Misconduct on Wall Street Coverage for Corporate Scandals

Transcription

1 Misconduct on Wall Street Coverage for Corporate Scandals Cara Tseng Duffield Wiley Rein LLP 1776 K Street NW Washington, DC (202) (202) [fax] [email protected]

2 Cara Tseng Duffield is a partner in the law firm Wiley Rein LLP. Her practice focuses on directors and officers and other types of professional liability insurance. Ms. Duffield regularly provides strategic counseling to insurers in connection with underlying exposures presented by corporate scandals, securities and derivative litigation, government investigations and bankruptcy. Ms. Duffield also represents insurers in coverage disputes, including bad faith and rescission litigation. The views and opinions expressed in this paper are the author s own. They do not express or represent the views of any Wiley Rein client.

3 Misconduct on Wall Street Coverage for Corporate Scandals Table of Contents I. Introduction...31 II. Anatomy of a Scandal: LIBOR and The Currency Markets...31 A. Regulatory Claims...31 B. Law Suits Antitrust suits Shareholder derivative suits against settling banks Securities fraud class actions lawsuits...32 III. D&O Insurance Coverage...32 A. Claims and Securities Claims...32 B. When Is There Coverage For Investigation Costs? Coverage for regulatory investigations Coverage for internal corporate investigations Coverage for regulatory settlements...37 IV. Considerations in Evaluating Coverage for Investigations...39 Misconduct on Wall Street Coverage for Corporate Scandals Duffield 29

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5 Misconduct on Wall Street Coverage for Corporate Scandals I. Introduction Over the last decade, charges of financial impropriety have plagued many large international financial concerns. Beginning with Enron and progressing through the credit crisis to recent insider trading probes, newspaper headlines and court dockets have been full of allegations of accounting chicanery, bribery and corruption. Cases of corporate wrongdoing present many different types of exposures: civil litigation, governmental investigations, and criminal liability, each of which has separate implications for a corporate insured s ability to obtain insurance coverage for these claims. In this paper we will examine the coverage issues under directors and officers ( D&O ) liability insurance policies in the specific context of the LIBOR rate-fixing scandal, focusing on regulatory investigation, in-house investigations and regulatory settlements. The paper concludes with a check list of practical considerations for evaluating the scope of D&O coverage for costs incurred by financial institutions for investigating and responding to allegations of financial impropriety. II. Anatomy of a Scandal: LIBOR and The Currency Markets The London Interbank Offered Rate (LIBOR) is a benchmark used to set interest rates for lending between banks. LIBOR is derived from the average of the interest rates that each of a panel of banks reports that it would pay to borrow money from other banks. Each panel bank s submission is published daily along with the LIBOR rate. LIBOR impacts swaps and futures contracts, commercial loans, home mortgages and other transactions. It is estimated that the value of all securities and loans relying on LIBOR is $800 trillion. As early as 2008, press reports began questioning the accuracy of LIBOR. In May 2008, the Wall Street Journal article reported that LIBOR submissions were diverging from other measures that LIBOR historically had tracked, causing commentators to speculate that banks were reporting lower-than-actual borrowing rates in order to avoid the appearance that they were desperate to borrow cash. See Carrie Mollencamp and Mark Whitehouse, Study Casts Doubt on Key Lending Rate: Banks May Have Filed Flawed Interest Data for Libor Benchmark, Wall Street Journal, May 30, A. Regulatory Claims In the wake of these reports, regulators launched a series of investigations against banks that might have conspired to fix the LIBOR rate. In June 2012, regulators announced a series of settlements with Barclays PLC, Barclays Bank PLC and Barclays Capital Inc. The U.S. Commodities Futures Trading Commission ( CFTC ) announced that Barclays had been ordered to pay a $200 million penalty for falsely reporting and attempting to manipulate LIBOR and another benchmark rate from approximately 2005 to According to the order, Barclays actions were intended to benefit the Bank s derivatives trading positions as well as to protect Barclays reputation from negative market and media perceptions concerning Barclays financial condition. Barclays also entered into a settlement with the U.S. Department of Justice to pay a $160 million penalty to resolve a criminal investigation into Barclays LIBOR reporting. Finally, Barclays also entered into an agreement with the U.K. Financial Services Authority relating to LIBOR and other benchmark rate submissions. In December 2012, UBS announced its own series of LIBOR-related regulatory settlements totaling almost $1.5 billion. The civil settlements included a settlement with the CFTC, pursuant to which UBS paid a Misconduct on Wall Street Coverage for Corporate Scandals Duffield 31

