Anticipating E&O Exposures
Anticipating E&O Exposures02.01.2017
During the past several weeks, I have been working on programs ranging from an insurance broker sharing an Errors & Omissions policy with its captive agents to a trade association offering a sponsored professional liability policy for its membership. The common thread running through these previously placed, then existing policies is that both failed to meet the needs and goals or otherwise inadequately protected the broker or association in question. These situations, unfortunately, are not unique, and a recent decision from the U.S. Court of Appeals for the Sixth Circuit is illustrative of how a policyholder could avoid such a pitfall with better communication and an understanding of the issues facing its industry.
Specifically, the Federals Appeals Court affirmed a Lower Court decision holding that the insurer was not obligated to provide E&O coverage to a licensed broker-dealer financial services firm (as well as under a fidelity bond). In this connection, the broker-dealer had discovered that a registered investment representative had embezzled $2.6 million of client funds by depositing checks endorsed or written by clients directly into his own bank accounts. The registered representative committed suicide two days after two clients commenced a FINRA arbitration against the financial services and the registered representative.
The broker dealer thereafter sought coverage which, for purposes of this discussion, was denied under the E&O policy’s “wrongful acts” exclusion that precluded coverage for claims arising out of any actual or alleged wrongful act “with the knowledge” that is was a wrongful act. In the insurance coverage litigation that ensued, the broker dealer argued that (i) the term “knowledge” was ambiguous; and, (ii) the exclusion was not applicable as the company did not have “knowledge” of the wrongful act. The Sixth Circuit disagreed, and found the exclusion barred coverage as it “plainly” pertained to the “knowledge” of the registered representative, an insured under the E&O policy, who had known what he was doing was a “wrongful act”.
I use this case as an example of exposures that should have been anticipated by a company handling money of others whether it be a law firm, accountant firm, or financial services company as embezzlement by an employee or, in this case a registered representative, is all too common. Perhaps this could have been avoided with the inclusion of an innocent insured clause in the E&O policy that protects an insured from the wrongful acts of another insured. There are several variations of such a clause, which could admittedly lead to covered or uncovered results depending on the specific innocent insured language, facts at issue, and the jurisdiction where the clause will be interpreted.
For example, one variation of the innocent insured clause provides that the “wrongful act” exclusion applies separately to each insured individual (or corporate entity). Another example of the clause more generally sets forth that one insured cannot lose coverage based on conduct or knowledge of another insured. Either way, if the broker dealer in this scenario or a professional insured in other cases raised the concern that it be insulated in an E&O policy from the wrongful acts of another, perhaps the Sixth Circuit or the District Court below would have reached a different result. (I recognize that the broker dealer in this case may have expressed such concerns, and the innocent insured clause was not available with the subject E&O policy or broker dealer chose not to purchase the same.)
The lesson learned is that a professional should understand its potential exposures particular to its industry, and explore all options available to tailor its professional liability policy to ensure its financial viability in the face of a claim.
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