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J.P. Morgan Securities Inc. v. Vigilant Insurance Co.

Supreme Court, New York County

April 17, 2017

J.P. Morgan Securities Inc., J.P. Morgan Clearing Corp., and the Bear Stearns Companies LLC, Plaintiffs,
v.
Vigilant Insurance Company, the Travelers Indemnity Company, Federal Insurance Company, National Union Fire Insurance Company of Pittsburgh, P.A., Liberty Mutual Insurance Company, Certain Underwriters at Lloyd's, London and American Alternative Insurance Corporation, Defendants.

          For plaintiffs: Steven Obus, Esq., Proskauer Rose LLP

          For defendant Vigilant Ins. Co.: Joseph Finnerty, Esq., DLA Piper LLP

          Hon. Charles E. Ramos J.S.C.

         In this insurance coverage action, plaintiffs [1] (together, plaintiffs) seek a declaration that its insurers are required to indemnify it for claims stemming from Bear Stearns' monetary settlement of Securities and Exchange Commission (SEC) and New York Stock Exchange (NYSE) investigations and related private litigation arising out of Bear Stearns' alleged facilitation of late trading and deceptive market timing.

         In motion sequence 018, defendant National Union Fire Insurance Company of Pittsburgh, Pa. (National Union) moves for partial summary judgment declaring that there is no coverage for plaintiffs' claims asserted under National Union Excess Professional Liability Policy No. 278-73-26 on the basis that all such claims for coverage are barred by the policy's known wrongful acts exclusion. Plaintiffs cross-move for partial summary judgment dismissing National Union's defense based upon this exclusion.

         In motion sequence 019, plaintiffs move for summary judgment dismissing defendants' defenses that 1) $140 million of the loss for which Bear Stearns claims coverage is uninsurable as ill-gotten gains; 2) the loss is otherwise excluded under the Personal Profit Exclusion; 3) public policy bars indemnification; and 4) the amounts Bear Stearns paid to settle the claims against it were unreasonable.

         In motion sequence 020, defendants Vigilant Insurance Company (Vigilant), The Travelers Indemnity Company (Travelers), Federal Insurance Company (Federal), National Union, Liberty Mutual Insurance Company (Liberty), Certain Underwriters at Lloyd's, London (Lloyds), and American Alternative Insurance Company (AAIC) (together, the Insurers) move for summary judgment in their favor.

         In motion sequence 021, Lloyd's and AAIC (together, the Underwriters) move for summary judgment dismissing all claims asserted against them under Lloyd's excess policy under the known wrongful acts exclusion.

         In motion sequence 022, plaintiffs move for partial summary judgment dismissing the Underwriters' defense under the known wrongful act exclusions.

         In motion sequence 023, plaintiffs move to supplement the record on the Insurers' pending motion for summary judgment (020).

         Motion sequence numbers 018 through 023 are consolidated for disposition.

         Background [2]

         In 2003, Bear Stearns subsidiaries, BS & Co., a registered broker-dealer, and BSSCorp., a clearing firm, were the subject of investigations conducted by the SEC and NYSE for possible violations of federal securities law in connection with their alleged facilitation of late trading and deceptive market timing by certain customers involved in buying and selling shares in various mutual funds. [3]

         At the conclusion of its investigation, the SEC notified Bear Sterns of its intention to formally charge it with violations of federal securities law, to seek injunctive relief and sanctions of $720 million. Bear Stearns disputed the proposed charges in a Wells Submission, and entered into settlement negotiations with the SEC. On March 16, 2006, pursuant to a Bear Stearns offer of settlement and without any admission by Bear Stearns of the SEC's findings, the SEC issued an order resolving its investigation (SEC order). To resolve the SEC claims, Bear Stearns agreed to pay a total of $250 million, of which $160 million was labeled "disgorgement" and $90 million was a penalty, in order to provide compensation to mutual fund investors for the alleged damages caused by late trade and deceptive market timing practices of Bear Stearns' customers. Bear Stearns also entered into a settlement with the NYSE, which imposed a disgorgement and penalty payment identical to that imposed by the SEC, deemed satisfied by Bear Stearns' tender of payment to the SEC (Plaintiffs' Response to Insurers' Rule 19-A Statements, ¶ 29).

         Bear Stearns was also named as a defendant in thirteen civil class actions (civil actions), commenced on behalf of mutual fund investors allegedly damaged by Bear Stearns' conduct. Bear Stearns ultimately agreed to pay $14 million to settle the civil actions.

