Protection for Your Practice
The current litigation environment makes questions about fiduciary liability incredibly important for advisers to answer.
“The last few years have made clear that lawsuits against any and all parties involved with retirement and welfare plans are here to stay,” says Lars Golumbic, a principal with Groom Law Group, Chartered, in Washington, D.C., and author of an extensive report on the subject, “Who May Sue You and Why,” published last year, for global insurance provider Chubb.
“The need for comprehensive fiduciary liability insurance is greater than ever,” he says.
For an advisory business weighing its insurance needs, the firm’s leaders must digest the fine print and understand exactly what a potential policy covers—not to mention how much it costs.
Challenges Confronting Advisers
According to Golumbic, fiduciary liability as to employer-sponsored benefit and retirement plans is one of the most misunderstood exposures that company directors, officers, employees and trustees face. Because many advisers today explicitly take on fiduciary discretion over client assets, they are equally exposed to litigation, Golumbic says. The exact terms of advisers’ exposure will vary somewhat based on the structure of their products and services, especially depending on which fiduciary status they take on—3(21) or 3(38) as defined by the Employee Retirement Income Security Act (ERISA)—but, in any case, it will be significant.
“Many fiduciaries fail to appreciate that they can be held personally liable for a breach of fiduciary duty, even when the breach is unintentional,” Golumbic says. “Moreover, plan fiduciaries are subject to a very high standard of care, the highest duty known to the law, even higher than the duty imposed on corporate directors and officers. Yet, plan fiduciaries’ decisions, unlike those of corporate fiduciaries, are not given the benefit of corporate law’s business judgment rule.”
To further complicate matters, Golumbic says, traditional directors’ and officers’ (D&O) insurance, generally in place at advisory firms, does not typically cover retirement plan fiduciary liability. This puts advisers in the same boat as the administrators at their plan sponsor clients, who cannot rely on general executive insurance to protect them in the case of an ERISA lawsuit.
He warns that there is a somewhat common misconception in the marketplace that a plan sponsor client’s fiduciary-specific insurance policy can be used to defend an adviser, or other third-party provider. But there are regulatory limitations on the ability of a benefit plan or employer to indemnify a third-party fiduciary who has been sued, even if that plan or employer wants to do so.
“Just as important as understanding who is an insured is knowing who is not an insured under any given policy,” Golumbic says. “Third-party service providers such as investment advisers, investment managers and third-party administrators [TPAs] who are hired by the plan or plan sponsor, but who aren’t employees of the insured, are typically not insureds under the standard fiduciary l
Misconceptions About Coverage Abound
According to Nancy Ross, a partner and head of the ERISA litigation practice at Mayer Brown in Chicago, some of the confusion about D&O policies stems from the fact that, even just 15 years ago, they typically offered fiduciary coverage within an attached rider. Fiduciary insurance coverage has since been carved out as a stand-alone, Ross says. If a sponsor or adviser thinks their D&O coverage extends to fiduciary insurance, they could be in for a surprise, she says.
Another misconception among sponsors and their fiduciary advisers, Golumbic says, is that fiduciary liability insurance can be used to restore losses to an employee benefit plan when a plan fiduciary discovers it made an error. In reading the fine print of the policy, advisers and sponsors will see this is just not the case.
“Fiduciary liability insurance is ‘third-party’ coverage, meaning someone must make a claim against an insured for a wrongful act,” Golumbic says. “In turn, the fiduciary liability insurance policy will provide a defense against the claim—assuming that the policy includes a duty to defend provision—and then pay for any covered award entered against the insured up to the policy’s limit of liability.”
The flip side is that fiduciary liability insurance is not “first-party” coverage, meaning the insured may not draw on the policy to restore losses to the plan. Likewise, Golumbic says, fiduciary liability insurance should not be confused with the mandatory ERISA bond that is required for all persons handling plan assets.
Ross recommends identifying and comparing multiple carriers that have operated in the space for a while and are familiar with the lawsuits. These groups should be able to help fiduciaries create an effective defense strategy, she says.
How Much Coverage?
When assessing how much insurance to have, it is critical for fiduciaries to consider how high their defense costs could run, Ross says. In a complicated ERISA class action alleging fiduciary breaches, defense fees can run anywhere from $10 million to $20 million. So, if those fees run on the high side and a fiduciary has a $50 million policy, will the remaining $30 million be enough to cover the cost of being hit with a judgment?
For very large advisory firms—and for large plan sponsor clients—coverage may need to be “stacked” to be sufficient.
“If you want $100 million in insurance, you certainly might have different carriers,” Ross says. “Generally, one carrier will provide only up to a certain level of coverage, say up to $25 million. Then the next two might each cover $15 million apiece.”
Other Considerations for Advisers
According to Ross and Golumbic, advisers who are at all unsure of their level of current coverage should consult with their existing insurance brokers, or consider establishing new relationships. It is also important to think about both future and past liability in such discussions, they say, because claims often relate to actions taken years in the past. Further, advisers should ask whether coverage may be available for legal and other costs that may be incurred if a lawsuit or regulatory investigation is a possibility but not yet formally initiated.
Something else to consider is whether the coverage includes a “choice of counsel” clause, which allows the adviser to select a preferred attorney and use the insurance payment to cover the fees, rather than having the insurer select the counsel.
And finally, once ERISA fiduciary coverage is in place, it is important to keep track of the requirement to notify the insurance carrier of possible claims. Usually, coverage depends on making a timely report if there is a potential lawsuit, or if a regulator initiates an inquiry. Failing to comply with policy notice requirements could result in a loss of some or all of the benefits of the fiduciary coverage.
- Any retirement plan adviser taking on fiduciary discretion over client plan assets needs insurance of their own; client policies will not cover advisers as third-parties.
- Fiduciary insurance is not always available as a rider to D&O policies but must be purchased as a standalone.
- When selecting a carrier, experts advise selecting one that has operated in the space for a while and is familiar with specific types of lawsuits and claims.