Insurance issues often influence the outcome of securities arbitrations and mediations, yet the workings of errors and omissions insurance is not fully understood by many lawyers, arbitrators and mediators. In fact, insurance information is generally not disclosable in securities arbitration, and is considered confidential information by many broker-dealers and insurance industry professionals. The overwhelming majority of securities arbitrations are litigated before the Financial Industry Regulatory Authority (FINRA). Yet the FINRA discovery guide does not require disclosure of insurance information in customer arbitrations, although a proposal has been floated which would make the respondent's insurance coverage potentially discoverable. This article will survey some common insurance issues in arbitration and mediation, including conflicts of interest.

Cumulating Claims

The existence and extent of insurance coverage is useful information for claimants' counsel and defense counsel alike, can significantly affect the outcome of mediation, and can sometimes even help claimant's counsel determine whether a claim is worth pursuing in the first place. While larger financial industry wire-houses tend to be largely self-insured, at least at most levels, most independent model broker-dealers have at least some form of errors and omissions insurance, which is typically subject to a self-insured retention.

Occasionally, in the case of smaller, independent model broker-dealers with small balance sheets, larger claims may prove to be uncollectable due to the erosion of policy limits or coverage limitations. Cumulating claims can have a tsunami effect, by which thinly-capitalized broker-dealers may not have the financial capacity to survive the exposure resulting from multiple cascading claims arising from a particular broker or product. For example, GunnAllen Financial, which was shuttered by FINRA in 2010 for insufficient capital, was overwhelmed by claims arising from a single registered representative, who sold approximately $74 million of investments to eight hundred investors in what turned out to be a Ponzi scheme. Other firms have been swamped by multiple claims arising from failed products.

Coverage Limitations

Claimant's counsel—and mediators—should be cognizant of potential insurance coverage limitations, which can also affect the ability to collect on an arbitration award at the conclusion of the case. For example, while individual insurance policies may have different terms, many policies exclude coverage for selling away claims, by which a registered representative sells unapproved products without the firm's knowledge. Since typically an insurance policy would contain an exclusion for selling away activity, such claims may be difficult to collect, particularly against an individual broker. In anticipation of such issues, claimants' lawyers routinely seek coverage by naming the broker-dealer and alleging a cause of action for failure to supervise, which may trigger coverage, depending on the policy terms. Other common exclusions might be for theft, churning, or repetitive buying and selling of the same securities positions in order to generate commissions for the broker, or charging excess commissions and fees.

Counsel should understand the limitations on errors and omissions insurance, and formulate their mediation strategy accordingly. Experienced claimants' counsel often anticipate the potential coverage aspects of the case, even in situations in which the policy itself may not be discoverable. For example, since fraud claims are generally excluded by most insurance policies, and uninsurable as a matter of public policy in many jurisdictions, claimants' counsel should know that a fraud-based mediation strategy is unlikely to gain much traction at a mediation with an insurance carrier. Claimants' counsel often attempt to steer their cases, both in pleadings and at hearing, away from claims likely to be uncovered, such as selling away and churning, and toward claims more likely to trigger coverage, such as supervision or suitability.

Attending Mediations

Another perennial issue is whether insurance claims professionals should personally attend securities mediations. As mentioned, insurance information is not generally discoverable in securities arbitrations. Most broker-dealers regard the existence of E & O insurance as confidential, and not to be disclosed to the claimants' bar, absent an explicit order by an arbitrator. A claims professional's presence at a securities mediation will obviously indicate the existence of insurance—and potentially raise the settlement price accordingly. Thus, the insurer's decision to attend a mediation should be carefully considered. In some circumstances, such as a series of multiple product arbitrations with sophisticated counsel, claimants' counsel may already be aware of the existence of insurance. Moreover, in most court cases, including federal court, insurance information is disclosable as a matter of course.