May an insured pursue claims against a carrier arising from an SEC suit for disgorgement of funds? Answer: Yes.
J.P. Morgan Securities Inc. v. Vigilant Insurance Company, 21 NY3d 324 (2013), involved an “insurance dispute arising from the insured’s monetary settlement of a Securities and Exchange Commission (SEC) proceeding and related private litigation predicated on the insured’s violations of Federal securities laws.” Id. at 330. The Supreme Court denied the carrier’s motion to dismiss. The Appellate Division reversed and dismissed the complaint. And the Court of Appeals granted leave to appeal, reversed and reinstated the complaint of the insured.
In addition to the SEC action, Bear Stearns, a subsidiary of JP Morgan, was named as a defendant in a number of private class action lawsuits brought by various mutual funds based on similar “late trading” and other “market timing allegations.” Id. at 331. Bear Stearns settled with the SEC for $250 million and the private actions for $14 million. Bear Stearns also alleged that the cost of defending the SEC proceeding and the private actions amounted to $40 million.
Subsequently, Bear Stearns sought indemnification from its primary carrier and excess carriers for three claims:
- $160 million SEC disgorgement payment (less a $10 million self-insured detention);
- $40 million in defense costs; and
- $14 million private settlement.
Bear Stearns did not seek coverage for the $90 million SEC penalty. Id. at 332.
The insurers denied coverage on all claims and Bear Stearns sued for breach of contract and a declaratory judgment. “The [i]nsurers moved to dismiss the complaint…arguing, among other things, that Bear Stearns could not be indemnified for any portion of the SEC disgorgement payment as a matter of public policy.” Id. at 333
The Court of Appeals:
“recognized two situations in which a countervailing public policy will override the freedom to contract, thereby precluding enforcement of an insurance agreement. First, an insurer may not indemnify an insured for a punitive damages award, and a policy provision purporting to provide such coverage is unenforceable… The rationale underlying the public policy exception emphasizes that allowing coverage ‘would defeat the purpose of punitive damages, which is to punish and to deter others from acting similarly’…Second, as a matter of public policy, an insured may not seek coverage when it engages in conduct ‘with the intent to cause injury’…” [citations omitted]. Id. at 334-35.
As to the public policy exception principles, Bear Stearns:
“urge[d] that they do not prohibit coverage here since the bulk of the disgorgement payment – approximately $140 million – represented the improper profits acquired by third-party hedge fund customers, not revenue that Bear Stearns itself pocketed. Put differently, Bear Stearns allege[d] that much of the payment, although labeled disgorgement by the SEC, did not actually represent the disgorgement of its own profits [and submitted] that the rule precluding coverage for disgorgement should apply only where the insured requests coverage for the disgorgement for its own illicit gains.” Id. at 336.
While noting that “we certainly do not condone the late trading and market timing activities described in the SEC order,” the Court of Appeals concluded that the defendant insurers “ha[d] not met their heavy burden of establishing, as a matter of law on their CPLR 3211 dismissal motions, that Bear Stearns is barred from pursuing insurance coverage under its policies.” Id. at 338.