New York Trial Court Holds that Administrative Orders Do Not Constitute "Final Adjudications"

by K&L Gates LLP

New York Trial Court Holds that Administrative Orders Do Not Constitute “Final Adjudications” For Purposes of Applying Fraud/Dishonesty Exclusion in Professional Liability Policy

A recent New York trial court decision shedding light on the treatment of Administrative Orders for purposes of professional liability insurance coverage should prove of interest to policyholders who are contemplating the settlement of securities claims while simultaneously hoping to maximize their insurance coverage rights. 

On February 28, 2014, in J.P. Morgan Sec. Inc., et al. v. Vigilant Ins. Co., 2014 N.Y. Misc. LEXIS 796, 2014 N.Y. Slip Op 50284(U) (N.Y. Sup. Ct., N.Y. Cnty. Feb. 28, 2014), Justice Charles E. Ramos of the Supreme Court of the State of New York, New York County, dismissed the defendant insurers’ affirmative defense based upon their policies’ fraud/dishonesty exclusion (Dishonest Acts Exclusion) in a dispute in which plaintiffs seek insurance coverage for their monetary settlement of administrative proceedings brought by the Securities and Exchange Commission (SEC) and the New York Stock Exchange (NYSE). The Court held that the SEC Order and NYSE decisions (collectively, “Administrative Orders”) resolving the proceedings were the products of settlements and did not constitute “final adjudications.” Because the insurers’ Dishonest Acts Exclusion applies only upon a final adjudication of dishonest conduct, the Court determined that the affirmative defense necessarily fails and granted partial summary judgment dismissing it. 

Plaintiffs are successors to various Bear, Stearns & Co., Inc. entities (Bear Stearns). The SEC investigated Bear Stearns in connection with Bear Stearns’ allegedly facilitating late trading and deceptive market timing on behalf of certain customers in connection with the purchase and sale of shares in mutual funds. During the course of the SEC’s investigation, it notified Bear Stearns of its intention to commence a civil proceeding against Bear Stearns.

Bear Stearns disputed the SEC’s allegations but negotiated a settlement, which the SEC memorialized in its Order. Pursuant to the SEC Order, “solely for the purpose of these proceedings,” and “without admitting or denying the findings,” Bears Stearns agreed to pay US$160 million labeled as “disgorgement” and US$90 million as a civil penalty. In addition, the NYSE issued two decisions pursuant to which it imposed a disgorgement and penalty payment identical to that imposed by the SEC, which was deemed satisfied by Bear Stearns’ payment to the SEC. Bear Stearns sought coverage from the defendant insurers under professional liability policies for the amount of the monetary settlement. 

The Dishonest Acts Exclusion in the relevant policies bars coverage for claims arising out of any “deliberate, dishonest, fraudulent or criminal act or omission,” but only if a “judgment or other final adjudication thereof” adverse to the insured(s) establishes that such insured was “guilty” of the excluded conduct. After the insurers disclaimed coverage, Bear Stearns commenced a coverage action. Bear Stearns eventually moved for summary judgment dismissing certain of the Insurers’ affirmative defenses on the ground that the Dishonest Acts Exclusion did not apply because the Administrative Orders were settlements and not judgments or other final adjudications of the underlying claims.

The Court agreed with Bear Stearns. After noting that exclusions must be narrowly constructed, the Court determined that “the settlements embodied in the Administrative Orders were not final adjudications or judgments establishing Bear Stearns’ guilt in the underlying proceedings that it engaged in the wrongful conduct covered by the Dishonest Acts Exclusion.” Although the Administrative Orders contained factual findings, those findings “were neither admitted or denied except as to the SEC’s jurisdiction and the subject matter of the proceedings, and were not the subject of hearings or rulings on the merits by a trier of fact.” The Court concluded that “to infer, as the Insurers urge, that the term ‘final adjudication’ encompasses settlement of an administrative order, is to expand its reasonable interpretation beyond what is permitted under New York law.” 

In addition, the Court dismissed the insurers’ affirmative defense that New York public policy bars Bear Stearns’ claims because the Administrative Orders establish that Bear Stearns acted with the intent to injure mutual fund investors. The Court applied the same reasoning, rejecting the public policy affirmative defense because, pursuant to the policies, the insurers must cover claims arising out of deliberate, dishonest, fraudulent or criminal conduct unless there is a final adjudication of guilt in the underlying proceedings. The Court concluded that since “the Administrative Orders do not trigger the Dishonest Acts Exclusion, the insurers cannot now be permitted to rewrite this contractual language out of the Policies.”

J.P. Morgan Sec. Inc. provides guidance as to how New York courts will treat Administrative Orders embodying settlements with administrative and regulatory entities such as the SEC or NYSE for purposes of insurance coverage. Although application in any particular case may be fact-sensitive, this decision indicates that policyholders who have resolved, or seek to resolve, administrative investigations and/or related claims under policies governed by New York law should understand these rules to assess how to maximize their insurance recovery.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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