6 $700 million penalty; a settlement with the U.K. Financial Services Authority involving a 160 million penalty; and an agreement with Swiss securities regulators involving a $64.3 million fine. UBS also entered into a non-prosecution agreement with DOJ, agreeing to pay a $400 million penalty. In addition, UBS s subsidiary UBS Securities Japan Co. Ltd. agreed to plead guilty to a one-count criminal information for felony wire fraud and pay a $100 million penalty. In February 2013, Royal Bank of Scotland announced settlements with regulators as well. RBS agreed to pay 87.5 million pounds to Britain s Financial Services Authority; $150 million to DOJ; and $325 million to the CFTC. Various other financial institutions have reported that they are being investigated for LIBOR rate-fixing. Among others, these institutions include Bank of America, Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, HSBC Holdings PLC, J.P. Morgan Chase & Co., Royal Bank of Scotland PLC, and UBS AG. B. Law Suits In addition to regulatory investigations, various types of lawsuits were filed against those banks that participated in setting LIBOR. 1. Antitrust suits Beginning in 2011, various private plaintiffs filed antitrust lawsuits against the panel banks involved in setting the interbank interest rate for the U.S. dollar. The lawsuits were consolidated as In re LIBOR-Based Financial Instruments Antitrust Litigation in the Southern District of New York. The plaintiffs allege that the defendant banks conspired to submit artificial rates and the plaintiffs suffered injury because their financial positions were negatively impacted by defendants alleged fixing of LIBOR. In March of this year, the antitrust claims in the lawsuit were dismissed, among other grounds, for failure to allege antitrust injury. Specifically, the court held that any injury stemmed from the banks misrepresentations as to borrowing rates, not injury to competition. 2. Shareholder derivative suits against settling banks Derivative suits have been filed against Citibank and Bank of America. The suits generally allege that these institutions directors breached fiduciary duties by failing to maintain adequate controls. 3. Securities fraud class actions lawsuits Barclays shareholders filed securities fraud class action complaints alleging that Barclays made statements about its internal controls and legal compliance practices that were false and misleading in light of the company s attempted manipulation of and false reporting regarding the LIBOR rate. See Gusinsky v. Barclays PLC et al., No (S.D.N.Y.). In May 2013, the court granted defendants motion to dismiss, holding that plaintiffs had failed to identify actionable misrepresentations connected to LIBOR practices and failed to plead loss causation. III. D&O Insurance Coverage A. Claims and Securities Claims D&O policy insuring agreements focus on three key terms: loss, claims, and wrongful acts. In their earliest forms, D&O policies generally afforded coverage only for directors and officers ( insured persons ) for loss resulting from claims against insured persons for wrongful acts. Today, most D&O 32 Insurance Coverage and Practice December 2013

7 policies afford some type of entity coverage as well. For public companies, entity coverage is generally circumscribed to securities claims, for loss resulting from securities claims against the company for company wrongful acts. Definitions of the term claim can vary widely between policies. The D&O marketplace is competitive and policyholders, particularly those using large and sophisticated brokers, can often obtain endorsements that broaden the coverage offered in a carrier s standard policy form. Most policies will contain a multipart definition of the term claim. The following is one example: (1) a written demand for monetary, non-monetary or injunctive relief; (2) a civil, criminal, administrative, regulatory or arbitration