Compliance is painful. Like going to the dentist, or paying your taxes, it’s a duty many tolerate while spending as little time as possible. That’s the main reason why so many Managers are frankly spending too much on the bonding coverage required by NI 31-103 and companion policies.

Is your firm guilty of “over-bonding”? Take a moment to ask yourself these questions:

• Do you know how regulators calculate the amount of Financial Bond coverage that you need?
• Do you know what constitutes a “material” increase or decrease prompting a change in your coverage requirements?
• Do you know what your Financial Bond actually protects?

If you don’t know the answers to these questions, then you probably also don’t know if your level of bonding is sufficient … or possibly over-sufficient.

Key misconceptions

National Instrument 31-103, section 12.3 outlines a complex formula for calculating your bond insurance requirements. The tricky part of the equation concerns “control” of client assets. You can actually still be considered to have control even if you don’t custody any client assets directly! In fact, there are many criteria that must be checked to determine which assets should considered under your “control” for the purpose of this formula.
Furthermore, many registered dealers assume that their bonding functions as crime insurance, and that it will be there to protect them if their clients’ money is lost due to fraudulent or criminal activity. With this assumption in mind, they feel good about maintaining a high level of bonding coverage. This is far from accurate.
In fact, the purpose of the bond is NOT to protect your clients’ money. The Financial Bond, in most cases, excludes client assets, especially when there is third-party custody, which applies in the majority of cases. The true purpose of the bond is to keep the Manager operational in the event that you become insolvent if your working capital is stolen. This bond ensures that your firm will have money to pay salaries, keep the lights on and the phones answered if and when you go out of business. As you might imagine, the financial requirements and capital needed to keep the lights on might be significantly smaller than the financial requirements of replacing your clients’ stolen money.

Which brings up a new question

Now that you understand the purpose behind your Financial Bond and what it actually protects, you may be wondering … If this bond doesn’t provide coverage if our clients’ money is lost due to fraud or crime, how is my firm protected against that exposure? This is an important question, indeed.
The answer is that there are other types of insurance you need to protect against a wide range of crime, cybercrime and professional liability exposures. Furthermore, if Managers stop over-paying for bonding, they can shift their insurance investment into areas with greater risks.

Next steps

First, if you haven’t taken an in-depth look at your bonding and insurance coverage allocations by exposure, now is a great time to do so.
There are methodical approaches, that if consistently used, can help you pay less for the Financial Bond. Furthermore, the COVID pandemic has created a spike in cybercrime. In addition, a multitude of factors are driving a hard insurance market, causing rates to go up and coverage capacity to shrink in many verticals. You don’t want to want to be caught off guard. Managing cyber coverage will be much easier in a renewal process than as a first-time buyer.
Reach out to your insurance partner or contact Joseph Mekhael for an assessment. We specialize in protecting Portfolio Managers, Private Funds, Multi-Family Offices, Dealer Firms and VC/PE Firms with a targeted and tailored approach.
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