nystate1In the latest round in the long-running battle over whether there is D&O insurance coverage for the amounts Bear Stearns paid in settlement of an SEC enforcement action for alleged market timing, the D&O insurers may have finally found an issue on which they may be allowed to try to dispute coverage. Even though, in its January 15, 2015 opinion (here), the N.Y. Supreme Court, Appellate Division, First Department, affirmed the trial court’s dismissal of the carrier’s affirmative defense based on the “Dishonest Acts Exclusion,” the intermediate appellate court modified the trial court’s dismissal of the carriers’ affirmative defense based on the public policy doctrine precluding coverage for losses caused by intentionally harmful conduct. The intermediate appellate court has, however, already been reversed once before in this protracted coverage battle, so it remains to be seen where this latest development ultimately will leave the parties.  



In 2006, the SEC notified Bear Stearns that the agency was investigating late trading and market timing activities that units of Bear Stearns allegedly had undertaken for the benefit of clients of the company. 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. Among other things the SEC Order expressly stated that “The findings herein are made pursuant to [Bear Stearn’s] Offer of Settlement and are not binding on any other person in this or any other proceeding.”


At the relevant time, Bear maintained a program of insurance that totaled $200 million. Bear Stearns sought to have the carriers in the program indemnify the company for the $160 million amount in the settlement labeled as “disgorgement.”  The carriers refused to pay, relying on several policy exclusions and public policy grounds, as well as on the doctrine providing against insurance for amounts that are in the nature of disgorgement. J.P. Morgan, into which Bear Stearns merged in 2008, filed an action in New York state court seeking a judgment declaring that the carriers’ policy provided coverage for the $160 million portion of the settlement, as well as the approximately $14 million paid to settle the parallel securities class action lawsuit, and defense fees.


The disgorgement issue went forward first. The trial court denied the defendants’ motion to dismiss finding that there was a question whether the $160 million Bear Stearns had agreed to make were for improperly acquired funds and thus truly in the nature of disgorgement. The N.Y Supreme Court, Appellate Division, First Department reversed the trial court, saying that the settlement documents “are not reasonably susceptible to any interpretation other than that” Bear Stearns facilitated late trading and that the settlement of the allegations “required disgorgement of funds gained through that illegal activity.”


However, as discussed here, in June 2013, the New York Court of Appeals reversed the appellate court, and denied the defendants’ motion to dismiss J.P. Morgan’s declaratory judgment action, holding that the language in the settlement documents did not “decisively repudiate Bear Stearns’ allegation that the SEC disgorgement payment amount was calculated in large measure on the profits of others,” as opposed to ill-gotten gains by Bear Stearns itself.


On remand, J.P. Morgan moved for summary judgment based on the Dishonest Acts exclusion and based on the public policy doctrine precluding insurance coverage for monies paid by the insured as a result of intentional harm to others. In a February 28, 2014 opinion (here), New York (New York County) Supreme Court Judge Charles E. Ramos granted J.P. Morgan’s motion to dismiss the affirmative defenses based on the Dishonest Acts Exclusion on, finding that the SEC’s administrative order did not represent a final adjudication so as to trigger the Dishonest Acts Exclusion or the public policy defense. The insurers appealed.


The Dishonest Acts Exclusion provides that the policy does not apply to claims “based upon or arising out of any deliberate, dishonest, fraudulent or criminal act or omission … provided, however, such Insured(s) shall be protected under the terms of this policy … unless judgment or other final adjudication thereof adverse to such Insured(s) shall establish that such Insured(s) were guilty of any deliberate, dishonest, fraudulent or criminal act or omission.”


The January 15 Opinion

On January 15, 2015, in a 22-page opinion written by Associate Justice Angela M. Mazzarelli for a unanimous five-judge panel, the N.Y. Supreme Court, Appellate Division, First Department, affirmed the trial court’s ruling dismissing the carriers’ affirmative defense based on the Dishonest Acts Exclusion, but modified the trial court’s ruling as to the carriers’ affirmative defense based on public policy grounds.