proceeding for monetary, non-monetary or injunctive relief which is commenced by (i) service of a complaint or similar pleading; (ii) return of an indictment, information or similar document (in the case of a criminal proceeding); or (iii) receipt or filing of a notice of charges; or (3) a civil, criminal, administrative or regulatory investigation of an Insured Person (i) once such Insured Person is identified in writing by such investigating authority as a person against whom a proceeding described in Definition (b)(2) may be commenced; or (ii) in the case of an investigation by the SEC or a similar state or foreign government authority, after the service of a subpoena upon such Insured Person. Definitions of the term securities claims also are policy-specific. Policies most commonly limit securities claims to that subset of claims arising from any actual or alleged violation of state or federal securities laws and regulations or claims for any actual or alleged act, error or omission in connection with the purchase or sale, or offer to purchase or sell, securities issued by the company. While some policies may contain endorsements broadening the definition of securities claim, in almost all instances the term will require a connection to securities issued by the company. In the case of LIBOR, the securities claim requirement may provide significant protection. As noted above, public company D&O policies generally limit entity coverage to securities claims, which are defined as claims arising out of securities issued by the company. The antitrust suits against the LIBOR panel banks do not allege violations of the securities laws or concern the defendant banks own securities. Similarly, lawsuits by other financial institutions or customers alleging damage from reliance on false LIBOR rates are unlikely to constitute securities claims (although they potentially could trigger errors and omissions coverage). A recent case illustrates this point. See Impac Mortgage Holdings Inc., et al. v. Houston Cas. Co., et al., Case No. SACV (C.D. Cal. Feb. 26, 2013). In that case, a mortgage company and its subsidiaries sold residential mortgages, securitized them, and deposited them into trusts. The trusts then issued certificates that the mortgage company sold to investors. Subsequently, several investors asserted claims against the mortgage company alleging that they suffered losses caused by the mortgage company s false and misleading statements in connection with the sale of the certificates. The company s D&O carrier denied coverage on the basis that the suit was not a securities claim, defined as a claim brought by any person or entity alleging, arising out of, based upon or attributable to... the purchase or sale of or offer or solicitation of an offer to purchase or sell any securities of the Organization. The court agreed that the mortgage-backed securities at issue were not securities of the Organization itself. On the other hand, the LIBOR-related securities fraud and derivative suits that have been filed against certain banks constitute classic D&O risks. At present, it is unclear whether these suits will present major exposures. Motions to dismiss the securities fraud suits have been successful. As to derivative suits, only three of the panel banks involved in LIBOR rate-setting are domiciled in the United States: Citigroup, Misconduct on Wall Street Coverage for Corporate Scandals Duffield 33

8 Bank of America and J.P. Morgan. While these institutions apparently all are under investigation, to date, none has publicly announced a regulatory settlement. Absent a large regulatory settlement, it may be difficult for plaintiffs to prove that defendant directors breached a duty of care. B. When Is There Coverage For Investigation Costs? As noted above, the defendants in the LIBOR-related lawsuits have fared relatively well to date, particularly as compared against regulatory settlements. Indeed, it is not uncommon for the costs of investigations resulting from revelations of financial misconduct to outstrip the costs of actual litigation. But are these costs covered? Policyholder requests for investigations coverage can raise a host of issues, including whether coverage exists for regulatory investigations; whether coverage exists for internal investigations; and whether coverage exists for amounts assessed by regulators. These issues are addressed below. 