New York’s Highest Court Sides With Insured: $140M Disgorgement Payment Is Covered Loss

December 13, 2021

On Nov. 23, 2021, the New York Court of Appeals sided with the policyholder, resolving a decades-long insurance coverage dispute, J.P. Morgan Sec. Inc. v. Vigilant Ins. Co., __ N.E.3d __, 2021 N.Y. Slip Op. 06528, 2021 WL 5492781 (Nov. 23, 2021). It held that a $140 million disgorgement payment to the Securities and Exchange Commission (SEC) was a covered “loss” rather than an uninsurable “penalt[y]” under the error and omissions/professional liability policies at issue.

The 6-1 majority opinion is a landmark decision on the insurability of disgorgement and restitution damages that will likely have ramifications for policyholders seeking to recover similar losses from their insurers in disputes in New York and throughout the country.


Beginning in 2003, the SEC accused Bear Stearns, the predecessor in interest to JP Morgan Securities Inc., of facilitating late trading and deceptive market timing practices[1] by its customers in connection with the purchase and sale of shares of mutual funds. Following an investigation, the parties reached a settlement pursuant to which Bear Stearns did not admit or deny any misconduct, but paid the SEC a $160 million “disgorgement” and $90 million for “civil money penalties” placed in a fund to compensate mutual fund investors allegedly harmed by the improper trading practices. 

Bear Stearns sought insurance coverage for the $140 million disgorgement payment, but the insurers denied coverage based primarily on the assertion that such damages were “penalties imposed by law” and therefore excluded under the policies. Consequently, Bear Stearns commenced suit against the insurers in 2009, seeking coverage for the disgorgement payment, among other relief. After years of motion practice, which included a dismissal and reinstatement of the complaint by the Court of Appeals in 2013, Bear Stearns moved for summary judgment on the insurers’ various coverage defenses and sought an order establishing that the $140 million payment represented disgorgement of its clients’ gains, as compared with Bear Stearns’ own revenue, and therefore was a covered and insurable “loss” under the policies. The insurers opposed the motion and cross-moved for summary judgment, contending that the $140 million payment did not represent client gains and relying on various policy exclusions and public policy-based arguments.

The Supreme Court, New York’s trial court, denied the insurers’ cross-motions and granted summary judgment to Bear Stearns, concluding that the disgorgement of $140 million in client gains constituted an insurable loss. Following an appeal by the insurers, the Appellate Division reversed and granted summary judgment in favor of the insurers, declaring that Bear Stearns was not entitled to coverage for the SEC disgorgement payment. Bear Stearns in turn appealed the decision to the Court of Appeals — New York’s highest court.

New York Court of Appeals Decision

The Court of Appeals majority overturned the Appellate Division’s ruling and agreed with policyholder Bear Stearns that the $140 million SEC-ordered disgorgement settlement payment was covered “loss.” The policies defined loss to include compensatory and punitive damages to the extent insurable by law but carved out “fines or penalties imposed by law” from the definition of “loss.” Thus, the $140 million question at issue on appeal was whether the disgorgement damages Bear Stearns paid to the SEC was a “penalt[y] imposed by law.”

In reaching its decision, the Court of Appeals relied on principles of insurance policy construction, including the rule that insurance policies must be interpreted in accordance with the policyholder’s reasonable expectations of coverage at the time of contracting, and that exclusionary clauses (such as the loss exclusion relied on by the insurers) must be construed narrowly in favor of coverage. Applying these rules of construction, the court determined that the insurers failed to prove that a reasonable insured in 2000 (when the policies were issued) would have understood the key phrase “penalties imposed by law” to preclude coverage for the $140 million SEC disgorgement payment. According to the majority, the SEC’s primary enforcement remedies in 2000 were injunctive relief, disgorgement, and monetary penalties. The majority pointed out that the policies were issued “to cover liability arising from ‘wrongful acts’ relating to Bear Stearns’ business as a securities broker and dealer subject to regulatory oversight by the SEC, and the policies expressly covered settlements and other sums related to investigations by a governmental regulator.”

Although the policies did not define the term “penalty,” the majority determined that, based on related statutory and legal definitions and its dictionary definition, the term “is commonly understood to reference 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.” Stated another way, “a penalty is distinct from a compensatory remedy and a penalty is not measured by the losses caused by the wrongdoing.” As such, “at the time the parties contracted [in 2000], a reasonable insured would likewise have understood the term ‘penalty’ to refer to non-compensatory, purely punitive monetary sanctions.”

The Court then held that Bear Stearns sufficiently demonstrated, without any material question of fact, that the $140 million disgorgement payment was a compensatory sanction “calculated based on wrongfully obtained profits as a measure of the harm or damages caused by the alleged wrongdoing that Bear Stearns was accused of facilitating.” In so holding, the majority relied on settlement communications between Bear Stearns and the SEC and corroborating testimonial and documentary evidence showing that the $140 million disgorgement amount Bear Stearns paid was calculated at the SEC’s direction based on valuations of customer gains and the resulting investor loss caused by the challenged trading practices. The $90 million payment, on the other hand, “was not derived from any estimate of harm or gain flowing from the improper trading practices.” In holding that “the $140 million payment served a compensatory goal,” the majority also pointed to the $90 million payment which, by contrast, was expressly treated as a penalty for tax purposes and could not be used to offset any private claims against Bear Stearns. The majority also considered evidence showing that, during the negotiations between Bear Stearns and the SEC, “it was contemplated that Bear Stearns would not seek insurance coverage for the civil penalty, presumably to prevent Bear Stearns from avoiding that aspect of the settlement that was designed purely to punish Bear Stearns’ wrongdoing.”

