Advisors using Schwab as a custodian will now be required to show proof that they have a $1 million errors & omissions (E&O) insurance policy, according to an email the financial services giant sent out yesterday.

The Schwab directive also requires advisors to obtain and maintain coverage for “social engineering, theft by hacker incidents, and theft by employee (if applicable),” according to a copy of the email obtained by Financial Advisor magazine.

“Each firm needs to have an aggregate minimum of at least $1 million of coverage,” said Schwab, adding that the firm has seen “an uptick in risks.”

E&O insurance, also known as professional liability insurance, can help cover the cost of lawsuits related to performance, a sign that Schwab is at least doing strategic planning for a market downturn.

“There are probably a lot more RIAs than we know who don’t have a E&O policy or Schwab would not have issued this requirement,” Scott Salaske, founder and CEO of FirstMetric, a RIA firm. "A part of it is they’ll be named in any lawsuit so if they can push that on advisors' insurance rather than eating it down the road, that’s good practice."

“This is good. Maybe other custodians will follow," he added.

A senior Schwab executive said the move was prompted by the growing operational risks both Schwab and RIAs face alike. “Independent advisors have been growing quickly, and while this growth and success is overwhelmingly positive for investors and RIAs alike, it does bring increased operational risks as firms expand and day-to-day operations become more complex,” Ian Muir, Managing Director, Advisor Controls and Trading, Schwab Advisor Services, said.

“This complexity, combined with rising industry fraud, cybercrime and trading volatility, means it is critical for advisors to evaluate how well their firm is protected. Schwab believes that insurance is a vital component to managing risk at Schwab and in advisors’ businesses and is consistent with the commitment to being a fiduciary for clients. Coverage protects a firm and its clients from the unexpected, transfers risk away from the firm’s balance sheet and advisors’ personal assets, and can provide coverage for legal costs, settlements, and the costs of operational errors,” Muir added.

Schwab also told Financial Advisor magazine it is currently working with a selected group of insurance providers to secure preferred pricing for Schwab clients. “More details about these providers will be available beginning in November,” the firm said.

Salaske said that most E&O policies don’t have coverage for all the new Schwab requirements, so “additional coverage through a fidelity bond, sometimes referred to as a financial institution bond, will be required as well.”

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