An intermediate New York State appellate court held late last year that there was a question of fact whether a component of an SEC settlement that was specifically labeled “disgorgement” actually constituted the kind of disgorgement that courts deem uninsurable as a matter of public policy.  On June 19, 2007, the court, recognizing the significance of the legal issues presented, certified an appeal to the New York Court of Appeals and granted the SEC’s motion to file an amicus curiae brief in connection with this appeal.

Brief Recap of Vigilant Ins. Co. v. Bear Stearns.

In April 2002, the SEC began investigating whether Bear Stearns’ research analysts were subject to conflicts of interest between producing objective research and supporting Bear Stearns’ investment banking unit.  Bear Stearns subsequently settled with the SEC and, in connection with this settlement, agreed to pay the following amounts:  $25 million “as disgorgement of commissions and other monies;” $25 million as a penalty; $25 million to provide its clients with independent research; and $5 million to be used for investor education.

Bear Stearns’ insurers denied coverage for the settlement based on various coverage issues and commenced a declaratory judgment action in the Supreme Court for New York County.  With respect to coverage for the $25 million “disgorgement” payment, the trial court granted summary judgment in favor of the insurers, holding that “a party may not recover disgorged funds through insurance because to do so would enable that party to retain the proceeds of its wrongful acts and shift the burden of the loss to the insurer.”

Bear Stearns appealed to the Appellate Division, which reversed the trial court’s grant of summary judgment in connection with the disgorgement issue.  Vigilant Ins. Co. et al. v. The Bear Stearns Cos., Inc., 34 A.D.3d 300 (1st Dep’t 2006).  With little discussion, the Appellate Division held that there was “an issue of fact as to whether the portion of the settlement attributed to disgorgement actually represented ill-gotten gains or improperly acquired funds,” and found significant that “the settlement amount was based on market share instead of being tied to the amount of commissions or fees it received.”