Repayment Of Alleged Ill-Gotten Gains Not Covered ByE&O Policy: N.Y. Court

Insurers could mark this as a victory that could impact otherpotential disputes against Wall Street investment banks.

On July 16, a New York state court ruled against Credit SuisseFirst Boston, stating that the investment banking firm cannot usean errors and omissions policy from Vigilant Insurance Company, aunit of Chubb Corp., to cover its $70 million disgorgement paymentin a regulatory settlement.

And this ruling–the first of its kind related to regulatorysettlements for investment banks and their alleged misconductduring the dot-com boom–could be “precedent-setting” for othersimilar cases, according to Joseph Finnerty III from New York-basedlaw firm Piper Rudnick LLP. Mr. Finnerty is the lead defenseattorney for Warren, N.J.-based Chubb.

CSFB declined to comment on whether it will appeal the decision,but Victoria Harmon, the company spokesperson, said it is“reviewing the court's judgment and will be evaluating the bestcourse of action for shareholders.”

This lawsuit, filed last summer and submitted to the court thispast January, involves the $100 million settlement reached betweenCSFB and financial regulators last year. CSFB had agreed to thearrangement last year after the Securities and Exchange Commissionand National Association of Securities Dealers accused theinvestment bank of abusive practices on initial publicofferings.

“In January 2002, the SEC and NASD accused CSFB of coercingcustomers into paying a portion of their profits to CSFB fromflipping CSFB-underwritten IPO stock,” Karla Moskowitz, the NewYork County Supreme Court justice, wrote in her decision.(“Flipping” refers to investors selling their purchased shares in ahot IPO in the immediate aftermarket to realize a quickprofit.)

Justice Moskowitz further noted, “SEC alleged that from at leastApril 1999 through June 2000, CSFB employees allocated shares ofIPOs to over 100 customers who were willing to funnel between 33and 66 percent of their profits to CSFB.”

These profits were passed on to the bank through excessivelyhigh commissions on unrelated stock sales from investors–a methodalso referred to as IPO “tie-in/laddering” practices. Regulatorscontend that customers funneled “tens of millions of dollars inprofits” back to the bank this way, Judge Moskowitz noted.

But in its defense, CSFB said in its court argument that denyingthe coverage would make this E&O policy “illusory” and woulddeprive the company of coverage “for which it paid millions ofdollars in premiums.” The investment bank also argued that sincethere was no verdict on its alleged misconduct, allowing coveragedoes not represent a wrongful benefit.

“In this lawsuit, the court is asked to decide whether insurancecompanies should reimburse CSFB for $70 million representing'disgorgement' that it agreed to pay to settle these accusations,”Justice Moskowitz said. “I agree with the insurer that CSFB is notcovered for the settlement amount,” she concluded.

Commenting on the decision, Mr. Finnerty explained that “CSFBhas sought coverage for $70 million out of the $100 million that ithas since paid in the settlement with the NASD and the SEC.” Theissue before the court, he added, was whether the $70 millionportion–which was noted in the settlement as disgorgement of moniesthat CSFB was accused of improperly obtaining–is covered underliability policies.

“And Justice Moskowitz decided, after the briefing and argument,that, indeed, the disgorgement payment was not something that iscovered, as a matter of public policy,” Mr. Finnerty said. “Thepublic policy is that, under the New York law, it would negate theremedial effect of the settlement if the party that had to giveback the disgorged money is repaid by an insurance company.”

Mr. Finnerty noted that from Chubb's perspective, this decisionclearly resolves the issue of whether or not the payment made intothe settlement is covered by an E&O policy. He added: “Thepolicy that is implicated here is an errors and omissions policyissued to the investment bank. But the precedent on disgorgementcould apply regardless of the type of liability insurance.”

He also predicted this verdict could potentially influence othersettlements. In particular, he pointed out investment banksinvolved in a $1.4 billion regulatory settlement for allegedconflicts of interest between their research and investment bankingunits.

This settlement, announced this past April, involves 10 leadinginvestment banks in New York and breaks down the $1.4 billionfigure into four separate categories: $487.5 million for penalty,$387.5 million for disgorgement, $432.5 million for fundingindependent research, and $80 million to help investoreducation.

And while these banks–which also include CSFB–have agreed not toseek “reimbursement or indemnification” from insurers or taxdeductions or tax credits for any penalties, some have left openthe possibility that they may seek insurance coverage in othercategories.

JeanMarie McFadden, co-head of corporate communications at CSFB,which agreed to pay $200 million under this settlement, had toldNational Underwriter, “We are continuing to analyze theinsurance connection. But we made no final determination on what,if any, specific claims we may pursue. No decision has yet beenmade.”

But Mr. Finnerty forecast that if any of the banks in thesettlement chooses to pursue coverage from liability policies,“this Chubb decision will have a negative impact on those effortsto obtain insurance coverage.”

“It will now be up to CSFB to determine whether or not it willchoose to appeal this decision,” he said.

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, July 28, 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.