Should F.A. Legal be part of your firm's defense strategy?

    It's no secret that our business brings with it a minefield of potential lawsuits. It's not something most of us think about daily because that would distract us from our main focus of helping clients. But we nonetheless must contend with the ugly realities of securities regulation and client litigation that comes when least expected from those we trust the most.
    For some, there's no administrative task more distasteful than complying with regulatory burdens designed to protect our clients from our less-scrupulous competitors. And it seems that annual renewal notices for E&O insurance premiums come far more often than once every 12 months. How frustrating is it, then, to see the cost and labor requirement for proper regulatory compliance increasing every year? E&O insurance premiums and deductibles also increase regularly, while protecting against fewer and fewer services advisors may see as necessary to remain competitive. Who would have thought that the lessons learned in marketing candy a half century ago could be applied to insurance? (Remember how everything about Hershey bars got smaller except for their price?)
    Yet, as optimists are wont to say, there are no problems, only opportunities. Jerry Reiter saw E&O coverage gaps as an opportunity. "There are now so many exclusions in E&O policies that the pages in those policies describing policy exclusions are more voluminous than those describing policy benefits," says Reiter. And a lot of advisors don't discover those exclusions, he says, until they have to use their policies. "It's sort of like with health insurance; people don't know they have a problem until they make a claim."
What are the exclusions? They differ with each insurer and policy, of course, but many insurers now exclude alternative investments, private placements, 1031 exchanges and consultancy services where the advisor is acting as a fiduciary-to name just a few. For some advisors, exclusions cover so much of their service mix that it no longer makes sense to purchase E&O coverage.
    Reiter further reasons that if advisors qualify for E&O insurance, then they're probably successful at what they do, as disclosed in their E&O applications and their ability (and willingness) to pay E&O premiums. Yet, what are they paying for? For this caliber of advisor, we all know that when they buy E&O coverage they are prepaying-not the cost of a negligence award, but the cost of their defense against a client who may someday bring a frivolous lawsuit.
    "It's not a case of 'if;' it's a case of 'when,'" says Reiter, a former oil and gas man who later started a consulting company called Higher Plateau to do due diligence training, compliance oversight and certified continuing education for financial professionals. "Then we morphed into a legal referral company," says Reiter, "as advisors kept asking us, 'Where can we find an attorney?'" Reiter incorporated Financial Advisors Legal Association as a professional association in 1999 to answer this question. What he now calls simply "F.A. Legal" ( doesn't replace E&O insurance, but fills many of its gaps.
    What does F.A. Legal do, exactly? "Litigation prevention and defense" is Reiter's concise response. "We're not an insurance solution, per se," he says. "We don't indemnify our member advisors against negligence claims; we cover legal costs."
    Reiter-whom I first met when interviewing him for my upcoming book co-authored with D. Shannon, CFP, The One Thing... You Need to Know from Each of the Industry's Most Influential Coaches, Consultants and Visionaries (The Financial Advisor Literary Guild LLC at recommends to F.A. Legal's members that they carry E&O. It's just that 86% of all claims brought against advisors are groundless, he says, so the real benefit of E&O is defense. Which is the crux of the problem. "The real cost to defend the typical claim is approximately $42,000," says Reiter, "and the deal with E&O carriers is they want to settle claims quickly because it's more economical for them."
    But is it the best thing for the advisor? Reiter explains, "Many of the claims filed against financial advisors are ludicrous. If the claims are settled and, particularly if they're settled quickly at the urging of the E&O carrier, then the advisor becomes a target. Attorneys see how easy it is to settle the claim and more claims follow-the advisor is seen to have a soft spot." Is this true primarily just for broker-dealer reps? No, says Reiter; independent RIAs are enduring the same phenomenon.
    An advisor who purchases F.A. Legal's Gold Membership for ($930 a year or $86 a month) and "eDefense Manager" ($395) gets the gaps in his E&O coverage plugged several ways. First, drawing on Reiter's expertise from his previous enterprises, the advisor is given the tools to prevent frivolous lawsuits. This is F.A. Legal's eDefense system, which includes:
    Proven procedures to avoid becoming a legal target
    Tips to prevail under a litigious attack
    A library of litigation-tested document templates
    Client management and practice simplification processes
    Up to 14 hours of CPE credits (CFP, PACE, and insurance)
    Real-time updates on critical issues

