On November 21, 2013, in a terse, two-page summary order (here), the Second Circuit affirmed a district court ruling applying New York law and holding that a D&O insurance policy’s professional services exclusion precludes coverage for claims brought against  broker-dealer David Lerner Associates, based on the firm’s offering underwriter and financial products sales activities. The March 29, 2013 opinion of Eastern District of New York Judge Joseph F. Bianco, which the appellate court affirmed, can be found here.



David Lerner Associates (DLA) is a broker-dealer that served as the underwriter and sole distributor for securities of the Apple Real Estate Investment Trust (REIT). In May 2011, the Financial Industry Regulatory Authority (FINRA) filed a disciplinary complaint against DLA (subsequently amended to include David Lerner individually). FINRA’s amended complaint alleged that DLA sold over $442 million of the REIT’s securities, allegedly by misrepresenting the value of the securities while failing to perform adequate due diligence.


In June 2011, investors who had purchased the Apple REIT securities filed three class actions against DLA, David Lerner and others, arising out the same circumstances as the FINRA action. The three class actions and a separate individual action were consolidated in the Eastern District of New York.


DLA submitted the FINRA action and the various private lawsuits to its D&O insurer, seeking coverage for its costs of defending the actions. The insurer denied coverage in reliance on the D&O policy’s professional services exclusion, which provides in pertinent part that


The Underwriter shall not be liable to may any payment for Loss in connection with any Claim made against the Insured based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving the Insured’s performance of or failure to perform professional services for others


The policy does not define the term “professional services.”


DLA filed a lawsuit against its D&O insurer alleging breach of contract and seeking a declaratory judgment that the D&O insurer is obligated under its policy to indemnify and defend DLA in the regulatory action and private lawsuits. The D&O insurer filed a motion to dismiss DLA’s action.


The District Court’s March 29 Ruling

In his March 29, 2013 Memorandum and Order, Eastern District of New York Judge Joseph Bianco granted the D&O insurer’s motion to dismiss. 


Judge Bianco held that the insurer does not have a duty to indemnify or defend DLA in the underlying litigation “due to the unambiguous language of the professional services exclusion.” He said that the allegations in the underlying complaints alleging that DLA — while acting as the underwriter and sole distributor of the Apple REIT securities had failed to engage in due diligence —  “quintessentially and unambiguously fall within the common-sense understanding of the term ‘professional service.’”


Judge Bianco rejected DLA’s argument that because the term “professional services” was undefined in the policy, it was ambiguous and should be construed against the insurer. After reviewing New York case law, Judge Bianco said that


It is clear under New York law that the allegations in the underlying lawsuits against DLA – relating to its purported failure to, inter alia, conduct due diligence on the REITs in connection with providing investment advice to its customers in the sale of this financial product – constitute “professional services” under the common understanding of the term, and, thus, the exclusion from coverage under the policy unambiguously applies here.


Judge Bianco added that “to perform due diligence on REITs and market those securities, individuals are employed in an occupation, they rely on specialized knowledge or skill, and the skill is mental rather than physical. There is simply no question, based on the allegations in the underlying lawsuits, that the professional services exclusion applies.”


The Second Circuit’s November 21, 2013 Summary Order

On November 21, 2013, in a two-page summary order, a three judge panel of the Second Circuit affirmed Judge Bianco’s dismissal, quoting with approval from Judge Bianco’s opinion and stating that “the claims for which DLA seeks coverage fall within the professional services exclusion of the policy at issue.” 


The Second Circuit emphasized that under New York law insurance policy terms are to be “read in light of common sense speech and the reasonable expectations of a business person.” The appellate court also noted, as the district court had observed, that “the standard test for professional services is whether the employees acted with the special acumen and training of professionals when the engaged in the acts.”



The determination of whether or not claims based on certain specified activities are precluded by a D&O insurance policy’s professional services exclusion is the other side of the coin from the determination of whether or not the claims constitute “professional services’ within the meaning of the coverage provisions of an Errors and Omissions (E&O) insurance policy.


Indeed, these judicial determinations that DLA’s underlying activities represent professional services do raise the question of why DLA submitted these claims to its D&O insurer, rather than to its E&O insurer. Neither the district court opinion nor the Second Circuit opinion refers to the possibility of coverage for these claims under a separate E&O policy.


There is always the possibility that DLA did not carry E&O insurance; however, give the size of its operations (the district court opinion notes that the firm has offices in two states and about 370 registered representatives), I find it unlikely that the firm did not have E&O insurance. My guess is that the firm also submitted these claims to its E&O insurer and that the E&O insurer also denied the claims, either because the offering underwriting activities that are the basis of the underlying claims fall outside the definition of “professional services” in the E&O policy or because the claims against DLA were not asserted by the customer for whom DLA performed the underwriting services (Apple REIT) but by third parties. I want to emphasize that I am speculating here, I have no way of knowing for sure why this insurance dispute arises under DLA’s D&O policy and there is no mention of DLA’s E&O policy.


It is not uncommon for coverage disputes to arise involving the professional services exclusion in a D&O insurance policy. A frequently recurring issue (that was not involved here) has to do with the use of the broad preamble language in the exclusion – that is, that the exclusion precludes coverage for claims “based upon, arising out of or in any way involving” the delivery of professional services. Insurers whose policies have this broad preamble will seek to apply the exclusion broadly, to sweep in a broad range of disputes involving the insured company’s operations. For that reason, it is preferable when the alternative wording is available to use the narrower “for” preamble, rather than the broader “based upon, arising out of” lead-in language. However, the narrower language often is not available.


It is interesting that one of the elements of the dispute in this case had to do with the fact that the D&O insurance policy precluded coverage for claims arising from the delivery of professional services but the policy does not define the term “professional services.” By contrast, in the typical E&O insurance policy, which designed to provide coverage for claims arising from the delivery of professional services, the term “professional services” is invariable a defined term, and typically is defined very narrowly. (For a recent discussion of the ways in which an E&O insurance policy’s definition of the term “professional services” can affect the availability of coverage under the policy, refer here.)


The difference in the ways that the two types of policies treat the term “professional services” raises the possibility that specific activities might constitute “professional services” for purposes of the D&O insurance policy’s exclusion, but might fall outside the definition of “professional services” for purposes of triggering coverage under the E&O insurance policy – which is one reason why it is preferable for financial services firms to have the D&O and E&O insurance provided by the same carrier.


As always when I stray into topics involving E&O insurance, I am interested in the thoughts and reactions of readers who work more frequently with those policy forms than I do. I encourage readers to add their comments to this post using the blog’s comment feature.