I Gave Bad Advice as an Advisor. Am I Financially Liable?

Financial investment advisors are critical in their clients’ lives. By leveraging their professional expertise, they can help families and individuals prepare for major life transitions — such as the birth of a child, a home purchase, retirement or marriage — and progress toward important financial goals.

But what happens if their insight isn’t so…insightful? What if a registered investment advisor (RIA) or investment advisor representative (IAR) gives bad, wrong or negligent advice?

As an advisor, you’re legally and financially responsible for the advice you give. If you make an improper or ill-advised recommendation to your client, and they experience a loss, they’d be within their rights to sue or file a claim against you. At the same time, even if a risky financial maneuver defies the odds and pays off for a client, they may still choose to pursue litigation if they feel you didn’t exercise due care or misrepresented the risk involved.

Your clients make important life decisions based on your words. If you misspeak or make a mistake while providing professional services, they may be entitled to financial compensation to be made whole again. Continue reading for examples of advisor blunders and how they can result in costly claims, plus discover the benefits of Errors and Omissions (E&O) Insurance in protecting your business, reputation and finances.

‘Business Opportunity’ is a Scam Investment

You know the common saying, “If it sounds too good to be true, it probably is.” In this real-life example, the SEC brought a Massachusetts investment advisor to court, resulting in penalties totaling more than $530,000 after he allegedly persuaded two of his clients, elderly retail investors, to partake in an opportunity in Turkey that was actually a scam.

The SEC alleged the advisor’s involvement began in 2016 after an acquaintance told him about an American woman living in Turkey who needed money to pay attorneys working to secure the release of her father’s $6 million estate.

Despite failing to confirm the woman’s identity or the existence of legal proceedings and being told by two banks the transaction was probably a scam, the advisor encouraged a long-time friend and retail client to invest, claiming a “100% return” on his investment. The advisor spent $10,000 of his own money, with the client wiring more than $135,000 to various people in Turkey at his advisor’s direction. A second client’s account, for whom the advisor served as a trustee, contributed $28,100.

Unsurprisingly, the advisor’s clients did not receive their promised payday. Their money was in the hands of international scammers. Professionals must exercise all due caution and care when evaluating investment opportunities, lest they end up with an investment advisor E&O claim orregulatory complaint. By not properly evaluating this scam — and failing to heed the banks’ warnings or disclose that information to his clients — his mistakes lost his clients’ significant assets and drew the ire of the SEC.

While E&O insurance can provide significant benefits during litigation, such as assistance with defense costs and court-ordered award settlements or amounts, it likely does not cover intentional mistakes. Because the advisor was cautioned by two banks regarding the potential scam and disregarded their warnings, it’s possible an E&O carrier would view his mistake as intentional and deny coverage.

Small Mistakes, Big Headaches

Not every piece of bad advice from an advisor results in an SEC investigation. Unhappy clients will pursue litigation if they experience a loss or feel you have acted negligently in some way. Here are some examples of bad advice and their potential impacts:

• Risky stock doesn’t pay off – Everyone’s comfort with risk differs. Let’s say you sign on an elderly client uncomfortable with undue risk. Despite this, you recommend an aggressive, high-risk investment to deliver higher returns. In spite of their discomfort, your client believes you know best as a professional. It turns out their trust was misplaced, as the value of your risky stock suddenly plummets due to market changes, resulting in a significant loss for your client. In this situation, your client could file a claim for unsuitability after you recommended an inappropriate strategy for their profile and needs.
• Disregarding client wishes – Clients may prefer or avoid certain stocks for various personal reasons. Suppose a client puts on the record that they want to avoid purchasing any pharmaceutical-related stocks. Regardless, you recommend major investments in companies like Pfizer and Eli Lilly due to their positive performance. Because your client communicated their desire to avoid such stock in writing, this mistake can be considered a breach of contract. Upset at your apparent disregard of their wishes, the client closes their account and takes you to court so they can recoup their investment.
• Overconcentrating stocks – Having a significant portion of a client’s investment portfolio tied up in a single stock, sector or asset class can significantly increase their risk. Like the adage, “Too many eggs in one basket,” investing too much in one sector can result in greater loss during a downturn. Let’s say you notice an up-and-coming energy company is skyrocketing in value, and you convince a client to purchase its stock and only its stock. As the value increases, you continue to push to invest. Then, the unexpected happens: The company collapses. All of that value — and your client’s investments — is lost in a moment. If you had taken the time to diversify your client’s portfolio, you could have softened the blow. Instead, putting all your trust in one company destroyed your client’s confidence in you and their finances. If severe enough, this bad advice could be considered a breach of fiduciary duty.

Some Good Advice for RIAs

Now that you understand the pitfalls of providing bad advice, here’s a piece of good advice for RIAs: Enroll in E&O Insurance to protect your business from the impact of bad advice. Mistakes are a fact of life, but as a professional, these events can damage your reputation, harm your firm’s finances and inhibit your ability to do business. Some issues, if caught early enough, can be resolved before they become litigation, but having this protection and a plan in place is a powerful safety net that provides valuable peace of mind.

RIA E&O Insurance from NAPA Premier starts at $72.08 per month, with different coverage options and limits of liability levels available depending on the services you provide. Coverage extends to your clerical and administrative staff, such as employed IARs and independent contractors, ensuring those acting on behalf of the firm are protected in the event of an RIA E&O claim. Learn more about RIA E&O Insurance from NAPA Premier today, or schedule your free consultation to speak with a policy expert to discuss your insurance needs.

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