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Vol. 11 - Issue 1

January 3, 2022


Massive Disgorgement Settlement Not An Excluded Fine Or Penalty
J.P. Morgan Securities Inc. v. Vigilant Insurance Co., 2021 N.Y. LEXIS 2519 (N.Y. Nov. 23, 2021)


I went back and forth on whether to include the New York Court of Appeals decision in J.P. Morgan Securities Inc. v. Vigilant Insurance Co. as a Top 10 coverage case of 2021.  The issue is certainly significant – coverage for disgorgement, which has gotten a fair amount of attention lately.  But I felt that the case is fact-driven, minimizing the extent to which it could affect cases nationally.        

However, coming from the New York high court, the significance of the issue and the likely ability of some lawyers to still find it applicable or relevant to other cases, put it over the top.  Not to mention that disgorgement claims, like this one, sometimes have huge amounts of money at stake. 

At issue was coverage for Bear Stearns, for a 2006 settlement that the investment company reached with the SEC, on account of allegations that the firm facilitated late trading and deceptive market timing practices in connection with the purchase and sale of mutual funds.  Facing a threat from the SEC, to commence a civil action and seek $720 million in monetary sanctions, Bear Stearns settled with the government, agreeing to make a $160 million “disgorgement” payment and $90 million payment for “civil monetary penalties.”

The court described the characterization of the settlement as follows: “Both payments were to be deposited in a ‘Fair Fund’ to compensate mutual fund investors allegedly harmed by the improper trading practices (see 15 USC § 7246). Further, ‘[t]o preserve the deterrent effect of the civil penalty,’ the settlement order directed that the $90 million payment—but not the disgorgement payment—was ineligible to offset any sums owed by Bear Stearns to private litigants injured by the trading practices. Bear Stearns was also required to treat the $90 million payment as a penalty for tax purposes.”

Seeking recovery, successors to Bear Stearns turned to numerous insurers’ policies that provided coverage for the company’s “wrongful acts” if there was a “loss,” defined as various types of damages, including compensatory and punitive damages, but not if the settlement qualified as “fines or penalties imposed by law.” 

Coverage litigation ensued.  Following a very long and winding road, the issue that made its way to the New York Court of Appeals was whether the settlement was a “loss.”  It would not be if it qualified as “fines or penalties imposed by law.”

Bears Stearns argued that $140 million of the disgorgement settlement was a covered “loss,” i.e., not a penalty, as it represented disgorgement of its client’s gains and not Bear Stearns’s own revenue.

At the outset, the court made the point that, “under relevant New York law, penalties have consistently been distinguished from compensatory remedies, damages, and payments otherwise measured through the harm caused by wrongdoing.”  The court described a “penalty” as a “monetary sanction designed to address a public wrong that is sought for purposes of deterrence and punishment rather than to compensate injured parties for their loss.”

Against this backdrop, the court concluded that $140 million of the settlement was compensatory, and, hence, not a penalty.  Therefore, it qualified as a “loss.”  The court’s reasons were several, but, principally, the settlement was measured by the firm’s clients’ ill-gotten gains and investor losses.  In other words, its purpose was to compensate parties injured by the wrongdoing facilitated by Bear Stearns.

A lengthy dissent, much longer than the majority opinion, saw it differently for several reasons, including: “While disgorgement of the wrongdoer’s own profits returns them to their pre-violation status, exaction of another party’s ill-gotten gains puts the wrongdoer in a worse position, as they must pay the proceeds wrongfully earned by someone else.  Whatever doubts the majority may invent as to the penal nature of the former, the latter is a quintessential penalty that maximizes deterrence. Put another way, it is one thing to risk the consequences of one’s own illegality and loss of personal gain and quite another to gamble on paying the additional price of another’s fraudulently earned profits.”        

As I said at the top, I went back and forth on whether to include J.P. Morgan Securities Inc. v. Vigilant Insurance Co. as a Top 10 coverage case of 2021.  As it does not involve the typical scenario -- disgorgement of the wrongdoer’s own profits – it may be too fact-driven to have affect on many cases nationally.  But, as also noted above, a case could be made for it to get the nod.           

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