The collapse of three banks over the course of a week has sent shockwaves throughout the global financial system. What does it all mean for investment managers, their funds, and their insurance programs?
While the situation continues to develop rapidly, this article highlights the key issues registered advisers and funds should consider when reviewing their private company directors’ & officers’ and errors & omissions (or professional indemnity) (D&O/E&O/PI) liability programs (“investment management liability insurance”) through the lens of these recent events.
On Friday, March 10, 2023, the California Department of Financial Protection & Innovation (DFPI) closed Silicon Valley Bank (SVB) and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver of the bank. This has resulted in the largest U.S. bank failure since Washington Mutual was shuttered in 2008 during the financial crisis. The dramatic collapse of SVB over the course of a just few days shocked the banking system and the customers it serves.
Confidence in the banking system is shaken. In addition to SVB, crypto bank, Silvergate Bank announced that it would voluntarily liquidate on March 8, 2023, while another crypto-friendly bank, Signature Bank, was taken over by the New York Department of Financial Services on March 12, 2023, in conjunction with the decision to backstop SVB. The closures of Silvergate Bank and Signature Bank now leave crypto companies searching for banking partners.
The implications of these events is being felt throughout the financial sector. Within the investment management industry, registered funds with meaningful exposure to SVB and Signature Bank experienced significant losses following the banks’ failure. Notably, funds with significant exposure to the broader banking sector, especially the regional banking sector, also realized sharp declines1.
Significant market events that negatively impact investment performance, such as those witnessed over the past week, may result in claims activity under investment management liability insurance programs. Such claims often come in the form of civil lawsuits and/or regulatory proceedings and may name the adviser, the funds, or both. Allegations may include misrepresentations and/or omissions by the adviser as it relates to the investment strategy, objectives and/or risks of a fund, and failure to provide proper oversight by the fund board of directors/trustees.
While any claim must be assessed against an insured’s specific insurance policy, the D&O component of investment management policies is generally intended to respond to claims made against the adviser’s individual directors and officers, as well as the entity itself, alleging certain wrongful acts in the management/mismanagement of the organization, while the E&O/PI component is generally intended to respond to claims made against the adviser alleging errors and/or omissions in the performance of, or failure to perform, investment management services. Similarly, many investment management liability policies include coverage for the advisers’ sponsored funds and are generally intended to respond to claims made against the fund directors, as well as the funds themselves, alleging a failure to provide proper oversight of the fund and fund services providers, including the investment adviser.
Accordingly, most well-endorsed investment management liability policy forms should generally respond to regulatory or investor claims (subject to policy terms and conditions). Coverage typically applies to defense and legal expenses, as well as judgements and settlements, incurred as a result of such claims. It is important, however, for insureds to review the scope (and limitations) of coverage available for such matters, especially with respect to formal and informal regulatory investigations. Lastly, it is imperative that insureds review and comply with claims reporting obligations applicable to these policies, as a failure to report claims in a timely manner may jeopardize coverage under the policy.
The market volatility that often follows significant events, such as the SVB collapse, often leads to a subsequent increase in trading activity. With greater trading activity comes the potential for trading errors and, in turn, an increase in Cost of Corrections and Mitigation claims. Typically included within the investment management insurance policy form or added by endorsement, Cost of Corrections and Mitigation coverage is intended to reimburse the adviser for certain costs it incurs in rectifying errors (e.g., trading errors) that, if not corrected, would result in an otherwise covered claim under the policy (subject to the policy terms and conditions). The breadth and scope of Cost of Corrections and Mitigation coverage will vary by insurer, but most impose strict reporting obligations upon the insureds. The failure to comply with these obligations may cause the insurer to disclaim coverage for Cost of Corrections and Mitigation claims due to late reporting.
These events are likely to generate questions from underwriters in advance of the investment management liability insurance renewal. While the specific questions and concerns will depend upon an insured’s unique risk profile, insureds should be prepared to address, at a minimum, their exposure to SVB and to the banking sector more broadly (including to regional banks), any communications or interactions with regulators on these issues, and whether any investors have raised concerns about their impacted investments, and if so, how the insureds addressed those concerns. Proactive engagement with your insurance broker on these issues may help mitigate any expected challenges in advance of the investment management insurance renewal.
WTW’s global Financial, Executive and Professional Risks team (FINEX) will continue to monitor the progress of these events and provide our clients with updates as they develop. If you have any questions or concerns in the interim, please contact your WTW broker.
1 Which Funds Are Taking the Biggest Hit on Silicon Valley Bank and Other Bank Stocks?
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