In the latest development in nearly decade-long legal battle, a New York intermediate appellate court has held in light of the U.S. Supreme Court’s 2017 decision in Kokesh v. SEC that amounts Bear Stearns paid under an SEC disgorgement order represent a “penalty” for which coverage is precluded under the bank’s insurance policy. This ruling, which overturned a trial court order holding that the disgorgement amount was covered, represents a substantial reversal of fortune for the claimants in this long-running and high-profile insurance coverage dispute. While further proceedings in the case seem likely, the ruling nevertheless represents a setback for policyholders seeking to establish insurance coverage for disgorgement amounts. The intermediate appellate court’s September 20, 2018 opinion 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.  Bear Stearns ultimately consented to the SEC’s entry of an Administrative Order, in which, among other things, Bear Stearns agree to pay a total of $250 million, of which $160 million was labeled “disgorgement” and $90 million as a penalty.


Bear Stearns sought to have the carriers in its $200 million program indemnify the company for the SEC settlement. However, the insurers 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 disgorgement amount. 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. The trial court, in an order subsequently affirmed by the intermediate appellate court, granted the insurers’ motion, holding that public policy considerations precluded coverage for the disgorgement amount.


However, as discussed here, in a June 2013, the New York Court of Appeal (the state’s highest court) reversed the lower court’s ruling, rejecting the insurers’ argument that public policy prohibited the indemnification of the amounts labelled as “disgorgement” in the Administrative Order. The court said because the disgorgement amount represented the gains of others and not Bear Stearns’ own ill-gotten gains, the public policy rationale did not apply. The court remanded the case to the trial court for further proceedings.


In subsequent proceedings following remand, the trial court granted J.P. Morgan’s motion for summary judgment, ruling that because the disgorgement amount represented third-party gains rather than Bear Stearns’s own ill-gotten gains, the amount represented covered loss. The trial court also held that because the amount represented the customers’ profits, the policy’s personal profit exclusion did not apply. In a subsequent order, the trial court held further that J.P. Morgan was entitled to prejudgment interest.  The insurers appealed to the intermediate appellate court.


The policy’s definition of “Loss” provides, in pertinent part that “Loss shall not include … fines or penalties imposed by law.”


The September 20, 2018 Decision

In a September 20, 2018 opinion written by Judge Richard Andrias for a unanimous panel of the New York Supreme Court Appellate Division, First Department,the appellate court reversed the trial court’s holding, ruling in light of the U.S. Supreme Court’s June 2017 opinion in Kokesh v. Securities and Exchange Commission (here) that the disgorgement amount represented a “penalty” as a matter of law, and therefore did not represent covered loss under the policy.


As discussed here, in Kokesh, the SEC had argued that its enforcement action against Charles Kokesh was not subject to the five year statute of limitations applicable to any action for the “enforcement of any civil fine, penalty, or forfeiture” because disgorgement does not constitute a penalty. The U.S. Supreme Court rejected this argument. In a unanimous opinion written by Justice Sonia Sotomayor, the court held that because disgorgement is “imposed as a consequence of violating a public law and it is intended to deter, not compensate,” it “bears all the hallmarks of a penalty,” and therefore the five-year statute of limitations applies.


In its decision in the J.P. Morgan case, the intermediate appellate court said that the U.S. Supreme Court’s “rationale at the nature of disgorgement … applies with equal force to the issue of whether the disgorgement … even if representing third-party gains, was a ‘Loss’ within the meaning of the policy.” Kokesh, the intermediate appellate court said, establishes that “disgorgement is a penalty, because it punishes a public wrong, and its purpose is deterrence, whether you are remitting your own ill-gotten gain or those you generated for your customers through violations of the securities law.”


The appellate court said further that Kokesh has significance beyond the narrow issue of the statute of limitations because the U.S. Supreme Court “analyzed the fundamental nature and purpose of the SEC’s disgorgement remedy, which does not change into some different nature for purposes of insurance coverage.” Kokesh and the principles on which it relied “fatally undermine the motion court’s holding” that the disgorgement amount is covered loss under the policy.



This long-running case has already made one trip to the New York Court of Appeals, and it seems likely that the case is about to make a return visit to New York’s highest court. But while further appeals in the case seem probable, if for no other reason that the amount of money involved, it is hard to see how J.P. Morgan is going to get around the holding in Kokesh that a disgorgement amount in an SEC enforcement order represents a “penalty.”


In the parties’ prior trip to the Court of Appeals, the issue had been whether or not coverage for the disgorgement amount was precluded as a matter of public policy. In the context of this prior argument about public policy principles, the fact that the amount represented the return of the gains of others rather than Bear Stearns’ own gains made a difference.


However, if the case goes back to the Court of Appeals, the fight is not going to be based on public policy notions, but on narrower and specific question of whether or not the disgorgement is a “penalty” for which coverage is precluded under the specific terms of the policy at issue. The intermediate appellate court said, in light of Kokesh, the disgorgement amount is a “penalty” and therefore coverage is precluded — not as a matter of public policy, but as a matter of contract. Under this analysis, the fact that the disgorgement amount represented the gains of others is irrelevant, at least in light of Kokesh.


One particular aspect of the intermediate appellate court’s opinion would seem to narrow the arguments that J.P. Morgan might otherwise seek to pursue on further appeal. It could be argued because of the narrow statute of limitations context of the Kokesh decision its analysis is inapplicable to the much different context of the interpretation of an insurance contract. However, the intermediate appellate court expressly rejected this argument, specifically stating that the U.S. Supreme Court’s analysis of disgorgement examined the “fundamental nature and purpose” of the remedy, which, the intermediate appellate court said “does not change into some different nature for insurance coverage.”


Given the likelihood of further proceedings in this case, it may be premature to try to analyze the larger significance of the intermediate appellate court’s ruling. One question worth asking in the wake of the intermediate appellate court’s decision is whether the prior Court of Appeals opinion continues to be a useful precedent for policyholders seeking to establish coverage for disgorgement amounts. If the intermediate appellate court stands, it would seem that the prior Court of Appeals decision will be of little help in the context of an SEC disgorgement order. However, outside of the SEC disgorgement order context, policyholder may still be able to rely on the Court of Appeals distinction between the return of the gains of others and the return of one’s own gains, at least for purposes of determining potential public policy preclusions to coverage. Even if this aspect of the Court of Appeals decision still stands, it usefulness would seem to be limited to a very narrow category of circumstances.


It probably should be noted that the outcome at the intermediate appellate court represents a substantial reversal of fortunes for J.P. Morgan. There is not only the matter of the $140 million amount itself for which J.P.  Morgan has been seeking insurance coverage (about which see below) but there is also the added matter of the prejudgment interest to which the trial court ruled that J.P. Morgan is entitled. Nine years of interest at the statutory interest rate represents a very substantial additional amount of money — according to Law 360, the interest alone amounts to $146 million. The total sum including interest amounts to $286 million, unquestionably enough for the bank to continue to fight this battle.


One final note about the intermediate appellate court’s order. The amount of the disgorgement in the SEC’s order is $160 million. However, the intermediate appellate court noted in a footnote that J.P. Morgan is not seeking insurance for a $20 million portion of the disgorgement amount that represented Bear Stearns’s own gains.  Thus, the court’s decision refers throughout to the $140 million amount for which insurance coverage is sought.