The Court ultimately held: “Inasmuch as it was derived from estimates of the ill-gotten gains and harm flowing from the improper trading practices, and was intended — at least in part — to compensate those injured by the wrongdoing allegedly facilitated by Bear Stearns, the $140 million disgorgement payment could not fairly have been understood as a ‘penalty’ in the context of this wrongful act professional liability insurance policy.”

The Court also found that evidence showing the SEC originally sought a higher sanction but then negotiated the settlement amounts “as representative of third-party gains/injured investor losses ($140 million) and Bear Stearns’ own revenues (approximately $20 million)” supported Bear Stearns’ position as to the nature of the disgorgement payment. Moreover, an SEC press release referring to a settlement requiring Bear Stearns to disgorge its own gains did not raise a material question of fact because Bear Stearns had conceded that it did disgorge approximately $20 million of its own revenue as part of the settlement.

The Court of Appeals also was not persuaded by the Appellate Division’s reliance on the U.S. Supreme Court’s holding in Kokesh v. SEC, 137 S. Ct. 1635, 1639 (2017), which found an SEC-ordered disgorgement to be a penalty. The majority did not consider Kokesh to be controlling because it did not interpret what a “penalty” was in the insurance contract context and noted that the “Supreme Court has since clarified that SEC-ordered disgorgement is not always properly characterized as a penalty insofar as the SEC may seek ‘disgorgement’ of a defendant’s net gain for compensatory purposes as ‘equitable relief’ in civil actions.”

Key Takeaways

One important lesson from the New York Court of Appeals’ J.P. Morgan decision for policyholders is that “neither the label assigned to the payment . . ., nor the mere fact that injured parties may ultimately receive the funds, is dispositive” of whether a disgorgement constitutes a “penalty,” and instead that “such factors must be taken together with the fact that the payment effectively constituted a measure of the investors’ losses.” In essence, the J.P. Morgan decision reaffirms that labels mean little when it comes to determining what is and isn’t a “penalty” under an insurance policy, and insureds should push back on insurers withholding coverage on that basis and instead assess the intended underlying purpose of the payments.

Notably, this decision is also a reminder that a large majority of jurisdictions have not adopted a common law or statutory rule that disgorgement or restitution damages are uninsurable as a matter of law. Insurers seeking to avoid or limit their coverage liability often cite Level 3 Communications v. Federal Ins. Co., 272 F. 3d 908 (7th Cir. 2001), for the blanket assertion that such losses are uninsurable and would provide a “windfall” to the policyholder.

However, some courts have rejected the Level 3 holding. See, e.g., Cohen v. Lovitt & Touche, Inc., 233 Ariz. 45, 49, 308 P.3d 1196, 1200 (Ct. App. 2013) (holding “we cannot harmonize the categorical preclusion of insurance for restitutionary losses, compelled by Level 3 and its progeny, with our state’s own approach mandating an exacting analysis of the impact of public policy on the enforceability of specific contractual agreements”). Other courts have distinguished Level 3 and held that the there is no categorical bar for the recovery of disgorgement or restitution damages, and that the question of whether such damages are uninsurable will depend on the law and public policy of each jurisdiction. See e.g., William Beaumont Hosp. v. Fed. Ins. Co., 552 F. App’x 494, 501 (6th Cir. 2014) (“As the district court noted, Federal has not identified any cases in the Sixth Circuit holding that disgorgement is not insurable. It still has yet to do so, relying only on cases not on point because they deal with intentional tortious or criminal act.”); Greater Cmty. Bancshares, Inc. v. Fed. Ins. Co., No. 4:14-CV-0266-HLM, 2015 WL 10714012, at *9 (N.D. Ga. Feb. 9, 2015), aff’d, 620 F. App’x 817 (11th Cir. 2015) (noting the “absence of controlling legal authority” for “the proposition that amounts paid by an insured amounting to restitution are uninsurable under Georgia law”).

As the J.P. Morgan decision makes clear, the question of whether disgorgement or restitution damages are covered will depend on the specific language of policy and the facts at issue. Therefore, policyholders should always look carefully at the definition of loss in their own policies and the controlling law of the applicable jurisdiction before drawing any conclusions about whether a loss is covered.

Moreover, the Court of Appeals’ decision in J.P. Morgan reaffirms fundamental rules of construction of insurance policies favoring policyholders in New York, a state that is often considered a pro-insurer jurisdiction. Specifically, the opinion makes one thing very certain — it is the reasonable expectations of the insured at the time of purchasing the policy that primarily govern the interpretation of policy exclusions. Indeed, the Court of Appeals specifically acknowledged that, were it “to now conclude that payments of that nature constitute an excluded penalty, indemnity for loss arising from otherwise covered governmental investigations would be substantially curtailed in a manner arguably inconsistent with an average insured’s reasonable expectations.”

[1] As the Court of Appeals explained: “Late trading is the practice of placing orders to buy, redeem or exchange mutual fund shares after the 4:00 p.m. close of trading, but receiving the price based on the net asset value set at the close of trading, which practice allows traders to obtain improper profits by using information obtained after the close of trading Market timing is the practice of frequent buying and selling of shares of the same mutual fund or the buying or selling of mutual fund shares to exploit inefficiencies in mutual fund pricing; although this is not per se improper, it can be deceptive if it induces a mutual fund to accept trades it otherwise would not accept under its own market timing policies.” (internal citations omitted).