Vigilant Ins. Co. v Bear Stearns Cos. Inc.

[*1] Vigilant Ins. Co. v Bear Stearns Cos. Inc. 2006 NY Slip Op 50047(U) [10 Misc 3d 1072(A)] Decided on January 11, 2006 Supreme Court, New York County Moskowitz, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on January 11, 2006
Supreme Court, New York County

Vigilant Insurance Company, FEDERAL INSURANCE COMPANY and GULF INSURANCE COMPANY, Plaintiffs,

against

Bear Stearns Companies Inc., Defendant.



602160/2003

Karla Moskowitz, J.

In this declaratory judgment action, plaintiffs Vigilant Insurance Company (Vigilant), Federal Insurance Company (Federal) and Gulf Insurance Company (Gulf) (collectively "Insurers") move, pursuant to CPLR 3212, for an order granting summary judgment. Specifically, they seek an order declaring that certain liability insurance policies they issued to defendant The Bear Stearns Companies, Inc. (Bear Stearns) do not cover any portion of Bear Stearns' settlement of various regulatory authorities' investigations and claims against it. For the reasons stated below, the motion is granted in part and denied in part.[FN1]

1. Background

Vigilant issued a Professional Liability Insurance Policy, dated October 27, 2000, to Bear Stearns, with a $10 million limit of liability in excess of a $10 million self-insured retention, for the period of May 5, 2000 to May 5, 2003. Federal issued an excess insurance policy to Bear Stearns for the period of May 5, 2000 to May 5, 2003. Gulf issued an excess insurance policy to Bear Stearns for the period of May 5, 1998 to May 5, 2001.[FN2]

The policies provided that the Insurers would cover Bear Stearns for any "Loss" it became legally obligated to pay. Loss was defined as: (1) compensatory damages, multiplied damages, punitive damages where insurable by law, judgments, settlements, costs, charges and expenses or other sums the Insured shall legally become obligated to pay as damages resulting from any Claim or Claim(s);[*2](2) costs, charges and expenses or other damages incurred in connection with any investigation by any governmental body or self-regulatory organization (SRO)...[FN3]

On April 29, 2002, Bear Stearns received a letter from the Securities and Exchange Commission (SEC), the NASD Regulation, Inc. (NASDR) and the New York Stock Exchange (NYSE) (collectively "Regulators"), informing it that those entities had commenced a "joint inquiry into market practices concerning research analysts and the potential conflicts that can arise from the relationship between research and investment banking." The letter further stated that the first phase of the inquiry would focus on the work of Bear Stearns' research analysts and investment bankers for the period from July 1, 1999 to June 30, 2001. The second phase would focus on Bear Stearns' compliance with new rules addressing research analyst conflicts of interest.

Bear Stearns was one of several entities the Regulators were investigating. On December 20, 2002, the Regulators announced that they had reached a global settlement with various investment banks, including Bear Stearns, that concluded the investigation that began in April 2002. On that same day, Bear Stearns executed a document titled "Settlement Principles", that set forth basic settlement terms, including various payment amounts. The Regulators did not sign this document.

On April 21, 2003, Bear Stearns executed a "Consent" to the entry of a judgment against it, Bear Stearns notified the Insurers of the execution of the Consent on April 24, 2003.

The SEC commenced a civil action against Bear Stearns on April 28, 2003 in the United States District Court for the Southern District of New York. The Complaint stated that "[f]rom July 1, 1999 to June 30, 2001...certain research analysts were subjected to investment banking influences and conflicts of interests between supporting investment banking business and publishing objective research." It further alleged that "research analysts at Bear Stearns were encouraged to participate in investment banking activities, and that was a factor considered in the analysts' compensation system." The SEC and Bear Stearns submitted a Proposed Final Judgment on that same day.

The District Court entered a Final Judgment on October 31, 2003, ordering Bear Stearns to pay 80 million dollars. Specifically, Bear Stearns was to pay: 1) $25 million as a penalty; 2) $25 million as disgorgement of commissions and other monies; 3) $25 million to procure independent research; and 4) $5 million to use for investor education. The Final Judgment provided that "[n]o portion of the payments for Independent Research or investor education shall be considered disgorgement or restitution, and/or used for compensatory purposes."

The Insurers now seek an order granting summary judgment and declaring that their policies do not cover the $25 million disgorgement payment and the $30 million payment for independent research and investor education as a matter of law. A party moving for summary judgment is required to make a prima facie demonstration that it is entitled to judgment as a matter of law by putting forth sufficient evidence to eliminate any material issues of fact from the [*3]case. Winegrad v NYU Medical Center, 64 NY2d 851 [1985]; Grob v Kings Realty Associates, LLC, 4 AD3d 394 [2d Dept 2004]. The party opposing the motion then has the burden of demonstrating that a factual issue exists requiring a trial of the action. Zuckerman v City of New York, 49 NY2d 557, 560 [1980].