1. Coverage for regulatory investigations Claim definitions in traditional D&O policies generally do not include investigations of the company itself, as opposed to the company s directors and officers. Nevertheless, policyholders may attempt to argue that they should be entitled to reimbursement of the costs of entity investigations. Regulatory investigations generally involve the service of a subpoena for documents. Policyholders may argue that, even if the policy s claim or securities claim definition does not include coverage for investigations of the entity, a subpoena qualifies as a written demand for nonmonetary relief and therefore is a claim. Numerous courts have addressed this issue. Some courts have held that a subpoena, particularly a governmental subpoena, may constitute a written demand for non-monetary relief. See, e.g., Syracuse Univ. v. National Union Fire Ins. Co., 2012EF63, 2013 WL (N.Y. Sup. Mar. 7, 2013); Agilis Benefit Services LLC v. Travelers Cas. & Surety Co., No. 5:08-cv-213 (E.D. Tex. Apr. 30, 2010); Minuteman Int l v. Great Am. Ins. Co., No. 03-c-6067, 2004 WL (N.D. Ill. Mar. 22, 2004). Other cases have held that a demand for documents is not a demand for relief in the plain and ordinary sense of the term. See, e.g., Employers Fire Ins. Co. v. ProMedica Health Systems, Inc., No , 2013 WL (6th Cir. Apr. 30, 2013). In ProMedica, the FTC opened a preliminary investigation into the insured healthcare provider s proposed acquisition of a not-for-profit hospital in July In August 2010, the FTC formalized the investigation and issued subpoenas and civil investigatory demands (CIDs) to the insured and the hospital. In January 2011, the FTC filed administrative and civil complaints against the insured seeking to enjoin the merger. The insured provided notice of the actions to its insurer that month. The insured s D&O policy defined a claim to include a written demand for monetary, non-monetary or injunctive relief as well as a civil, criminal, administrative, regulatory or arbitration proceeding. The insurer contended that the FTC s August 2010 subpoenas constituted a claim and therefore the insured had provided late notice. The district court agreed. On appeal, however, the United States Court of Appeals for the Sixth Circuit reversed. The Sixth Circuit held the subpoenas and civil investigative demands were not demands for relief : the subpoenas and CIDs sought information related to the FTC s investigation, not a remedy provided by a court. Id. at *10. In addition, the subpoenas and CIDs did not redress [any] alleged wrong; they simply enabled the FTC to further investigate whether an antitrust violation would occur. Id. See also Diamond Glass Co. Inc. v. Twin City Fire Ins. Co., No. 06-cv-13105, at *4 (S.D.N.Y. Aug. 18, 2008) (grand jury subpoena and search warrant did not constitute written demands for non-monetary relief; relief means redress or remedy and not request for documents and information); Center for Blood Research v. Coregis Ins. Co., No , 2001 WL , 34 Insurance Coverage and Practice December 2013

9 at *3 (D. Mass. Nov. 14, 2001) (investigative subpoena from U.S. Attorney s Office was not a written demand for relief ; relief should be interpreted to mean redress for a wrong or a remedy in the nature of a courtordered benefit ). Where a policy s claim definition expressly includes limited coverage for investigations, courts have been skeptical of expanding investigations coverage beyond that contemplated by the policy. The leading case on this topic is Office Depot, Inc. v. National Union Fire Insurance Company, 734 F. Supp. 2d 1304 (S.D. Fla. 2010), aff d 453 Fed. App x 871 (11th Cir. 2011). Office Depot received a whistleblower letter alleging accounting irregularities relating to the company s recognition of revenue from certain vendor rebate programs. Office Depot commenced an internal review of the allegations, including an internal investigation by its Audit Committee. It also self-reported the issues to the SEC, which began its own investigation of the issues. After the company announced a restatement of its financials, securities and derivative suits followed. Office Depot sought reimbursement for $23 million in legal fees and expenses for responding to the various matters. Its insurer acknowledged coverage for defense costs for the securities and derivative lawsuits. It also acknowledged coverage for costs incurred by individuals to respond to SEC subpoenas and Wells notices pursuant to the policy s definition of the term Claim, which included a regulatory investigation of an Insured Person... once such Insured Person is identified in writing by such investigating authority as a person against whom a proceeding... may be commenced or, in the case of an SEC