WASHINGTON, D.C. (December 11, 2019)—In a report released today, the North American Securities Administrators Association (NASAA) encourages broker-dealers to use errors and omissions (E&O) insurance as a resource to help meet their potential obligations to pay arbitration awards to their customers.
Arbitration is the most frequently used method to resolve securities disputes between investors and broker-dealer firms. Almost every broker-dealer includes in its customer agreements an arbitration provision that requires public investors to submit all disputes that they may have with the firm or its representatives to mandatory arbitration rather than through the courts. Unfortunately, many customers that prevail through the arbitration process are not being paid their award by the broker-dealers or representatives.
“Investors who prevail in an arbitration should be able to collect that award,” said Christopher Gerold, NASAA President and Chief of the New Jersey Bureau of Securities. “Yet unpaid arbitration awards remain an unresolved and well-documented investor protection concern. In failing to pay arbitration awards, broker-dealers breach their legal, regulatory and ethical obligations.”
The Financial Industry Regulatory Authority (FINRA) reports that arbitration awards totaling $199 million went unpaid between 2012 and 2016. Research by the Public Investors Arbitration Bar Association (PIABA) shows that in 2017 alone, 36 percent of investors who won their arbitration cases collected nothing. “We appreciate that this issue is complicated and are pleased that FINRA and others are studying it. But this problem is not fixing itself,” Gerold said, adding that a survey of investors conducted earlier this year on NASAA’s behalf showed that Congress would find broad public support should it act to reduce or eliminate unpaid arbitration awards.
Gerold said that while NASAA recognizes E&O insurance cannot provide a complete solution to this problem such as when an award falls outside a policy’s coverage; greater use of E&O insurance in the broker-dealer industry could lead to fewer unpaid awards.
In July, the Market and Regulatory Policy and Review Project Group of NASAA’s Broker-Dealer Section conducted an in-depth survey to determine whether broker-dealers carried E&O insurance and, if so, the scope of coverage of such policies. The report released today analyzed information obtained from this survey in the context of the unpaid customer arbitration award data released by FINRA. Firms were selected for the survey based on size and location, focusing on small- to mid-sized firms.
The survey found that more than two-thirds of the 64 responding firms carried E&O insurance and at least 28 insurance companies offered these policies. While all the insurance policies contained limitations and exclusions, the survey showed covered claims generally were being paid – suggesting that at least some firms are using E&O insurance to meet their potential arbitration obligations. Notably, only 4% of broker-dealers without coverage cited the cost of coverage as the reason for not obtaining it and only 9% of broker-dealers with coverage considered the coverage expensive. “This rebuts blanket assertions that E&O insurance is too expensive or too difficult for smaller firms to obtain,” said Leslie Van Buskirk, Wisconsin Securities Administrator and Chair of NASAA’s Broker-Dealer Section.
Further, the report suggested that requiring brokerage firms to disclose whether they have E&O insurance and whether that insurance covers the business conducted by the brokerage firm and its representatives could provide a valuable investor protection safeguard. “This would incentivize broker-dealers to obtain E&O coverage and would also allow investors to make more informed decisions about brokerage firms with which to do business. Some investors may wish to avoid firms without E&O insurance,” the report said.