         Bear Stearns has sought indemnity from the Insurers under an insurance program which provided professional liability insurance coverage to Bear Stearns and its subsidiaries, directors, officers and employees. The insurance program provided Bear Stearns with $200 million in coverage, above a $10 million retention. The Insurers disclaimed coverage on the ground that the settlement constituted disgorgement of ill-gotten gains which are not insurable as a matter of law.

         Thereafter, plaintiffs commenced this insurance coverage action seeking a declaration that the Insurers are obligated to indemnify Bear Stearns for the non-penalty portion of the SEC settlement (less a $10 million retention), plus defense costs and pre-judgment interest. Bear Stearns also seeks a declaration for entitlement to coverage arising out of its payment of $14 million to settle the civil actions. In their answers, the Insurers maintain that Bear Stearns' claims for coverage are barred under exclusions contained in the Policies and violate public policy.

         Previously, Insurers sought dismissal of the complaint pursuant to CPLR 3211, which this court denied in 2010 (J.P. Morgan Securities Inc. v Vigilant Ins. Co., 2010 NY Slip Op 33799[U] [Sup Ct, NY County 2010]). The First Department reversed this Court's denial of the Insurers' motion to dismiss the complaint (J.P. Morgan Securities Inc. v Vigilant Ins. Co., 91 A.D.3d 226');">91 A.D.3d 226 [1st Dept 2011]). In June 2013, the Court of Appeals reversed the First Department, and reinstated this Court's decision (21 N.Y.3d 324 [2013]).

         In 2014, this Court addressed defenses based upon the applicability of the dishonest acts exclusion in plaintiffs' motion for partial summary judgment. This Court granted the motion and dismissed the affirmative defenses based upon the exclusion, holding that Bear Stearns' settlements with the regulatory agencies did not constitute adjudications of wrongdoing (42 Misc.3d 1230[A]]).

         In July 2016, plaintiffs moved for partial summary judgment dismissing certain Insurers' defenses based upon assertions that Bear Stearns failed to obtain the Insurers' consent to settle and breached the duty of cooperation; several Insurers cross-moved for summary judgment. With respect to the obligation to obtain the Insurers' consent to settle, this Court held that Bear Stearns was excused from complying because the Insurers effectively disclaimed coverage prior to Bear Stearns' settlement with the SEC (53 Misc.3d 694');">53 Misc.3d 694). With respect to the duty to cooperate, this Court held that the Insurers' failed to meet their burden that they diligently sought Bear Stearns' cooperation or that Bear Stearns obstructed these efforts (Id.).

         Discussion

         I. Defenses Common to All Insurers

         Plaintiffs move for summary judgment to dismiss the Insurers' remaining defenses on the grounds that Bear Stearns is entitled to coverage for the $140 million disgorgement payment because it is undisputed that this payment represents the profits of third parties and not Bear Stearns, and it suffered an insurable loss under the Policies.

         In opposition to plaintiffs' motion and in support of their own motions for dismissal, the Insurers argue that plaintiffs cannot demonstrate that the SEC ordered Bear Stearns to disgorge its customers' ill-gotten gains as opposed to its own ill-gotten gains. The Insurers additionally argue that, irrespective of whether Bear Stearns can establish that it was in fact ordered to disgorge only its customers' ill-gotten gains, the $140 million payment is not insurable because it was not a loss under the Policies.

         As stated by the Court of Appeals previously in this action, under both public policy grounds and insurance contract interpretation principles, "the return of improperly acquired funds does not constitute a 'loss' or 'damages' within the meaning of insurance policies (J.P. Morgan Sec. Inc. v Vigilant Ins. Co., 21 N.Y.3d 324, 335-36 [2013]). Thus, an insured will be barred from obtaining coverage for a settlement payment made to a regulatory body that is labeled disgorgement where the regulatory body's findings "conclusively link the disgorgement payment to improperly acquired funds in the hands of the insured" (Millennium Partners, L.P. v Select Ins. Co., 68 A.D.3d 420');">68 A.D.3d 420 [1st Dept 2009], appeal dismissed 14 N.Y.3d 856');">14 N.Y.3d 856 [2010]).

