J.P. Morgan Sec., Inc. v. Vigilant Ins. Co.J.P. Morgan Sec., Inc. v. Vigilant Ins. Co.
Defendants appeal from a judgment of the Supreme Court, New York County (Charles Ramos, J.), entered August 14, 2017, awarding plaintiffs sums of money, including prejudgment interest, as against defendant insurers Vigilant Insurance Company, The Travelers Indemnity Company and Federal Insurance Company, National Union Fire Insurance Company of Pittsburgh, Pa., and Liberty Mutual Insurance Company and from the order of the same court and Justice, entered April 17, 2017, as amended by the order of the same court and Justice, entered on or about August 11, 2017.
Holwell Shuster & Goldberg LLP, New York (James M. McGuire, Daniel M. Sullivan and Gregory Dubinsky of counsel), and DLA Piper LLP (US), New York (Joseph G. Finnerty III, Megan Shea Harwick and Eric S. Connuck of counsel), for Vigilant Insurance Company and Federal Insurance Company, appellants.
Kaufman Borgeest & Ryan LLP, New York (Scott A. Schechter, Andrew E. Oldis and Matthew Mawby of counsel), for Liberty Mutual Insurance Company, appellant.
Drinker Biddle & Reath LLP, Philadelphia, PA (David F. Abernethy of the bar of the State of New Jersey and the State of Pennsylvania, admitted pro hac vice, of counsel), and Drinker Biddle & Reath LLP, New York (Marsha J. Indych of counsel), for The Travelers Indemnity Company, appellant.
D'Amato & Lynch, LLP, New York (Kevin J. Windels, Luke D. Lynch and Liza A. Chafiian of counsel), for National Union Fire Inssurance Company of Pittsburgh, PA, appellant.
Clyde & Co. US LLP, New York (Edward J. Kirk, Gabriela Richeimer and Matthew Prutting of counsel), for Certain Underwritters at Lloyd's, London, appellant.
Landman Corsi Ballaine & Ford P.C., New York (William Ballaine of counsel), for American Alternative Insurance Corporation, appellant.
Proskauer Rose LLP, New York (Steven E. Obus and Seth Schaffer of counsel), for respondents.
ANDRIAS, J.
In this insurance dispute arising out of the
In 2003, the SEC began an investigation to determine whether Bear Stearns violated securities laws between 1999 and September 2003 by knowingly facilitating "late trading" and deceptive "market timing" for certain hedge fund customers, and affirmatively assisting those customers in evading detection, thereby enabling them to earn hundreds of millions of dollars in profits at the expense of mutual fund shareholders. In 2006, the SEC notified Bear Stearns that it intended to institute civil proceedings against it seeking monetary sanctions of $720 million.
In March 2006, after Bear Stearns made a formal offer of settlement, the SEC issued an "Order Instituting Public Administrative and Cease-and-Desist Proceedings Pursuant to
In a prior appeal, this Court held that, as a matter of public policy, Bear Stearns could not seek recoupment of any portion of the $160 million disgorgement payment and dismissed the complaint (91 AD3d 226 [1st Dept 2011]). The Court of Appeals reversed and reinstated the complaint, stating that "the Insurers
While recognizing that other courts, as a matter of contract interpretation or public policy, have held that the risk of being ordered to disgorge "ill-gotten gains" is not insurable, the Court of Appeals, referencing Bear Stearns's argument that the rule "should apply only where the insured requests coverage for the disgorgement of its own illicit gains," stated that "the documentary evidence does not decisively repudiate Bear Stearns' allegation that the SEC disgorgement payment amount was calculated in large measure on the profits of others" (21 NY3d at 336). With respect to the public policy prohibition barring an insured from seeking indemnification for intentionally harmful conduct, the Court found that "[t]he SEC order, while undoubtedly finding Bear Stearns' numerous securities laws violations to be willful, does not conclusively demonstrate that Bear Stearns also had the requisite intent to cause harm" (21 NY3d at 335).
As to the personal profit exclusion, which bars coverage for claims against the insured "based upon or arising out of the Insured gaining in fact any personal profit or advantage to which the Insured was not legally entitled," the Court found that "[b]ecause Bear Stearns alleges, and the SEC order does not conclusively refute, that its misconduct profited others, not itself, this exclusion does not defeat coverage under
In the April 2017 order (57 Misc 3d 171), the motion court granted plaintiffs' motions for summary judgment and denied the defendants' motions for summary judgment. The Court found that (i) based on the broad definition in the policy, the $140 million disgorgement payment at issue constituted a covered loss because it represented third-party gains; (ii) the public policy exception for loss arising out of intentionally harmful conduct did not bar coverage because nothing indicated that Bear Stearns deliberately intended to cause injury to mutual fund investors, and the hearsay statements by Bear Stearns's employees that customers' late trading and market timing transactions harmed mutual fund investors were insufficient to raise a triable issue of fact; (iii) the personal profit exclusion did not bar coverage because it applied to claims based upon or arising out of the insured "gaining in fact any personal profit or advantage" to which the insured was not legally entitled and here the profit accrued to third parties and Bear Stearns did not derive any greater compensation for late trading and market timing transactions than it did for other mutual fund trades that it cleared; (iv) the prior knowledge exclusion did not bar coverage because, construing the ambiguous clause in favor of the insured, the term "officer" did not refer to all employees whose job title included the term "officer," but was limited to employees with important executive and managerial duties; and (v) the $140 million settlement, after defendants denied coverage, was reasonable in view of Bear Stearns's exposure and the probability that the SEC would prove its claims. In August 2017, the court amended the order (2017 NY Slip Op 31690[U]), to award plaintiffs prejudgment interest against all defendants because they wrongfully disclaimed and the first loss triggered each of the policies simultaneously on the day it occurred. The court found that the exhaustion provisions did not apply because Bear Stearns suffered a single large loss which exceeded the limits of each insurer on the very date that it was incurred. In August 2017, judgment was entered in plaintiffs' favor.
