If Your E&O Insurance Doesn’t Cover Crypto Investing Blow-Ups, Kiss Your Business Good-Bye in the Next Black Swan Event
“Go to hell, you old dinosore [sic]. Check out REAL crypto experts on TikTok.”
This is just one of a large number of surprisingly hostile messages I received from my last column for WSR, “The Crypto Craze Could Murder Financial Advisors’ Careers.”
And believe it or not, this was one of the more PG-rated emails that I received. Apparently, there are certain industry crypto enthusiasts whose passion for the product supersedes their ability to spell.
Let me be clear: Contrary to the reactions of these crypto fans, I am not a hater of cryptocurrencies – In fact, I don’t hate or love any investment.
As a compliance and supervision professional, I have to look at the reasons why investors want to commit their money to certain investments. Are the reasons rational? Or are they inspired by irrational exuberance?
And as a strategic advisor to independent wealth management firms, I have to ask: Does irrational exuberance around a specific new product open the door to escalated business risk for firms and the businesses of their affiliated financial advisors?
The Latest and Biggest Potential Crypto Blind Spot – E&O Insurance
These questions have assumed a magnified importance in light of the latest – and potentially most significant – crypto blind spot for financial advisors that has emerged in recent months.
What’s that, you may ask?
Well, as firms and financial advisors explore renewal of their error and omissions (E&O) insurance coverage for the following year, it is increasingly clear that many existing E&O policies – especially lower-cost and off-the-shelf E&O solutions – do not explicitly cover cryptocurrency transactions in all its many forms.
Typically, wealth management firms and their financial advisors have error and omissions insurance (E & O insurance) to protect against lawsuits and regulatory actions that can result in significant financial damages. Among other functions, E&O insurance policies can cover paying any such damages, so that firms and advisors don’t face an existential threat in the face of such regulatory or legal challenges.
Think of E&O insurance as the ultimate financial safety net for firms and advisors when, despite the best of intentions, investment recommendations don’t create the outcomes desired by clients, who then seek – and win – legal or regulatory recourse.
Read the Fine Print in Your E&O Policies!!
Most financial advisors won’t notice these details when a particular asset class not covered by E&O insurance is going through a wave of popularity, with multiple investment products being created around the asset class, from ETFs, to SMAs, to TAMPs, and beyond.
During moments like these, it’s easy to succumb to pressure from clients about getting them into the asset class so they don’t miss out on the action.
But black swan events are inevitable. And, as with every asset class – especially newly emerging asset classes where the quality of product is highly variable – a black swan event that burns investors creates legal and regulatory feeding frenzies towards the firms and advisors who placed clients in that product.
For wealth management firms and financial advisors placed in such a situation, just remember this: If your E&O policy doesn’t clearly cover a specific asset class or product transactions within that asset class, good luck getting the insurer to cover legal and regulatory penalties.
I’m Not Here to Rain on Your Parade
One other item I’d add: This old “dinosore” frequently scans social media platforms to observe the information being disseminated by “influencers” and other people that old investors and horse racing enthusiasts alike would call touts. In fact, I’ve been checking out TikTok since the platform was first launched.
And as somebody who is extremely familiar with crypto influencers and their touts via TikTok, let’s just say the overwhelming majority of their claims are beyond lunacy.
TikTok and other social media crypto afficionados throw out modern terms like blockchain, mining, NFTs, and so forth with the tenor of a carnival barker. None of them discuss risk. None.
These same influencers scoff at 10x returns, and show icons of dogs and fish and other memes as if each of these images are the Mona Lisa. I have seen hundreds of videos on how to convert a stick figure drawing into millions of dollars simply by uttering the letters NFT.
They love to show themselves off in their (probably rented) mansions, driving their (probably rented) Lamborghinis, all while proudly proclaiming that they will never have to work another day in their lives thanks to the miracle of cryptocurrencies.
Hate mail or love mail, I tremendously enjoy getting responses from my readers. Worst case scenario, you dismiss my perspectives. No harm done there. Best case scenario, I’ve provoked some thought on how to protect your businesses and your clients.
And at the end of the day, that’s my job: To protect wealth management firms and financial advisors from decisions on client service that will harm everybody in the equation.
I can’t do much for DIY investors, but I can warn brokerage firms and their financial advisors of potentially disastrous consequences if they don’t pay attention to various key details of their business. Forewarned is forearmed!
Sander Ressler is Managing Partner of Essential Edge Compliance Outsourcing Services, LLC, a national consultancy that delivers comprehensive compliance supervision solutions to independent broker-dealers, Super-OSJ groups and hybrid RIA firms