Fidelity Bonds

The fidelity bond is a member firm's insurance against insider losses. It does not cover market risk, customer-relationship losses, or fraudulent investments.

The rule generally covers members required to join SIPC, subject to specified exemptions. Required insuring agreements address fidelity, on-premises losses, transit, forgery and alteration, securities, and counterfeit currency. Actual recovery depends on the policy's terms.

What the Bond Covers

A fidelity bond insures the firm against specified employee-related and operational perils:

• Employee dishonesty (theft, embezzlement, fraud by employees)
• Misplaced or lost securities certificates
• Forgery of signatures on customer or firm documents
• Other specified perils (e.g., computer-system fraud, transit losses)

The bond does NOT cover:

• Customer market losses (decline in value of investments)
• Customer-suitability losses (poor recommendations)
• Operational errors that do not involve dishonesty (clerical mistakes that do not rise to fraud)

Think of it this way: The fidelity bond is the firm's protection against the people working at the firm. It assumes that even with good controls, an employee somewhere will at some point steal, forge, or otherwise misappropriate. The bond is the financial backstop that lets the firm cover the loss without depleting its capital. The fidelity-bond requirement ensures every firm has that backstop in proportion to its size.

Minimum Coverage Tiers

Coverage scales with the firm's net capital requirement (NCR) under the net-capital rule:

The "Greater of" Test for Small Firms

For firms with NCR less than $250,000, the bond floor is the greater of:

• 120% of the firm's NCR, OR
• $100,000

A firm with a $50,000 NCR (introducing firm) faces:

• 120% of $50,000 = $60,000
• vs. $100,000 floor
• The greater is $100,000, so the bond must be at least $100,000

A firm with a $200,000 NCR faces:

• 120% of $200,000 = $240,000
• vs. $100,000 floor
• The greater is $240,000, so the bond must be at least $240,000

The Table for Larger Firms

Firms with NCR of $250,000 or more use the table. A requirement of $250,000–$300,000 requires $600,000 in coverage; $300,001–$500,000 requires $700,000; and $500,001–$1 million requires $800,000. Higher bands increase to a $5 million required minimum for NCR above $12 million. A firm may purchase more than its required minimum.

Exam Tip: Gotchas

• For firms with NCR less than $250,000, the bond is the GREATER of 120% of NCR or $100,000. Common exam trap: students forget the $100,000 floor and apply only the 120%. A firm with a $50,000 NCR has a $100,000 bond requirement, not $60,000.
• Use the applicable net capital requirement, including the dollar minimum, aggregate-indebtedness test, or alternative standard as applicable. Actual excess capital does not itself set the bond requirement. Do not assume the dollar minimum controls when a ratio requires more.

Per-Loss Coverage and the No-Aggregate-Limit Requirement

The ordinary requirement for covered members is per-loss coverage with no aggregate limit of liability, regardless of capital tier. A member that does not qualify for that coverage may use the rule's alternative: substantially similar coverage complying with all other provisions, supported by written correspondence from two insurance providers stating that the member does not qualify for the ordinary coverage. The correspondence must be retained as required.

What "Per-Loss" Means

Per-loss coverage means each separate loss event is covered up to the bond's per-loss limit. The firm can recover for multiple loss events without depleting a shared aggregate cap. This contrasts with a typical commercial insurance policy that has both a per-loss limit and an aggregate annual limit.

Why No Aggregate Limit

Without the no-aggregate-limit requirement, a firm hit by multiple losses in the same policy year could exhaust its aggregate cap and be left without coverage for later losses. The fidelity-bond requirement's structure ensures each loss has its full coverage available, regardless of how many other losses have occurred.

Exam Tip: Gotchas

• A commercial aggregate cap fails the ordinary requirement. Check the specific alternative-coverage conditions before concluding that an aggregate limit is prohibited in every circumstance.

Deductibles: 25% Cap with a 10% Trigger

The bond may include a deductible up to 25% of the coverage amount. Any deductible above 10% must be deducted from net worth in the firm's net-capital computation under the net-capital rule.

The Logic of the 10% Trigger

The 10% level is a trigger, not a free allowance. Once the elected deductible exceeds it, the entire deductible is charged. For a subsidiary of another FINRA member, the amount may be deducted from the parent's net worth if the parent guarantees the subsidiary's net capital in writing.

Example: A $1 million bond with a 15% deductible has a $150,000 deductible. Because 15% exceeds 10%, the net-worth deduction is $150,000, not $50,000.

Exam Tip: Gotchas

• The deductible is capped at 25% of coverage. A firm cannot satisfy the fidelity-bond requirement with a 30% deductible. The exam may probe higher deductible levels; 25% is the ceiling.
• Deductibles above 10% trigger deduction of the entire elected amount, not just the portion above 10%.

Annual Recalibration

The annual review uses the highest applicable net capital requirement in the preceding 12 months, including the applicable dollar or ratio method. The permitted lookback includes a 12-month period ending 60 days before the bond anniversary. Multi-year policies still require annual review. FINRA may grant specified annual-review exemptions for good cause, and a special second-year calculation applies to eligible firms using the aggregate-indebtedness method.

Why "Highest" and Not "Current"

A firm's NCR can vary during a year as the firm's business mix changes (e.g., from introducing-firm status to carrying-firm status). The rule prevents firms from gaming the bond floor by shrinking back to a smaller NCR for the bond-renewal period. The bond is sized to the firm's peak NCR over the prior 12 months.

Renewal Process

Each year, the firm:

1. Reviews its NCR over the prior 12 months
2. Identifies the highest NCR reached during that window
3. Sizes the bond to satisfy the fidelity-bond requirement's tier for that highest NCR
4. Renews or amends the bond to reflect the appropriate coverage

Exam Tip: Gotchas

• The bond is sized to the HIGHEST net capital requirement during the prior 12 months, not the current NCR. A firm whose business shrank during the year does not get to lower its bond to match the lower current NCR; the bond must still cover the peak.

What Should You Check on Exam Day?

• Can you state the fidelity bond formula for a firm with a net capital requirement under $250,000, the greater of which two amounts?
• Do you know the 25% deductible ceiling and when the entire deductible reduces net worth?
• Can you state which 12-month figure, current or highest, sets a firm's fidelity bond coverage floor for the next year?
• Can you distinguish ordinary per-loss coverage from the documented alternative-coverage conditions?