A recurring D&O insurance issue is the question of whether or not coverage for a particular claim is precluded under the relevant policy’s professional services exclusion. A recent decision by the Second Circuit addressed questions concerning the applicability of a professional services exclusion in a D&O insurance coverage dispute arising out of the mistake-plagued Facebook IPO. In a January 22, 2018 opinion (here), the appellate court affirmed the district court’s ruling that coverage for the settlement of Facebook IPO investors’ claims against NASDAQ was precluded by the NASDAQ’s D&O insurance policy’s professional services exclusion. The opinion includes some interesting discussion of considerations relevant to the exclusion’s applicability.



Facebook completed its IPO on May 18, 2012, as a result of which its share traded on the NASDAQ stock exchange. The offering did not go smoothly. NASDAQ’s trading platform suffered a series of technical failures, resulting in the flawed processing of orders to buy and sell Facebook shares.


Retail investors filed numerous actions against Facebook and against NASDAQ. The claims against NASDAQ ultimately were consolidated before Southern District of New York Judge Jed Rakoff. The claimants’ consolidated complaint named as defendants NASDAQ and certain of its officers, and asserted securities fraud claims pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as well as state law negligence claims.


NASDAQ maintained two relevant towers of insurance, a tower of E&O insurance and a tower of D&O insurance. The E&O tower provided a total of $50 million of insurance, arranged in three layers – a primary layer of $15 million, a first level excess layer of $15 million, and a second level excess layer of $20 million. NASDAQ also maintained a separate tower of D&O insurance. For relevant purposes of this discussion, the NASDAQ D&O tower was arranged in a $15 million primary layer and a $15 million excess layer.


NASDAQ submitted the Facebook investors’ claim both to its E&O insurers and to its D&O insurers. The E&O insurers accepted coverage for the claim subject to a reservation of rights, but the D&O insures disclaimed coverage in reliance on the “professional services” exclusion in the primary D&O policy.


NASDAQ ultimately agreed to settle the Facebook investor claim for $26.5 million. The E&O insurers funded the settlement. The first level excess E&O insurer paid out its full $15 million limit in connection with the settlement, pursuant to an agreement under which NASDAQ assigned to the excess E&O insurer its (that is, NASDAQ’s) rights under the D&O insurance policies.


In June 2015, the E&O insurer, proceeding on the basis of NASDAQ’s assignment of rights, sued the D&O insurers seeking to have them pay for the costs of the settlement. The E&O insurer moved for summary judgment, seeking a judicial declaration that the D&O insurers had a duty to indemnify in connection with the settlement. In a July 7, 2016 order (here), Judge Rakoff denied Beazley’s motion and granted the D&O insurers’ motion, holding that coverage under the D&O insurance policies was precluded under the primary policy’s professional services exclusion. Beazley appealed.


The primary D&O insurance policy’s professional services exclusion provides in relevant part that the insurer “shall not be liable for Loss on account of any Claim … by or on behalf of a customer or client of the Company, alleging, based upon, arising out of, or attributable to the rendering or failure to render professional services.”


The January 22, 2018 Opinion

On January 22, 2018, the Second Circuit, in an opinion written by Judge Rosemary Pooler for a unanimous three-judge panel, affirmed Judge Rakoff’s grant of summary judgment in the D&O insurers’ favor.


In seeking to have Judge Rakoff’s opinion reversed, the E&O insurer had argued, first, that the retail investor claimants in the underlying lawsuit were not “customers” within the meaning of the professional services exclusion, and, second, that the underlying claims did not involve “the rendering or failure to render professional services.”


The Investor Claimants Were “Customers” within the Exclusion’s Meaning

In rejecting the E&O insurer’s argument that the claimants were not customers of NASDAQ, the appellate court said that the district court “properly relied custom and usage of the term ‘customer’ in determining that the retail investors were ‘customers” of NASDAQ” within the meaning of the exclusion, adding that “we have little trouble finding that the vast majority of federal courts to consider the issue find retail investors to be ‘customer’ of a stock exchange.”


The appellate court rejected the E&O insurer’s argument that the professional services exclusion is a standard clause and therefore should be interpreted according to industry custom and usage rather than according to federal law. The court said “the parties are not required to tailor language for every policy in order for the terms to have industry-specific meaning.” What is relevant, the court said “is that the insurer sold the policy to its insured, a stock exchange, against the backdrop of well-established federal securities law that unambiguously considers retail investors to be customers of the exchange.”


The appellate court also rejected the E&O insurer’s argument, based on recent NASDAQ rule changes, that NASDAQ considered its customers to be broker-dealers who dealt with NASDAQ, not the broker-dealers’ customers. The fact that “retail investors are customers of NASDAQ’s member broker-dealers does not mean that retail investors were not also NASDAQ’s customers.”


The Claimants’ Claims Involved the Alleged Delivery of Professional Services

In order to try and show that the D&O insurance policy’s professional exclusion did not apply, the E&O insurer had also argued that the plaintiffs’ claims asserted under the federal securities laws do not arise out of the rendering of professional services. The E&O insurer argued that the underlying claimants’ allegations that NASDAQ had misrepresented its technical capabilities were merely advertising statements of a kind that do not involve the delivery of professional services.


