Registered Investment Advisors

THE BASIS OF RISK

Registered Investment Advisers face risks associated with rendering investment advice to their clients, managing their clients’ assets, publishing written materials related to investment advice, and, from regulators, for violations of Federal and State law governing their practices. The discussion below highlights the sources of the risks that Investment Advisers encounter in their practices.

LEGAL DUTIES OF INVESTMENT ADVISERS

Sources of the Fiduciary Duty

An investment adviser’s duties as a fiduciary derive from various sources, including state and federal statutes, as well as longstanding common law (legal principles developed by courts independent of statute). Some of the duties that flow from that fiduciary status include:

1. Acting in good faith solely for the benefit of the principal;
2. Disclosing all actual and potential conflicts of interest;
3. Avoiding deals in which the adviser is adverse to the client, except where the client has given informed consent;
4. Disclosing all material facts concerning the cost at which securities were sold and the current market price;
5. Executing trades at the best price discoverable in the exercise of reasonable diligence.

Definition of an “Investment Adviser” Under Federal Law

Section 202 of the IAA defines an “investment adviser” as any natural person or entity who: (1) for compensation, (2) is engaged in the business, (3) of providing advice to others or issuing reports or analyses regarding securities. Note the law’s inclusion of the word “person”. Such clarification within the law clarifies the intent and magnitude of our society’s congregational unity on the role of a fiduciary, of the inability for the corporate entity to act as the commonly used traditional barrier and legal protector to the individual, and for the confirmation of an adviser’s personal liability to the public for the adviser’s actions or inactions.

CATEGORIES OF RISK

The risk exposures of an investment adviser’s practice fall within three categories:

Common Law Liabilities

Negligence/Professional Malpractice – Failure to act with the same degree of care as a typical investment adviser under the same or similar standards.

Negligent Misrepresentation – Definition: Investor suffers loss by reasonably relying on material, false misrepresentation or omission by an adviser who was compensated for providing such advice, when the adviser honestly believes the truth of the statement but without reasonable grounds for that belief.

Breach of Fiduciary Duty – Failure to act loyally, in good faith, and in the absolute best interest of the client with full disclosure of all possible material information including potential conflicts of interest.

Breach of Contract – Failure or alleged failure to honor and/or fulfill the trust, faith or promise made as described within your client agreements, investment policy statements or trust documents.

Agency Liability—Acts of Another – Liability for the acts of another, independent securities professional.

Employee Dishonesty/Fidelity – Theft by RIA employees of RIA in-house assets or from client accounts.

Statutory Liabilities

Involvement in Sale of Security (Federal Securities Statutes) – Making a false statement or omission in connection with the purchase or sale of a security.

Uniform State Securities Act (2002) – Engaging in a deceptive or fraudulent act or scheme when rendering investment advice. Uniform Act (2002), Section 509(b).

Elder Abuse – State statutes provide for punitive or multiple damages involving persons over a certain age, plus attorney’s fees, where there is proof of recklessness, oppression, fraud, or malice.

ERISA – Employee Retirement Income Security Act of 1974 imposes heightened fiduciary responsibilities over advisers with certain levels or kinds of discretion or control over retirement plans.

Investment Adviser Act Violations Relevant To Other Causes Of Action

Arbitrator-Created Causes of Action – An arbitration panel holding an adviser civilly liable for a regulatory or statutory violation that does not, at law, create a private cause of action.

Trade Execution/Error – Failure and/or alleged failure to execute a securities trade transaction as intended or preferred.

Regulatory Compliance/Audit – Failure and/or alleged failure to meet regulatory requirements of the SEC, DOL & various State Regulators.

Conflicts of Interest – Placing or alleged to have placed one’s own interest above a client’s.

“Best Execution” (Trading) Practices – Inability or alleged breach of an obligation to execute transactions in such a manner that the client’s total cost or proceeds in each transaction is the most favorable under the circumstances; failure or alleged failure to exercise reasonable care to obtain the most advantageous terms for a customer/client.

Suitability of Investments – Breach or alleged breach of the fiduciary duty owed to client to determine, provide and transact investment management concurrent and suitable to the client’s financial situation, investment objectives and risk tolerance.

Client Information Privacy Breach – Clients’ private information improperly disclosed to, or used by, third parties or employees.

CLAIM EXAMPLES

The following allegations are examples of claims experienced by various Golsan Scruggs’ insured investment adviser clientele:

• Unsuitable Trading
• Breach of Fiduciary Duty
• Failure to Disclose & Conflict of Interest
• Breach of Contract
• Failure to Supervise
• Erroneous Trade
• Unsuitable & Risky Investment Recommendations
• Unauthorized Transaction
• Unsuitable Investment

WHAT EVERY INVESTMENT ADVISER SHOULD KNOW

Based upon these legal duties, risk categories, case law, and claim examples, every investment adviser should understand these five important facts:

1. There is no higher professional standard than that of a fiduciary (“duty of care”).
2. Cases brought against advisers can be groundless or unwarranted but trigger and demand attention (defense) regardless (i.e. alleged vs. actual) of circumstances.
3. The legal framework (IAA – the Act) imposes liability to an Adviser (IAR) personally as an Individual – as well as to the IA entity. The definition of “adviser” includes “personal”. The corporate entity may not necessarily act as a shield of protection.
4. Categories of risk are wide and multiple.
5. Monetary exposures can be deep and catastrophic. The occurrence of an “action” against an adviser should be expected, based on success and longevity. The degree of severity is somewhat unknown.

TRANSFERRING RISK THROUGH INSURANCE

What are the primary insurance coverage forms available in the insurance marketplace to wholly or partially insure (transfer) the risks of operating as an Investment Adviser?

• Errors & Omissions Liability
• Directors & Officers Liability
• Employee Dishonesty
• ERISA Bond (In-House)
• ERISA Bond (Client/3rd Party Plans)
• Cyber/Data Breach Liability

Caution is recommended to the RIA community to recognize the specialty of the RIA underwriting marketplace and to solicit advice from qualified and experienced professionals possessing superior knowledge of fiduciary exposures and risk-transfer solutions.

THE RISK ASSESSMENT PROCESS

Golsan Scruggs has developed an RIA risk assessment called RIASURE. This process helps us understand your practice and analyze coverage issues so that a proper solution is structured to mitigate the exposures of your practice. At Golsan Scruggs, we believe it is incumbent upon us to earn the right to be appointed as your insurance and risk-management agent. Our RIASURE process exists to serve that purpose.

To obtain your complimentary Registered Investment Advisor RIASURE Review, please provide the following information or contact us at (800)273-5883.

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GROUP PROGRAM & AFFILIATE DISCOUNTS

If you are a member in one of the following affiliates, you may be able to receive a discount on the annual premium. Contact us for more details.

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CUSTODIAL VENDOR PARTNERS:
Fidelity Institutional Wealth Services
Interactive Brokers
Pershing Institutional
Schwab Advisor Services
TD Ameritrade Institutional

INSURANCE PRODUCTS:
Errors & Omissions Liability
Cyber Security
Business Insurance