Bonding Considerations for Advisors
By Greenwich Compliance, an Interactive Brokers company
In Part 1 (Do RIAs Need Liability Insurance?) of this two-part article series, we explored the various errors & omissions insurance policies registered investment advisors (RIAs) might consider. Going hand-in-hand with these insurance policies are bonding considerations. While the federal government does not require RIAs to hold insurance policies, some states do require investment advisors to post a bond in certain circumstances. We’ll discuss these requirements in this article.
State surety bonds
Unlike the Securities and Exchange Commission (SEC), some states impose net worth and bonding requirements on RIAs. Many states have adopted the following approach:
- Advisors with “custody” of client funs and/or securities must maintain a minimum net worth of $35,000.
- Advisors with discretionary trading authority, but no custody, over client funds/and or securities must maintain a net worth of $10,000
- Advisors allowing clients to prepay advisor fees of more than $500 per clients and six or more months’ worth of fees must always maintain a positive net worth
- Advisors with “custody” of, or discretion over, client funds or securities who do not meet the net worth requirements listed above may obtain a bond to cover the deficiency (up to the nearest $5,000)
- This surety bond is essentially an agreement by the insurance carrier to take on secondary responsibility for a default or debt of the investment advisor. The bond makes funds available in case the state or advisor’s clients sue for damages resulting from the advisor’s violation of the state’s security laws or other conditions of the bond.
- State securities regulators often require the surety and/or its agent to execute a bond form or affidavit.
- The bond must be issued by a company qualified to do business in the state, and the bonded funds must be available for claims of all of the advisor’s clients regardless of their state residence.
Find the Model Rules on these net worth and bonding requirements on the North American Securities Administrators Association website.
Advisors should be aware that not all of the states have adopted the NASAA model rules on net worth and bonding, and stricter requirements may apply. For instance, some states require a bond (sometimes as high as $50,000) to be posted by all investment advisors maintaining custody or discretionary authority over client accounts, while others only require those same advisors to maintain a minimum net worth or a bond in the same amount as the required minimum net worth. Some states require all investment advisors registered in the state to maintain a surety bond. Other states require that all advisors, regardless of whether they have custody or discretionary authority, be solvent and maintain a positive net worth. And some states require advisors to submit copies of the surety bond to the state securities regulator.
When an advisor does business in multiple states with different state provisions on net worth and bonding, the advisor may take advantage of the federal home state rule. That rule provides that advisors registered and in compliance with the minimum net worth and bonding requirements of the state where the advisor has its principal office do not need to meet the (higher) requirements of any other states where the advisor does business. 15 U.S.C. § 80b-18a(c).
Because state rules on net worth and bonding requirements vary widely, advisors should research their state’s specific requirements and/or consult legal counsel on this issue.
ERISA fiduciary bonds
Section 412 of the Employee Retirement Income Security Act of 1974 (ERISA) requires every fiduciary responsible for managing a pension, profit-sharing or thrift plan and every individual or entity handling the assets of these plans to be bonded. Registered broker-dealers subject to the bond requirements of a self-regulatory organization, and certain trusts and insurance companies, are exempt from this requirement.
Investment advisors may be subject to ERISA’s bonding requirement if they provide investment advice to ERISA plans for a fee (or other remuneration) or have the right or power to exercise discretionary authority over purchases and sales of plan assets. The ERISA bonding requirement may also apply to advisors providing these services to an ERISA plan participant directly, if the plan allows the participant’s advisor to make investment decisions for some or all of his assets with the plan.
The bonding requirement protects a plan’s assets against loss due to fraudulent or dishonest behavior. The bond must be at least 10 percent of the amount of funds handled by the fiduciary up to a maximum of $500,000 per plan and a minimum of $1,000. If the plan holds employer securities, the cap is $1,000,000 (for plan years after Dec. 31, 2007).
Have a question about insuring your advisory business? Greenwich Compliance can help! Submit your inquiry to [email protected] and one of our trained staff members can help.
Disclaimer: The information in this article is intended to provide investment advisors with basic, general information on the insurance options available to them. Advisors should consider consulting with legal counsel and/or and insurance broker to determine the type, scope and amount of insurance coverage most appropriate for their investment advisory services and clients. Please keep in mind that insurance is heavily regulated by the states, and advisors should research the applicable provisions in their state(s) and keep informed of changes in state law.