No Coverage for Lawsuit Where SEC Notices Issued Prior to Policy Period Alleged Related Investment Misconduct

The United States Court of Appeals for the Tenth Circuit, applying Utah law, has held that no coverage exists for a lawsuit filed against an insured where an SEC investigation and proceeding conducted prior to the policy’s inception and the lawsuit both alleged a scheme of defrauding investors over a period of several years by means of “related” misconduct under the policy’s Interrelated Wrongful Acts provision.  Morden v. XL Specialty Ins., 2018 WL 4292227 (10th Cir. Sept. 10, 2018).

The insured, a registered investment adviser, held a claims-made financial-services-liability policy.  The insured counseled clients regarding their investments, either recommending that they make investments or exercising authority they granted the adviser to make investments before getting client approval.  Prior to the start of the policy period, the SEC began investigating the insured with respect to client investments in four ventures. The SEC sent notices informing the insured that a civil injunctive action was forthcoming for alleged securities laws violations.  After the policy’s inception, the SEC issued an order instituting administrative cease-and-desist proceedings that included allegations concerning misconduct related to the four ventures.  Four months later, a client-investor filed a lawsuit against the insured alleging the same misconduct as alleged by the SEC.

The insurer denied coverage on the basis that the Wrongful Acts alleged in the client’s complaint and those made by the SEC were Interrelated Wrongful Acts and therefore deemed a single claim made at the time of the earlier claim predating the policy period.  The insured and the client-investor ultimately reached a settlement that mentioned only the misconduct concerning one of the four ventures alleged in the complaint.  As assignee of the insured, the client-investor then sued the insurer for bad faith and breach of fiduciary duty in denying coverage.  The insurer counterclaimed.  On cross-motions for summary judgment, the trial court denied summary judgment on the insurer’s counterclaim regarding the Interrelated Wrongful Acts provision but granted it summary judgment for insufficient evidence supporting the bad faith and fiduciary duty claims.

On appeal and cross-appeal, the client-investor did not dispute that the initial SEC notices constituted a claim within the meaning of the policy, nor that those notices encompassed the alleged misconduct relating to some of the ventures. He contended, however, that the “Wrongful Acts” underlying his specific claims about the venture addressed in the settlement agreement were not included in the original SEC notices.  The client-investor argued that those allegations formed the basis of the settlement and were too distinct from the misconduct relating to the other three ventures to constitute Interrelated Wrongful Acts.

The court disagreed and found that the Wrongful Acts claimed with respect to the ventures were interrelated.  The court noted that the policy treated Wrongful Acts as interrelated if they are “in any way involving any of the same or related or series of related facts, circumstances, situations, transactions or events.”  Noting that it had previously found similar claims to be interrelated under a narrower provision requiring “common” facts, the court found that the Wrongful Acts were interrelated because they were committed by the same entity, against the same victims, using the same techniques, during the same time frame, and therefore “alleged a practice – a scheme – of defrauding investors over a period of several years by means of ‘related’ misconduct.”

Having found that the Interrelated Wrongful Acts provision barred coverage, the court reversed the trial court’s order and remanded with instructions to grant summary judgment on the insurer’s counterclaim.

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