Maine District Court Holds Insurer Has No Duty to Defend SEC Enforcement Action Because Disgorgement Constitutes a Penalty

In a case in which Wiley Rein represented the insurer, a federal district court in Maine has held that an insurer had no duty to defend an enforcement action brought by the Securities and Exchange Commission (SEC) under a lawyers’ professional liability policy because none of the relief sought constituted “damages” as defined in the policy.  Marcus v. Allied World Ins. Co., No. 2:18-cv-253-DBH, 2019 WL 1810954, (D. Me. Apr. 23, 2019).  The court held that when sought by the SEC, disgorgement is properly characterized for insurance purposes as a penalty.  The court also held, however, that the policy’s investment advice exclusion did not apply to negate the insurer’s duty to defend a related securities fraud class action, but it rejected the insured’s argument that because the actions were “related claims,” the insurer’s duty to defend the securities lawsuit also obligated it to defend the SEC enforcement action.

The SEC brought an enforcement action against the insured attorney alleging that the attorney participated in a fraudulent scheme involving the sale of certain securities by his client.  The SEC sought injunctive relief, civil monetary penalties, and disgorgement.  The insurance policy’s definition of “damages” excluded equitable or non-monetary relief and “penalties (statutory or otherwise)” but did not expressly exclude disgorgement.  In reliance on the Supreme Court’s decision in Kokesh v. Securities and Exchange Comm’n, 137 S. Ct. 1635 (2017) – which held that SEC disgorgement is a penalty for purposes of determining the applicable statute of limitations – the district court held that disgorgement likewise constitutes a penalty in the insurance coverage context.  The court reasoned that SEC disgorgement (1) is imposed for a violation against the United States, rather than an aggrieved individual; (2) is imposed for punitive purposes; and (3) in many cases, is not compensatory.  Because the SEC enforcement action did not seek any covered “damages,” the insurer had no duty to defend.

The district court held that an investment advice exclusion, which applies to claims arising from “the alleged rendering of investment advice, including advice given by any Insured to make any investment or to refrain from doing so,” did not bar coverage for a related securities fraud class action brought against the insured lawyer and his law firm.  The court concluded that the insureds performed legal work in connection with their client’s securities transactions, but they did not give plaintiffs or other investors advice on whether or not to make their investments.  Thus, the court held that the insurer had a duty to defend the securities fraud action.

Finally, the court noted that, although the claims were “related claims” and therefore deemed a single claim under the policy, the insurer was only required to defend the putative class action lawsuit and not the related but non-covered SEC proceeding because the “related claims” provision does not “broaden[] the insurer’s duty to defend by folding in a claim that is otherwise outside policy coverage.”