In the latest development in the long-running saga involving the efforts by J.P. Morgan to obtain D&O insurance coverage for the $140 million “disgorgement” that its predecessor-in-interest, Bear Stearns, paid to settle SEC market-timing allegations, the New York Court of Appeals (the state’s highest court) has reversed the intermediate appellate court’s ruling that the payment represented a “penalty” for which coverage is precluded. The Court of Appeals rejected the intermediate appellate court’s conclusion, made in reliance on the U.S. Supreme Court’s 2017 Kokesh decision, that a “disgorgement” payment to the SEC is a “penalty.” The Court of Appeals held that Kokesh did not control, and that because the payment was compensatory in nature, it did not represent a “penalty” for which coverage is precluded under the policies. The Court’s November 24, 2021 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. Of the $160 million disgorgement amount, $140 million represented the market timing-related profits of Bear Stearns’s third-party clients and $20 million represented the fees and other amounts Bear Stearns earned in providing service to the third-party clients.


Bear Stearns sought to have the carriers in its $200 million D&O insurance 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 $140 million of disgorgement amount that represented third-party clients’ profits. 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.


As discussed here, in September 2018, 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. J.P. Morgan, as Bear Stearns successor in interest, appealed the ruling to the New York Court of Appeals, the state’s highest court.


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


The November 24, 2021 Opinion

In a November 24, 2021 majority opinion written by Chief Judge Janet DiFiore, the New York Court of Appeals reversed the intermediate appellate court, concluding that the settlement payment was not excluded from coverage as a “penalt[y] imposed by law.” Judge Jenny Rivera dissented from the majority opinion.


The court begins its analysis with a consideration of what the parties to the insurance contract would have understood the term “penalties” to have meant at the time they entered the contract. After consideration of dictionary definitions and case law, the court concluded that a “penalty is distinct from a compensatory remedy and a penalty is not measured by the losses caused by the wrongdoing.” The court went on to say that “our analysis indicated that a reasonable insured purchasing a wrongful act policy would expect an award or settlement payment that has compensatory purposes and is measured by an insured party’s losses and third-party gains to fall within its coverage grant and, concomitantly, not be deemed a penalty.”


In considering whether the settlement payment meets this standard, the court observed that Bear Stearns had “demonstrated that the $140 million disgorgement payment was calculated based on wrongfully obtained profits as a measure of harm or damages caused by the alleged wrongdoing Bear Stearns was accused of facilitating.” The insurers, the court said, “failed to submit any evidence rebutting this proof.”


The court specifically rejected the intermediate appellate court’s conclusion based on the U.S. Supreme Court’s decision in Kokesh that the $140 million disgorgement payment must be considered a penalty within the meaning of the policies. Kokesh, the court said, “does not control here.” The U.S. Supreme Court was not interpreting the term “penalty” in an insurance contract; moreover, Kokesh, decided nearly two decades after the parties entered the insurance contract, could not have informed the parties’ understanding of the meaning of the term “penalty.”


The court concluded that the insurers had “failed to establish that the $140 million ‘disgorgement’ payment … clearly and unambiguously falls within the policy exclusion for ‘penalties imposed by law.’” Therefore, the court reversed the intermediate appellate court. Because there are additional coverage issues that the appellate court had not addressed, the Court of Appeals remanded the case to the intermediate appellate court for further proceedings.


Judge Rivera, in dissent, said that “the majority’s conclusion that the disgorged funds are recoverable from the insurers is contrary to the insurance policy language and undermines both federal regulation of illegal conduct in the securities market and the SEC’s efforts to discourage future violations.”



In thinking about the latest development in this long-running (indeed, seemingly interminable) coverage dispute, it is worth considering that the Court of Appeals’ opinion is the third reversal of a lower court ruling in the as yet still incomplete procedural history of this case. If nothing else, the procedural record in this case shows that the issues involved are incredibly close. Moreover, the case is nowhere near the finish line.


The upshot of the Court of Appeals decision is that the case will be remanded to the intermediate appellate court for the appellate court to take up the other issues addressed in the trial court’s  determinations of other coverage issues in dispute.  (The various other issues the trial court addressed are discussed here.) Assuming the intermediate appellate court addresses the issues, the case then will undoubtedly then go back up to the Court of Appeals for what will be the third time.


The Court of Appeals’ most recent ruling in this case is interesting to the extent it represents a judicial conclusion that there can be insurance coverage for an amount in a settlement that has expressly been labelled as a “disgorgement.”  And, further, that the “disgorgement” is not a “penalty” for which coverage is precluded, even though the U.S. Supreme Court held in Kokesh that a “disgorgement” to the SEC is a “penalty.” However, while the Court of Appeals’ latest conclusions are interesting, and arguably even surprising, they are going to be of very limited value to litigants in other cases raising similar issues, as the court’s opinion here was very much tied to what specifically happened in the underlying SEC matter. Even after this ruling by the state’s highest court, there will still be plenty for other parties in other cases to argue about.


There is one particular aspect of the court’s ruling that is worth noting here, and that is that New York’s highest court has issued what is by any measure a very policyholder-friendly decision. The reason this is noteworthy (at least to me) is that in the recent debate about whether or not insurers should be inserting choice of law clauses in their policies, insurer-side advocates have frequently contended that if there is to be a choice of law provision, the provision should designate the law of New York. The assumption in making these assertions is that New York is generally perceived as an insurer-friendly jurisdiction. New York may indeed be insurer-friendly as a general matter, but there is nothing insurer-friendly about the Court of Appeals’ most recent decision in this case.


In any event, this case continues to grind on. Even after 12 years of litigation.