We first consider whether or not the insurers should have been granted summary judgment dismissing the complaint
The primary professional liability policy, to which the excess policies follow form, provides that the Insurers are to "pay on behalf of [Bear Stearns] all Loss which [Bear Stearns] shall become legally obligated to pay as a result of any Claim . . . for any Wrongful Act of [Bear Stearns]." "Loss" is defined as:
"(1) compensatory damages, multiplied damages, punitive damages where insurable by law, judgments, settlements, costs, charges and expenses or other sums [Bear Stearns] shall legally become obligated to pay as damages resulting from any Claim or Claim(s);
"(2) costs, charges and expenses or other damages incurred in connection with any investigation by any governmental body or self-regulatory organization (SRO), provided however, Loss shall not include:
"(i) fines or penalties imposed by law; or . . .
"(v) matters which are uninsurable under the law pursuant to which this policy shall be construed."
Vigilant argues that there is no coverage because the United States Supreme Court in Kokesh v Securities and Exchange Commission (_ US_, 137 S Ct 1635 [2017]) conclusively defined the nature of the SEC disgorgement remedy as a penalty, not a loss, and that the Court of Appeals did not resolve this issue when it reversed to deny the insurers' motions to dismiss.
In Kokesh, decided after the Court of Appeals' prior decision reinstating the complaint, the United States Supreme Court held that SEC disgorgement constitutes a penalty, and is therefore subject to the five year statute of limitations of
Plaintiffs argue that even if the Supreme Court's reasoning behind the holding that disgorgement is a penalty extends beyond the limited context of Kokesh, it has no application here because the Court of Appeals has rejected the argument that the instant claim is not a Loss under the policies and has suggested that a disgorgement payment of a third-party gain is recoverable under an insurance policy. However, application of the doctrine of the "law of the case" is not warranted under the particular circumstances before us.
The law of the case is applicable to "legal determinations that were necessarily resolved on the merits in a prior decision" (Brownrigg v New York City Hous. Auth., 29 AD3d 721, 722 [2d Dept 2006]). On the prior appeal, the Court of Appeals stated that "the Insurers do not earnestly dispute that the claims fall within the policy's definition of Loss" (21 NY3d at 333), but did not rely on the policy language in denying defendants' motions. Instead it focused on the public policy issue. Furthermore, the doctrine does not apply where a motion for summary judgment follows a motion to dismiss that was not converted to a motion for summary judgment pursuant to
Even if the Court of Appeals' prior determination is viewed as addressing the contractual issue, "while the law of the case doctrine is intended to foster 'orderly convenience' . . ., it is not an absolute mandate which limits an appellate court's power to reconsider issues where there are extraordinary circumstances,
In reinstating the complaint, the Court of Appeals stated that "at this
"Moreover, the cases upon which the Insurers rely are distinguishable (see e.g. Millennium Partners, L.P. v Select Ins. Co., 68 AD3d 420 [1st Dept 2009], appeal dismissed 14 NY3d 856 [2010]; Credit Suisse, 10 AD3d at 528). In each, the insured was barred from obtaining coverage for SEC-ordered disgorgement because the SEC's findings 'conclusively link[ed]' the disgorgement payment to improperly acquired funds in the hands of the insured (Millennium Partners, 68 AD3d at 420 [internal quotation marks omitted]; see also Credit Suisse, 10 AD3d at 529). In other words, they directly implicated the policy rationale for precluding indemnity for disgorgement—to prevent the unjust enrichment of the insured by allowing it to, in effect, retain the ill-gotten gains by transferring the loss to its carrier. In this case, in contrast, Bear Stearns alleges that it is not pursuing recoupment for the turnover of its own improperly acquired profits and, therefore, it would not be unjustly enriched by securing indemnity. The Insurers have not identified a single precedent, from New York or
otherwise, in which coverage was prohibited where, as Bear Stearns claims, the disgorgement payment was (at least in large part) linked to gains that went to others. Consequently, at this early juncture, we conclude that the Insurers are not entitled to dismissal of Bear Stearns' insurance claims related to the SEC disgorgement payment" (21 NY3d at 337).
