Specific Litigation Exclusion Bars Coverage for Puerto Rico Mutual Fund Suits and Arbitrations

In a win for Wiley Rein’s client, a Puerto Rico federal district court has held that a policy’s broadly worded specific litigation exclusion bars coverage for a series of lawsuits, regulatory investigations, and arbitrations filed against the insured because the matters all involve facts, situations, or circumstances alleged in the claims listed in the exclusion.  UBS Financial Servs. Inc. v. XL Specialty Ins. Co., No. 3:15-cv-3099 (D.P.R. Feb. 1, 2018).

The insured was the subject of an investigation by the SEC begun 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 it sold.  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 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 civil 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 court agreed with the insurers that each of the later-filed matters involve facts, circumstances, or situations alleged within the 2009 SEC investigation or the 2010 civil action.  The insured had argued that the insurers must demonstrate sufficient overlap between the prior matters and each cause of action or allegation in each later-filed matter.  The court rejected this argument, holding that because the policy defines “Claim” as a “civil proceeding” or “regulatory investigation,” the focus is the matter as a whole, not individual allegations or causes of action.  The court also rejected the insured’s attempt to “have it both ways” by contending that all of the later-filed matters, many of which were filed after the policies’ expiration, are related to one another and thus made within the policy period, but then “simultaneously disaggregate the same Disputed Matters into thousands of claims to disconnect them from the Prior Matters to avoid exclusion.”  Accordingly, the court held that no coverage is available because all of the later-filed matters involve sufficient overlap with a prior matter listed in the specific litigation exclusion.

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