Putting an end to a 12-year-old dispute between J.P. Morgan Securities’ predecessor, Bear Stearns & Co., and several of its insurers, on November 23, 2021, New York’s high court held that J.P. Morgan’s $140 million payment to the Securities and Exchange Commission (SEC) did not constitute an uninsurable “penalty” under J.P. Morgan’s excess directors & officers (D&O) liability policies. This is welcome news for policyholders faced with coverage denials from their insurers based on “public policy,” “fines or penalty,” “disgorgement” or other grounds of alleged uninsurability.
In J.P. Morgan, J.P. Morgan’s $140 million “disgorgement” payment was part of a larger $250 million settlement between J.P. Morgan and the SEC. $90 million of the settlement was specifically allocated to “civil money penalties.” The settlement resolved allegations that Bear Stearns & Co. and other securities broker-dealers facilitated late trading and deceptive market timing practices by their customers in connection with the purchase and sale of mutual funds.
J.P. Morgan’s excess policies covered “loss” that the insured entities became liable to pay as the result of any civil proceeding or governmental investigation alleging wrongful acts constituting violations of laws or regulations. The policies defined “loss” to include various types of compensatory and punitive damages where “insurable by law,” but specifically excluded matters uninsurable as a matter of public policy and “fines or penalties imposed by law.” The insurers argued that the disgorgement payment was uninsurable as a matter of New York law both as form of restitution of ill-gotten gains and as a penalty imposed by law.
After its complaint was dismissed by the intermediate appellate court, then reinstated by New York’s high court (the New York Court of Appeals), J.P. Morgan moved for summary judgment. J.P. Morgan distinguished the type of “disgorgement” held uninsurable under the seminal case on the issue, Level 3 Communications, Inc. v. Federal Insurance Co., 272 F.3d 908, (7th Cir. 2001) and its progeny, from the payment J.P. Morgan paid to the SEC, which represented the “disgorgement” of its customers’ gains – not J.P. Morgan’s own gains – and thus was more compensatory in nature and not an uninsurable “loss” under the policies.
New York’s high court agreed. In its November 23, 2021 order, the New York Court of Appeals held that J.P. Morgan’s $140 million payment was not an uninsurable “penalty” within the meaning of the policies. The court held that the term “penalty” (undefined by the policies) is most commonly understood to mean a monetary sanction sought for purposes of deterrence and punishment rather than to compensate injured parties for their loss: “[T]he word penalty . . . does not apply to actual damages, but, rather, exact sums from a wrongdoer that exceed the injured party’s actual damages.” Moreover, the court held that “where a settlement payment has compensatory purposes [exclusively or in combination with punitive components] and is measured by an injured party’s losses and third-party gains,” the payment will not be deemed a “penalty” under New York law. Because the $140 million settlement payment was based on valuations of J.P. Morgan’s customers’ gains and the corresponding injury suffered by investors as a consequence of the challenged trading practices, the payment served a compensatory goal and did not constitute an uninsurable “penalty” under New York law.
J.P. Morgan marks the latest decision to further narrow the Seventh Circuit’s landmark decision in Level 3 Communications, Inc. v. Federal Insurance Co., 272 F.3d 908 (7th Cir. 2001), employed by insurers to deny coverage under D&O policies for fraudulent conveyances, certain breaches of fiduciary duty, securities-related investigative costs, and other causes of action seeking fines and disgorgement. Insurers routinely categorize such suits as uninsurable without a proper analysis of the nature of the relief sought against the insured. J.P. Morgan highlights that the focus of whether damages settled or awarded by judgment are uninsurable and therefore do not constitute “loss” under a typical D&O policy is whether the amounts paid are tied to the profits – or “ill gotten gains” – the insured received as a result of its wrongful acts. Where an insured is required to pay more than the “net benefit” of its wrongful conduct or where the amount the insured is required to pay includes the profits of others – in each case, amounts never actually received by the insured, or where the measure of the damages awarded is tied to something other than the insured’s ill-gotten gains, the net damages are insurable regardless of whether classified as a fine, penalty, or disgorgement.
J.P. Morgan is the final word on insurability under New York law, but it is not the final word in every jurisdiction. The policy language at issue is commonplace, however, and courts routinely look outside of their own jurisdiction for persuasive authority. Because, whether a loss is “uninsurable” is a fact-intensive inquiry driven by the particular policy language at issue and the applicable law, corporate policyholders faced with a denial from their insurer on uninsurability grounds should be sure to consult an insurance recovery attorney as needed.