investigation, after service of a subpoena on such Insured Person. The insurer denied coverage, however, for Office Depot s own costs of responding to the SEC investigation. The district court agreed that Office Depot s own costs to respond to the SEC investigation were not covered. While the policy s definition of claim included specified coverage for investigations of insured persons, the policy limited entity coverage to securities claims. While the definition of securities claim included administrative or regulatory proceeding[s] against the company if and only during the time that such proceeding is also commenced and continuously maintained against an Insured Person, it expressly did not include regulatory investigations. The court rejected Office Depot s argument that the SEC investigation qualified as a securities claim because it was an administrative or regulatory proceeding, holding that the argument improperly conflated the policy s distinct treatment of regulatory proceedings and investigations. The U.S. Court of Appeals for the Eleventh Circuit affirmed. In a recent case, a bankruptcy court reached a similar result. See In re DBSI, Inc. et al., Adv. No , 2012 WL (Bankr. D. Del. Jun. 27, 2012). In that case, litigation trustees sought coverage for the costs of responding to a FINRA investigation. The debtor s D&O policy defined a D&O claim against insured persons to include, among other things, regulatory proceedings and regulatory investigations. The policy s definition of insured organization claim, in contrast, included only prongs for written demands, civil and criminal proceedings, and requests to toll statutes of limitation. The court rejected the trustees arguments that the investigation constituted a covered insured organization claim. The court reasoned: [u]nlike the definition of a D&O Claim, the definition of an Insured Organization Claim does not include a formal regulatory proceeding or an investigation, such as the FINRA Investigation. Nor can the FINRA Investigation be considered a written request for non-monetary relief, as this reading... would make [the investigation prong] of the D&O claim definition redundant. Id. at *7. Policy forms and endorsements evolve over time, however. In recent years, at least one carrier has developed a standalone product to specifically provide entity investigation coverage. See, e.g., Other carriers offer endorsements that provide some form of entity investigation coverage. See, e.g., MBIA, Inc. v. Federal Insurance Company, 652 F. 3d 152 (2d Cir. 2011) ( securities claim definition included formal or informal administrative or regulatory proceed- Misconduct on Wall Street Coverage for Corporate Scandals Duffield 35

10 ing or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document ); ACE American Ins. Co. v. Ascend One Corp., 570 F. Supp. 2d 789 (D. Md. 2008) ( claim definition included a civil, administrative or regulatory investigation against any Insured commenced by the filing of a notice of charges, investigative order or similar document ). 2. Coverage for internal corporate investigations Companies facing regulatory investigations or civil liability often will institute internal investigations. As with regulatory investigations, most traditional D&O policies do not afford coverage for such internal investigations. Insurers often contend that such investigation costs are corporate compliance costs, not loss resulting from claims. In response, policyholders contend that a robust internal investigation can be critical to the successful defense of regulatory investigations or lawsuits. Many policyholders contend that company investigation costs should be covered because they are reasonably related to other covered defense costs. Early D&O policies, true to their name, afforded coverage only for directors and officers, not companies. The question of entity coverage sometimes arose under such policies when individual directors and officers and the company were defendants in the same proceeding and were represented by common defense counsel. Insurers often took the position that they should be entitled to assign a portion of the common defense costs to the non-covered entity; policyholders took the position that the same costs would have been incurred even absent the entity defendant and therefore no allocation was proper. In the absence of clear policy language, courts attempted to devise default rules to determine coverage for the non-insured entity. One such default rule was the reasonably related test. See, e.g., Safeway Stores, Inc. v. National Union Fire