Eastern District of Michigan Holds Selling Unregistered Securities, as Defined by the Securities Act of 1933 and Securities Exchange Act of 1934, Constitutes “Professional Services”

The United States District Court for the Eastern District of Michigan, applying Michigan law, has held that (1) offers to sell unregistered securities constitute “wrongful acts in the rendering of professional services”; (2) an insurer did not waive its right to assert that an exclusion bars coverage for a claim where the insurer failed to provide the insured with a clear coverage determination; and (3) where securities constituting short-term notes are not issued on “commercial paper,” coverage involving those securities may be barred by an unregistered securities exclusion.  Saoud v. Everest Indem. Ins. Co., 2021 WL 3186736 (E.D. Mich. July 28, 2021).

A company called 1 Global offered alternative short-term loans to small and medium businesses.  It obtained its funds through investors who signed “memoranda of indebtedness” to memorialize the terms of the financing.  The insured signed a memorandum after two attorneys advised him that the memorandum was not a “security” and that he did not need to be registered as a securities broker or agent to sell it.  Despite the attorneys’ advice, there was evidence that the insured knew that there was a strong chance that the memoranda did constitute a “security.”  Even so, the insured marketed the loan product to 1 Global’s clients.  The insured later faced lawsuits by three clients, a subpoena from the SEC, and an investigation by the Michigan Department of Licensing and Regulatory Affairs, each alleging that the insured had improperly sold unregistered securities.

The insured sought coverage from its professional liability carrier for the claims and ultimately filed a declaratory judgment action.  Responding to that action, the insurer argued that there was no coverage for any of the claims because they did not involve the insured providing “professional services” as required by the insuring agreement, and that each claim was barred from coverage by the unregistered securities exclusion.

With respect to the question of whether the claims alleged that the insured had provided “professional services,” the court sided with the insured.  The court noted that “a reasonable jury could find that when [the insured]” offered the 1 Global loan to clients, he had engaged in “financial planning activities in conjunction with services described” in the policy, which was a “professional service” as defined by the policy.

However, the court held that the insurer could still prevail on summary judgment if the 1 Global loan, which was indisputably unregistered, was a “security” as defined by the Securities Act of 1933 and the Securities Exchange Act of 1934, such that the unregistered security exclusion barred coverage.

Considering the definitions contained in those statutes, the court determined that the 1 Global loan was a “note” and thus presumptively a “security,” which would entitle the insurer to summary judgment.  However, pursuant to the statutes’ definitions, if the note “has a maturity at the time of issuance of not exceeding nine months” and/or it constitutes “commercial paper,” then the note is not a “security” and the exclusion does not bar coverage.  Because the parties had not provided evidence that spoke to these issues, the court ordered further briefing.

Lastly, the court addressed the insured’s arguments that the insurer had waived its right to deny coverage on the basis of the exclusion because the insurer had not provided a clear coverage position before the insured filed the declaratory judgment suit.  The court sided with the insurer and held it had not waived its right to deny coverage because there was no basis in Michigan case law for the insured’s assertion.  The court noted that, contrary to the cases that permitted waiver, here there was no concern with collateral estoppel, and separately, because the insured had retained its own independent defense counsel, the risk of forcing the insurer to provide coverage for an uncovered risk outweighed the possibility that the insured might have “suffered” because of the insurer’s actions.