A California appellate court has held that the application exclusion of a broker-dealer’s professional liability policy barred coverage for claims by customers who invested in the same Ponzi scheme involved in a previous claim. Crown Capital Securities, L.P. v. Endurance Am. Spec. Ins. Co., 2015 WL 1607164 (Cal. App. Ct. Apr. 10, 2015).

The broker-dealer received a claim by a customer alleging that the broker-dealer had failed properly to investigate investments in a real estate firm that had filed for bankruptcy and was alleged to have been running a Ponzi scheme. The broker-dealer later submitted an application for professional liability insurance that asked if any claims had been made against the entity. The broker-dealer answered “yes” and submitted a loss run from its prior insurer containing the claim by the customer. The application also asked if the applicant was aware of any fact, circumstance, situation, or accident that may result in a claim. The insured answered “no.” The application contained an “application exclusion” barring coverage for “any claim or lawsuit . . . arising from any fact, circumstance, act, error or omission disclosed or required to be disclosed in response” to those questions. After the policy was issued, three additional claims were made by customers of the insured broker-dealer who invested in the same real estate firm. The insured sought coverage under the professional liability policy, contending that each of these claims involved a separate investment that did not “arise out of” the prior investment in the real estate firm that was at issue in the initial claim. The insurer denied coverage pursuant to the terms of the application exclusion, and coverage litigation ensued.

The California appellate court rejected the insured’s argument and held that coverage was precluded by the application exclusion contained in the policy. In so holding, the court concluded that the insured was aware, prior to the submission of its application for insurance, that (1) the real estate firm had declared bankruptcy and allegedly had been operating a Ponzi scheme; (2) an initial claim had been made by an investor of the real estate firm; and (3) its broker-dealers had sold other investments in the real estate firm to their customers. The court therefore reasoned that the insured was aware of facts and circumstances that might result in claims being made against it for any investment in the real estate firm. Accordingly, the application exclusion barred coverage for the subsequent claims, even though the later claims asserted causes of action other than the failure to exercise due diligence alleged in the initial claim. The court held that the claims concerned facts and circumstances of which the insured was aware prior to submitting the application because they “concerned the purchase of [real estate firm] investments” by the insured’s customers.