However, Kokesh has now provided the missing precedent, establishing that disgorgement is a penalty, whether it is linked to the wrongdoer's gains or gains that went to others. In Kokesh, the Supreme Court, emphasizing that when a sanction "can only be explained as . . . serving either retributive or deterrent purposes," it is a "punishment," rejected the SEC's argument that disgorgement is remedial because it simply puts the defendant back in the position "he would have occupied had he not broken the law." The Court explained:
"The Government's primary response to all of this is that SEC disgorgement is not punitive but 'remedial' in that it 'lessen[s] the effects of a violation' by 'restor[ing] the status quo.' . . . As an initial matter, it is not clear that disgorgement, as courts have applied it in the SEC enforcement context, simply returns the defendant to the place he would have occupied had he not broken the law. SEC disgorgement sometimes exceeds the profits gained as a result of the violation. Thus, for example, 'an insider trader may be ordered to disgorge not only the unlawful gains that accrue to the wrongdoer directly, but also the benefit that accrues to third parties whose gains can be attributed to the wrongdoer's conduct.' SEC v. Contorinis, 743 F.3d 296, 302 (C.A.2 2014). Individuals who illegally provide confidential trading information have been forced to disgorge profits gained by individuals who received and traded based on that information—even though they never received any profits. Ibid.; see also SEC v. Warde, 151 F.3d 42, 49 (C.A.2 1998) ('A tippee's gains are attributable to the tipper, regardless whether benefit accrues to the tipper'); SEC v. Clark, 915 F.2d 439, 454 (C.A.9 1990) ('[I]t is well settled
that a tipper can be required to disgorge his tippees' profits'). And, as demonstrated by this case, SEC disgorgement sometimes is ordered without consideration of a defendant's expenses that reduced the amount of illegal profit. App. to Pet. for Cert. 43a; see Restatement (Third) § 51, Comment h, at 216 ('As a general rule, the defendant is entitled to a deduction for all marginal costs incurred in producing the revenues that are subject to disgorgement. Denial of an otherwise appropriate deduction, by making the defendant liable in excess of net gains, results in a punitive sanction that the law of restitution normally attempts to avoid'). In such cases, disgorgement does not simply restore the status quo; it leaves the defendant worse off. The justification for this practice given by the court below demonstrates that disgorgement in this context is a punitive, rather than a remedial, sanction: Disgorgement, that court explained, is intended not only to 'prevent the wrongdoer's unjust enrichment' but also 'to deter others' violations of the securities laws.' App. to Pet. for Cert. 43a." (137 S Ct at 1644-1645 [emphasis added]).
The United States Supreme Court has thereby made clear that SEC disgorgement is a penalty because it punishes a public wrong, and its purpose is deterrence, whether you are remitting your own ill gotten gains or those you generated for your customers through violations of the securities law, even if you did not directly share in those profits.
Kokesh has significance beyond the narrow issue of the statute of limitations because the Supreme Court analyzed the fundamental nature and purpose of the SEC's disgorgement remedy, which does not change into some different nature for purposes of insurance coverage. Thus, as defendants argue, Kokesh and the longstanding legal principles on which it relied fatally undermine the motion court's holding that the $140 million of the SEC disgorgement remedy that plaintiff seeks to recover is a covered loss under the policies. Indeed, if the $140 million portion of the disgorgement payment Bear Stearns seeks to recover reflects the gains of Bear Stearns's customers rather than of Bear Stearns itself, it makes it more, not less, of a penalty.
The fact that the disgorgement payment was later placed in a Fair Fund for distribution and could be used to offset Bear
Accordingly, the judgment of the Supreme Court, New York County (Charles Ramos, J.), entered August 14, 2017, awarding plaintiffs sums of money, including prejudgment of the interest, as against defendant insurers Vigilant Insurance Company, The Travelers Indemnity Company, Federal Insurance Company, National Union Fire Insurance Company of Pittsburgh, Pa., and Liberty Mutual Insurance Company, should be reversed, on the law, without costs, plaintiffs' motion for summary judgment denied, defendants' motions for summary judgment declaring that plaintiffs are not entitled to coverage for the SEC disgorgement payment granted, and it is so declared. The appeals from the order of the same court and Justice, entered April 17, 2017, as amended by the order of the same court and justice entered on or about August 11, 2017, should be dismissed, without costs, as subsumed in the appeals from the judgment.
All concur.
Judgment, Supreme Court, New York County (Charles Ramos, J.), entered August 14, 2017, reversed, on the law, without costs, plaintiffs' motion for summary judgment denied, defendants' motions for summary judgment declaring that plaintiffs are not entitled to coverage for the SEC disgorgement payment granted, and it is so declared. Appeals from order, same court and Justice, entered April 17, 2017, as amended by order, same court and Justice, entered on or about August 11, 2017, dismissed, without costs, as subsumed in the appeals from the judgment.
Opinion by Andrias, J. All concur.
Sweeny, J.P., Richter, Andrias, Kahn, JJ.
THIS CONSTITUTES THE DECISION AND ORDER OF THE SUPREME COURT, APPELLATE DIVISION, FIRST DEPARTMENT.
ENTERED: SEPTEMBER 20, 2018
CLERK