Carriers generally contend that insurance does
not cover amounts that represent "disgorgement" or that are "restitutionary" in
nature. But what makes a particular payment a "disgorgement"? In a
December 13, 2011 opinion (here), the
New York Supreme Court, Appellate Department, First Division, held that amounts
Bear Stearns paid in settlement of SEC late trading and market timing
allegations represented a disgorgement that is not covered under
its insurance program. Because the appellate court's decision
reversed the lower court ruling that the settlement payment did not
constitute a disgorgement, the case provides an interesting perspective of the
question of what makes a particular payment a "disgorgement" for purposes of
determining insurance policy coverage.
Background
In 2006, the SEC notified Bear Stearns that the agency
was investigating late trading and market timing activities units of Bear
Stearns had undertaken for the benefit of clients of the company. The agency
advised the company that it intended to seek injunctive relief and monetary
sanctions of $720 million. Bear Stearns disputed the allegations, among other
thing arguing that it did not share in the profits or benefit from the late
trading, which generated only $16.9 million in revenue.
Bear Stearns ultimately made an offer of settlement and
--without admitting or denying the agency "findings" - consented to the SEC's
entry of an Administrative
Order, in which, among other things, Bear Stearns agree to pay a total of
$215 million, of which $160 million was labeled "disgorgement" and $90 million
as a penalty.
At the relevant time, Bear maintained a program
of insurance that, according to the subsequent complaint, totaled $200
million. Bear Stearns sought to have the carriers in the program indemnify the
company for the company's settlement with the SEC. However, the carriers
claimed that because the $160 million payment was labeled "disgorgement" in the
Administrative Order, it did not represent a covered loss under the insurance
policies.
In 2009, J.P. Morgan (into which Bear Stearns merged in
2008) filed an action seeking a judicial declaration that the insurers were
obliged to indemnify the company for the amount of the $160 million payment in
excess of the $10 million self insured retention. The company's supplemental
summons and amended complaint can be found here. The company
argued that notwithstanding the Administrative Order's reference to the amount
as "disgorgement," its payment to resolve the SEC investigation constituted
compensatory damages and therefore represented a covered loss under the
insurance program. In support of this contention, the company further argued
that Bear Stearns' earned only $16.9 million in revenue and virtually no profit
from the late trading and market timing activities, and therefore the SEC
settlement amount could not have represented a disgorgement. The carriers moved
to dismiss the company's declaratory judgment action
The Lower Court's September 14, 2010 Order
In an order entered September 14, 2010, (here), New
York (New York County) Supreme Court Charles
E. Ramos denied the carriers' motion to dismiss. He held that the
Administrative Order's use of the term "disgorgement" did not conclusively
establish that the settlement amounts were precluded from coverage.
In reaching this conclusion, he noted that the
Administrative Order "does not contain an explicit finding that Bear Stearns
directly obtained ill-gotten gains or profited by facilitated these trading
practices," and he found that the provision of the Order alone "do not
establish as a matter of law that Bear Stearns seeks coverage for losses that
include the disgorgement of improperly acquired funds." He also found that
the Order does not, as would be required to preclude coverage "conclusively
link the disgorgement to improperly acquired funds." He noted in that
regard that "there are no findings that Bear Stearns directly generated profits
for itself as the result" of the alleged misconduct and for him to so conclude
now "would be to resolve disputed issues of material fact."
Because he found that he was "unable to conclude, on the
basis of the language of the Administrative Order alone that the disgorgement
is specifically linked to the improperly acquired funds," he rejected the
insurers' argument that they were entitled to dismissal.
The December 13 Appellate Decision
A December 13, 2011 opinion written by Justice Richard Andrias of
the N.Y. Supreme Court, Appellate Division, First Department, reversed
the lower court's holding, granted the motions to dismiss and directed the
entry of judgment in favor of the insurers. Contrary to Justice Ramos, the
appellate court concluded that the sequence of events and allegations "read as
a whole" are:
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.
The Court went on to state that "the fact that the SEC
did not itemize how it reached the agreed upon disgorgement figure does not
raise an issue as to whether the disgorgement payment was in fact
compensatory."
The Court further noted that in generating revenue of at
least $16.9 million, "Bear Stearns knowingly and affirmatively facilitated an
illegal scheme which generated hundreds of millions of dollars for collaborating
parties and agreed to disgorge $160,000,000 in its offer of
settlement."
Discussion
Given that the SEC Administrative Order expressly
identified the $160 million portion of the settlement as a "disgorgement," it
was always going to be an uphill battle to establish that the amount was not
a disgorgement. The company argued essentially that the amount was not a
disgorgement because the payment did not correspond to any specific pecuniary
benefit that Bear Stearns received. The company argued in paying the amount it
was not so much disgorging anything so much as it was paying damages. Justice
Ramos concluded that the Administrative Order was not factual conclusive and
that there was enough of an issue that dismissal was not appropriate.
The appellate court essentially concluded that the
question was not so much whether Bear Stearns was disgorging an amount
corresponding to its own specific pecuniary gain, but rather whether or not it
was disgorging amounts that its "illegal scheme" had "generated." In
effect, it was enough to show that there was a benefit from the illegal
conduct, whether or not person making the disgorgement directly received that
benefit.
This case is fairly fact specific, but it still a useful
and interesting decision because it reaffirms the basic principles around the
insurability of disgorgements and because it illustrates the issues to be
considered in determining whether or not a specific amount represents a
disgorgement or not.
All of that said, the company may still seek to appeal
this decision to the New York Court of Appeals and so there may yet be more to
be heard in connection with this case.
Chris Dolmetch's December 13, 2011 Bloomberg
article discussing the opinion can be found here.
Advisen Management Liability Journal: Although
I suspect that most readers of this blog have already seen it, if you have not
yet had a chance, you will want to take a look at the inaugural issue of the Advisen
Management Liability Journal, which can be found here. The
publication is attractive and interesting and it clearly represents a welcome
addition to help in the exchange of ideas in the D&O insurance industry. My
congratulations to everyone at Advisen for this inaugural issue, particularly
my good friend, Susanne Sclafane, the publication's senior editor. I am sure
everyone in the industry is looking forward to future editions of this
publication.
Read
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
For more information about LexisNexis
products and solutions connect with us through our corporate site.