$140 million SEC Disgorgement Payment Not a “Penalty” and Insurable Under New York Law

The New York Court of Appeals has held that a $140 million disgorgement payment in an SEC settlement is not a non-covered “penalty” under a professional liability policy.  According to the court, the payment had compensatory purposes and was measured by an injured party’s losses and third-party gains.  J.P. Morgan Secs. Inc. v. Vigilant Ins. Co., 2021 WL 5492781 (N.Y. Nov. 23, 2021).

In 2003, the SEC and other regulatory agencies began investigating a securities broker-dealer for allegedly facilitating late trading and deceptive market timing practices.  The broker-dealer’s insurers denied coverage for the regulatory investigation.  In early 2006, the broker-dealer entered into a settlement with the SEC in which it agreed to pay $160 million in “disgorgement” and $90 million for “civil money penalties.” 

In the ensuing coverage litigation, the broker-dealer argued that $140 million of the disgorgement payment was an insurable “loss” under the policies because it represented disgorgement of its clients’ gains, as compared with its own revenue.  The trial court agreed and granted summary judgment to the broker-dealer.  The Appellate Division reversed and held that the broker-dealer was not entitled to coverage for the disgorgement payment because, under Kokesh v. SEC, 137 S. Ct. 1635 (2017), the disgorgement payment constituted a penalty and thus was carved out from the policy’s “loss” definition as a “penalty imposed by law.” 

The Court of Appeals reversed the Appellate Division’s decision and held that a reasonable insured purchasing the professional liability policy in 2000 would not have understood the phrase “penalty imposed by law” to preclude coverage for the $140 million disgorgement payment.  The Court of Appeals found that the $140 million disgorgement payment represented the estimated client gains and concomitant investor losses resulting from the alleged improper trading practices.  The Court of Appeals also found that the $140 million was placed in a fund to compensate the injured parties and was not treated as penalty for tax purposes.  The Court of Appeals concluded that a reasonable insured would expect an award or settlement payment that has compensatory purposes and is measured by an injured party’s losses and third-party gains to fall within the coverage grant and not be deemed a penalty.  The Court of Appeals further concluded that Kokesh did not control because, in that case, the Supreme Court was not interpreting the term “penalty” in an insurance contract, let alone under New York law.  The Court of Appeals thus reversed and remitted to the Appellate Division.

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