What is E&O insurance?
Errors and Omissions (E&O) insurance is a type of coverage designed for professionals that offers financial protection from litigation claims stemming from various professional mistakes. While technically, E&O is a type of professional liability, there are slight differences between the two policies. Professional liability covers mistakes made by service-oriented fields, whereas E&O tends to cover advice-driven professionals, such as accountants or registered financial advisors (RIA).
For investment advisors, Errors and Omissions (E&O) insurance provides essential coverage against claims related to mistakes, oversights, or negligence that may arise when offering clients investment advice or financial services.
E&O insurance can cover legal defense costs and any resulting settlements or judgments arising from a lawsuit against your firm. For instance, if a client sued your firm due to an advisor’s error in a financial analysis that negatively impacted them, E&O insurance could help cover the associated costs.
This post details what exactly E&O insurance covers and the exemptions for RIAs.
Also read: 5 Considerations for Your Accountant E&O Policy
The importance of E&O insurance for investment advisors
It can be tempting to opt out of E&O insurance. A competent, well-informed RIA should not have to worry about getting sued, right? That line of reasoning is faulty for the following reasons:
- Litigation expenses: Legal costs can be very high even if the advisor is not at fault. E&O insurance covers these costs, allowing the advisor to continue operations without bearing the financial burden of a lawsuit.
- Client trust: It helps demonstrate that the advisor is committed to professionalism and protecting their best interests, enhancing credibility and trust.
- Peace of mind: With the risks inherent in financial advice and market conditions, advisors can focus on serving clients without fearing the economic impact of potential legal claims.
- State requirements: RIAs are not federally required to have E&O insurance, although some states, such as Oregon, require it.
- Brokerage requirements: Some firms, like Schwab, require advisors to have a set amount of E&O coverage.
E&O insurance coverage categories
Here’s a breakdown of what E&O insurance typically covers for investment advisors:
Professional negligence
If an investment advisor fails to provide appropriate advice, makes an error in calculations, or fails to recommend an investment strategy that meets the client’s needs, E&O insurance can cover claims related to professional negligence.
For example, if an advisor recommends a risky investment without fully explaining the associated risks and the client suffers financial losses, the advisor could be liable. Note that a mis-trade—mistyping a stock ticker and purchasing the wrong stock—is also covered by E&O.
Errors in financial advice or planning
E&O insurance protects against common claims involving mistakes in financial plans, portfolio management, or investment strategies. If the advisor’s recommendation leads to financial harm or loss, this insurance will cover legal defense costs and any settlements.
Omissions
If an investment advisor fails to disclose important information (like risks, fees, or conflicts of interest) that would have influenced the client’s decision to invest, E&O insurance can provide coverage.
Failure to act
If an advisor does not take timely action regarding the client’s portfolio or investment plan (such as missing an opportunity to rebalance the portfolio or failing to act on market changes) or fails to promptly execute an order to sell a security based on a client’s instruction and the client suffers financial loss, the advisor could be held responsible.
Breach of fiduciary duty
Investment advisors owe a fiduciary duty to their clients, meaning they must act in the client’s best interests. If they breach this duty (e.g., by recommending investments that benefit them financially but are not in the client’s best interest), E&O insurance can protect them against related claims.
Misrepresentation of investment products
An advisor could misrepresent an investment product or make false statements about the performance or risks associated with an investment.
Example: A client sues an advisor for recommending a mutual fund that was marketed as a low-risk option but was more volatile than advertised.
Failure to disclose conflicts of interest
If the advisor fails to disclose any conflicts of interest (e.g., they have a financial stake in recommending a particular product), which leads to a client’s loss, E&O insurance can provide coverage for litigation and damage.
Defamation or libel
If an advisor is accused of making defamatory statements about a client or another advisor during their professional activities, E&O insurance can cover defense costs related to such claims.
Caveat
It is important to note that even if there is no provable negligence, error, or any of the types of mistakes discussed above, that does not prevent a client from suing. Legal fees will be incurred regardless of whether a case has merit.
E&O exemptions
- Fraud or criminal acts: E&O insurance will not cover fraudulent, illegal, or intentionally harmful actions by the advisor.
- Personal issues or personal lawsuits: This insurance focuses on professional liability, not personal liability.
- Damages beyond professional advice: Property damage or bodily injury claims would be outside the scope of E&O insurance and fall more under general or other types of liability.
The cost of E&O insurance coverage
Premiums for RIAs can vary widely, depending on the firm’s size and various risk factors. One estimate says the national medium for E&O insurance for RIAs is around $220 per month/$2600 annually.
While this may seem like an optional expense, consider the costs of not getting coverage: exposure to lawsuits (frivolous or not).
McGowan PRO is the leading independent agency specializing in Errors & Omissions Insurance for Investment Advisors, Brokers/Dealers, Third-Party Administrators, and other Investment Professionals. We offer resources specifically for RIAs, including white papers, legal opinions, articles, and more.
Get in touch to learn how we can support your investment journey with advice, coverage, and resources.
FAQs
What is Errors and Omissions (E&O) Insurance?
- E&O protects professionals from claims of negligence, inadequate work, or mistakes made while providing professional services.
Who needs it?
- Service-based professionals like consultants, real estate agents, and IT professionals.
What does it cover?
- E&O Insurance commonly covers legal defense costs, settlements, and court judgments related to claims of professional errors, omissions, or negligence.
Common exclusions:
- Criminal acts, general liabilities, and intentional wrongdoing.
Why is it important?
- Offers financial protection and peace of mind, allowing professionals to focus on their work without fearing litigation.
How does it boost credibility?
- Reassures clients of a professional’s commitment to high standards and risk management.
How to choose the right policy:
- Assess the risks associated with your services, compare insurance providers, and ensure coverage matches your industry needs.
Coverage limits:
- Dictate the maximum payouts for claims, which are divided into per-claim and aggregate limits.
Cost:
- Varies depending on factors like business size, revenue, industry, employee training, contracts, location, claims history, and coverage limits.
Is it required?
- There is no national mandate, but it is required in some states and always recommended. Some brokerages also require it.
What type to buy?
- Policies vary and can cover different risks, but they typically cover legal defense costs and attorney fees if sued for negligence, errors or omissions, misrepresentation, inaccurate advice, or violation of good faith and fair dealing.