A New York trial court, applying New York law, has held that a $140 million disgorgement payment by an insured broker-dealer to the U.S. Securities and Exchange Commission constitutes insurable loss, based on evidence that the payment did not disgorge the insured’s ill-gotten gains, but rather those of its customers.  J.P. Morgan Secs. Inc. v. Vigilant Ins. Co., 2017 WL 1399820 (N.Y. Sup. Ct. Apr. 17, 2017).  The court also held that the policies’ personal profit exclusion did not bar coverage and that the disgorgement payment was not uninsurable as a matter of public policy.  Finally, the court held that the insurers failed to show that an issue of material fact existed with respect to whether the settlement was unreasonable.

Following an SEC investigation of the insured broker-dealer for possible violations of federal securities law in connection with alleged late trading and deceptive market timing practices, the insured entered into a settlement with the SEC in which it agreed to pay a $160 million “disgorgement” payment and a $90 million penalty.  The insured’s professional liability insurers denied coverage for the $160 million payment on the basis that the settlement constituted uninsurable disgorgement of ill-gotten gains.

The trial court held that $140 million of the disgorgement payment was not uninsurable disgorgement because it represented the profits of third parties – the insured’s customers – and not those of the insured.  The insurers argued that the SEC order, on its face, did not show that the disgorgement payment represented only the customers’ ill-gotten gains.  While the court agreed that the SEC order did not establish whose ill-gotten gains the disgorgement payment represented, the insured presented evidence showing that $140 million of the $160 million payment was predicated on its clients’ profits.  The insurers did not offer any specific evidence to refute this, and the court therefore granted the insured’s motion for summary judgment dismissing the insurer’s disgorgement defense.

The court also granted the insured’s motion for summary judgment that the amount constituted “loss” under the policies.  The court held that, under New York law, an insured is barred from obtaining coverage for a settlement paid to a regulatory body only where the regulator’s findings “conclusively link” the disgorgement payment to improperly acquired funds possessed by the insured.  The court reasoned that the policies’ definition of “loss” was broad, and that the SEC order did not “conclusively link” the disgorgement to any improperly acquired funds in the hands of the insured.

The court also held that the policies’ personal profit exclusion did not preclude coverage because, by its plain terms, the exclusion applies only if the loss is based upon a personal profit or advantage actually derived by the insured and the profit itself is unlawful.  Because the insurers could not show that the insured’s profit or gain was in itself unlawful, the court held that the exclusion did not bar coverage.

The court also rejected the insurers’ argument that public policy barred indemnification.  The court held that public policy bars coverage only where the insured acted intentionally and with the intent to harm or injure others, and concluded that the findings in the SEC order did not establish, nor did the insured admit, that the insured had intended to cause harm.

With respect to the prior knowledge exclusion, the court held that the exclusion’s use of the undefined term “officer” in identifying whose knowledge was material for the purposes of the exclusion, created ambiguity that must be construed in the insured’s favor.  It therefore construed “officer” narrowly to include only those persons appointed to officer positions by the board of directors and held that the insurers failed to raise a triable issue regarding whether any officers could reasonably have foreseen a claim based on the market timing and late trading practices.

Finally, the court held that the insurers failed to raise a triable issue of fact regarding the reasonableness of the SEC settlement, as well as several civil settlements.  The court rejected the insurers’ argument that the settlements were unreasonable as a matter of law because the insured blocked the insurers from discovering any information regarding its own evaluation of its exposure based on the attorney-client and work-product privileges, reasoning that the need to determine the reasonableness of settlements does not require waiver of privileges.  Given that the insured had faced $520 million in potential liability when it settled, and because the insurers failed to adduce evidence that the settlement was unreasonable, the court held that the settlements were reasonable under the circumstances.