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SECURITIES AND EXCHANGE COMMISSION v. CREDIT BANCORP

June 27, 2001

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF, STEPHENSON EQUITY COMPANY, PLAINTIFF-INTERVENOR,
v.
CREDIT BANCORP, LTD., CREDIT BANCORP, INC., RICHARD JONATHAN BLECH, THOMAS MICHAEL RITTWEGER AND DOUGLAS C. BRANDON, DEFENDANTS.



The opinion of the court was delivered by: Sweet, D.J.

  O P I N I O N

Carl H. Loewenson, Jr., Esq., the court appointed receiver in the above-captioned action (the "Receiver") has moved under Rule 56, F.R.Civ.P., to dismiss certain of the affirmative defenses asserted by the Insurers in the answer. This third party action was initiated by the Receiver on February 23, 2000 against third-party defendants, Certain Underwriters at Lloyd's ("Lloyd's"); London Market Companies; and Gulf Insurance Company ("Gulf") (collectively the "Insurers"). The Insurers have cross-moved for summary judgment on the affirmative defenses, and other grounds, as described herein. By separate motion of July 26, 2000, which was deferred for consideration in connection with the instant motions, the Receiver sought a declaratory judgment that he is not required to make a second premium payment on two of the policies at issue. The Insurers have cross-moved to dismiss all claims under either policy since the payment was not timely made.

On the findings and conclusions set forth below, the Receiver's motion is granted in part and the Insurers' motion is denied.

Prior Proceedings

Certain of the proceedings in this action which preceded the filing of the instant motions are set forth in the prior opinions of this Court, familiarity with which is presumed. See SEC v. Credit Bancorp, Ltd., 194 F.R.D. 457 (S.D.N.Y. 2000).

On November 17, 1999, the primary action was initiated by the plaintiff, Securities and Exchange Commission (the "SEC") to freeze the assets of Credit Bancorp, Ltd. and its related entities (collectively, "CBL") upon the allegations that Richard Jonathan Blech ("Blech") and others had engaged in a complex securities fraud. The fraud affected over 200 customers with interests exceeding $200 million. An equity receivership was established on January 21, 2000. The Receiver marshalled the assets and is in the process of effecting a plan of partial distribution (which is in essence a pro rata return of customer-deposited property of the CBL customers, either in the form of deposited property, i.e. securities, or in the form of cash or replacement securities) pursuant to the opinions of November 29, 2000, SEC v. Credit Bancorp Ltd., 2000 WL 1752979 (S.D.N Y January 19, 2001), SEC v. Credit Bancorp Ltd., 129 F. Supp.2d 259 (S.D.N.Y.), and orders of January 19, 2001 and May 16, 2001.

Facts*fn1

A. The Policies

In the London Insurance market, a lead underwriter sets the terms of the policy and premiums, and is responsible for the administration of the policies, including the addition of endorsements or modifications to the policy and claims handling. The rest of the insurers who subscribe to a policy besides the lead, whether as part of the line slip or independently, are referred to as the following market. Members of the following market tend to rely on the underwriting, administration and claims handling of the leader. Marsh, Inc. ("Marsh") is the broking division of Marsh & McLennan Companies. Marsh's London affiliate is a Lloyd's broker licensed by Lloyd's to place insurance in the London insurance market. All of CBL's policies that are relevant to this action were brokered by Marsh.

The policies at issue in this coverage action as of November of 1999 are described below.

1. The Primary Policy

Lloyd's and Gulf sold CBL a primary policy bearing policy number 509/QA472597 (the "Primary Policy") for the period November 1, 1997 through April 1, 2001. The Primary Policy is described as a "blended" policy, and combines various standard forms used in the London insurance market. It provides an aggregate of $10 million in insurance and is divided into three sections. Payment of a single premium on a multi-year Primary Policy is the common practice at Lloyd's.

Section 1(A) of the Primary Policy provides "Comprehensive Crime" coverage under a Bankers Blanket Bond. The fidelity portion of Section 1(A) provides:

UNDERWRITERS hereby undertake and agree, subject to the following terms, exclusions, limitations and conditions, to make good to the Assured . . . such direct financial loss sustained by the Assured subsequent to the Retroactive Date [November 1, 1997] and discovered by the Assured during the period of the Policy and subject always to the Policy Limits as stated in the Schedule.
INSURING CLAUSE I FIDELITY
. . . [I]t is agreed that with regard to trading or other dealings in securities, commodities, futures, options, currencies foreign exchange and the like, and loans, transactions in the nature of a loan or other extensions of credit, this Policy covers only loss resulting solely and directly from the dishonest or fraudulent acts by Employees of the Assured committed with the intent to make and which result in improper financial gain for themselves other than salary, fees, commissions, promotions or other similar emoluments.

