New York Court Holds Disgorgement Payments Uninsurable as a Matter of Public Policy

By Brian Margolies

In its recent decision in J.P. Morgan Sec., Inc. v. Vigilant Ins. Co., 2018 N.Y. App. Div. LEXIS 6130, the New York Appellate Division, First Department, had occasion to revisit the issue of insurability of disgorgement of ill-gotten gains under professional liability policies.

Bear Stearns sought coverage under its primary and excess policies in connection with its alleged securities law violations whereby it earned hundreds of millions of dollars at the expense of mutual fund shareholders. Following an SEC investigation, Bear Stearns agreed to pay disgorgement in the amount of $160 million, as well as $90 million in civil penalties. Bear Stearns’ professional liability insurers denied coverage for these payments on the basis that they did not come within their policies’ definition of “Loss,” defined in relevant part 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.”

The declaratory judgment action had a long history. In 2011, the Appellate Division affirmed the trial court’s decision granting the insurers’ motion to dismiss Bear Stearns’ coverage action, concluding that Bear Stearns, as a matter of public policy, was not entitled to coverage for disgorgement of ill-gotten gains. The decision, however, was reversed by New York’s Court of Appeals in 2013 based on a finding that the insurers had not satisfied their burden, on a motion to dismiss, of demonstrating that Bear Stearns was not entitled to pursue insurance recovery for these amounts. On remand in 2017, the trial court granted summary judgment in favor of Bear Stearns, concluding among other things that the disgorgement payment constituted “Loss” because it represented third-party gains.

On appeal, the insurers argued that the United States Supreme Court’s decision in Kokesh v Securities and Exchange Commission, 198 L. Ed. 2d 86 (2017), decided after the Court of Appeal’s 2013 ruling, conclusively established that SEC disgorgement payments are a penalty. In particular, the Kokesh Court ruled that a disgorgement payment “(i) is imposed as a consequence for a wrong committed against the public, rather than a wrong against particular individuals; (ii) is meant to punish the violator and deter others from similar violations; and (iii) in many cases, does not compensate the victims of securities violations; rather, the wrongdoer pays disgorged profits to the district court, which has discretion to determine how and to whom to distribute the money.”

The Appellate Division concluded that the rationale in Kokesh, which was not decided in an insurance context, should apply with equal force to the question of whether disgorgement payments are insurable. Specifically, the court reasoned that because the purpose of SEC disgorgement payments are to penalize the wrongdoer and deter future misconduct, such amounts are uninsurable as a matter of public policy. The court further reasoned that as a penalty, the disgorgement payment necessarily did not come within the policies’ definition of “Loss.”

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