A New York appellate court has held that a $140 million disgorgement payment by an insured broker-dealer to the U.S. Securities and Exchange Commission does not constitute insurable loss even though the payment did not disgorge the insured’s own ill-gotten gains, but rather those of its customers. J.P. Morgan Secs. Inc. v. Vigilant Ins. Co., 2018 WL 4494692 (N.Y. App. Div. Sept. 20, 2018).
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 resulted in a settlement under which the insured agreed pay a $160 million “disgorgement” payment and a $90 million penalty. The insured sought coverage under its professional liability policies for $140 million of the “disgorgement” payment, which the insured argued represented profits to the insured’s clients, not the insured. The insured’s professional liability insurers denied coverage on the basis that the settlement did not constitute covered “Loss,” which the relevant policy defined to exclude matters uninsurable by law, as well as fines or penalties.
In April 2017, the trial court held that the $140 million was not uninsurable disgorgement because it consisted of profits of third parties rather than the insured. But in June 2017, the U.S. Supreme Court ruled in Kokesh v. Securities and Exchange Commission, 137 S. Ct. 1635 (2017), that an SEC disgorgement remedy is a penalty because it punishes a public wrong and acts as a deterrent. Relying on Kokesh, the New York appellate court reversed the trial court’s decision, holding that the $140 million disgorgement payment is a penalty, and thus uninsured. The appellate court held that the Kokesh rationale as to the nature of disgorgement applies even when the disgorgement represents third-party gains. The court reasoned that allowing the insured to obtain insurance coverage for this disgorgement would “shield the wrongdoer from the consequences of its deliberate malfeasance . .. and violate the fundamental principle that no one should be permitted to take advantage of his own wrong.” Accordingly, the court held that the $140 million was not covered loss.