J.P. Morgan Securities, Inc. v. Vigilant Ins.
J.P. Morgan Securities Inc., et al. v. Vigilant Ins. Co., et al., Index No. 600979/2009 (1st Dep't Dec. 13, 2011)
On December 13, 2011, in a unanimous decision, New York’s Appellate Division, First Department, issued a decision dismissing claims by J.P. Morgan Chase, as successor to Bear Stearns (“JPMC”), against six of Bear Stearns’ professional liability insurers. J.P. Morgan Securities Inc., et al. v. Vigilant Insurance Company, et al. Of note, this decision appeared on the front page of the December 14, 2011 issue of the New York Law Journal. The decision confirms and expands the principle that disgorgement of ill-gotten gains or restitutionary damages is uninsurable under New York case law and public policy, and thus does not constitute an insurable loss under a liability insurance policy. As Justice Richard T. Andrias, writing for the First Department, stated: “[T]he deterrent effect of a disgorgement action would be greatly undermined if wrongdoers were permitted to shift the cost of disgorgement to an insurer . . . .”
In March 2006, the SEC entered an order, and the NYSE issued decisions, resolving the regulatory agencies’ respective investigations into Bear Stearns’ role in facilitating illegal late trading and deceptive market timing in mutual funds. Following considerable discovery and lengthy settlement negotiations, Bear Stearns agreed, among other things, to pay $160 million in disgorgement and $90 million as a penalty. JPMC sought insurance coverage for the $160 million paid by Bear Stearns as disgorgement, arguing that, because Bear Stearns had earned only $16.9 million in fees and commissions from the illegal trades by its customers, the $160 million labeled as “disgorgement” in the SEC order and NYSE decisions was not really disgorgement, but rather constituted insurable compensatory damages.
In its decision, the First Department rejected JPMC’s argument, holding for the first time 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 (“joint and several liability for combined profits may be imposed on collaborating or closely related parties”). In finding that the illegal gains of its customers were attributable to Bear Stearns, the Court stated: “In addition to admittedly generating at least $16.9 in revenues for itself, Bear Stearns knowingly and affirmatively facilitated an illegal scheme which generated hundreds of millions of dollars for collaborating parties.” Furthermore, the Court held that the fact that the SEC did not itemize how it calculated the disgorgement payment did not raise an issue as to whether the payment was disgorgement or some other form of payment for which coverage might be available. As long as a disgorgement payment is “causally connected to the violation … the SEC is not required to trace every dollar of proceeds.”
In response to JPMC’s protestation that Bear Stearns had not admitted to any wrongdoing, the Court noted that the SEC had detailed numerous examples of knowing, intentional conduct by Bear Stearns, had made specific findings that Bear Stearns had willfully violated five separate provisions of the securities laws, and had censured Bear Stearns and ordered it to cease and desist from further illegal activity. The Court thus concluded that, “read as a whole, the offer of settlement, the SEC Order, the NYSE order and related decisions are not reasonably susceptible to any interpretation other than that Bear Stearns knowingly and intentionally facilitated illegal late trading for preferred customers … .” More so, the Court found that “Given these findings [by the SEC in its order], it cannot be seriously argued that Bear Stearns was merely found guilty of inadequate supervision and a failure to place adequate controls on its electronic entry system.”
For more information about this decision, please contact Luke D. Lynch, Jr. (at LDLynchJr@damato-lynch.com), Richard F. Russell (at RRussell@damato-lynch.com) or Liza A. Chafiian (at LChafiian@damato-lynch.com).
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