New York Court of Appeals Allows Coverage for Disgorgement Paid to SEC 

Global Insurance Alert

On June 11, 2013, the New York Court of Appeals, in J.P. Morgan Securities, Inc., et al. v. Vigilant Insurance Company, et al., reinstated a declaratory judgment action against D&O Liability insurers, reasoning that an SEC order requiring Bear Stearns & Co., Inc. (Bear Stearns) to pay $160 million in disgorgement did not conclusively establish that the payment was uninsurable.

In 2006, the SEC accused Bear Stearns of facilitating illegal late trading and market timing mutual fund trades for preferred customers between 1999 and 2003. The SEC sought sanctions of $720 million. Bear Stearns contended that its activities generated only $16.9 million in revenues for itself. The parties entered into a settlement agreement obligating Bear Stearns to pay disgorgement in the total amount of $160 million and civil monetary penalties in the amount of $90 million. Bear Stearns neither admitted nor denied the SEC’s allegations.

In a subsequent declaratory judgment action filed in the New York Supreme Court, New York County, plaintiff1 demanded that its D&O insurers cover the portion of the disgorgement payment that exceeded the $10 million retention, or $150 million. The insurers moved to dismiss citing New York law deeming “disgorgement” uninsurable. The lower court rejected these arguments and denied the motion.

On appeal, the Appellate Division, First Department, reversed, concluding that Bear Stearns’ offer of settlement, the SEC order, and related documents were not susceptible to any interpretation other than that Bear Stearns knowingly and intentionally facilitated illegal late trading for preferred customers, and that the SEC order required disgorgement of funds gained through the illegal activity. The First Department, therefore, held that disgorgement may be found as a matter of law when settlement funds are identified as “disgorgement,” the facts establish that those amounts arose from an illegal enterprise, and the amounts paid constitute a reasonable approximation of the total profits from that enterprise. It is not necessary, according to the court, that the individual party profit directly to the full extent of the amount disgorged.

On further appeal , however, New York’s highest court reversed the First Department decision and sent the action back to the trial court for discovery and resolution. In its opinion, the court addressed two issues.

First, based on findings in the SEC order regarding Bear Stearns’ participation in the late trading activities, the insurers argued that indemnification of the plaintiff would contravene New York public policy against indemnifying for intentional injury. The court noted that this public policy was narrow, “under which it must be established not only that the insured acted intentionally but, further, that it acted with the intent to harm or injure others.” The court concluded, that although the SEC order found numerous violations of the securities laws to be willful, it did not conclusively establish that Bear Stearns had the “requisite intent to cause harm.”

Second, the court agreed with plaintiff that “the SEC Order does not establish that the $160 million disgorgement payment was predicated on moneys that Bear Stearns itself improperly earned as a result of securities violations.” Plaintiff had argued that the vast majority of the disgorgement payment was based, not on Bear Stearns’ profits, but on profits made by its hedge fund customers. The court noted that the insurers did not identify any precedent in which coverage was prohibited when the disgorgement payment was linked to gains that went to others.

Significantly, the court did not hold that coverage existed for the disgorgement payment. The case merely returns to the trial court for discovery and a subsequent determination at summary judgment or after trial. Nevertheless, the court’s decision may be troublesome for insurers both in this case and generally. The court’s narrow reading of the public policy against insuring for intentional injury may render that defense of limited utility in this and other cases. Although discovery may reveal that participants in the late-trading program intended to generate profits for themselves, proof that they intended to cause injury to others may be hard to come by.

In addition, to the extent that the decision may be read to permit insurance for disgorgement payments by one participant in an enterprise based on profits earned by other participants, the opinion may create a moral hazard. The non-paying customer participants may keep their profits from the enterprise. The paying participant meanwhile may escape the financial consequences of its acts simply by purchasing insurance and sharing profits from the enterprise with customers from whom it will engender good will.


To date, insurers have relied on a long line of cases holding that disgorgement does not constitute insurable loss. As a result of the J.P. Morgan Securities decision, insurers may seek to modify their policy language expressly to preclude coverage for any disgorgement regardless of whether it is based on gains by the insured or by others.

1 J.P. Morgan Chase purchased Bear Stearns in 2008.


Angelo G. Savino

Chair, Professional Liability Practice Group

(212) 908-1248

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To discuss any questions you may have regarding the issues discussed in this Alert, or how they may apply to your particular circumstances, please contact Angelo Savino at 212.908.1248 or