After a preliminary injunction hearing, the United States District Court for the Southern District of Texas has determined that D&O insurers for the Stanford Financial Group and various related entities are no longer required to advance defense costs relating to criminal charges and civil litigation filed against Mark Kuhrt, Gilbert Lopez and R. Allen Stanford. Pendergest-Holt v. Certain Underwriters at Lloyds of London, et al., 4-09-CV-03712 (S.D. Tex. opinion filed October 13, 2010). The court’s decision focused narrowly on the applicability of the D&O policies’ Money Laundering Exclusion, finding the Exclusion applied to each of the three individuals. [Note that Plaintiff Laura Pendergest-Holt settled her dispute with the insurers prior to the hearing.]

By way of background: Allen Stanford is and was the sole owner of more than 100 Stanford related entities, including Stanford International Bank Limited (“SIBL”). SIBL, which was marketed through financial advisors, purported to “invest proceeds of CD sales in order to provide investment returns sufficient to cover inter alia the required interest payments on the CDs, redemptions of CDs, and overhead.” The CDs were promoted as liquid, conservative investments. After the economic crisis of 2007 and 2008, however, questions about the legitimacy of SIBL’s operations surfaced. Only days after Allen Stanford distributed a letter assuring investors that everything was safe, SIBL was placed in receivership and the SEC filed suit. It was later determined that the market value of all Stanford-related entities were overstated by billions of dollars.

Following the initiation of an action by the Securities and Exchange Commission (“SEC”) on February 17, 2009 and a criminal action initiated on June 18, 2009, Kuhrt, Lopez, and Stanford sought coverage for their defense costs under several related D&O policies. Although the insurers initially agreed to pay defense costs for these three individuals under a reservation of rights, the insurers denied coverage as of August 27, 2009, the date on which James M. Davis plead guilty to conspiracy to commit wire, mail and securities fraud. The insurers relied on a Money Laundering Exclusion that “bars coverage for loss (including defense costs) resulting from any claim arising directly or indirectly as a result of or in connection with any act or acts (or alleged act or acts)” of money laundering, as that term is defined in the Policy. Although the Money Laundering Exclusion did not require a final adjudication, it did require an “in fact” determination that Money Laundering had occurred.

The District Court initially granted the individuals’ motion for preliminary injunction, forcing the insurers to continue to cover the defense costs incurred by Kuhrt, Lopez, and Stanford (for a summary of the district court decision, please click here). On appeal, the Fifth Circuit disagreed with the court’s reasoning and remanded the case on the coverage question (i.e., for a determination of whether Money Laundering, as defined in the policy, had, in fact, occurred).

On remand, the district court analyzed the applicability of the exclusion to each of the three individuals to determine whether they “knew or suspected, or reasonably should have known or suspected, that the CD purchasers’ funds were Criminal Property in that the funds were ‘a benefit obtained from or as a result of or in connection with [C]riminal [C]onduct’ and whether [the three individuals] engaged in an act included in the Policy’s definition of Money Laundering.”

As to Kuhrt and Lopez, the insurers argued that the exclusion applied, among other reasons, because those individuals reverse engineered SIBL’s revenue numbers each month. The court agreed, finding that the explanations given by Kuhrt and Lopez through their expert, Alan Westheimer, strained credulity. According to the court, the procedure used by Kuhrt and Lopez for finalizing SIBL’s annual reports was “illogical and without accounting or business justifications.” The court reached the conclusion that the Money Laundering exclusion applied to Kuhrt and Lopez based on its finding that Kuhrt and Lopez knew, suspected, or reasonably should have known or suspected that the investment figures provided to them were not accurate reflections of SIBL’s investment performance and therefore that the CDs were being sold under false and misleading pretenses.

As to Allen Stanford, the insurers argued the exclusion applied because he was personally aware that SIBL CDs were being marketed on the basis of important misrepresentations about SIBL’s investment portfolio and investment performance. The court again agreed. It based its findings on communications Stanford sent and received, personal interest he took in SIBL’s CD program, and the direct financial interests he had in the companies at stake. The court found that it was clear by 2006, that the annual reports contained important false information about SIBL’s asset and investment allocation and that Stanford knew these misrepresentations were untrue. The court noted that when matters had reached crisis mode, Stanford sent a letter to calm investors, despite having no basis for the statements in his letter that SIBL was in good financial health. The court reached the conclusion that the Money Laundering exclusion applied to Stanford based on its finding that Stanford knew or suspected that the SIBL revenues from CD sales were “property which constitutes a benefit obtained from … or in connection with criminal conduct.” The court also found that the insurers had proven a substantial likelihood that a preponderance of the evidence would establish that Stanford knowingly committed acts of Money Laundering involving the Criminal Property.

Accordingly, the court vacated the preliminary injunction, and relieved the insurers from the duty to continue to advance defense costs to Kuhrt, Lopez, and Stanford. A copy of the decision is available here.