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BD/IA Risk Review – January 2021

By Brian Cavanaugh , Jack Jennings and Jeremy Sokop | January 7, 2021

Risk and insurance considerations and approaches

Come hang with us

January 21 at 3:00 p.m. Eastern we’re co-hosting a webinar titled “Studying Behavioral Issues in Cyber Breaches, Trade Errors and Firm Culture.” Hosted by Lilian Morvay of IBDC/RIAC, we’ll discuss:

  • The four aspects of workplace culture that correlate to a higher likelihood of a cyber incident; learn strategies that managers can use — especially during this time of COVID-19 — to engage remote workers to overcome these challenges
  • The business case for forging a CRO/CISO/HR alliance to advance lasting cyber resilience; how to determine if certain behavioral characteristics may contribute to a greater likelihood of a trade error claim
  • The increase in cost of correction/trade error claims year to date; applying proven risk management techniques to everyday firm compliance to advance a preventative approach to reducing trade errors
  • Why supplementing your existing risk management practices with a comprehensive insurance program is essential to preserving your business

Our speakers are Lilian Morvay, Tom Finan, Jack Jennings and Brian Cavanaugh. Come hang with us for an hour if you can.

A fresh start

The Financial Times reported that investor sentiment is so positive that 71% of 200 surveyed asset allocators (including CIOs and investment strategists) thought equities prices would be higher by year end 2021 than they are now. That sentiment is shared by 67% of nearly 1,000 professional investors surveyed, who believe the US S&P will rise over the next 12 months. Other market indicators are similarly optimistic. The VIX spiked to a 10-year high of $82.69 on March 16, 2020 and has fallen to $22.60 as of this writing, reflecting significantly lower expected volatility in the next 30 days as stocks continue their upward trajectory.

Some investing experts have warned against what they view as brewing “group think.” The Financial Times article quoted Jim Reid of Deutsche Bank who conducted the survey: “It’s fair to say that in the 25 years I’ve been doing this I can’t remember a time when so few (if any) disputed the central narrative.”

Needless to say, we’re all in need of some optimism for 2021. Rising investor sentiment has provided opportunity for firms like Robinhood, Stash Invest, Acorns, You Invest and Ally to ride the surge of retail investment in 2020.

In prior articles we’ve discussed the importance of comprehensive E&O and D&O coverage for FinTech firms as they grow to scale, including coverage for regulatory investigations. That advice is underscored by the recently announced complaint filed against Robinhood by Massachusetts securities regulators for perceived violations of the new Massachusetts Fiduciary rule.

The outcome of this case is a crucial test for FinTech firms doing business in the state of Massachusetts, but also for traditional B/Ds and wealth managers. How will state enforcement stack up against Regulation Best Interest/Form CRS? As we discussed in our introductory letter in December, perhaps the federal landscape of enforcement may also change in the coming weeks and months ahead. A recent article by Cleary Gottlieb discussed what to expect from the incoming Biden administration.

Of particular interest in the Cleary Gottlieb article was this quote from author Giovanni P. Prezioso, partner and former general counsel of the SEC, “Democratic administrations have tended to identify areas for increased regulatory oversight of market participants and intermediaries, in areas ranging from enhanced disclosures and process changes, including a universal proxy ballot, to higher capital and customer suitability requirements. It would not be surprising to see those efforts renewed in the new administration, including in areas where over the last few years the SEC has adopted rules that Democratic commissioners viewed as insufficiently rigorous (e.g., Regulation).”

Bringing it all back to insurance, what does this mean for buyers? We’re in the midst of the hardest insurance market in 30 years. Why would a buyer make strategic changes to their insurance program with purchasing conditions dramatically skewed in favor of the seller? We think the current market may dictate a change in the size of decision making, but it shouldn’t change the risk-transfer framework altogether. For example, in June we encouraged buyers to reconsider retention adjustments in the face of price increases alone. We think the same logic applies to critical coverage extensions like regulatory investigations. The best time to buy coverage is before you have the claim, even in a hard market like today.

Bitcoin $500,000

As of this writing Bitcoin is trading at $23,091 representing an incredible 226.37% increase since January 1, 2020. While that’s quite a return, it’s little league compared to the return on investment you would have received if you bought in when the currency first traded in 2009 at a mere $0.03 per Bitcoin (a 769,700% return).

In a recent interview with CNBC and blog post, Tyler Winklevoss predicted Bitcoin will rise to $500,000 within the next decade. There are countless similar predictions in the market, including from Nigel Green, founder and CEO of the Dubai-based financial advisory firm deVere Group (predicting a 50% increase in the currency in 2021.)

While we make no endorsement of these predictions or of the cryptocurrency, the returns are impressive and quite amusing to consider. What’s less amusing to consider is the professional liability market’s appetite for cryptocurrency risks. With limited capacity to begin 2020, the current hard market conditions have not done much to improve carrier appetite for cryptocurrency risk; however, there are a handful of markets that will write cryptocurrency risks, whether as a partial allocation of your portfolio or your exclusive investment strategy.

For established BD/RIAs insurance buyers, firms will want to keep a close watch on their excluded products list and cryptocurrency-specific exclusions that may inhibit coverage in the event of a claim. Cryptocurrency exclusions may also extend to ETFs and ETNs involving cryptocurrency derivatives. As we’ve previously discussed, structured notes and derivatives bring a host of separate issues in wealth management E&O, and it’s generally always best to confirm coverage in writing with your insurance partners.

As we discussed, we’re fortunate to have long-standing relationships with insurance partners that offer coverage for these products, whether as an allocation of the portfolio or as the exclusive investment focus. If your firm has a need reach out to us, we look forward to discussing with you.

Regulators mount up

On December 21, 2020, the SEC released a statement concerning new examination initiatives around Regulation Best Interest: “the Division intends to begin its next phase by conducting more focused examinations as outlined below beginning in January 2021.” This statement was prompted by findings disclosed during an October roundtable hosted by Chairman Jay Clayton including various other divisions of the SEC and staff from FINRA. The roundtable shared preliminary observations by the SEC and FINRA around Best Interest compliance.

While the reviews and comments were largely positive, some members commented that testing around Reg BI’s record-keeping mandate was lacking among firms the SEC and FINRA interviewed. Other concerns included delayed training around Reg BI, and the accuracy of assertions around whether recommendations were being made to investors (firms asserted that recommendations weren’t being made while the SEC observed otherwise). The positive commentary was encouraging in a year that’s been volatile for many B/Ds. View the full roundtable webinar.

In expectation of increased examination activity, firms will want to ensure their regulatory investigations coverage is as robust as possible. Typically, sweeps and routine inspections are excluded in E&O and D&O policies. But to the extent these examinations could lead to an inquiry or subpoena by the Commission, firms will want to ensure their being proactive about their insurance. To this end it’s important to understand the difference between informal and formal investigations coverage provided by your insurance contract.

Broker-Dealer firms will want to ensure they’re requesting investigations coverage on their E&O policies at every renewal and achieving broad-form wording with minimal or no retention structures. Coverage for these firms will often come at a sub-limit on a per rep and company basis. Commonly available to RIAs at full limits, firms will want to ensure they’re maximizing the use of the pre-claim components of the policy. This might include a comprehensive understanding of the notice of circumstance triggers of the policy. Reach out to us to discuss our perspective on approaches and preferred wording.


Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed subsidiaries of Willis North America Inc., including Willis Towers Watson Northeast Inc. (in the United States) and Willis Canada, Inc.

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