The appellate court said that the insurers stressed the issue whether the resolution of the SEC enforcement action represented an “adjudication” for purposes of the exclusion, the insurers ignored the part of the exclusion requiring that any adjudication “establish” that the insureds were guilty of the precluded conduct. The dictionary, the court noted, defines establish as “to put beyond doubt,” adding that:


It can hardly be said that the SEC Order … put Bear Stearns’s guilt “beyond doubt,” when those same documents expressly provided that Bear Stearns did not admit guilt, and reserved the right to profess its innocence in unrelated proceedings. Again, in interpreting the policy we are guided by reason, and the defendants’ position that the settlement documents “establish” guilt is not reasonable.


However, while the appellate court held that the trial court had “properly dismissed” defendants’ affirmative defense based on the Dishonest Acts exclusion, the appellate court said that the trial court should not have dismissed the affirmative defense based on “the doctrine precluding, on public policy grounds, insurance coverage for monies paid by the insured as a result of intentional harm to others.”  


In addressing the apparent inconsistency in refusing to rely on the “findings” in the SEC Order as a basis to support the enforcement of the Dishonest Acts Exclusion while referring to the same findings as possible support for the invocation of the public policy doctrine, the appellate court said “we have a stronger interest in enforcing public policy than we do in regulating private dealings between insurance companies and their customers that do not have an impact on public policy.”


The court added that it is not the business of courts to prevent companies and their regulators “from agreeing to submit to language in consent order that preserves claims of innocence for the purposes of avoiding exclusions like the one at issue here.” At the same time, the court said, “courts should not countenance the use of such language for the purpose of preserving coverage for wrongful acts intended to harm others.”  The intermediate appellate court added that the N.Y. Court of Appeals had said that “one of the two situations in which the contractual language of a policy may be overwritten is where an insured engages in conduct ‘with the intent to cause injury.’”



This case’s shuttle between the various levels of the New York state court system is the kind of thing that drives litigation parties and other non-lawyers absolutely nuts. The piecemeal appellate review of the parties’ disparate arguments not only has resulted in a protracted procedural history, but each stage seems to extend the eventual time of the ultimate resolution of this case further and further out into endless future. It would be one thing if this case were now going to go back to the trial court for further proceedings on the question of whether or not the provision of insurance for the SEC settlement would be against public policy. However, if the prior history of this case is any indication, it seems probable that if J.P. Morgan can find a basis to appeal, it will seek to have the N.Y. Court of Appeals address the intermediate appellate court’s ruling allowing the carriers to assert their affirmative defense on public policy issues.


If J.P. Morgan were to seek a further review by the Court of Appeals, the company likely will argue among other things that the intermediate court of appeals ruling here on the public policy issues arguably depends on a strained distinction that allowed the intermediate appellate court to reject the applicability of the SEC’s “findings” for purposes of triggering the Dishonest Acts Exclusion, yet rely on the very same “findings” as a sufficient basis from which to allege that Bear Stearns had an intent to cause harm sufficient to trigger the public policy doctrine.   J.P. Morgan has an incentive to pursue the review if it is able, if for no other reason than the last time around it was able to convince the Court of Appeals to reverse the intermediate appellate court.


For practitioners in this area, the intermediate appellate court’s consideration of the carriers’ defense based on the Dishonest Acts Exclusion makes for interesting reading. In particular, it is noteworthy not only that the appellate court considered whether or not the entry of the Consent Order represented an “adjudication” within the meaning of the exclusion. It is also noteworthy that the court emphasized the question of whether the entry of the consent order – even if it constituted an “adjudication” – “established” that Bear Stearns had been guilty of the precluded conduct. The word “established” is not often a focus of the discussion of the issues arising under this type of exclusion. This ruling underscores the fact that it is not alone sufficient that there may have been an adjudication, but the adjudication must establish that the exclusion applies.


The one thing that is clear at this point is that this long-running proceeding will go on. The SEC first launched its investigation in 2003. Bear Stearns entered the settlement with the SEC in March 2006. The insurance coverage case is already on it second passage through the appellate court system. But this dispute is far from over. The fundamental problem for everyone is that there is just too much money at stake. Anytime you have sums of money running approaching a fifth of a billion dollars in dispute, the possibility of compromise is going to prove elusive, if not impossible.