Trade Error! Are We covered?

In a recent conversation with one of our key Prime Brokerage relationships, we were asked whether or not their client had protection for trade errors. It was their understanding that the error itself wasn't covered but the defense and legal bills typically would be. Please see our exchange below:

Prime Broker Question

"Quick question – what do you usually see in D&O and E&O for Cost of Corrections? Is it typical that the cost to correct a trading error isn’t covered, but the cost to defend a claim related to that error would be?"

Our response:

No that isn’t typical. Coverage for the Trade Error would be available! There is a bit of a misnomer about Cost of Corrections Coverage (“COC”) also known as Trade Error Protection. Without a specific endorsement extending COC to a particular policy, coverage for trade errors still exists. The intent of any joint Advisor/Fund E&O/D&O Insurance policy is to provide coverage for any actual or alleged negligence in the rendering of professional services (i.e. Providing investment advice for a fee). A trade error would most certainly constitute negligence in the rendering of investment services. COC coverage simply amends the policy trigger! It effectively changes the contract from a third-party policy to a first-party policy as it pertains to Trade Errors.

What does this mean? The coverage trigger for most E&O/D&O policies is the receipt of a third-party claim. (i.e. customer complaint/demand for monetary damages etc. resulting from a wrongful act). In the event of an actual trade error, the Investment Adviser/Investment Manager who has full discretion of the assets would most likely want to close out the position and reconcile the account without notifying the client or customer. If the policy contains a COC coverage extension, then the Inv. Manager would simply report the error to the carrier and collect under the policy. Without the COC coverage extension, the Investment Manager wouldn't be covered for the error unless he/she received a complaint or demand from a third-party client, customer, limited partner and/or shareholder.

Cost of Corrections Coverage simply changes the process under which coverage is granted. Coverage for trade errors already exists under most Investment Advisor E&O Contracts.

About the Author

Louis D’Agostino is a Partner and Senior Vice President of Iron Cove Partners, LLC. Mr. D’Agostino is responsible for the oversight and management of Iron Cove's Financial Institutions Practice which is dedicated to addressing the unique and complex risk management needs of companies engaged in the arena of financial services. i.e. Private Equity Funds, Hedge Funds, Investment Advisors, Securities/Dealers, Mutual Funds and the like. Mr. D'Agostino & his team currently serve as insurance advisor to some of the world's largest Asset Managers and Financial Institutions.