First Circuit Holds UBS Puerto Rico Bond Claims Barred by Specific Litigation Exclusion
Ruling in favor of Wiley Rein’s client—a primary D&O insurer—and two excess insurers, the U.S. Court of Appeals for the First Circuit today held that a broadly worded specific litigation exclusion bars coverage for a series of lawsuits, regulatory investigations, and arbitrations filed against the insured, a Puerto Rico subsidiary of UBS, because the matters all involve facts, situations, or circumstances alleged in the prior claims listed in the exclusion. UBS Financial Servs. Inc. v. XL Specialty Ins. Co., No. 18-1148 (1st Cir. July 3, 2019).
The insured was the subject of an SEC investigation starting in 2009 and a defendant in an investor derivative lawsuit filed in 2010, both arising from the insured’s role with respect to certain Puerto Rico closed-end mutual funds. In particular, the investigation and civil action alleged that the insured had conflicts of interest because it underwrote risky municipal bonds, dumped the bonds into the funds, incentivized its financial advisors to sell the funds to customers, and marketed the funds by misrepresenting their safety and liquidity, while secretly controlling the market for fund shares.
Thereafter, the insured purchased new primary and excess D&O policies that contained a specific litigation exclusion barring coverage for “any Claim in connection with any proceeding set forth below, or in connection with any Claim based on, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any such proceeding or any fact, circumstance or situation underlying or alleged” in one or more of the five listed matters in the exclusion, including the 2009 SEC investigation and the 2010 derivative action.
Beginning in 2013, the insured sought coverage under the primary and excess policies for the 2013-2014 policy period for two civil lawsuits, two regulatory investigations, and approximately 1,600 FINRA arbitrations. The matters alleged that the insured manipulated the market for the closed-end funds; that the insured used the funds as a “dumping ground” for bonds it underwrote; and that the closed-end funds were illiquid, highly leveraged and over-concentrated in risky Puerto Rico bonds, all of which was inconsistent with investors’ preferences for stable securities.
In subsequent coverage litigation, the First Circuit affirmed summary judgment for the insurers. The court held that the clear and unambiguous specific litigation exclusion precluded coverage for the underlying matters. The court rejected the insured’s various arguments to evade the specific litigation exclusion. First, the court disagreed with the insured’s argument that each of the hundreds of underlying proceedings should be parsed into multiple Claims. The court “s[aw] no reason why we should read a single subpart defining a ‘claim’ as a ‘written notice’ to mean that claims should be divided into multiple fractions for purposes of applying the Specific Litigation Exclusion” or “why the first prong [of the Claim definition] should govern instead of the more pertinent ones regarding civil proceedings, arbitrations, or investigations.” Thus, the court “refuse[d] to construe the definition of ‘claim’ in a way that would make two-thirds of it meaningless.” Second, the court held that the insured could not rely on Puerto Rico contract interpretation principles favoring policyholders. The court noted that the insured was a sophisticated financial institution assisted by expert brokers and legal counsel during the negotiation of the D&O policies. The insured had sought to narrow the wording of the specific litigation exclusion, but the primary carrier refused. The court concluded that the insured “therefore could have reasonably expected that it bargained for the plain reading construction we give the exclusion today.” Third, the court held that Puerto Rico’s “remote possibility of coverage” standard, which might apply at the preliminary injunction stage, did not apply to the present summary judgment dispute.