Sixth Circuit Finds That Bank’s Fidelity Policy Provides Coverage for Theft of Funds from Clients’ Accounts

Affirming an Ohio district court ruling, the Sixth Circuit held that fidelity policies issued to three financial institutions provided coverage for the theft of funds from clients’ brokerage accounts by an employee of a bank-holding company. First Defiance Financial Corp. v. Progressive Cas. Ins. Co., 688 F.3d 265 (6th Cir. 2012).

The insurance coverage dispute arose after an employee of First Defiance Financial Corp., a bankholding company, stole nearly $1 million from various client brokerage accounts. After First Defiance learned of the theft, it reimbursed the stolen money, plus funds to cover lost interest and unrealized client income. First Defiance then filed a proof of loss with Progressive, its fidelity insurer, which Progressive denied on the ground that the loss did not arise from theft of the insured’s own funds but rather from theft of the insured’s clients’ accounts. In the ensuing coverage litigation, an Ohio federal court held that First Defiance’s losses were covered under the policy as a matter of law. The Sixth Circuit affirmed.

Although fidelity policies are typically called upon to cover an insured’s own direct losses arising from employee dishonesty, the Sixth Circuit held that the policy language at issue provided coverage for losses stemming from the theft of money from third-parties (here, the clients). The Sixth Circuit reasoned that coverage was implicated because the following three policy requirements were met: (1) the stolen money was “covered property”; (2) the theft caused a “direct loss” to the insured entity; and (3) the dishonest act was committed “with the manifest intent” to cause the loss. Under the policy, “covered property” included property “owned and held by someone else under circumstances which make the [i]nsured responsible for the [p]roperty prior to the occurrence of the loss.” The court explained that because First Defiance had authority over the clients’ discretionary accounts, and owed the clients a fiduciary duty in that respect, the funds fell within the definition of “covered property.” Employing the same reasoning, the court also concluded that the insured banks suffered a “direct loss” even though the funds were stolen from customer accounts, rather than from the institutions themselves.