Why it matters: Applying California law, the U.S. Court of Appeals for the Ninth Circuit determined that a professional services exclusion in a D&O policy precluded coverage for a lawsuit against a policyholder based on a Ponzi scheme. The case involved a group of investors who sued a parent company and its subsidiaries asserting that the defendants operated a Ponzi scheme and sold them unregistered securities. The parties to the underlying suit settled by assigning the insureds’ claims against insurance to the plaintiffs.

Pursuant to the assignment, the plaintiffs sued the insurer, which moved to dismiss. The federal district court granted the insurer’s motion to dismiss, and the Ninth Circuit affirmed. The courts agreed with the insurer that the claims were excluded under a professional services exclusion that prohibited claims “for any act, error or omission in connection with the performance of any professional services by or on behalf of the Company for the benefit of any other entity or person.” The investors attempted to circumvent the exclusion by arguing that the provision barred coverage only for acts “directly” connected to professional services and that the acts at issue were “indirectly” performed by the subsidiaries, leaving the provision inapplicable. The courts rejected this argument as unsupported by the contractual language.

Detailed discussion: William Jamison and several other investors filed multiple lawsuits against ePlanning and its subsidiaries ePlanning Securities, Inc. and ePlanning Advisors, Inc. The plaintiffs allegedly purchased millions of dollars’ worth of debt securities from Asset Real Estate & Investment Co. (AREI) on the defendants’ recommendation.

According to the investors, ePlanning misrepresented the assets as carefully vetted, safe investments that met each plaintiff’s investment objectives and risk tolerances. Plaintiffs claimed that the securities in fact were highly speculative, illiquid assets offered in connection with a massive Ponzi scheme operated by ePlanning and AREI.

ePlanning’s E&O policy was exhausted due to other claims, including plaintiffs’ claims in FINRA arbitrations. ePlanning then took the position that the investors’ claims were covered by ePlanning’s separate Directors, Officers and Company Liability Policy (D&O policy) with various underwriters at Lloyd’s.

ePlanning settled with the investors by assigning the company’s potential claims against Lloyd’s. The investors then filed suit against Lloyd’s for failure to defend and indemnify.

A federal district court judge granted the insurer’s motion to dismiss, declining to adopt the investors’ “novel” construction of the D&O policy. The plaintiffs argued that the exclusion was “partial” because it barred coverage for primary liability for the performance of professional services but not for secondary liability incurred by virtue of the subsidiaries’ actions.

The investors pointed to language in the exclusion for applicability to claims “for any act, error, or omission in connection with the performance of any professional services by or on behalf of the Company,” while other policy exclusions featured broader terminology to claims “based upon, arising out of, directly or indirectly from[,] or in consequences of, or in any way involving” the excluded conduct.

Finding the plaintiffs’ interpretation of the exclusionary language “strained to the breaking point,” the district court dismissed their claims.

In an unpublished opinion, the Ninth Circuit agreed, emphasizing the language of the policy.

“The Exclusion is not reasonably susceptible to Jamison’s interpretation,” the panel wrote. “To the extent Jamison’s interpretation would distinguish between ‘direct’ and ‘indirect’ connections to professional services, the Exclusion does not so qualify the phrase ‘in connection with.’”

The court also shot down the investors’ contention that the exclusion did not apply to acts relating to secondary, as opposed to primary, liability.

“Further, Jamison alleges that ePlanning’s subsidiaries rendered ‘direct’ professional services to third party customers without alleging that ePlanning, Inc. also rendered such ‘direct’ services to third party customers,” the panel wrote. “To the extent Jamison’s interpretation would distinguish between primary and secondary liability, the Exclusion would apply to ePlanning, Inc. differently from how it would apply to ePlanning’s subsidiary insureds, without the policy or the Exclusion distinguishing between ePlanning, Inc. and its subsidiaries.… [T]he Exclusion is not readily susceptible to Jamison’s interpretation.”

To read the Ninth Circuit’s decision in Jamison v. Certain Underwriters at Lloyd’s, click here.

To read the district court’s order, click here.