy on behalf of its 6,000 advisers with American International Group Inc. of New York.

“Lawyers are soliciting lawsuits, and they’re definitely targeting the things covered in insurance policies,” says Tim Welsh, a director of marketing with Schwab Institutional who helped arrange the AIG deal (see related story, Page 6).

a bigger target

Mr. Welsh and Tom Bradley, head of institutional services for TD Waterhouse Group Inc. in New York, both say they have yet to see a rash of suits against advisers.

But Timothy D. McGonigle, a lawyer in Los Angeles who runs advertisements in various newspapers and has targeted brokers and financial advisers for 17 years, says the proliferation of advisers has caught his attention. Now he mentions them in his ads.

“You’ve always had cyclical markets, but this time you have more advisers and more individual investors” to file suit, notes Christopher M. Buckman, an insurance broker for Seabury & Smith, a Marsh & McLennan Cos. Inc. company in Denver. After big wins over tobacco companies and asbestos manufacturers, he says, plaintiffs’ lawyers in general are also looking for other target-rich environments, adding to the legal perils for advisers.

Mr. Buckman, who sells errors-and-omissions policies, says the most recent rash of lawsuits triggered by a down market was in 1987.

Although market conditions are ripe for another such onslaught, as much as 90% of the advisers in business do not carry errors-and-omissions (malpractice) insurance, according to estimates from insurance and brokerage executives.

Evan Rosenberg, senior vice president with the Chubb Group of Insurance Cos.’ department of financial institutions in Warren, N.J., estimates that only 2,000 of the nation’s 22,000 independent advisers carry any E&O insurance.

Many other advisers are underinsured because they never raised their coverage higher than $1 million as their companies grew.

In contrast, only about 14% of lawyers and 14% of certified public accountants are “flying without a net,” Mr. Buckman adds.

C. Anthony Bougher, senior vice president of marketing for Cambridge Alliance, a Burlington, Vt., insurance agency, says registered investment advisers still tend to be fairly bulletproof to lawsuits.

“Advisers taking time to do due diligence with their clients weather the storm. The ones winging it are the ones who get into trouble,” says Mr. Bougher, whose company insures only registered advisers and offers a 5% discount to TD Waterhouse advisers.

Fidelity Investments in Boston has offered its advisers E&O insurance from Chicago’s CNA Financial Services through Marsh & McLennan at preferred pricing since 1997.

insurance a factor

Mr. McGonigle says he rarely sues RIAs because they usually have strong relationships with their clients and tend to make sure to diversify their clients’ portfolios.

Mr. McGonigle says he seeks cases where clients have all their assets in a concentrated portfolio, a circumstance almost always associated with stockbrokers.

But an even greater issue, he says, is planners’ lack of insurance coverage.

“With the financial planner, it’s a collectibility issue,” he says.

“You just don’t know if they’ll have the ability to pay [a judgment],” unlike brokers who are covered by their companies.

James O. McKinney, president of Financial Marketplace Group LLC in Plano, Texas, which has $60 million under management, says he would rather be covered than take a chance.

He lost his errors-and-omissions insurance after leaving H.D. Vest Financial Services in Irving, Texas, last year to become one of Schwab’s independent advisers. So he went directly to AIG seeking such coverage.

“I was quite astounded” by the premium, he says. “It was $8,000 to $10,000 a year.” He then noticed that AIG’s coverage was offered through Schwab’s website.

Through Seabury & Smith, he was offered premiums on AIG coverage for just $4,300 per year. The key was that Seabury & Smith tailored the coverage specifically for Schwab advisers, he says.

If he purchased a policy from AIG directly, he could not unbundle it from coverages – relating to the custody of assets – that he did not necessarily need.

In fact, AIG has gone to a minimum $10,000 premium for advisers outside of Schwab, a Marsh & McLennan broker says.

Schwab also got AIG to agree to give the discount broker’s advisers the flexibility of choosing their own lawyers for litigation.

In addition, under the agreement with Schwab, AIG cannot arbitrarily cancel the policy of an insured, so advisers can avoid getting black marks on their records and gain time to find new coverage.

Mr. Welsh adds that on average Schwab advisers should expect to see premiums 25% lower than they could get on their own.

Premiums run from about $2,000 for a small adviser up to $30,000 for one with substantial assets.

Since Schwab put the AIG program into motion in the fourth quarter of 2000, Mr. Welsh says, about 20% of its advisers have at least made an inquiry about the coverage.

Schwab is now negotiating fidelity coverage with Seabury & Smith for its advisers and expects to offer it in the next couple of months.

Fidelity coverage is required for advisers with employees handling 401(k) and other pension assets subject to federal regulation.