In late May, 2017, HBO released the movie The Wizard of Lies, chronicling the discovery of the Bernard L. Madoff Ponzi Scheme. Literally robbing Peter to pay Paul, Madoff ran his fraud scheme for decades, amassing almost $65 billion in investments before he was caught in December, 2008. As a result of his arrest and the discovery of the fraud, individual investors, hedge funds, charities, and businesses discovered that their money was gone. Unable to reclaim their investments from Madoff or his insolvent companies, many turned on their investment firms and banks to recover at least some of their losses. In turn, these institutions scoured their insurance policies looking for any avenue of potential coverage for both their defense in the lawsuits and any resulting monetary award.

While there may be other sources of coverage available, many of the insurance cases resulting from Ponzi schemes focus on these three areas of coverage: Directors and Officers Liability Policies, Errors and Omissions/ Professional Liability Policies, and Fidelity Bonds.

Directors and Officers Liability Policies

Directors and Officers Liability Policies (“D&O policies”) are designed to protect corporations and directors and officers from liability for decisions made on behalf of the corporation. If the policy is triggered and provides coverage, however, D&O policies often have combined limits for defense costs and indemnification costs, meaning that as litigation against the director or officer drags on, the costs of defense decrease the total amount available for recovery once a final judgment is issued. Moreover, common policy exclusions can prevent an investor’s ultimate recovery. If the policy excludes coverage for fraud and/or money laundering, the insurer will likely be required to provide defense costs to the director or officer until there is a final judgment, but will not be required to provide indemnification in the event the court concludes that the director or officer is liable for fraud or money laundering. See Pendergest-Holt v. Certain Underwriters at Lloyd’s of London, 600 F.3d 562 (5th Cir. 2010). More recent exclusions prevent any coverage for Ponzi schemes, including for losses arising out of a company’s insolvency, which is how Ponzi schemes are often discovered, or losses attributable to the rendering of professional services, in which directors or officers are often engaged when recommending investment in a Ponzi scheme. See Associated Community Bancorp, Inc. v. The Travelers Cos., Inc., Case No. 3:09-CV-1357, 2010 WL 1416842 (D. Conn. April 8, 2010).

Errors and Omissions/ Professional Liability Policies

Errors and Omissions liability policies (“E&O policies”) and professional liability policies provide coverage for losses arising out of the provision of professional services. Like D&O policies, coverage of losses from a Ponzi scheme under these policies will often turn on the applicability of an exclusion; and one popular exclusion among these policies is for claims resulting from violations of state or federal securities laws. Whether there is coverage for the underlying lawsuits resulting from a Ponzi scheme depends on whether there is a separate, stand-alone negligence action, apart from a securities violation claim, that can trigger coverage under the policy. Compare Endurance Am. Specialty Ins. Co. v. Brown, Miclette & Britt, Inc., Case No. H-09-2307, 2010 WL 55988 (S.D. Tex. Jan. 4, 2010) with Hiscox Dedicated Corporate Member Ltd. v. Partners Commercial Realty, L.P., Case No. H-08-3411, 2009 WL 1794997 (S.D. Tex. June 23, 2009). Additionally, for employees acting without company approval, some E&O and professional liability policies preclude coverage for losses resulting from “unapproved” sales, meaning that there would be no potential coverage if the company did not approve of the investment in the Ponzi scheme and the employee continued with the transaction. See Smith v. Continental Cas. Co., 347 Fed. Appx. 812, 2009 WL 3214234 (3d Cir. Oct. 8, 2009).

Fidelity Bonds

The primary purpose of a fidelity bond is to protect a company from an employee’s dishonest conduct. See Fidelity National Financial, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA, 2014 WL 4909103 (S.D. Cal. Sept. 30, 2014). Sometimes, this protection can also extend to the company’s outside agents such as Madoff, who ran his own, separate company and acted alone in his dishonest acts. In Jacobson Family Investments, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 129 A.D.3d 556 (N.Y. 1st. Dep. 2015), the remaining plaintiff, MDG 1994 Grat, LLC (“MDG”) sought to recover for losses arising from the investment of MDG’s assets with Madoff. The fidelity bond provided coverage for “loss resulting directly from the dishonest acts of any Outside Investment Advisor, named in the schedule below, solely for their duties as an Outside Investment Advisor.” Madoff was listed as an Outside Investment Advisor in the schedule for the bond and the loss was a result of Madoff’s dishonest acts. As a result, the lower court found that the bond provided coverage for the loss.

The appellate court, however, reversed the trial court’s decision based on the requirement that the loss must result “solely” from Madoff’s duties as an Outside Investment Advisor. Because Madoff also served as a securities broker at the same time he was an investment advisor, the appellate court reasoned that the loss suffered by MDG was not solely a result of Madoff’s duties as an Outside Investment Advisor and, thus, did not fall under the coverage of the bond. The court also noted that an exclusion for losses resulting from dishonest acts of a non-Employee securities broker would also prevent coverage in this case. See also United States Fire Ins. Co. v. Nine thirty FEF Investments, LLC, 132 A.D.3d 413 (N.Y. 1st Dep. 2015).

Investing in the market is always a risk. As such, there are very few sources of insurance coverage for any resulting losses. When someone improperly manipulates the system through a fraudulent scheme, however, there may be some coverage available. The possibility and extent of such coverage will depend on the particular policy language implicated by the claim. In the case of lawsuits resulting from Ponzi schemes, coverage will often depend on who is named in the lawsuit, what role he played in the scheme and the nature of the allegations against him. In any case, investors in Ponzi schemes will likely face a long road to recovery.