E&O Fraud At FINRA Member Firm Leaves Brokers E&Owing

May 15, 2012

A tightrope walker  performs on July 28, 2010 ...

You know that E&O safety net that you think you paid for?

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Ann Gay Phelps submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted.In the Matter of Ann Gay Phelps, Respondent (AWC 2010023780201, May 11, 2012).

Phelps entered the securities industry with PaineWebber in 1983 and joined Omnivest, Inc. in 1988. She held registrations as a General Securities Representative, General Securities Principal, and an Introducing Broker/Dealer Financial Operations Principal.  During the times relevant to this AWC, Phelps owned half of Omnivest and was the firm's operating partner, Chief Compliance Officer, and FINOP.

In late August 2009, Phelps sent a letter to the Omnivest's registered representatives informing them that each representative was required to pay $1,389 to the firm for the purchase of an Errors & Omissions ("E&O") insurance policy. Shortly thereafter, Phelps began deducting $1,389 from their commission accounts or by obtaining checks from them made payable to Omnivest. During the relevant period of August 2009 through March 2010, Phelps purportedly collected $33,336 from twenty-four Omnivest representatives at Omnivest for payment of the E&O policy premium. The collected funds were deposited into Omnivest's operating account (over which Phelps had control) and commingled with other Omnivest funds.

The AWC alleges that Phelps used the representatives' purported premium payments for both Omnivest and personal expenses. Among the alleged misuses of the E&O earmarked funds were to pay Phelps and her husband, and to pay the couple's personal credit card accounts.

The AWC alleges that in furtherance of her scheme, Phelps sent false and misleading letters to three registered representatives in response to their requests for proof of individual E&O coverage, which they needed in connection with their selling arrangements with certain insurance carriers. Although no such coverage existed, two of those letters dated October 12, 2009, and one dated March 18, 2010, stated:

[Registered Representative] carries E&O through the broker/dealer OmniVest, Inc. The policy is currently pending and we are awaiting the declarations page. [Registered Representative] has in fact paid for the coverage in full with the broker/dealer. Should you have any questions, please feel free to call me at any time.

Contrary to Phelps' representations,  Omnivest's prior E&O policy had been in force from August 2008 through May 2009, when the carrier cancelled the policy as a result of Phelps's failure to pay the required premiums. As of August 2009 when Phelps notified the registered representatives of the E&O premium payments and implemented a system to collect those fees, no such policy was in effect.

In accordance with the AWC, FINRA imposed upon Phelps a bar from association with any FINRA member in any capacity.

Bill Singer's Comment

Marsh U.S. Consumer, a service of Seabury & Smith, Inc., FINRA's insurance program administrator, is a third-party provider of insurance products, and the company provides the following explanation on its website:

Exposures and Risks

Without adequate Errors & Omissions Liability Insurance, your firm and its representatives could be at risk from the following:

Capital Depletion - Securities firms are required by the SEC to maintain a minimum net capital requirement position as outlined in SEC Rule 15C3-3. A successful client suit, if substantial, could impair the firm's ability to comply with the rule and thus maintain its operation.

Personal Assets - Registered representatives of securities firms are often not entitled to indemnification from the firm, and in many instances are required to make the firm whole for losses incurred by their actions. Having E&O insurance protects your representatives, provides a unified defense and preserves the working relationships between the registered representatives and the firm's management.

Defense Cost Expenses - Legal costs associated with a defense in litigation and/or arbitration can be substantial. Large amounts of time and money can be spent on claims no matter what their outcome.

E&O Liability Insurance can protect your firm against financial loss from the following claims:

Failing to supervise a registered representative.

Recommending an unsuitable or misrepresenting investments.

Breach of Fiduciary Duty.

Giving insufficient notification on a margin call.

Violating a client agreement.

Failing to inform regarding the impact of the tax laws on a recommended security.

Optional Coverages

Trade Error/Cost of Corrections


M&A Activity


 How does E&O insurance differ from Fidelity Bond coverage?

E&O Insurance provides protection for the insured with certain limitations for mistakes and unintentional acts or violations of regulatory statutes - (such as suitability or Fiduciary standards) whereas Fidelity Bonds provide coverage to the insured from criminal activity such as theft of customer funds, or forgery by an employee or Registered Representative.

  How could Errors & Omissions Liability Insurance protect my firm?

Errors & Omissions Liability Insurance can provide important supplemental coverage to your general liability policy, and can help protect your firm's assets from the costs associated with lawsuits alleging errors or omissions on the part of your firm or its registered representatives. E&O coverage includes legal defense costs for covered professional services. E&O Liability Insurance will also pay for customer settlements for covered claims against your firm, including court costs, up to the coverage limits on your policy.