“Unregistered Securities Exclusion” Applies to Lawsuits Alleging Violations of State Securities Laws

Applying Michigan law, the U.S. Court of Appeals for the Sixth Circuit has held that an “Unregistered Securities Exclusion” applied to lawsuits against a financial advisor who allegedly sold an unregistered security in violation of Michigan state securities laws. Saoud v. Everest Indem. Ins. Co., 2022 WL 2758274 (6th Cir. July 14, 2022). The court also rejected the insured’s arguments that the insurer waived or was estopped from asserting the coverage defense because it failed to timely disclaim coverage.

A financial advisor sold an investment product issued by a commercial lending business. Soon after the financial advisor began selling this product, the commercial lending business declared bankruptcy and was sued by the SEC for violations of the Securities and Exchange Act. Several of the financial advisor’s clients sued him for falsely representing that the product was a secure investment and for selling an unregistered security in violation of Michigan securities laws. The financial advisor sought coverage from his professional liability insurer, which initially told him to hire his own attorney while the insurer analyzed coverage and that he would be reimbursed if the insurer concluded that there was coverage. Throughout the course of the lawsuits, the financial advisor continued to reach out to his insurer with no response. He ultimately settled the suits and then filed a coverage action against the insurer. 

The policy contained an “Unregistered Securities Exclusion” that excluded coverage for any claim “[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 district court, finding that the exclusion applied, granted summary judgment in favor of the insurer. The Sixth Circuit affirmed, emphasizing that the investment product was a “security” because it was a “note,” and a note is presumed to be a security under securities laws. The financial advisor argued that the exclusion only applied to complaints arising out of securities required to be registered by the SEC under federal law rather than securities required to be registered under state law. The court rejected this argument as untimely because it was not raised until after motions for summary judgment and their respective responses were filed and first appeared in supplemental briefing that the district court expressly limited to a different issue.  

The financial advisor also argued that the insurer waived or was estopped from asserting the exclusion because it failed to timely disclaim coverage. The court disagreed and distinguished cases in which waiver or estoppel applied, because here the insurer never represented the financial advisor or controlled the underlying litigation to the detriment of the insured.

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