Over $141 Million in Trading Losses for Illegal Trade Deemed “Direct Financial Loss” for “Malicious Act”

A New York intermediate appellate court has held that an insured was entitled to coverage under its fidelity bond for over $141 million in losses it sustained after an independent broker used the insured’s electronic trading system to illegally trade commodities futures that ultimately required the insured to settle the broker’s loss.  New Hampshire Ins. Co. v. MF Glob. Fin. USA Inc., 2022 WL 803473 (N.Y. App. Div. Mar. 17, 2022).  The court held that its prior decision deeming the loss a direct financial loss precluded the insurers’ arguments that certain exclusions applied, and that the independent broker’s admission of his intent to defraud was sufficient to show he committed a malicious act.

The insured in this case was a commodity futures brokerage.  In 2008, an independent broker initiated a series of trades using the insured’s electronic trading system.  The trades were not successful and the broker was forced to liquidate his positions at significant losses, which he did not have the ability to satisfy.  The day after the trades, the insured transferred $150 million to settle the trades and recorded $141 million in loss on its books as a bad debt.  It then submitted coverage under its fidelity bonds.

The insurers denied coverage for the claim under the fidelity bonds, and coverage litigation ensued.  In earlier proceedings, the insurers asserted that the brokerage did not suffer a “direct financial loss” as required for the bond to apply, because the insured was only indirectly obligated to cover the losses sustained by the independent broker.  As the bonds applied only to direct loss for (a) “any wrongful act committed by any employee” or (b) “any theft, fraudulent act or malicious act committed by any other person, which is committed with the intent to cause the insured to sustain a loss or with the intent to obtain financial gain for themselves,” the insurers argued that the broker was not an “employee” and that the broker had not committed theft, a fraudulent act or malicious act.  The trial court ruled that the broker was an “employee” and that the loss was “direct,” granting summary judgment for the insured.  On appeal, the court vacated summary judgment on the question of whether the broker was an “employee” and vacated summary judgment on the basis that there were other defenses that had not been raised at the trial court level, but it affirmed summary judgment to the extent of declaring that the insured sustained a direct financial loss under the bonds.

In further proceedings, the insurers made several additional arguments that the bonds did not cover the losses at issue.  The trial court ruled in favor of the insured, and the insurers appealed.  On appeal, the court again ruled in favor of the insured, finding that the bonds covered the loss.

First, the court held that the insurers’ argument that the contractual liability exclusion applied was barred by the law of the case because in the previous appeal the court ruled that the exclusion was inapplicable because the payment was made in accordance with the clearing house’s rules that were premised upon the CFTC’s regulatory scheme, and not pursuant to a traditional contractual obligation. 

Second, the court held that the insurers’ argument that an exclusion that precluded coverage for indirect loss based upon an error in programming applied because an electronic order routing system in place failed to identify that the trade was above the permissible limit and prevent the trade, was similarly barred by the court’s previous decision declaring that the insured sustained a direct financial loss under the bonds.  The court declined to contradict its previous ruling, holding that the broker’s willful conduct was the cause of the loss, not the alleged programming error.

Third, the court rejected the insurers’ argument that the insured failed to mitigate damages when it failed to act upon learning of the broker’s prior risky trades.  The court noted that the bonds contain no provision or condition addressing the insured’s alleged duty to mitigate loss and the insurers did not cite authority supporting a common law duty to mitigate for failing to prevent covered loss from occurring.  

Finally, the court held that the insurers could not reverse their position that the broker was not an employee to argue that the broker did not commit a wrongful act given their prior pursuit of reversal of the trial court’s ruling that the broker was an employee and subsequent success on appeal.  Dismissing the insurers’ argument that a malicious act could not be inferred solely because the broker’s trading resulted in losses as unpersuasive given the broker’s admission that he attempted to defraud the insured knowing the insured would be responsible for any losses, the court found the broker committed a malicious act.

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