2. Consent to Settle

Initially, the Insurers contend that there is no coverage here because Bear Stearns failed to acquire their consent to the settlement of the action against it. Specifically, they contend that they received no notice before Bear Stearns executed the December 20, 2002 document entitled "Settlement Principles." They also contend that Bear Stearns failed to obtain their consent before executing the Consent to entry of a judgment against it on April 21, 2003.

Bear Stearns argues that neither of these documents represented a final, binding settlement agreement because the terms of the final judgment were open to further negotiation and required approval from the court. Therefore, Bear Stearns argues that it did not require the Insurers' consent yet.

The policies provided that Bear Stearns agreed "not to settle any Claim, incur any Defense Costs or otherwise assume any contractual obligation or admit any liability with respect to any Claim in excess of a settlement authority threshold of $5,000,000 without the Insurer's consent, which shall not be unreasonably withheld." The policies further stated that each of the insurers "shall not be liable for any settlement, Defense Costs, assumed obligation or admission to which it has not consented."

The Insurers have not demonstrated that they are entitled to summary judgment on the issue of consent. It is undisputed that Bear Stearns executed the December 20, 2002 document, entitled "Settlement Principles," without the consent of the Insurers. It is also undisputed that Bear Stearns executed the Consent to entry of a judgment against it on April 21, 2003 without the Insurers' consent. However, with regards to both documents, Bear Stearns was the only party to sign the document. The Regulators did not do so. Further, Bear Stearns' legal counsel, Patrick Maloney, states in his affidavit that it was his understanding that the final judgment was subject to court approval and that, if the court required any changes to the settlement, Bear Stearns would not be obligated to consent to such changes. He further states that, in fact, the District Judge required the parties to renegotiate certain portions of the settlement in September of 2003.

Based on the foregoing, the court finds that questions of fact exist as to whether Bear Stearns failed to acquire the consent of its Insurers before settling the relevant claims against it or assuming some type of liability that required the consent of the Insurers. Among other things, it is not clear whether the documents at issue were final agreements that were binding on Bear Stearns or subject to further negotiation and ultimately approval of the court. Thus, it is not clear at what point the Insurers' consent was required. Therefore, the court denies this portion of the motion for summary judgment.

3. Investment Banking Exclusion

The policies contained an exclusion the parties referred to as the "investment banking exclusion." It provided, in relevant part, that the policies would not apply to any claims made against Bear Stearns "based upon, arising from or in consequence of any underwriting, syndicating, or investment banking work..." The Insurers argue that this exclusion is a complete bar to coverage for any of Bear Stearns' payments, "because the wrongful conduct that was [*4]alleged and formed the basis for the Settlement was based upon, arose from and was in consequence of Bear Stearns' investment banking and associated counseling and investment activities." (The Insurers' Memorandum of Law at 19).

As noted above, the Complaint alleged that the research analysts were subjected to investment banking influences and conflicts of interests between supporting investment banking business and publishing objective research and that the analysts were encouraged to participate in investment banking activities, a factor in calculating their compensation. However, it is not clear at this point that the entirety of the alleged wrongful conduct that formed the basis for the settlement was connected to Bear Stearns' investment banking activities as the Insurers argue. Therefore, the Insurers have not demonstrated that Bear Stearns's claim for coverage is barred in its entirety and the motion is denied as to this issue.

4. Disgorgement

The Final Judgment states that "[a]s a result of the violations alleged in the Complaint", Bear Stearns was required to pay $25 million, "as disgorgement of commissions and other monies." The Insurers now argue that Bear Stearns cannot recover this money because New York law prohibits insurance coverage for disgorgement of improperly obtained funds.

It is well-settled that a party may not insure itself against the risk of having to return money that it has obtained improperly. See, Vigilant Ins Co v Credit Suisse First Boston Corp, 10 AD3d 528 [1st Dept 2004]. This is because "[r]estitution of ill-gotten funds does not constitute 'damages' or a 'loss' as those terms are used in insurance policies." Id, citing Reliance Group Holdings, Inc v National Union Fire Ins Co of Pittsburgh, Pa, 188 AD2d 47, 55 [1st Dept 1993]; Level 3 Communications, Inc v Federal Ins Co, 272 F3d 908, 911 [7th Cir 2001].

Disgorgement is a procedure designed both to deprive a party of ill-gotten gains and to deter improper conduct by making that conduct unprofitable. Vigilant Insurance Company v Credit Suisse First Boston, 600854/02 [NY Sup July 8, 2003], aff'd Vigilant Ins Co v Credit Suisse First Boston Corp, 10 AD3d 528 [1st Dept 2004]; see, SEC v Wang, 944 F2d 80, 85 [2d Cir 1991]; SEC v Tome, 833 F2d 1086, 1096 [2d Cir 1987], cert denied, 486 US 1014 [1988]; SEC v Commonwealth Chem Sec, Inc, 574 F2d 90, 102 [2d Cir 1978]. In general, a party may not recover disgorged funds through insurance because to do so would enable that party to retain the proceeds of its wrongful acts and shift the burden of the loss to its insurer. Vigilant Ins Co v Credit Suisse First Boston Corp, 10 AD3d 528, supra; see, Bank of the West v Superior Court, 2 Cal 4th 1254, 1269 [1992]. Such a result would also eliminate the party's incentive for obeying the law. Bank of the West, supra at 1269.