"Employees" are defined as, "[t]he Assured's officers, clerks, servants and other employees while employed by the Assured and guest students pursuing studies or duties at the Assured's premises."

Upon discovery of a loss during the policy period, the Primary Policy requires notice of the loss be provided to the Insurers:

As a condition precedent to their right to be indemnified under this Policy, the Assured shall . . . within 30 days after discovery by the Assured of any loss hereunder, give written notice thereof to Underwriters.

Thus, under Section 1(A), coverage is provided for losses sustained after the retroactive date of November 1, 1997 and discovered during the policy period, provided that notice is given within thirty days of the discovery.

Section 2 of the Primary Policy provides insurance for losses arising from professional malpractice claims ("E&O"):

Underwriters shall reimburse the Assureds for Loss resulting from any Claim first made during the Policy Period for a Wrongful Act in connection with the performance of Professional Services.

The term "Wrongful Acts" is defined in the E&O Section as: "any actual or alleged error, omission, or negligent act in rendering or failing to render professional services." Exclusion E provides:

Underwriters shall not be liable for loss . . .

E. brought about or contributed to in fact by any dishonest, fraudulent or criminal act or omission by any of the Assureds, . . . provided, however, no Wrongful Act shall be imputed due to any other person for the purpose of determining the applicability of Exclusion E.

Section 3 of the Primary Policy provides Directors and Officers and Company Reimbursement coverage ("D&O"). Insuring Clauses A and B provide:

A. Underwriters shall pay on behalf of the Directors and Officers Loss resulting directly from any Claim first made during the policy Period for a Wrongful Act.
B. Underwriters shall pay on behalf of the Company any Loss which the Company pays as indemnification to any of the Directors and Officers resulting from any claim first made during the Policy Period for a Wrongful Act.

"Wrongful Act" is defined as "any actual or alleged error, omission, misstatement, misleading statement, neglect, breach of duty or negligent act by any of the directors or officers, while acting solely in their capacity as a director or officer of the Company."

Exclusion G bars coverage for claims:

brought about by or contributed to in fact by any dishonest, fraudulent or criminal act or omission, or any personal profit or advantage gained by any of the Directors and Officers to which they are not legally entitled.
No Wrongful Act shall be imputed to any other person for the purpose of determining the applicability of Exclusion G.

The Primary Policy was placed in the London insurance market pursuant to a "line slip." A line slip is an application made by an insurance broker to insurance underwriters. The broker was Marsh and the lead underwriter for various Lloyd's syndicates was D.P. Mann. Lance Dalzell-Piper was the individual at D.P. Mann who was the line-slip leader and acted as the lead underwriter. In this case, the line slip was a contract between various Lloyd's syndicates and Marsh, pursuant to which Marsh agreed to bring the subscribing syndicates a certain volume of a particular type of business and to administer claims under those policies on the syndicates' behalf. The Primary and First Excess Crime Policies were subscribed to by the Lloyd's syndicates on the Marsh line slip and Gulf Insurance Company of the United States.

2. The First Excess Crime Policy

The First Excess Crime Policy, 509/QA474097, also sold to CBL by Lloyd's and Gulf, provides $40 million in coverage excess of Section 1 of the Primary Policy (the "First Excess Crime Policy") and covers the period from November 1, 1997 to April 1, 2001. It is a "follow form" policy which incorporates the terms and conditions of Section 1 of the Primary Policy and provides exactly the same coverage as the primary comprehensive crime coverage. Like the Primary Policy, this policy contains a clause which renders the policy void if a "false or fraudulent" claim is filed. The Gulf Insurance Company policy is subject to the same terms and conditions and follows form as to the Lloyd's Policy.

The underwriting of the First Excess Crime Policy was accomplished in conjunction with the underwriting of the Primary Policy and Lance Dalzell-Piper was the individual underwriter at D.P. Mann who acted as the lead underwriter. The syndicates on the Marsh line slip that subscribed to the Primary Policy also bound themselves, along with Gulf (US), to the First Excess Crime Policy.

