On June 11, 2013, the New York Court of Appeals ruled in favor of Bear Stearns, now J.P. Morgan Securities, Inc., denying a motion to dismiss its complaint seeking approximately $140 million in policy proceeds from its insurers for money paid to the SEC as “disgorgement.” The “disgorgement” was part of a settlement of market timing violations claims by the SEC in which Bear Stearns allegedly facilitated market timing trades by its hedge fund customers, thereby allowing the customers to make hundreds of millions of dollars, but only earning approximately $16 million in commissions for Bear Stearns. Bear Stearns did not retain any other proceeds from the trades.

After denying its claim, Bear Stearns brought suit against its primary and excess companies seeking indemnification for its defense costs related to the SEC investigation, a private settlement, and the $160 million disgorgement payment. Bear Stearns initially survived a motion to dismiss at the trial court level, only to have its complaint dismissed in its entirety on appeal on the grounds that any indemnification of the disgorgement payment violated public policy.

On appeal to the New York Court of Appeals, Bear Stearns argued that while it is reasonable to preclude a policyholder from obtaining indemnity for the disgorgement of its own ill-gotten gains, in this case Bear Stearns was not unjustly enriched because at least $140 million of the disgorgement payment was attributable to its customers. The insurance companies did not dispute that Bearn Stearns’ claims fell within the policy definition of Loss, but instead argued that as a matter of public policy, Bear Stearns should be prohibited from recovery.

The New York Court of Appeals decided that, despite the description by the SEC of $160 million of the $250 million paid by Bear Stearns ($90 million was a civil penalty that Bear Stearns did not seek coverage for) to settle the charges as “disgorgement,” the figure did not actually represent the disgorgement of Bear Stearns’ own illicit gains. The New York Court of Appeals determined that the insurers did not demonstrate that the portion of the $160 million above the amount of commissions paid to Bear Stearns (i.e., the amount representing illicit profits made by Bear Stearns’ customers) was uninsurable as a matter of public policy, or excluded from coverage as a result of any ill-gotten gains exclusion.

This decision is important because the SEC has the authority to hold one party liable in disgorgement for the improper profits of another, and many of these alleged violations are centered in New York, where the stock trades and exchanges on which the SEC bases its claims are located. This decision will help policyholders by allowing them to seek coverage or indemnification for disgorgement payments where the profits were not retained by them. It is important to note that this decision does not disturb the prevailing public policy prohibition of insuring disgorgement of a policyholder’s own ill-gotten gains, which is typically the subject of a specific exclusion in any event. It is also important to note that the New York Court of Appeals did not treat as conclusive, the SEC’s labeling of the $160 million as “disgorgement,” which the insurance companies relied on to deny coverage. This potentially aids policyholders by not allowing insurance companies to deny coverage merely because a claim or term is labeled improperly. Instead a proper investigation into the facts and circumstances surrounding the claim should be conducted, but as of today, policyholders based in New York, or having claims made against them based on activities occurring in New York, have a far better chance of obtaining coverage based on what the policy covers, instead of facing an insurance company’s efforts to avoid coverage based on a “public policy” argument that is not included as an exclusion from coverage in the body of the policy itself.