Custodians Heighten Concern Regarding RIA Insurance

By Golsan Scruggs

01 Nov Custodians Heighten Concern Regarding RIA Insurance

Posted at 13:12h in Risk Tips by

We are experiencing a new frontier of risk in financial services.  More specifically, the risks of running an independent RIA firm have indeed increased over the past 20 plus months.  Custodians have taken note.  According to a notable insurance carrier in this space, trade error claims for RIAs spiked 500% in 2020 as compared to 2019.  Wire Fraud and Social Engineering events, conducted by increasingly sophisticated cybercriminals, targeting RIAs and their client funds have seen a strong rise recently as well.

What is driving the increase in trade errors?  There are two key drivers here:

  1. Market Volatility – According to Yahoo Finance, The S&P 500 closed at 3,380.16 on February 10, 2020 and then by March 16, 2020 closed at 2,304.92, a 31.8% drop in less than a month!  It then rose to 3,508.01 by August 24, 2020, a 52.2% increase in about 5 months!  The S&P 500 opened at 4,616.30 on November 1, 2021, a 100.2% increase since March 16, 2020!   There were multiple “opportunities” to be on the wrong side of the market over the past 20 months.  Trade errors during periods like this are amplified by the large pricing swings.
  2. Work From Home (WFH) – Simply put, trading policies and procedures changed when the world moved to WFH.  Checks and balances were harder to keep in place and more errors have been made.

What is driving the increase in Wire Fraud and Social Engineering events?  Three key drivers:

  1. Work From Home (WFH) – Policy and procedure breakdowns and longer communication cycles have created vulnerabilities that have been exploited by cybercriminals.
  2. Overall Increase in Cyber-Crime Attempts – According to Forbes, In 2020, malware increased by 358% overall and ransomware increased by 435% as compared to 2019.  Malicious emails are up 600% due to COVID-19 according to ABC News.
  3. Americans are Moving – Statistics show that more Americans have moved and plan to move in the near future than usual.  This may seem like an odd driver, but we have seen multiple six and seven figure wire fraud events centered around down payments on homes.  In these events, the cybercriminal is hacked into the RIA clients’ email account waiting for them to request a wire and then interrupts the communication with the RIA firm as well as creates a “dummy” account imitating the title company and creating false wire instructions.  The wire simply is sent to the wrong routing number and bank account on the day of closing.

Custodians have witnessed the above loss trends and are now acting.  Schwab Advisor Services is implementing specific requirements and we are seeing other custodians take note and strongly recommend coverage for the aforementioned events.

Finally, we would be remiss to not mention that not all E&O will cover trade errors, and frustratingly, in most cases “cyber insurance” will not cover direct loss of dollars or securities due to wire fraud or social engineering!  That said, properly structured E&O can cover trade errors and crime coverage (not cyber insurance) can extend to cover wire fraud and social engineering losses, but i’s must be dotted, and t’s must be crossed.  As we have been communicating for years to the RIA industry, these specialty types of insurance are not standardized.  Buyer beware, this is the Wild West of insurance!

Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.

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