Most companies that provide specialized or professional services, like stock exchanges, carry both directors and officers liability insurance (“D&O”) and errors and omissions insurance (“E&O”). These coverages are meant to be complimentary and not overlapping. D&O covers “wrongful acts” by directors and officers. D&O covers negligent acts in performing professional services. D&O policies typically exclude coverage for claims that arise out of the provision of professional services. All of this seems clear until the actual facts of the claim arise. Then the fight becomes which policy or whether both policies are required to respond to a claim. The Second Circuit recently addressed this issue in the context of claims arising out of an initial public offering on a stock exchange that did not go as well as anticipated.

In Beazley Insurance Co. v. Ace American Insurance Co., No. 16-2812 (2d Cir Jan. 22, 2017), the insured stock exchange’s E&O carrier paid out a settlement and then took an assignment of the insured’s rights against the D&O carriers. The assignee E&O carrier sued the D&O carriers for coverage. The district court granted the D&O carriers summary judgment on the issue of indemnity and the Second Circuit affirmed.

The key issue was whether the retail investors who brought the underlying securities claims against the exchange were customers of the exchange so that the underlying claims arose out of the exchanges’s provision of professional services within the D&O policies’ exclusion. The professional services exclusion provided that the D&O carriers “shall not be liable for Loss on account of any Claim . . . by or on behalf of a customer or client of the Company, alleging, based upon, arising out of, or attributable to the rendering or failure to render professional services.”

As a result of an initial public offering that occurred during a series of technical failures on the stock exchange, more than 40 lawsuits were launched against the exchange. Notice of these cases were provided to both the E&O and D&O carriers. The D&O carriers disclaimed coverage based on the professional services exclusion. Notably, the D&O policies were renewed twice by the exchange without anyone raising the professional services exclusion.

The E&O carrier attempted to get the D&O carriers to reconsider their denial, but failed. An initial motion by the E&O carrier for partial summary judgment on the obligation to provide a defense was successful, but the court made it clear that it was not interpreting customers or clients to exclude retail investors as a matter of law. The E&O carrier’s motion for summary judgment on indemnity, however, failed and was affirmed on appeal.

In affirming, the Second Circuit rejected the E&O carrier’s argument that retail investors were neither customers nor clients for purposes of the professional services exclusion. Because the policy provided no definitions of relevance, the court looked to federal law to determine if there was an established meaning or custom and usage. The court found that based on established federal law, retail investors were customers of the exchange within the meaning of the exclusion. The court noted that many courts regularly characterize retail investors as customers of stock exchanges. What the court found relevant was that these policies were sold with a “backdrop of well-established federal securities law that unambiguously considers retail investors to be customers of the exchange.”

In construing the professional services exclusion, the court noted that the D&O carriers had to demonstrate that the claims arose out of the rendering of or the failure to render professional services. The court found that it was undisputed that the negligence claims arose out of the exchange’s alleged failure to properly render professional services. The court rejected the E&O insurer’s argument that the exchange’s action to promote its trading platform for the initial public offering was not the performance of professional services. The court held that to prevail on the merits in a private securities fraud action, the investors must demonstrate that the defendant’s deceptive conduct caused their claimed economic loss. In the underlying cases here, the loss causation was based on failures in the technical services provided by the exchange. Accordingly, said the court, the failures to properly execute orders and deliver timely order confirmations, not the exchange’s self-marketing, went to the heart of the exchange’s provision of professional services, and the determination that the professional services exclusion applied.