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Bear Stearns Agreement to Pay SEC $160 Million in Disgorgement Not Covered By Insurance

Wednesday, December 14, 2011

Michael L. Calder | Bloomberg Law J.P. Morgan Secs., Inc. v. Vigilant Ins. Co., 2011 N.Y. Slip Op. 08995 (N.Y. App. Div. 1st Dep't Dec. 13, 2011) A New York appellate court dismissed J.P. Morgan Securities, Inc.’s suit against several insurers, holding that Bear Stearns & Company, Inc.’s and Bear Stearns Securities Corp.’s (collectively, Bear Stearns) settlement with the U.S. Securities & Exchange Commission (SEC) did not constitute an insurable loss under a professional liability policy.

Wells Notice

In 2006, the SEC notified Bear Stearns that it intended to institute proceedings against the financial services firm for violations of securities laws. Bear Stearns was alleged to have knowingly facilitated late trading and deceptive market timing practices for certain hedge fund customers, and assisted the hedge funds to avoid detection. These practices allowed them to make hundreds of millions of dollars in profits at the expense of mutual fund shareholders. The SEC sought $720 million from Bear Stearns for the violations, which the SEC said took place between 1999 and 2003. Bear Stearns disputed the charges in a Wells Submission noting that it only made $16.9 million on the transactions at issue, and that it did not knowingly violate the law. Nevertheless, Bear Stearns offered to settle the case with the SEC without admitting or denying the findings. The SEC accepted Bear Stearns’ offer, which included $160 million in disgorgement and $90 million in civil money penalties. In 2008, during the global financial crisis, and after the settlement had been reached, J.P. Morgan Chase & Co. acquired Bear Stearns.

Bear Stearns’s Policy

Bear Stearns carried a program of professional liability insurance issued by several insurers. The policy provided coverage for “Loss which the insured shall become legally obligated to pay as a result of a Claim . . . for any Wrongful Act.” The policy defined “Loss” as including compensatory damages, but excluding fines or penalties imposed by law. J.P. Morgan demanded payment from the insurers for the amounts Bear Stearns paid in disgorgement, claiming that, despite its label, the disgorgement settlement was actually compensatory in nature. The insurers refused to pay on the grounds that the payment was not an insurable loss and was otherwise excluded. J.P. Morgan filed suit, naming as defendants the insurers in the program’s layers of coverage up to $200 million. The trial court denied the insurers’ motion to dismiss, and they appealed.

Disgorgement of Ill-Gotten Gains Is Not Insurable

The First Department noted that disgorgement is an equitable remedy that forces defendants to give up ill-gotten gains, and under New York law is not insurable. The court explained that the rationale for the rule is that the deterrent effect of disgorgement would be undermined if defendants could shift the cost of disgorgement to their insurers. The court rejected J.P. Morgan’s argument that the settlement was compensatory, rather than disgorgement, because the SEC Order, the order of settlement, and other documents, read as a whole, could lead only to the conclusion that the settlement was for the purpose of disgorging ill-gotten gains. J.P. Morgan also argued that the $250 million settlement was paid into the Fair Fund pursuant to the Sarbanes-Oxley Act in order to compensate mutual fund investors, and that this demonstrated that the payment was compensatory in nature. The court rejected this argument, citing SEC v. Bear, Stearns & Co.,626 F. Supp. 2d 402 (S.D.N.Y. 2009) for the proposition that “once the primary purpose of disgorgement has been served by depriving the wrongdoer of illegal profits, the equitable result is to return the money to the victims of the violation.”1 Accordingly, the court reversed the trial court’s order denying the insurers’ motion to dismiss and directed the clerk to enter judgment dismissing the complaint. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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