New York Appeals Court: Dishonest Acts Exclusion Does Not Preclude Coverage For SEC-Ordered Payment
January 23, 2015
Last week, the Appellate Division (First Department) of the New York State Supreme Court issued its latest ruling in the matter of JP Morgan Securities, Inc. v. Vigilant Insurance Company. The matter has been the subject of prior blog entries. This latest decision focused on the insurers’ efforts to invoke their professional liability policies’ “Dishonest Acts” exclusions to preclude coverage for some $250 million in penalties imposed by the SEC against the now-defunct investment bank Bear Stearns & Company for market-timing practices in the early 2000’s. In a decision that is sure to be welcomed by policyholders, the appeals court found that the carriers could not invoke the exclusion, notwithstanding that Bear Stearns had stipulated to detailed factual findings that outlined Bear Stearns’ late trading activity. A copy of the decision is available here.

The underlying dispute stemmed from the SEC’s investigation of Bear Stearns (which merged with J.P. Morgan in 2008) for facilitating late trading and market timing on behalf of its hedge fund clients. In 2006, Bear Stearns entered into a settlement with the SEC; therein, “without admitting or denying the findings,” Bear Stearns agreed to pay $160 million as “disgorgement” and $90 million as a civil penalty. The SEC order memorializing the settlement stated that Bear Stearns “knowingly or recklessly processed thousands of late trades;...took affirmative steps to hide from mutual funds the identity of customers that were known market timers by…assigning multiple account numbers to customers;…[and] willfully violated [the ’33 Act and the ’34 Act].”

Bear Stearns’ insurers had issued it professional liability insurance policies, which contained the following “Dishonest Acts” exclusion: “This policy shall not apply to any Claim(s) made against the Insured(s)…based upon or arising out of any deliberate, dishonest, fraudulent or criminal act or omission by such Insured(s), provided, however, such Insured(s) shall be protected under the terms of this policy with respect to any Claim(s) made against them in which it is alleged that such Insured(s) committed any deliberate, dishonest, fraudulent, or criminal act or omission, unless judgment or other final adjudication thereof adverse to such Insured(s) shall establish that such Insured(s) were guilty of any deliberate, dishonest, fraudulent or criminal act or omission.”

As Bear Stearns’ successor, JP Morgan moved for summary judgment in the trial court, arguing that the carriers could not rely on the Dishonest Acts Exclusion as a defense to payment of the SEC penalties because the administrative orders were neither final judgments nor adjudications. The court granted JP Morgan’s motion. In so doing, the trial judge rejected the carriers’ argument that the detailed findings made by the SEC were the equivalent of a final judgment or adjudication.

The Appellate Division affirmed, holding that the SEC’s administrative order did not constitute an adjudication, because Bear Stearns remained free to contest its liability as against anyone other than the SEC or other agencies with which it entered into similar agreements. Accordingly, the carriers could not satisfy their burden of proving that an adjudication had established that Bear Stearns was guilty of any deliberate dishonest, fraudulent, or criminal act or omission for purposes of the policies’ Dishonest Acts exclusion.

In making its ruling, the Appellate Division took pains to distinguish its 2009 holding in Millennium Partners v. Select Insurance Company, 68 A.D.3d 420, in which the same court held that disgorgement payments were uninsurable as a matter of law, based on New York public policy. The difference between the instant case and the Millennium Partners case is that the instant case dealt with the construction of an insurance policy exclusion, while the Millennium Partners case dealt with the insurability of disgorgement as a question of public policy. Accordingly, the Appellate Division noted that the carriers could still rely on Bear Stearns’ settlement agreement with the SEC for the limited purpose of showing whether the settlement payments constituted disgorgement.


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