Insurance Debate Looms On Investment Banks' Settlement,Lawsuits

By Michael Ha

The regulatory settlement announcementinvolving 10 of the nation's top investment banks and theiragreement to pay $1.4 billion for alleged conflicts of interestbetween their research and investment banking units garnered plentyof business headlines late last month.

But despite this agreement, the issue of the collectibility ofinsurance on the settlement and on other private lawsuits is farfrom being settled between these banks and their insurers. In fact,some industry experts who spoke to National Underwriterpredicted that the debate could go on for years.

The settlement, which involves 10 investment banks in New York,breaks down the $1.4 billion figure into four separate categories:$487.5 million for penalty, $387.5 million for disgorgement, $432.5million for funding independent research, and $80 million to helpinvestor education.

Of these categories, the settlement states that the banks haveagreed not to seek “reimbursement or indemnification” from insurersor tax deductions or tax credits for any penalties. As for othercategories, a spokesperson for the Securities and ExchangeCommission told National Underwriter that it's up to statelaws and the courts to decide, but it's the Commission's beliefthat these are not insurable either, he added.

Still, “these banks will try to make claims, most likely,”argued Robert Hartwig, senior vice president and chief economist atthe Insurance Information Institute in New York. “I expect thatthey will. But they are likely to be hotly contested by theinsurance industry,” Mr. Hartwig said.

If any of the investment banks decide to file insurance claimsfor part of the settlement, the most likely scenario would involvefiling claims under errors and omissions policies. These policieswould come into play for private lawsuits, which some expertsbelieve could be bolstered by the details contained in the SECsettlement announcement, providing a roadmap for lawyersrepresenting investors.

Most of the banks involved in the settlement declined to commenton whether they would pursue this course. But Credit Suisse FirstBoston, which has agreed to pay $200 million under the settlement,said it is currently evaluating this possibility.

“We are continuing to analyze the insurance connection. But wemade no final determination on what, if any, specific claims we maypursue. No decision has yet been made,” JeanMarie McFadden, co-headof corporate communications at Credit Suisse First Boston, toldNational Underwriter.

But if such claims are made, there is likely to be an incrediblepushback from the insurance community, noted one senior manager ata major insurance company, who spoke on condition of anonymity.“There are many reasons why insurance companies are going to feelthat this shouldn't be insurable,” he said.

First, when one looks beyond the four categories specified inthe settlement amount, it really amounts to one big fine orpenalty.

“So I am not sure just because it's being segregated into thosebuckets, that the insurance carriers will necessarily agree withthat assessment.”

Additionally, these are voluntary agreements that these banksentered into, so insurers might not be convinced that this is a“liability,” he said.

It also appears that the agreement had basically been settledlast December, and the insurance community is going to say, “'Hey,this wasn't with our consent,'” he said.

Furthermore, the disgorgement payment is generally viewed asrelated to ill-gotten gains or personal profit type matters, andthese contracts aren't geared to insure those types ofelements.

“Frankly, insurance companies are reading about this in thepapers like everyone else. There are just so many differentelements to this so that, unfortunately, there are probably goingto be some real battles over whether this is insured or not,” thesenior manager predicted.

“The final piece of this would be that some of this behaviorseems so pre-planned and so pervasive, and intentional misconductis never insurable either. There are just a lot of angles here thatthis may very well have to be debated for years to come.”

He also added that the settlement and evidence of allegedmisconduct by these banks–thousands of pages of documents ande-mails issued by regulators–could fuel plaintiffs' attorneys tofile individual private actions against these banks. But this maypose less of a problem than meets the eye, he suggested.

“Frankly, the worse these e-mails look, the more I think you getinto this scheme or pattern of intentional misconduct that mightlead to further reason why it shouldn't be an insurablesituation.”

Mr. Hartwig agreed with that assessment, adding that from theinsurers' perspective, the division between what's actually calledthe penalty category and the rest are “utterly arbitrary.”

“In fact, errors-and-omissions policies are not and have neverbeen intended to fund independent research establishments. And whatbrought these banks to the settlement table to begin with doesn'tfall under the definition of errors and omissions.”

“These were intentional, willful acts, not errors oromissions.”

There are also lots of “smoking guns” in the documents released,Mr. Hartwig noted, that would essentially make the case for a somekind of denial, or at least extreme limitations, for thecompensability under errors-and-omissions policies.

“I understand that there are positions being taken both by thecarriers and investment banking companies,” added Fred T. Isquith,attorney at New York-based Wolf Haldenstein Adler Freeman &Herz LLP. Mr. Isquith as been a co-lead counsel in an“IPO-laddering” lawsuit against more than 300 companies that wentpublic during the tech-boom in late 1990s. The case is stillongoing, with a judge presiding over the case largely denying themotion to dismiss, he noted.

(In general, IPO laddering cases allege wrongdoing in theprocess that lead securities underwriters who handle initial publicofferings to allocate IPO shares to their customers. SeeNU, Nov. 12, 2001, page 10 for more on laddering.)

Mr. Isquith argued that, as for other private lawsuits, thislatest settlement “certainly can't hurt.”

He observed that the settlement and the investigation by the NewYork State Attorney General Elliot Spitzer's office has providedfurther details that could trigger private lawsuits, offering an“enormous amount of credibility” to those charges in the lawsuits.The lawsuits, he said, argue that ordinary investors were investingin what was, in effect, a manipulative and crooked market.

But Mr. Isquith took a cautious approach to the insurance issue,saying that the collectibility of insurance may very well bepolicy-specific, depending on how the coverage is even phrased.

Patrick Watts, assistant vice president of regulations andclaims at the Alliance of American Insurers in Downers Grove, Ill.,also noted, “It's certainly true that some plaintiffs' attorneyswill take their cue from regulatory activities and try to pursueprivate lawsuits.”

But Mr. Watts added that an errors-and-omissions policy is notdesigned to cover intentional, willful activities that some banksmay have been involved in.

“In the technical, legal sense, there are seven or eightelements of fraud. But generally you are talking about somematerially untrue representation being made with intent to deceive,causing damages because of that,” he said.

“Whether this settlement involves that kind of situation or notis open to interpretation,” he said.

Mr. Hartwig of I.I.I. added another argument for insurers,noting that it would be a “horrible precedent and a poor publicpolicy” if these banks are allowed to pass these costs ontoinsurance companies, policyholders and taxpayers.

“If they try to pass it along to insurers, the insurers wouldrecord any payment as an expense, so ultimately, there is anegative impact to the U.S. Treasury and taxpayers.”

“It runs counter to the Internal Revenue Service's intent. It'salso counter to the New York State Attorney General Spitzer'sintent, [which is] not to allow anyone to subsidize the settlementcost,” he said.

Reproduced from National Underwriter Edition, May 19, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.