3. The Second Excess Crime Policy

The Second Excess Comprehensive Crime Policy, 509/QA539299, provides $150 million in insurance excess of the $40 million First Excess Crime, which in turn is excess of Section 1 of the Primary Policy (the "Second Excess Crime Policy") and covers the period from April 22, 1999 to April 1, 2001. It is also a "follow form" policy, incorporating the terms and conditions of Section 1 of the Primary Policy "as far as applicable."

The Second Excess Crime Policy incorporates certain terms and conditions of Section One of the Primary Policy. Section One of the Primary Policy contains the following language:

(a) General Condition 1(a) provides:

This policy should immediately cease to afford any cover of any kind in the event of the liquidation (voluntary or compulsory) of the Assured, or the appointment of a Receiver or Manager, or the entering into any Scheme of arrangement or compensation with creditors.

(b) General Condition 2 provides):

In the event of a takeover/merger, all premiums and brokerage is deemed fully earned and coverage hereunder should continue until expiry hereof, but only in respect to any loss(es) sustained prior to the effective date of any such takeover or merger.

There are no provisions contained, either directly or by incorporation, in the Second Excess Crime and Excess E&O Policies which provide that the second premium payment must be paid after the policy has been terminated as a result of the appointment of a receiver.

The draft slips explicitly allocate the first premium payment to the period April 22, 1999 to March 31, 2000; and the second premium payment to the period April 1, 2000 to March 2, 2001.

The first premium payments for the Second Excess Crime and Excess E&O policies were paid. The second premium payments on those policies were due to be made to the London defendants on July 1, 2000, but were not made.

The lead syndicate on the Second Excess Crime Policy was the D.J. Marshall syndicate, and the lead underwriter was William Knapman.

4. The Excess E&O Policy

CBL also bought additional errors and omissions coverage in the form of an Excess Bankers Professional Indemnity Insurance, 509/QA539399 (the "Excess E&O Policy") which provided coverage from April 22, 1999 to April 1, 2001. The policy provides $15 million of insurance excess of Section 2 of the Primary Policy (for claims arising out of wrongful acts in the performance of professional services).

The Excess E&O Policy incorporates certain terms and conditions of Section Two of the Primary Policy. Section Two of the Primary Policy contains the following condition:

In the event of a takeover/merger, all premium and brokerage is deemed fully earned and coverage hereunder shall continue until expiry hereof, but only in respect to any loss(es) sustained, or claim made prior to the effective date of any such takeover or merger.

Section Two of the Primary Policy does not contain a provision equivalent to General Condition 1 of the Section One of the Primary Policy.

The lead syndicate on the Excess E&O Policy was the Marshall syndicate and the lead underwriter was William Knapman.

5. The Electronic All Risk Policy

CBL purchased an Electronic Securities and Physical Property Excess Policy, 509/QR029198 (the "Electronic All Risk Policy"), which provided $300 million in insurance excess of $200 million. Although generally in excess of Section 1 of the Primary Policy, as well as the First and Second Excess Crime Policies, the Electronic All Risk Policy does not "follow form" to those policies. Section A (Electronic Securities) insures against the loss or damage to Electronic Securities "held by the Insured in any capacity or for which the Insured is legally liable" from the fraudulent input of data into CBL's computer system and other similar acts. Section B insures against:

physical Loss of or Physical Damage to Property owned by or in the custody of the Insured whilst upon any premises of the Insured or at any other recognized place of safe deposit or whilst in transit.

Section B provides the traditional "All Risk" coverage that was sold to financial institutions to provide protection for physical loss of or damage to customers' property and securities.

The lead underwriter on this policy was Angus Roberts, from Janson Green, Ltd., underwriting agents for Syndicate 79 at Lloyd's London. Michael Moss was the second lead underwriter.

Conduct of the Parties

In January of 1998, representatives of three syndicates (Jane Bennett and Chriss Warrior of D.P. Mann, Simon Allport of Ashley Palmer, and David Foster of Janson Green) met with Virginia "Susie" Allen, the director of marketing and administration of CBL, in San Diego, California during an annual meeting of bank risk managers.

