NY-First Department Holds $286 Million SEC Disgorgement Is Not Covered

In J.P. Morgan Sec., Inc. v Vigilant Ins. Co., the First Department held that the insurers of Bear Stearns were not required to pay for the $140 million disgorgement fine, and additional $146 million in statutory interest, resulting from the bank’s settlement with the SEC for improper profits acquired by third-party hedge fund customers.  The ruling represents the latest chapter in the costly, decade-old litigation between J.P. Morgan (into which Bear Stearns in 2008) and Bear Stearns’ insurers.

As background, in 2006, Bear Stearns paid out almost $215 million to the SEC as part of a settlement after the SEC brought proceedings for various trading violations.  Of the $215 million, $160 million was labeled a “disgorgement” and $90 million was labeled a “penalty.”  Bear Stearns’s insurance policies, which covered a “Loss,” provided that “Loss shall not include … fines or penalties imposed by law.”  When Bear Stearns sought reimbursement for $140 million of the $160 disgorgement from its insurers, the insurers disclaimed coverage on the basis that the $160 million payment was labeled “disgorgement”, and thus it did not represent a covered loss under the insurance policies.  In 2013, the New York Court of Appeals held that Bear Stearns was entitled to coverage, as the public policy rule against insuring “ill-gotten gains” “should apply only where the insured requests coverage for the disgorgement of its own illicit gains,” and that “the documentary evidence does not decisively repudiate Bear Stearns’ allegation that the SEC disgorgement payment amount was calculated in large measure on the profits of others. 21 N.Y.3d 324, 336.  Thus, because the disgorgement represented the gains of others, the public policy rationale was inapplicable.  On remand, the trial court granted summary judgment for J.P. Morgan, which included over $146 million of statutory interest, bringing the total amount to approximately $286 million.

In the present case, the First Department reversed the trial court in light of the United States Supreme Court’s 2017 decision in Kokesh v. Securities and Exchange Commission, 137 S.Ct. 1635 (2017).  Kokesh involved the application of a federal statute of limitations to any action for the “enforcement of any civil fine, penalty, or forfeiture.”  The Supreme Court held that SEC disgorgement was explicitly a penalty, and therefore the statute of limitations did not apply.  The First Department held that the Supreme Court’s “rationale at the nature of disgorgement … applies with equal force to the issue of whether the disgorgement … even if representing third-party gains, was a ‘Loss’ within the meaning of the policy.”  Because Kokesh established that disgorgement “punishes a public wrong, and its purpose is deterrence,” it was a penalty and not covered under the policy.

Given the amount at stake and significance of the claim, it is likely that the Court of Appeals will have a second crack this case.  On appeal, however, the argument will not focus on public policy rationales, as it had previously.  Rather, J.P. Morgan will attempt to argue that the Supreme Court’s holding in Kokesh is limited to its application to statutes of limitation, and should not be expanded to encompass language in an insurance policy.

Thanks to Douglas Giombarrese for his contribution to this post.