         Here, the Policies' definition of loss is broad. The definition lists both "damages" and "other costs" that the insured is legally obligated to pay. It covers "compensatory damages, multiplied damages, punitive damages where insurable by law, judgments, settlements, costs, charges and expenses or other sums the Insured shall legally become obligated to pay as damages resulting from any Claim, " and "costs, charges and expenses or other damages incurred in connection with any investigation by any governmental body or self-regulatory organization" (Exhibit 8, § II.B, annexed to the Siegelaub Aff.).

         Based on a plain reading of this term, the $140 million disgorgement payment that Bear Stearns made to settle the SEC's late trading and market timing claims clearly constitutes a loss as damages resulting from a claim, provided that this payment represented the gains of third parties and not Bear Stearns. As noted by the Court of Appeals, the SEC order does not establish that the $140 million payment, although labeled disgorgement, was predicated on profits that Bear Stearns improperly acquired (J.P. Morgan Sec. Inc., 21 N.Y.3d at 336). Indeed, the SEC order emphasized that Bear Stearns facilitated and enabled its customers, through Bear Stearns' provision of clearing services, to receive millions of dollars of improperly acquired gains. The SEC order makes no mention of Bear Stearns' having improperly earned revenue as a result of its facilitation of such trading practices.

         Notwithstanding the lack of a conclusive link in the SEC order between the disgorgement payment and any improperly acquired funds in the hands of Bear Stearns, plaintiffs go further by submitting extensive evidence to demonstrate that the settlement payment it made to the SEC actually represents the gains of its customers, rather than its own gains. For the reasons set forth below, the Insurers fail to rebut this showing with any competent evidence.

         To demonstrate that the settlement payment they are seeking insurance coverage for is not ill-gotten gains, plaintiffs submit the testimony and contemporaneous notes of Lewis Liman, Esq., of Cleary Gottlieb Steen & Hamilton LLP (Clearly Gottlieb) who represented Bear Stearns in its defense of the regulatory investigations.

         Further, plaintiffs point to documents that Bear Stearns produced in response to an April 2004 SEC subpoena, which requested the production of documents sufficient to show Bear Stearns' own profit or loss for those who placed late trading and market timing trades through Bear Stearns, in addition to any related revenue received by Bear Stearns for such trades (Exhibit 30, annexed to the Siegelaub Aff.). In response to this subpoena, Bear Stearns performed calculations - which it presented to SEC staff - of the revenues Bear Stearns had earned from these accounts and customers it had identified as potentially engaging in deceptive market timing and late trading (Exhibit 39, annexed to the Siegelaub Aff.).

         In addition, according to Liman's unequivocal testimony of his firsthand discussions with SEC staff on behalf of Bear Stearns, coupled with the testimony of other witnesses, following the production of documents pursuant to the subpoena, both the SEC and Bear Stearns engaged in a process of identifying the universe of customers who may have been engaged in late trading and market timing, in order to calculate both Bear Stearns' revenues and the profits earned by Bear Stearns' customers engaged in market timing and late trading. To this end, Bear Stearns prepared a "Combined Accounts List" which it presented to the SEC in December 2004 (Exhibits 41-44, 82, Moreno Dep Tr 304, annexed to the Siegelaub Aff.).

         The Combined Accounts List identified correspondent broker-dealer accounts that the documents and trading data identified may have employed a market timing strategy (Id.). The Combined Accounts List also included an analysis of Bear Stearns revenues from mutual fund trades in these accounts, which showed that Bear Stearns' revenues from the mutual funds transactions in the accounts the SEC determined were associated with late trading and deceptive market timing totaled $16.9 million (Liman Aff., Exhibit A, ¶ 4; Exhibits 46, annexed to the Siegelaub Aff.). The SEC staff accepted this revenue calculation, which became the basis of the discussions between Bear Stearns and SEC staff with respect to that component of the investigation (see Liman Aff., ¶ 6; Liman Dep Tr 295-97, 822:5-11, Exhibits 81, annexed to the Siegelaub Aff.).

         SEC staff also requested the production of customer gain information, based upon the understanding, from Bear Stearns' perspective, that Bear Stearns should be held liable through disgorgement for the gains of its customers. Similarly, where there was a broker/customer relationship, it was understood from communications with SEC staff that a clearing broker should be liable for its own profits and also for the profits of the brokers' customers (Exhibit 81, annexed to the Siegelaub Aff.; (Liman Dep Tr 170-71, 173:5-16, 174:22-25, 175:12-18, 243:10-24-244:2-15). Liman testified that SEC staff informed him that it was interested in the fees and revenues ascribed to those customers that were engaged ...


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