In May 1998, Credit Bancorp provided written notice of two separate claims against the Primary and First Excess Crime Policies for the disappearance of Fortune Financial Systems, Inc. ("Fortune Financial") and Colorado Casino Resorts, Inc. ("Colorado Casino") stock certificates from the premises of Citibank, N.A., New York ("Citibank").*fn2 In support of each claim, Richard Blech executed and notarized the Proof of Loss filed by CBL. In both instances, Insurers reimbursed CBL for the premiums paid to obtain the sole obligor lost instrument bonds ("LIBs") required by the transfer agents to issue new certificates. Insurers also authorized the issuance of "backup letters of indemnity," whereby Insurers agreed to indemnify and hold CBL harmless, subject to the terms, conditions and limitations of the Primary Policy, against loss which CBL might sustain by reason of the issuance of the LIBs.

Each claim was submitted under Section 1(A), the "Bankers Policy" section, of the Primary Policy and the First Excess Crime Policy. The First Excess Crime Policy follows form to the Primary Policy. General Condition 12, "Fraud," of the Primary Policy provides:

If the Assured shall make any claim knowing the same to be false or fraudulent, as regards amount or otherwise, this Policy shall be void and all claims hereunder shall be forfeited.

These Claims were investigated by the law firm of Pattison & Flannery (London Insurer's defense counsel in this case) and paid under the Primary Policy.

On June 9 and 10, 1998, two of the principal underwriters on the Primary and First Excess Crime Policies (Lance Dalzell-Piper of D.P. Mann and Simon Allport of Ashley Palmer) flew to Geneva and met with Richard Blech, the chairman and CEO of CBL, at the Geneva office of CBL, the purpose of which was to help the underwriters learn more about CBL's business.

On July 9, 1998, Richard Blech and Thomas Rittweger, the managing director of North American operations of CBL, flew to London and met with the underwriters who were considering whether to subscribe to the Electronic All Risk Policy. At the London meeting, Richard Blech told Michael Moss that CBL made money by engaging in "risk free" arbitrage using funds "that they could raise against the stock to trade on behalf of customers."

The Underwriters reviewed the agreements between Douglas Brandon, as Trustee, and the CBL customers related to the credit facility and they represented that Mr. Brandon would be the sole signatory on the account holding the customers' securities and that the customer-deposited securities would be held in trust. Marsh also provided the Insurers with examples of the actual agreements between CBL and the institutions that held CBL's customers' securities as part of the credit facility; those agreements were inconsistent with CBL's representations to customers about the credit facility, and showed that Richard Blech, not trustee Brandon, was the sole signatory on the accounts.

Many of the institutions that acted as depositories were separately insured by Insurers. Though it is not the general practice to do so, Insurers testified that they could have checked with those institutions about CBL but did not.

The underwriters commissioned an investigation by CBL by Robert Bishop, an investigator retained by Lloyd's underwriters to investigate policyholders who drafted a report on CBL (the "Bishop Report") dated July 27, 1998.

Michael Moss and Angus Roberts received the Bishop Report on CBL, and the other Lloyd's underwriters who were considering whether to subscribe to the Electronic All Risk Policy had access to the Bishop Report. Angus Roberts, the Janson Green syndicate's underwriter who was considering whether to subscribe to the Electronic All Risk Policy, also was an underwriter on the Primary and First Excess Crime Policies.

The Bishop Report stated that the insurance policies were being purchased to solve a "marketing problem for CBL" and noted that "the CBL Insured Credit Facility Agreement is silent on whether CBL may use collateral [customers securities] for a corresponding loan arrangement with a foreign bank and how the bank's collateral interest would be established in the securities held by the insured trustee."

In September of 1998, Malcolm Woolgar of the investigative unit of the Corporation of Lloyd's received a report on CBL prepared by an investigator named Michael Lloyd. Woolgar received the report from one of his superiors, Andrew Wragg, whom in turn had received the report from Great Britain's Financial Services Authority (the "FSA"), which was investigating CBL; Andrew Wragg concluded that: "[CBL's insurance] is probably being mis-stated, and being dressed up to look like FG [a financial guarantee]."

The Lloyd Report provided a brief overview of CBL and stated that the information available "poses more questions that it answers," and stated that "we have severe doubts as to the viability of this organization."

On September 2, 1998, another of Malcolm Woolgar's superiors at the Corporation of Lloyd's, John Baker, spoke to a former director of CBL named Anthony Baron and concluded that "the Company [CBL] was believed to be operating a fraudulent scheme." Baron told John Baker that he had reported CBL to both the Bank of England and to the Irish Banking Authorities. Mr. Woolgar provided the Lloyd Report to Angus Reports and ...


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