Ins. Co., 64 F.3d 1282 (9th Cir. 1995). D&O policies evolved, however. Today, most D&O policies include some form of entity coverage and carefully define the parameters of that coverage. When a policy defines what entity coverage is and is not available, there is no need for recourse to default rules. Nevertheless, policyholders often seek to avail themselves of the early reasonably related case law to argue that entity investigation costs should be covered if such costs are reasonably related to covered defense costs. Such efforts should be rejected. Most D&O policies cover loss, including defense costs, that result from a claim, not amounts that are reasonably related to covered loss. If the matter for which the insured seeks defense costs is not a covered claim, that should end the inquiry. In Office Depot, the company argued that, even if the SEC investigation of the company was not a covered claim, the company s costs of responding to the investigation, including internal investigation costs, should be covered nonetheless because those costs benefitted the insureds defense of securities and derivative litigation. The court rejected the argument. Office Depot, Inc. v. Nat l Union Fire Ins. Co. of Pittsburgh, Pa., No CIV (S.D. Fla. Oct. 27, 2010 & Feb. 16, 2011). The court analyzed the policy language and held that covered loss must result solely from a covered claim. The court disagreed that the company s investigation costs constituted covered loss simply because that activity proved to be a useful and economically efficient means of managing the SEC litigation that materialized. While the circumstances did not concern an internal investigation, the court in Telxon Corp. v. Federal Insurance Company, 309 F.3d 386 (6th Cir. 2002), similarly rejected a reasonably related argument. A company and its officers were defendants in securities litigation and had separate defense counsel. The policy covered loss incurred by insured persons, but not the company. The company nevertheless contended that its separate defense costs should be covered because its counsel had taken the lead role in a coordinated defense of the litigation. The court rejected the argument, noting that the policy only afforded coverage for loss, defined as amounts the insured persons were legally obligated to pay. The court held there was no evidence 36 Insurance Coverage and Practice December 2013

11 that the officers were legally obligated to pay for the company s defense costs and, therefore, regardless which counsel served as lead, the company s defense costs did not constitute covered loss. In MBIA v. Federal Insurance Company, 652 F. 3d 152 (2d Cir. 2011), the Second Circuit reached a different result and held that the insurer was responsible for covering the costs of the policyholder s internal investigation undertaken to investigate a derivative lawsuit. In that case, the policyholder provided financial guarantee insurance to municipalities and other government entities for their bonds and structured finance obligations. The policyholder subsequently was investigated by the SEC and New York Attorney General. During the pendency of the regulatory investigations, shareholders demanded that the company file suit against its directors and officers. The company set up an independent committee to investigate the shareholder demands. The shareholders then filed derivative actions, and the insured reconstituted the investigative committee as a Special Litigation Committee ( SLC ). The SLC then successfully moved to dismiss the derivative suits. The company tendered the SLC costs to its insurers. The insurers agreed to cover $200,000 of the investigation costs pursuant to an endorsement providing as sublimit for derivative demands but denied coverage for the remaining SLC costs. The court held that the policies provided coverage for costs incurred by the SLC in the derivative litigation. The court rejected the insurers arguments that the SLC constituted an entity separate from the company or its directors and therefore did not qualify as an Insured. The court acknowledged the insurers contention that the SLC needed to be independent but held that [i]ndependence of judgment does not generate a new source of authority to terminate derivative litigation; that authority is still exercised by the corporation, which can act only through its agents. The court then held that the policy s $200,000 sublimit for Investigation Costs... on account of all Shareholder Derivative Demands did not mean that only $200,000 of coverage was available for SLC costs. The court agreed that the sublimit applied to investigations of the presuit shareholder demands but held that the sublimit s applicability is less obvious once demand is rejected and suit is brought because [a]t that stage, the other insuring agreements afford coverage for costs incurred in investigating Securities Claims. Following both Office Depot and MBIA, carriers began to sell endorsements that offer specified coverage for internal investigations. As always, the best touchstone for determining the scope of coverage is the policy itself. 