01
May
2002

Securities Professional Liability Policy Coverage

Financial Services Alert

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PUBLISHED ON: May 1, 2002

Professional liability policies designed for securities professionals (sometimes known as “errors and omissions” or “E&O” policies) typically provide coverage for Wrongful Acts, which are commonly defined as “any negligent act, error or omission,” in providing specified types of securities-related services.

A claim against the professional or the professional’s firm will therefore have to fall within one of the specified types of services to trigger coverage. Some policies specify the activities by stating that the Wrongful Act must be performed in connection with certain roles, such as a Security Broker/Dealer, an Investment Advisor, and an Administrator. Other policies directly list the covered activities.

Coverage can be structured with separate policies for separate activities, such as Broker/Dealer and Investment Advisor activities, or with single policies that cover all, or at least several, securities-related activities.

Defense Coverage

Securities E&O policies typically place the obligation of defending the claim on the policyholder, who has to obtain the consent of the insurance company before incurring any defense costs, admitting liability or settling any claim. The insurance company is required to reimburse defense costs, but only within the limits of liability. In addition, Defense Costs are commonly defined to be incurred by the Insurance Company or by the Policyholder with the written consent of the [Insurance] Company. Accordingly, it is important to check your policy for such requirements and to obtain the necessary written approvals before incurring significant defense costs. Such consent should not be unreasonably withheld, even if the policy does not so state.

Trigger of Coverage

Securities E&O policies are generally claims-made policies. This means that they are triggered when someone makes a claim against the policyholder. Most policies define the making of a claim to be the service of a complaint or demand for arbitration, as well as any written demand for compensation based upon a Wrongful Act. Other policies expand the definition to include even oral demands. Policyholders cannot rely on this definition, however, to determine when it is necessary to provide notice to their insurance companies, as many policies contain provisions that require that the policyholder give notice not only of claims, but of circumstances and events that are likely to give rise to claims in the future.

Potentially Applicable Exclusions

The seeming breadth of the coverage grant is contrasted with the myriad exclusions that are tacked onto the policy, which have the potential to take away much of what appears to be given by the coverage grant. It is not uncommon for a securities E&O policy to have more than 20 standard exclusions, plus others added by endorsement.

Insurance policy exclusions should be construed narrowly in favor of coverage. Jefferson Ins. Co. of N.Y. v. Travelers Indemnity Co., 92 N.Y.2d 363, 371, 681 N.Y.S.2d 208, 212 (1998); Continental Cas. Co. v. Rapid-American Corp., 80 N.Y.2d 640, 652, 593 N.Y.S.2d 966, 972 (1993). Moreover, as the Second Circuit noted, the doctrine of contra proferentum—pursuant to which policy language is construed against the insurance company drafter and in favor of coverage—is afforded a “heightened application,” where ambiguities exist in an exclusionary provision. Sea Ins. Co. Ltd. v. Westchester Fire Ins. Co., 51 F.3d 22, 25 n.4 (2d Cir. 1995) (citing Breed v. Ins. Co. of N. Am., 46 N.Y.2d 351, 353, 413 N.Y.S.2d 352, 357 (1978)).

Most Common Exclusions

Two common exclusions appear in most securities E&O policies and are the most likely to affect coverage for the bulk of claims brought against securities professionals—one exclusion bars coverage for claims for criminal, fraudulent or dishonest acts, the other bars coverage for claims in the nature of unjust enrichment.

Other Troublesome Exclusions

Other exclusions of potential concern include one relating to claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. While not in every policy, it has the potential to eviscerate coverage in any policy of which it is a part. Other exclusions reduce or eliminate coverage for specific types of activities, such as underwriting or private placements.

If your policy contains exclusions that preclude coverage for activities that you or your firm engage in, then you should either shop for a new policy, or attempt to negate the exclusion through an endorsement.