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New York’s First Department Rules Bear Stearns’ $160 Million Disgorgement Payment to SEC Was Not Insurable Loss, Despite Failure to Admit Wrongdoing in Settlement Agreement

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In March 2006, the Securities and Exchange Commission (“SEC”) issued an administrative order pursuant to which Bear Stearns & Co., Inc. and Bear Stearns Securities Corp. (collectively, “Bear Stearns”), “without admitting or denying the findings [made pursuant to its offer of settlement],” agreed to pay “disgorgement in the total amount of $160,000,000” and “civil money penalties in the amount of $90,000,000” in settlement of charges that the companies willfully facilitated illegal mutual fund trading practices. During the same month, the New York Stock Exchange (“NYSE”) issued a similar order and levied a sanction of “$160,000,000 as disgorgement” and “$90,000,000 as a penalty” against Bear Stearns, which would be deemed satisfied by payment of the sanctions imposed by the SEC.

In J.P. Morgan Sec. Inc., et al. v. Vigilant Ins. Co., et al., 2011 N.Y. Slip Op. 08995 (1st Dep’t Dec. 13, 2011), Bear Stearns’s successors-in-interest sought a declaration that six professional liability insurers – including Vigilant Insurance Company (part of the Chubb Group), Travelers Indemnity Company and Liberty Mutual Insurance Company – had duties to indemnify Bear Stearns for the $160 million disgorgement payment under various insurance policies. Plaintiffs argued that Bear Stearns had not admitted any wrongdoing in settling with the SEC and, despite its label, the disgorgement payment constituted “compensatory damages” – i.e., an insurable loss.

The First Judicial Department of New York’s Supreme Court, Appellate Division rejected plaintiffs’ argument in all respects, finding that when “read as a whole, the offer of settlement, the SEC Order, the NYSE order and related decisions” demonstrated that Bear Stearns not only wrongfully generated
$16.9 million in revenues for itself, but also “knowingly and affirmatively facilitated an illegal scheme which generated hundreds of millions of dollars for collaborating parties.” Applying the theory of joint and several liability, the Court concluded that “all gains flowing from the illegal activities” were properly included in the disgorgement amount. Moreover, the Court found that the SEC’s failure to itemize how it reached the agreed-upon disgorgement figure did not raise an issue as to whether the disgorgement payment was, in fact, compensatory.

Accordingly, the long-standing rule that “disgorgement of ill-gotten gains or restitutionary damages does not constitute an insurable loss” applied to bar plaintiffs’ indemnity claims.