In a June 11, 2013 opinion, the New York Court of Appeals held that Bear Stearns is not barred from seeking insurance coverage for a $160 million portion of an SEC enforcement action settlement labeled as “disgorgement,” where Bear Stearns’ customers rather than Bear Stearns itself profited from alleged misconduct.  The Court’s opinion reversed the ruling of an intermediate appellate court which had held that Bear Stearns could not seek insurance coverage for the settlement amount labeled as “disgorgement.” The opinion of the Court of Appeals can be found here.



In 2006, the SEC notified Bear Stearns that the agency was investigating late trading and market timing activities units of Bear Stearns had undertaken for the benefit of clients of the company. The agency advised the company that it intended to seek injunctive relief and monetary sanctions of $720 million.


Bear Stearns ultimately made an offer of settlement and –without admitting or denying the agency “findings” – consented to the SEC’s entry of an Administrative Order, in which, among other things, Bear Stearns agree to pay a total of $215 million, of which $160 million was labeled “disgorgement” and $90 million as a penalty.


At the relevant time, Bear maintained a program of insurance that, according to the subsequent complaint, totaled $200 million. Bear Stearns sought to have the carriers in the program indemnify the company for the SEC settlement. However, the carriers claimed that because the $160 million payment was labeled “disgorgement” in the Administrative Order, it did not represent a covered loss under the insurance policies.


In 2009, J.P. Morgan (into which Bear Stearns merged in 2008) filed an action seeking a judicial declaration that the insurers were obliged to indemnify the company for the amount of the $160 million payment in excess of the $10 million self insured retention. The company argued that notwithstanding the Administrative Order’s reference to the amount as “disgorgement,” its payment to resolve the SEC investigation constituted compensatory damages and therefore represented a covered loss under the insurance program. The carriers moved to dismiss the company’s declaratory judgment action.


In a September 14, 2010 order (here), New York (New York County) Supreme Court Charles E. Ramos denied the carriers’ motion to dismiss. He held that the Administrative Order’s use of the term “disgorgement” did not conclusively establish that the settlement amounts were precluded from coverage.


In reaching this conclusion, he noted that the Administrative Order “does not contain an explicit finding that Bear Stearns directly obtained ill-gotten gains or profited by facilitating these trading practices,” and he found that the provision of the Order alone “do not establish as a matter of law that Bear Stearns seeks coverage for losses that include the disgorgement of improperly acquired funds." Judge Ramos rejected the insurers’ argument that they were entitled to dismissal.


As discussed here, in a December 13, 2011 opinion (here), the N.Y. Supreme Court, Appellate Division, First Department, reversed the lower court’s holding, granted the motions to dismiss and directed the entry of judgment in favor of the insurers. The appellate court concluded that the “SEC Order required disgorgement of funds gained through that illegal activity,” and that “the fact that the SEC did not itemize how it reached the agreed upon disgorgement figure does not raise an issue as to whether the disgorgement payment was in fact compensatory.”


The intermediate appellate court  further noted that in generating revenue of at least $16.9 million, “Bear Stearns knowingly and affirmatively facilitated an illegal scheme which generated hundreds of millions of dollars for collaborating parties and agreed to disgorge $160,000,000 in its offer of settlement.”  Bear Stearns appealed the intermediate appellate court’s ruling.


The June 11 Court of Appeals Decision

In a June 11 opinion written by Judge Victoria Graffeo for a unanimous court, the Court of Appeals reversed the intermediate appellate court and reinstated Bear Stearns’  complaint.


The insurers had argued that coverage for the “disgorgement” amount was precluded on two different coverage ground; first, that public policy prohibits insurance when an insured has engaged in conduct “with the intent to cause injury;” and second, that public policy prohibits insurance for disgorgement amounts.


The Court of Appeals first rejected the intentional injury argument, holding that though the SEC’s order recited that Bear Stearns has willfully violated federal securities laws, the Court of Appeals could not conclude that the public policy coverage preclusion applied. The SEC order, “while undoubtedly finding Bear Stearns’ numerous securities law violations to be willful, does not conclusively demonstrate that Bear Stearns also had the requisite intent to case harm.”


The Court of Appeals also rejected the insurers’ argument that public policy prohibits insurance for the “disgorgement” amounts. The Court of Appeals found that the SEC Order “does not establish that the $160 disgorgement payment was predicated on moneys that Bear Stearns itself improperly earned.” Rather, the order recites that Bear Stearns’ misconduct allowed its customers to profit.


The Court of Appeals found that the cases on which the insurers sought to rely in arguing that insurance coverage is precluded for disgorgement amounts linked the disgorgement payment to improperly acquired funds in the hands of the insured. The cases, the Court of Appeals said, “directly implicated the public policy rationale for precluding indemnity – 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, the Court said, “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 carriers, the Court of Appeals said, had not identified a single case where coverage was prohibited when the disgorgement payment was, at least according to Bear Stearns’ allegations, linked to gains that went to others.


The Court of Appeals also rejected the insurers’ argument that the improper profit exclusion precluded coverage for Bear Stearns’ claims. The Court said that because Bear Stearns alleged that its misconduct profited others, not itself, “the exclusion does not defeat coverage.”



Bear Stearns faced an uphill battle trying to argue, that a portion of the SEC settlement expressly labeled as “disgorgement” is not precluded from coverage based on case law establishing that public policy bars insurance coverage for “disgorgement” amounts.


Nevertheless, Bear Stearns was able to successfully argue that because at least $140 million of the disgorgement amount represented its customers’ profits, not its own, the company was not seeking to retain its own ill-gotten gains. The Court of Appeals observation that the insurers were unable to cite a single case in which coverage had been precluded under these kinds of circumstances is interesting.


The Court of Appeal’s holding suggests that there may be circumstances in which an insured might seek insurance coverage for an amount labeled as “disgorgement,” at least where the insured itself did not profit from the improper conduct that was the basis of the disgorgement. However, this holding is only going to be useful for insured’s seeking coverage in a limited range of circumstances. The Court of Appeals opinion will be of no help to insureds seeking coverage for “disgorgement” under the more typical circumstances where the insured is alleged to have profited from the wrongful conduct that was the basis of the disgorgement.


Nevertheless, the Court of Appeals decision does provide at least one example where an insured was permitted to seek insurance coverage for amounts labeled as a “disgorgement.”  Insureds will undoubtedly seek to rely on this decision when trying to seek insurance coverage for disgorgement amounts and insurers undoubtedly will argue that the insured’s claim does not involved the kind of circumstances presented here.


It probably should be noted that the Court of Appeals did not rule that the insurers’ policies covered the disgorgement amount. The Court of Appeals held only that Bear Stearns was not, based on the allegations in its complaint, precluded from seeking insurance coverage. The parties must now return to the trial court, where there will be further proceedings to determine whether or not there is coverage under the policies for the “disgorgement” amount.


A June 11, 2013 Memorandum by the Troutman Sanders law firm discussing the Court of Appeals decision can be found here.