Findings In SEC and NYSE Administrative Orders Do Not Trigger Dishonest Act Exclusion Under Professional Liability Policy

On February 28, 2014, Justice Ramos of the New York County Commercial Division issued a decision in J.P. Morgan Securities Inc. v. Vigilant Insurance Co., 2014 NY Slip Op. 50284(U), ruling that administrative orders by the SEC and a New York Stock Exchange hearing panel did not constitute a "judgment or other final adjudication" sufficient to trigger a Dishonest Acts Exclusion under a professional liability policy.

J.P. Morgan v. Vigilant, arose from regulatory investigations of Bear Sterns "for allegedly facilitating late trading and deceptive market timing on behalf of certain customers for the purchase and sale of shares in mutual funds." In connection with a settlement of its investigation, the SEC issued an order that "set forth 40 pages of detailed findings pertaining to Bear Stearns' facilitation of late trading and market timing practices," and concluded that Bear Stearns "willfully aided and abetted violations of the federal securities law." The order expressly stated that Bear Stearns was not "admitting or denying the findings." A similar settlement was reached with the NYSE, after which Bear Stearns settled 13 civil class actions lawsuits involving late trading and market timing allegations.

Bear Stearns' insurers disclaimed coverage, arguing that the SEC and NYSE findings triggered a Dishonest Act Exclusion in the applicable policies, which barred coverage for any claims

made against the Insured(s) . . . based upon or arising out of any deliberate, dishonest, fraudulent or criminal act or omission by such Insured(s), provided, however, such Insured(s) shall be protected under the terms of this policy with respect to any Claim(s) made against them in which it is alleged that such Insured(s) committed any deliberate, dishonest, fraudulent or criminal act or omission, unless judgment or other final adjudication thereof adverse to such Insured(s) shall establish that such Insured(s) were guilty of any deliberate, dishonest, fraudulent or criminal act or omission.

(Emphasis added).

The court rejected this argument, finding that "the settlements embodied in the Administrative Orders are not final adjudications or judgments establishing Bear Stearns' guilt in the underlying proceedings":

[A]lthough the Administrative Orders contain factual findings, it was the product of a settlement between Bear Stearns, the SEC and the NYSE. Bear Stearns consented to entry of the orders "[s]olely for the purpose of these proceedings and any another other proceedings brought by or on behalf of the Commission or to which the Commission is a party" . . . .

The factual findings were neither admitted or denied except as to the SEC's jurisdiction and the subject matter of the proceedings, and were not the subject of hearings or rulings on the merits by a trier of fact. To infer, as the Insurers urge, that the term "final adjudication" encompasses settlement of an administrative order, is to expand its reasonable interpretation beyond what is permitted under New York law. . . .

In its offer of settlement which preceded the SEC order, Bear Stearns expressly reserved the right to take contrary legal and factual positions in proceedings in which the SEC was not a party. Therefore, the Administrative Orders were the product of settlements and do not constitute a "judgment or other final adjudication" in the underlying proceedings establishing the excluded conduct.

This decision demonstrates the strict and narrow construction the New York courts apply to exclusionary provisions in insurance policies and serves as a reminder that counsel negotiating settlements in complex parallel proceedings should carefully weigh the insurance implications of any such settlements.