3. Coverage for regulatory settlements Conventional coverage wisdom is that, while regulatory investigations may be expensive to defend, regulatory settlements generally are not covered. Most D&O policies contain carveouts from the definition of loss for fines, penalties and amounts uninsurable at law. In the D&O arena, regulatory settlements almost always require payment of amounts that expressly are denominated as fines, penalties, disgorgement or restitution. For instance, the amounts that Barclays, UBS and Royal Bank of Scotland paid to the CFTC for LIBORrelated violations all were explicitly labeled as civil monetary penalties. Similarly, the SEC, perhaps the most common regulator in D&O space, only can assess disgorgement and penalties in cease-and-desist proceedings. See 15 U.S.C. 77h-1(e), (g); 15 U.S.C. 78u-2(a), (e); 15 U.S.C. 78u-3(e). It is well-settled that the return of amounts to which an insured was never entitled does not constitute loss and is not insurable at law. See Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 800 N.Y.S.2d 358, 2003 WL , at *3 (2003), aff d 10 A.D.3d 528 (2004) (the deterrent effect of [an SEC] enforcement action would be greatly undermined if securities law violators were not required to disgorge illicit profits ); Millennium Partners L.P. v. Select Ins. Co., 882 N.Y.S.2d 849, 853 (2009), aff d 68 A.D.3d 420 (2009) ( one may not insure against the risk of being ordered to return money or property that has been wrongfully Misconduct on Wall Street Coverage for Corporate Scandals Duffield 37

12 acquired ); Nortex Oil & Gas Corp. v. Harbor Ins. Co., 456 S.W.2d 489, 494 (Tex. Ct. App. 1970) (the insurer did not contract to indemnify the insured for disgorging that to which it was not entitled in the first place, or for being deprived of profits to which it was not entitled ); Bank of the West v. Superior Court, 833 P.2d 545, 10 Cal. Rptr. 2d 538, 555 (Cal. 1992) ( [w]hen the law requires a wrongdoer to disgorge money or property acquired through a violation of the law, to permit the wrongdoer to transfer the cost of disgorgement to an insurer would eliminate the incentive for obeying the law ); Conseco, Inc. v. Nat l Union Fire Ins. Co., No. 49D130202CP000348, 2002 WL , at *8 (Ind. Cir. Ct. Dec. 31, 2002) (an ill-gotten gain to Conseco [] cannot be considered Loss ); St. Paul Fire & Marine Ins. Co. v. Prairie Title Svcs., Inc., No. 04-C-4178, 2005 WL , at *3 (N.D. Ill. Oct. 26, 2005) ( under Illinois law, an insurance company does not have a duty to defend for loss in cases where the plaintiff is seeking restitution of the defendant s improper gains ); Executive Risk Indemnity, Inc. v. Pacific Educ. Serv., Inc., 451 F. Supp. 2d 1147, 1162 (D. Haw. 2006) (a conclusion that restitution is insurable would contravene the express purpose of restitution recognized by Hawaii courts, which is to deter wrongdoers from benefiting or otherwise profiting from their improper actions ). Insurers and policyholders frequently dispute whether amounts labeled as disgorgement in a regulatory settlement should be deemed to constitute amounts uninsurable at law. The New York Court of Appeals addressed this issue in the recent case J.P. Morgan Sec., Inc. v. Vigilant Ins. Co., No. 113, 2013 WL (N.Y. June 11, 2013). In that case, the court analyzed potential coverage for an SEC settlement. Bear Stearns settled an SEC investigation into late trading and market timing by agreeing to pay $160 million in disgorgement. Bear Stearns settled without admitting or denying liability. Notably, Bear Stearns maintained that it had received only $16.9 million in commissions from its allegedly wrongful actions. Bear Stearns sought coverage for the $160 million; its insurers denied coverage; and Bear Stearns filed coverage litigation. The insurers filed a motion to dismiss on the grounds that the disgorgement payment was uninsurable as a matter of law. The trial court denied the motion; the intermediate appellate court reversed; and the Court of Appeals affirmed the original denial of the motion to