For example, in Vigilant, supra, this court determined that the plaintiff-insurers were not required to reimburse the defendant for 70 million dollars representing "disgorgement" of funds that the defendant agreed to pay to settle accusations in an underlying SEC and NASDR prosecuted action.

The defendant, Credit Suisse First Boston (CSFB), had been accused of coercing customers into paying a portion of their profits to CSFB from the flipping of CSFB-underwritten IPO[FN4] stock. This court ultimately found that CSFB could not recoup the $70 million disgorgement payment because such a result would defeat the purpose of the disgorgement by [*5]allowing CSFB to recoup the money that it had improperly obtained.

The Appellate Division, First Department, affirmed this court's decision. The court noted that CSFB could not recoup the disgorged money even though the final judgment directing the disgorgement was based on a settlement and not on an adjudication after trial. The First Department also noted, among other things, that the final judgment expressly stated that CSFB had improperly obtained the disgorged money as a result of the conduct alleged in the Complaint and that CSFB had agreed not to contest the allegations of the complaint.

The Insurers argue that the case at hand is analogous to Vigilant. They contend that the disgorgement payment here is uninsurable as a matter of law based on public policy because, to allow Bear Stearns to recover this money through insurance, would enable it to retain money that it had improperly obtained and would eliminate its incentive to obey the law. They further argue that the return of such "ill-gotten funds" does not constitute damages within the meaning of the policies.

Bear Stearns argues that the disgorgement payment does not constitute the return of improperly obtained funds because the Complaint does not identify any specific monies that Bear Stearns improperly obtained. As such, Bear Stearns contends that the $25 million payment is recoverable under the policies.

The court finds that Bear Stearns cannot recover the $25 million payment. First, the payment is specifically labeled "disgorgement," that, as set forth above, is a procedure designed to deprive a party of ill-gotten gains. Moreover, the Final Judgment specifically states that the payment was to be made "[a]s a result of the violations alleged in the Complaint." Thus, it specifically links the disgorged commissions to the wrongful acts set forth in the Complaint. Therefore, it is clear that Bear Stearns was disgorging money that it had obtained as the result of wrongful acts that the Complaint describes. That these acts were not adjudicated at trial does not change the nature of the disgorgement payment, as set forth in Vigilant, supra.

To permit Bear Stearns to recover the $25 million disgorgement payment would allow Bear Stearns to reap the benefit of its improper behavior and defeat the purpose of disgorgement. Moreover, under the circumstances here, as set forth above, the disgorgement of wrongly obtained funds does not constitute damages as set forth in the policies. See, Vigilant Ins Co v Credit Suisse First Boston Corp, 10 AD3d 528 [1st Dept 2004]. Therefore, the court grants this portion of the motion.

5. Investor Education Payments

The Insurers argue that Bear Sterns cannot recover the combined payment of $30 million for independent research and investor education because it is not a "Loss" as the policies define. As set forth above, Loss is: (1) compensatory damages, multiplied damages, punitive damages where insurable by law, judgments, settlements, costs, charges and expenses or other sums the Insured shall legally become obligated to pay as damages resulting from any Claim or Claim(s);(2) costs, charges and expenses or other damages incurred in connection with any investigation by any governmental body or self-regulatory organization (SRO)...[*6]

The Insurers describe the payments for investor education and independent research as "prophylactic" or "forward-looking." The Insurers state that these payments are intended to implement reforms in the industry and heighten investor awareness rather than compensate investors for past injuries. Thus, the Insurers argue that these payments do not constitute damages as set forth in the insurance policies.

The Insurers have not demonstrated that they are entitled to summary judgment on this issue. It is true that the Final Judgment states that the combined $30 million payment was not intended for use as compensation. However, the policy does not set forth a definition of damages or otherwise limit that term to monies paid to compensate past injuries. Thus, the Insurers have not demonstrated the $30 million payment is not covered as a "Loss" as set forth in the policies.[FN5] Accordingly, it is

ORDERED that plaintiffs' motion for summary judgment is granted to the extent that the court declares that Bear Stearns cannot recover the $25 million disgorgement payment through its insurance policies with plaintiffs and it is further

ORDERED that the motion is otherwise denied.

Dated: January 11, 2006ENTER:

_____________________ J.S.C. Footnotes

Footnote 1:Plaintiffs also seek an order dismissing defendant's counterclaims. However, their papers do not specifically address these counterclaims. Therefore, that portion of the motion is denied.

Footnote 2:The excess policies incorporated the terms of the primary policy except to the extent specifically noted in the excess policies.

Footnote 3:The policies provided that Loss would not include fines or penalties imposed by law or certain other items not at issue here.

Footnote 4:Initial Public Offering.

Footnote 5:The Insurers do not address whether the payment would be covered under any of the additional terms set forth in the policies under the definition of "Loss" such as costs, charges, expenses or settlements.