“Securities Claim” Exclusion Applied Where Notes Constituted a “Security” as Defined by the Securities Acts

The United States District Court for the Eastern District of Michigan, applying Michigan law, has held that an exclusion in an investment adviser’s professional liability policy applicable to claims arising from the sale of an unregistered “security” barred coverage for lawsuits arising out of an investment product because it constituted a “security” as defined by the federal Securities Act and Securities Exchange Act.  Saoud v. Everest Indem. Ins. Co., 2021 WL 4458680 (E.D. Mich. Sept. 29, 2021).

The insureds offered their clients an investment product wherein the insureds would lend money to businesses that did not want to or could not borrow from traditional banks and receive a percentage of those businesses’ daily revenues in return.  The insureds allegedly used $50 million in investor funds to buy bad credit card debt and another $28 million for personal use.  The Securities Exchange Commission and several clients brought a number of lawsuits against the insureds for which they sought coverage from their professional liability insurer.  The insurer denied coverage based on an exclusion barring coverage for any “Loss resulting from any Claim against an Insured ... [b]ased upon, attributable to, or arising out of the use of or investment in any security that is not registered with the Securities and Exchange Commission.”  

The insureds sought a declaratory judgment that the insurer was required to reimburse them for the attorneys’ fees they expended and the settlements they paid in the state court suits.  After discovery, both parties filed motions for summary judgment.  The court found that the insurer might be entitled to summary judgment on the basis of the “securities claim exclusion,” but requested further briefing regarding whether the investment product was a “security” as defined by the Securities Exchange Commission because the term was not defined in the policy.  Specifically, the court requested briefing regarding whether the investment product fell under one of the carve-outs to the definition of a “security”: (1) whether the note had a maturity at the time of issuance of not exceeding nine months; and (2) if it did, whether the product qualified as “commercial paper.” 

First, the court held that, because the notes automatically rolled over at nine months absent a request to terminate at the nine-month mark, the notes had a maturity at the time of issuance exceeding nine months.  Second, the court held that even if the notes did have a maturity not exceeding nine months, the exclusion still applied because the notes did not constitute commercial paper.  “Commercial paper” is defined as notes that are “made to mature in a few months and ordinarily not advertised for sale to the general public” and that are “eligible for discounting by Federal Reserve banks.”  The court noted that the investment product raised $287 million from 3,400 investors located in at least 25 states as support for finding that the product was sold to the public and not only to “highly sophisticated investors.”  Thus, finding that neither of the carveouts to the definition of “security” under the Securities Acts applied to the investment product at issue here, the court held that the “securities” exclusion applied and granted summary judgment in favor of the insurer. 

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