dismiss. The Court of Appeals reaffirmed the general proposition that the return of ill-gotten gains is not insurable. The court noted, however, that at the motion to dismiss stage it must accept Bear Stearns s allegations as true, including that only a fraction of the $160 million payment represented Bear Stearns s own profits and the remainder, though labeled disgorgement, constituted profits made by Bear Stearns s customers without Bear Stearns ever having possessed the amounts. The court opined that, because the SEC order recited only that Bear Stearns s misconduct had permitted its customers to generate hundreds of millions of dollars in profits, there was no conclusive finding that the amounts labeled disgorgement constituted the return of ill-gotten gains by Bear Stearns. The court therefore ruled that the trial court properly denied the insurers motions to dismiss. In some respects, the J.P. Morgan case arises out of a fairly unique set of circumstances. In the vast majority of regulatory settlements where a company is ordered to pay disgorgement, the company will actually have retained the profits it is being forced to disgorge. In those instances, the settlement amounts squarely would be uninsurable at law. Policyholders may attempt to read J.P. Morgan as standing for the proposition that insurers must re-litigate the findings in regulatory settlements before they can deny coverage for a regulatory settlement payment as constituting disgorgement uninsurable at law. That likely is an over-reading of the case. It is well-established that amounts paid pursuant to a settlement may constitute disgorgement that is uninsurable at law. See Credit Suisse, 2003 WL , at *4 ( CSFB correctly states that the [agreed final judgment in the SEC proceeding] is not the same as a final adjudication of the facts after a trial. However, the effect of the Final Judgment, under the particular facts of this case, is essentially the same because the Final Judgment states that CSFB is disgorging money that it obtained improperly. ); see also Credit Suisse, 10 A.D.3d 38 Insurance Coverage and Practice December 2013

13 at 529 (final judgment ordered disgorgement based on allegations in complaint, and Credit Suisse agreed not to contest allegations in complaint); Millenium, 68 A.D.3d at 576 ( the findings recited in the SEC s cease-anddesist order to which plaintiff consented....conclusively link the disgorgement to improperly acquired funds, notwithstanding that plaintiff consented and agreed to these orders without admitting or denying the findings therein. The fact that no judgments resulted from the negotiated settlements in which these findings were made does not affect the validity of the findings ); Level 3 Communications, Inc. v. Federal Ins. Co., 272 F.3d 908, 911 (7th Cir. 2001) (rejecting insured s contention that as long as the case is settled before entry of judgment, the insured is covered regardless of the nature of the claim against it ); Ryerson, Inc. v. Federal Ins. Co., 676 F.3d 610 (7th Cir. 2012) (settlement payment constituted non-insurable loss); CNL Hotels & Resorts, Inc. v. Twin City Fire Ins. Co., 291 Fed. App x 220 (11th Cir. 2008) (same). IV. Considerations in Evaluating Coverage for Investigations The following checklist contains various practical considerations in evaluating whether and to what extent an insurance policy affords coverage for regulatory or internal investigations. 1) Does the policy have a specific endorsement allowing or disallowing coverage for regulatory or internal investigations? Did the insured/broker request such an endorsement during policy underwriting? 2) What is the policy s claim definition? Does it expressly contain a subpart for investigations? 3) Does investigations coverage extend to the entity, or is it limited to insured persons? 4) What is the law of the jurisdiction? Is there case law holding that subpoenas constitute written demands for non-monetary relief? 5) What regulators are investigating the insureds? Does the regulator have statutory authority to assess damages, or is its authority limited to fines, penalties, and disgorgement? 6) Do the entity and insured persons have the same counsel or separate counsel? 7) Is the insured conducting an internal investigation? Is the same counsel conducting the internal investigation and also responding to regulators? 8) Is civil litigation also proceeding against the insureds? What is the status of the civil litigation? Misconduct on Wall Street Coverage for Corporate Scandals Duffield 39

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