Legal defence fund touted as adjunct to E&O

(August 17, 2004) Advisors worried about exclusions in their errors and omissions insurance policies and rising premiums have another option to consider: purchasing a membership in a legal defence fund service.

It’s a niche market that’s been successfully tapped by Las Vegas-based Financial Advisors Legal Association (F.A. Legal), which offers legal consultation and counsel to both individual advisors and brokerage firms.

The firm has thrived in the U.S., mostly due to the fact that Americans are more likely to take complaints against financial professionals to the courts. “In the U.S., the advisor is the number one litigious target of any profession,” says association chair Jerry Reiter. “It’s easy to calculate a loss in a mutual fund, compared to pain and suffering, so a lot of personal injury attorneys here are switching to litigation against advisors.”

Although the practice of clients suing advisors and their firms hasn’t reached epidemic levels in Canada, Reiter predicts we’re no more than a few years away from a similar scenario. “What we saw five years ago in the U.S., Canada is just now starting to see.”

F.A. Legal opened a Toronto office two years ago, but Reiter admits they’re not getting as much interest in Canada, with membership in the hundreds, as opposed to thousands south of the border.

At $930 US a year (or $86 US a month) and an initial $45 US enrolment fee, membership in the association isn’t cheap. There’s also a $1,500 deductible for each claim and a further $2,500 for each additional claim in the same membership year. But with the average cost to defend a legal claim in the U.S. currently carrying a $42,000 price tag, Reiter says it could be the right choice for advisors interested in offering products that may not be covered under the E&O umbrella.

“For example, if you selling a private placement in the U.S. and you’re sued, the coverage costs $2,500 and you pay the first $75,000,” under a typical E&O policy, he notes.

Reiter says F.A. Legal has calculated that 86% of claims against advisors are groundless, but 92% of those claims are eventually settled because advisors are not prepared to defend. E&O carriers also have a tendency to try to settle claims, rather than defend them, he adds.

Still, Reiter concedes that his legal service is not for everyone and suggests that advisors also stick with their E&O coverage. “We highly recommend E&O if you can get it. As a matter of fact, three-quarters of our members have E&O. It’s just that litigation hits them in areas that aren’t covered under E&O.

“If you’re selling products that are covered by your E&O, you don’t need us. But you might if you’re selling products that are excluded by E&O or if you’re into full-scope financial planning.”

Reiter says some broker-dealer firms in the U.S. can’t survive simply selling products that are covered by E&O, because that market is getting smaller and the E&O deductibles and premiums are getting higher.

The new soft spot for legal action in the U.S. is insurance, says Reiter, who says agents are generally “great salespeople but very poor on documentation.”

In one particular case the association is currently handling, a husband and wife sued their agent for not selling them long-term care insurance.

“In this case, the guy offered the product five times, but it wasn’t documented. The irony is that he’s the family’s godfather. Sometimes, you hear advisors say they don’t need legal defence because we deal with friends and family, but so do the Sopranos.”

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com