The appellate court noted that there have indeed been cases that have held that a company’s advertising activities do not involve the delivery of professional services. However, in rejecting the E&O insurer’s argument with respect to NASDAQ, the appellate court noted that in asserting that NASDAQ’s alleged deceptive conduct caused them financial harm, the underlying claimants had asserted loss causation based on the failures in NASDAQ’s technical services. The appellate court noted that the claimants had asserted their losses were attributable to NASDAQ’s failure to “properly execute” the purchase and sale orders, not to NASDAQ’s advertising activities. The court said that “failures to properly execute orders and deliver timely order confirmations go to the heart of NASDAQ’s provision of professional services.”



Regular readers know that I have made something of a hobby horse issue out of the way that D&O insurers interpret and apply the professional services exclusion. My general concern has to do with what I see as the D&O insurers’ willingness to extend the exclusion’s preclusive effect beyond its intended purpose.


As I see it, the professional services exclusion in a D&O insurance policy is one of the kinds of exclusions that are there to keep claims in their proper lanes. For example, the BI/PD exclusion is there to make sure that the D&O policy does not wind up picking claims that properly should be dealt with under the GL policy. By the same token, the professional services exclusion is there so that the D&O policy does not wind up picking up claims that properly should be dealt with under the E&O policy.


In other words, the professional services exclusion is there to ensure that if a claim arises out of the performance of professional services for others, then the claim should fall under the E&O policy, not the D&O policy. The reverse should also be true; that is, if a claim does not arise out of the performance of professional services, coverage should not be precluded. The problems arise when the exclusion is interpreted and applied so broadly that it precludes coverage under the D&O policy for claims that would not be covered under the E&O policy.


These broader concerns about the professional services exclusion arguably are not present here. NASDAQ’s E&O insurers did respond to and paid the underlying claim. This isn’t a situation where the D&O policy’s professional services exclusion is being extended to situations to which the insured’s E&O coverage wouldn’t apply. To be sure, there were valid and good faith arguments here that the professional services exclusion nevertheless was not triggered because the claimants were not “customers” within the meaning of the exclusion or the claimants’ claims did not involve the delivery of professional services, and that is reason for this coverage dispute. However, notwithstanding these arguments, it was always going to be a tough battle here for the E&O insurer to argue that the claim that was admittedly covered under the E&O policy was not precluded from coverage under the D&O policy. This isn’t the kind of situation where the D&O insurer was trying to extend the exclusion beyond its purpose of keeping claims in their proper lanes.


The question about whether or not the underlying claim involved the delivery of professional services is an interesting one. The claimants’ securities law claims were based on alleged misrepresentations and omissions in NASDAQ’s public statements about its technical capabilities. I have reviewed on this blog cases in which courts have held that the insured company’s advertising or marketing activities do not involve the delivery of professional services. Here, I recognize the appellate court’s conclusion that the underlying claimants’ allegations nonetheless involved professional services because the alleged harm on which the claimants’ relied arose from supposed technical errors that caused the trading problem.


While I understand the appellate court’s analysis, the court’s reasoning by which it considered not just the wrong alleged but also the harm claimed in order to conclude that the exclusion applies makes me uncomfortable, at least in the context of the exclusion’s broad  “based upon, arising out of, or attributable to” wording. The suggestion is that the exclusion can apply even if the claimant is not alleging a breach any alleged wrong in the delivery of a professional service, as long as the harm alleged is arising out of or attributable to the delivery of a professional service. Particularly for a company in the business of delivering professional services, this view of the exclusion could extend its preclusive effect far beyond the exclusion’s intended purpose.


All of these problems flow directly from the exclusion’s use of the broad “based upon, arising out of” preamble. The exclusion is only supposed to preclude coverage under the policy for claims that appropriately should be dealt with by the E&O policy. Fine. Then it should be worded with the narrower “for” wording, rather the overly broad “based upon or arising out of” language.


In the broad run of public company D&O insurance policies, it is relatively rare for there to even be a professional services exclusion on the policy – except with respect to companies in financial services industries, where the inclusion of professional services exclusion is more standard. Even if the presence of a professional services exclusion is viewed as necessary for financial services companies, there is no compelling reason why the exclusion should have the broad “based upon, arising out of” wording. The “for” wording is sufficient to keep the claims in their proper lanes.


C5 Conference in London in April: C5 will be sponsoring its annual D&O liability insurance conference in London again this April. C5’s 27th Annual D&O Liability conference will take place April 18 and 19, 2018. The conference will be held at the Crown Plaza London- The City Hotel. The conference will  offer practical insights on the latest developments and challenges facing the industry, as well as featuring a specific cross-industry panel on the role of Risk Managers and the difficulties they encounter when engaging with the Board. I will be speaking on the first day of the conference on the topic of “The Rise of Class Actions: A Comparative View of Class Actions in Europe and the U.S.” The conference brochure can be found here. Readers of The D&O Diary  can receive a 15% discount off the conference price. Quote the following code at registration to redeem this offer: D15-999-DOD18.