When advisors act in a fiduciary capacity for their clients, they take on a type of legal liability that differs from ordinary contract or tort liability. The Department of Labor’s new fiduciary rule will confer this status upon a large number of financial advisors who work with retirement plans and accounts in any capacity. Advisors who will be affected by this change need to familiarize themselves with the new rules in order to ensure that they stay compliant.
The DoL rules provide a new structure under which advisors can be held liable for any failure in this area. Lawsuits alleging breach of capacity for fiduciary duty can be brought by individuals and trusts, employee benefits and pension plans along with other entities. The standard lines of insurance that have traditionally been used to protect against tort or contract lawsuits may not be suitable for liability protection, and advisors need to make sure that their insurance provides them with the proper type of protection.
Here is some help with other types of insurance. (For related reading, see: The New Fiduciary Rule: Will Lawsuits Overturn It?)
Sifting Through Insurance Details
Standard forms of liability insurance cover such errors, and omissions insurance and business practice liability coverage are usually geared towards providing protection from failure of fiduciary liability. But advisors need to carefully review the language in their current policies in order to ensure that it adequately covers the definition of a fiduciary under the revised rules stemming from the DoL fiduciary rule. The coverage rules may be important depending upon whether the business or individual functions as a bank, broker-dealer or advisory firm, as the specific protections that they provide can vary depending upon the language in the policy.
Policies should clearly state who is protected for what and whether other parties such as employees and contractors will be given coverage. And the policy should extend to include more than simple coverage for negligence, and should probably include other factors such as fees that are charged, investigational costs and payment of damages. Another important area of coverage is protection from ERISA liabilities, which many policies today unfortunately exclude. Failure to include this section of coverage greatly diminishes the value of the policy. There should also not be any exclusions for specific services such as those pertaining to insurance or securities, as these could also leave the advisor vulnerable in key areas. (For related reading, see: The Fiduciary Rule: What Will Implementation Cost?)
Given that the coverage afforded to an external consultant has traditionally been limited, external consultants will need to carefully review their coverage in the wake of the expanded definition of fiduciary under the new DoL rule. Of course, this should be done sooner rather than later, before claims are filed and the advisor is left with liabilities stemming from customer complaints. Insurance companies will be sure to cite policy exclusions and other language in their policies that drastically limit the amount of coverage that advisors thought they had. Many of them will focus on exclusions for fraud and dishonesty, the enforcement of governmental and other regulations and for known losses.
Policyholders will need to be able to present adequate documentation for their coverage. But having a dishonest employee will not necessarily present the company or advisor from obtaining coverage. However, this may require regulatory authorities to conduct a costly investigation of the matter. If this happens, then the plaintiffs are hopefully able to show both regulators and the insurance companies that the dishonesty was contained or limited.
The Bottom Line
Advisors will need to scrutinize their policy coverage to ensure that it contains specific protections for fiduciary coverage. Many general liability and D&O coverage exclude these provisions, although these exclusions can often be added back in. The insurance companies are going to do everything in their power to limit their exposure to the new fiduciary rule, and advisors need to be prepared not to take the language in their coverage at face value. (For related reading, see: What the DoL's Fiduciary Policy Means for Advisors.)