Court Holds That Professional Services Exclusion In D&O Policy Applies To Broker-Dealer’s Distribution of REITs


    A federal court, applying New York law, recently held that a “professional services” exclusion in a D&O policy applied to lawsuits against a broker-dealer arising out of its underwriting and marketing of shares issued by a set of real estate investment trusts (or “REITs”).  See David Lerner Assocs. v. Philadelphia Indem. Ins. Co., No. 2:12-cv-01609-JFB-AKT (E.D.N.Y. Mar. 29, 2013).

    The insured, a broker-dealer, served as the underwriter and sole distributor for share issued by a set of REITs.  The Financial Industry Regulatory Authority (“FINRA”) later filed a disciplinary proceeding against the insured, alleging that it had misrepresented the value of these shares and failed to perform due diligence.  Private class actions followed.  The broker-dealer sought reimbursement of the cost of its defense of all of these suits under its D&O policy.  The insurer, however, denied coverage on the basis of the policy’s exclusion for any claim arising out of “professional services.”  The broker-dealer sued the insurer, and the insurer moved to dismiss.

    The court granted the insurer’s motion, holding that the “professional services” exclusion – even though “professional services” was undefined in the policy – unambiguously applied to the underlying complaints.  The court noted that the lack of a definition does not render a term ambiguous if, under its plain meaning, it clearly applies to the case at hand – as it did in this case.  In short, ambiguity is determined on a case-by-case basis.

    Aside from a general appeal to “ambiguity,” the insured’s main argument was an analogy to malpractice law: the insured argued that “professional services” should be interpreted to refer only to activities engaged in by individuals recognized as “professionals” under malpractice law, such as doctors, lawyers, and the like.  The court rejected this argument as unsupported in insurance law.  Rather, courts have interpreted the phrase “professional services” in insurance policies according to its common understanding, which results in a broader meaning than the technical definition proposed by the insured.  Applying that meaning, the court found there was “no question” the activities at issue were “professional”, reasoning that “[t]o perform due diligence on REITs and market those securities, individuals are employed in an occupation, they rely on specialized knowledge or skill, and the skill is mental rather than physical.”

    For support, the court cited New York cases holding that sales of life insurance, falsification of patient records, and insurance claim handling were “professional services.”  The court also cited several cases in other jurisdictions specifically involving claims against financial institutions.  Those cases also held that “professional services” exclusions (usually in D&O policies) applied to claims arising out of the management or marketing of investments.

    Many investment companies purchase both D&O and E&O coverage, or policies containing a combination of both coverages, in which case this issue is less likely to arise.  But this case illustrates that some financial institutions attempt to obtain liability coverage for their core financial services under their D&O policies.  (In fact, in one case cited in David Lerner, the court specifically noted that the insured had elected to purchase only D&O and employment coverages, and not the professional services coverage available from its insurer.  See Reinhardt v. Certain Underwriters at Lloyd’s, London, No. A06-949, 2007 WL 900731, at *1 (Minn. Ct. App. Mar. 27, 2007).)  For these situations, the David Lerner decision provides much-needed clarification to insurers, particularly under New York law.

    Click here for a full copy of the Decision.

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