F.A. Legal's Quarterly Newsletter, "The Litigious Times"
    "If the advisor will practice the proactive and preventative behaviors embodied in eDefense Manager, he will find most potential claims will be dismissed before they become an emotional and financial nightmare," says Reiter.
    The heart of eDefense is good record keeping, and it has a prominent role in the defense process-not to help an advisor defend against a claim as much as to stop litigation dead in its tracks. "We want to mediate whenever a claim is brought against one of our members to let the opposition know we're ready for them," explains Reiter. "When we go into mediation, the attorney thinks we're going to settle, but we just want to know what their case is and we want to let them know that we have our records [needed to refute the claim] in order. Since many of these claims are made on a contingency basis, when the attorney goes back to his client, the plaintiff, and tells him the advisor has documentation and the attorney now wants the plaintiff to pay him something up front, the plaintiff often drops the case. In the Old West, they used guns and bullets; we use attorneys and money."
Reiter once helped resolve a claim that was brought against an advisor by a client's estate and five children. The advisor, an insurance agent, was being sued for not selling his client long term care insurance. "He had offered it to his client on five different occasions but, initially, he couldn't prove it," says Reiter. The client went into a nursing home and their children's inheritance was eaten up by their costs of care. The children were now suing for $3.5 million.
"We settled with hardly any cash outlay because we were finally able to find a letter the advisor had sent the client showing he had offered them insurance," says Reiter. As a result of this experience, he now recommends that advisors send follow-up letters to clients for anything they recommend. "Thank God we found that letter; without it, we would have ended up settling the claim." The irony in this particular case was that the defendant was a godfather to one of the plaintiff's children. Says Reiter, lest you think this kind of relationship will protect you in situations like this, "Money knows no friends, family or religion."
Of course, some claims must be settled, and that's another eventuality in which F.A. Legal brings great improvements to the typical E&O process. Reiter doesn't contract with just a few lawyers but deals, instead, with a network of 25 independent law firms specializing in securities and investment law. "E&O insurers will often use the cheapest, generic lawyers they can find, not the best lawyers."
    F.A. Legal's Gold Membership advisors pay a deductible of only $1,500 on their first claim and $2,500 on any claims thereafter. "Actually," says Reiter, "it's more of a retainer than a deductible. If we settle a claim for $750, that's all the advisor pays.
    What initially confused me about F.A. Legal was how it coordinates with E&O coverage the advisor may also have in force. Reiter gave me the answer. The first step is to determine whether a claim is even covered by the advisor's E&O. If it isn't, as with an alternative investment type his E&O carrier has excluded, then F.A. Legal takes over. If it's a claim that could be covered by either F.A. Legal or the advisor's E&O carrier, he needs to make a choice. Frequently, the manner in which the E&O carrier proposes to handle the situation will persuade an advisor to bypass the E&O coverage and go with F.A. Legal's defense strategy.
    Reiter's concept of how financial advisors can best protect themselves is made clear in F.A. Legal's service mix: "We offer unlimited phone consultation as part of membership because we want to talk to the advisor when she anticipates a problem, not when a problem becomes certain. Whereas E&O insurance does nothing to educate the policyholder, we can mitigate a lot of issues by showing our members how to prepare for claims."
    Over the years, I've heard many advisors say that to be good at addressing clients' needs we must be proactive, not reactive. It makes sense, then, that advisors apply this same philosophy to their own legal defense. Simply remembering to pay your annual E&O premium while going about business as usual may give you a false sense of security, not to mention some nasty surprises.

David J. Drucker, M.B.A., CFP, a financial advisor since 1981, sold his practice 20 years later to write, speak and consult with advisors. His latest book is The One Thing... You Need to Know from Each of the Industry's Most Influential Coaches, Consultants and Visionaries. For more information, visit