Publications

20 Dec 2011

Disgorgement is disgorgement is disgorgement: it is not insurable as a matter of New York law and public policy

Insurance Litigation Alert

Joseph G. Finnerty III
Christopher M. Strongosky
Megan Shea
Miles D. Norton

A unanimous five-justice panel of New York’s Appellate Division, First Department, has issued a watershed decision dismissing claims by JP Morgan (as successor to Bear Stearns) against six of Bear Stearns’ professional liability insurers.  J.P. Morgan Securities Inc., et al. v. Vigilant Ins. Co., et al., Index No. 600979/2009 (1st Dep't Dec. 13, 2011) (See the decision here).

JP Morgan had sought insurance coverage for more than US$300 million connected with Bear Stearns’ settlement of regulatory investigations by the SEC and the New York Stock Exchange. 

The Appellate Division decision, issued December 13, 2011, is fundamentally important because it sets to final rest arguments seeking to limit enforcement of the accepted New York case law and public policy that disgorgement of ill-gotten gains or restitutionary damages does not constitute an insurable loss under a liability insurance policy.  As framed by Justice Richard T. Andrias for the First Department, “the deterrent effect of a disgorgement action would be greatly undermined if wrongdoers were permitted to shift the cost of disgorgement to an insurer, thereby allowing the wrongdoer to retain the proceeds of his or her illegal acts.”

In particular, the decision dismisses JP Morgan’s claims to obtain insurance coverage for (a) the US$160 million Bear Stearns paid as disgorgement to resolve investigations by the SEC and the NYSE into Bear Stearns’ role in facilitating illegal mutual fund late trading and deceptive market timing, (b) the more than US$45 million in associated attorneys fees and defense costs alleged, (c) the US$14 million paid by Bear Stearns to settle civil class actions based on the same conduct and (d) more than US$100 million in pre-judgment interest.

The Appellate Division’s decision is cardinally important because it states for the first time the principle inherent in earlier cases that a payment of disgorgement of ill-gotten gains is not insurable even if the payment may reflect illegal gains by third parties with whom the wrongdoer collaborated.  The Appellate Division thus rejected arguments that Bear Stearns’ payment of disgorgement was insurable because it may have been measured by the illegal gains of Bear Stearns’ co-conspirators and clients, and the amounts disgorged may not have been traced dollar-for-dollar to Bear Stearns’ pockets.

The Appellate Division’s holding grows out of important principles identified in earlier New York disgorgement case law, but Justice Andrias and the Appellate Division took the opportunity to dismiss with great clarity many arguments presented by Bear Stearns (and others) seeking to limit the application of disgorgement law.

First, the Appellate Division rejected arguments by Bear Stearns that the word “disgorgement” as found in the SEC Order and NYSE decision was simply a “label.”  The court held that the SEC and NYSE proceedings and the documentation of the settlement, read as a whole, were “not reasonably susceptible to any interpretation other than that Bear Stearns knowingly and intentionally facilitated illegal late trading for preferred customers, and that the relief provisions of the SEC Order required disgorgement of funds gained through that illegal activity.”  With this Appellate Division holding, an insured now may not contradict its own settlement agreement and argue for purposes of obtaining insurance that amounts clearly identifiable as disgorgement in the settlement, read as a whole, were somehow not disgorgement.

Second, whether or not a plaintiff itemizes the total of the disgorgement paid in a settlement, that failure to itemize will not create a legal issue whether the payment was disgorgement or was some other form of payment for which coverage might be available.  As long as a disgorgement payment is causally connected to the violation, a plaintiff is “not required to trace every dollar of proceeds” or “identify misappropriated monies which have been commingled” in order for the payment to retain its identity as disgorgement.

Finally, the ultimate use of the disgorged ill-gotten gains will not alter the uninsurable nature of the disgorgement payment.  The Appellate Division held that the disgorgement in the Bear Stearns case was not insurable even though the amounts disgorged may have been placed in a “Fair Fund” (under Sarbanes-Oxley) and distributed to injured investors.

The court concluded by reversing the trial court’s order and directing the clerk to enter judgment dismissing Bear Stearns’ complaint against its insurers in its entirety.  With this unanimous decision, Justice Andrias and the Appellate Division have clarified the common-sense reach of New York’s public policy that does not permit insurance coverage to refill the coffers of an insured who disgorges ill-gotten gains or illegal profits.

DLA Piper served as lead litigation counsel at oral argument (Joseph G. Finnerty III, arguing) for the insurers.

For more information about this decision, please contact:

Joseph G. Finnerty III