United States: Disgorgement Not Always Uninsurable: New York Trial Court Holds Bear Stearns' 2006 "Disgorgement" Payment To SEC Covered Loss

Authored by Darren S. Teshima and Joseph Trujillo.

The New York Supreme Court disposed of a longstanding dispute between J.P. Morgan and the insurers of the now defunct Bear Stearns, rejecting the insurers' various arguments to avoid indemnity coverage for a $160 million payment made by Bear Stearns in connection to a 2006 settlement with the Securities and Exchange Commission ("SEC") and New York Stock Exchange. As previously discussed in our August 2016 post about the prior motion for summary judgment order in this case, that settlement resulted from allegations that Bear Stearns, through its brokers, had facilitated late trading and deceptive market timing practices.

In a 36-page decision, Justice Ramos of the New York Supreme Court addressed the parties' cross-motions for summary judgment, rejecting all six of the insurers' remaining arguments disclaiming coverage.

Justice Ramos first considered whether the $140 million portion of the $160 million settlement payment, labeled as "disgorgement" in the 2006 SEC Settlement Order, was uninsurable. Relying on a 2013 Court of Appeals decision (analyzed in our July 2013 post), the Court held that it was not.  Justice Ramos reasoned that while the SEC labeled the payment "disgorgement," the evidence did not conclusively establish that it was linked to "improperly acquired funds in the hands of the insured."  The Court recognized that under the policies' broad definition of the "loss," which includes both "'damages' and 'other costs' that the insured is legally obligated to pay," the $140 million portion of the payment may trigger coverage, "provided that this payment represented the gains of third parties and not Bear Stearns."  Reviewing the evidence presented, including Bear Stearns' communications and negotiations with the SEC, the Court found that the $140 million portion of the payment reflected an estimate of those unlawful gains allegedly received by Bear Stearns' customers, and not Bear Stearns itself.

The Court also relied on the fact that Bear Stearns' clients benefited from the alleged late trading to reject the insurers' argument that the personal profit exclusion barred coverage. The insurers contended that because $20 million of the $160 million payment represented the revenues that Bear Stearns received from allegedly facilitating its customers' late trading, this exclusion barred coverage for the remaining $140 million in ill-gotten gains received by the customers as a result of the late trading.  The Court rejected this argument, interpreting this exclusion to apply to profit gained by Bear Stearns "'in fact,'" which the $140 million portion of the payment did not reflect.  The Court added that adopting the insurers' interpretation of the personal profit exclusion would eviscerate coverage "for any securities violation under the policies."

The Court also considered whether the policies' insured capacity exclusion was triggered on the ground that the claims against Bear Stearns depended upon the liability of its customers, who were not parties to the policies. The Court described this theory as a mischaracterization, concluding "with certainty" that the underlying claims were brought against Bear Stearns in its capacity as an insured.

The insurers' remaining arguments—premised on intentionally wrongful harm, unreasonableness, and supposed prior known acts—were stopped short by a lack of evidentiary support, particularly in the 2006 SEC Settlement Order. While the Court's rejections of those former two arguments were routine, its holding on the third was notable.

Relying on a factual finding in the 2006 SEC settlement order that Bear Stearns' "timing desk knowingly or recklessly processed thousands of late trade," some insurers posited that Bear Stearns officers knew of the trading practices at least several months before their policies' inceptions. The Court rejected this position because of ambiguity in the meaning of the term "officer," which was undefined in those excess policies.  The Court refused to adopt the insurers' definition of the term, which would include any Bear Stearns employee whose job title used the term "officer."  It instead adopted the policyholder's interpretation, which focuses on whether the Bear Stearns employee performed "important executive and managerial duties."

This decision is unlikely to be the last chapter in the parties' litigation. Indeed, the July 2016 motion for summary judgment decision (the topic of our August 2016 post), which held that an insurer may not object to an insured's unapproved settlement of a claim if that insurer improperly disclaimed coverage, is still under review by the New York intermediate appellate court.  Regardless, this decision provides a helpful explanation for understanding that a settlement payment, even if labeled as "disgorgement," is not necessarily one of uninsurable disgorgement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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