Insurance Debate Looms On Investment Banks' Settlement, Lawsuits

By Michael Ha

The regulatory settlement announcement involving 10 of the nation's top investment banks and their agreement to pay $1.4 billion for alleged conflicts of interest between their research and investment banking units garnered plenty of business headlines late last month.

But despite this agreement, the issue of the collectibility of insurance on the settlement and on other private lawsuits is far from being settled between these banks and their insurers. In fact, some industry experts who spoke to National Underwriter predicted 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, $432.5 million for funding independent research, and $80 million to help investor education.

Of these categories, the settlement states that the banks have agreed not to seek “reimbursement or indemnification” from insurers or tax deductions or tax credits for any penalties. As for other categories, a spokesperson for the Securities and Exchange Commission told National Underwriter that it's up to state laws and the courts to decide, but it's the Commission's belief that 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 at the Insurance Information Institute in New York. “I expect that they will. But they are likely to be hotly contested by the insurance industry,” Mr. Hartwig said.

If any of the investment banks decide to file insurance claims for part of the settlement, the most likely scenario would involve filing claims under errors and omissions policies. These policies would come into play for private lawsuits, which some experts believe could be bolstered by the details contained in the SEC settlement announcement, providing a roadmap for lawyers representing investors.

Most of the banks involved in the settlement declined to comment on whether they would pursue this course. But Credit Suisse First Boston, 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 we made no final determination on what, if any, specific claims we may pursue. No decision has yet been made,” JeanMarie McFadden, co-head of corporate communications at Credit Suisse First Boston, told National Underwriter.

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

First, when one looks beyond the four categories specified in the settlement amount, it really amounts to one big fine or penalty.

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

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

It also appears that the agreement had basically been settled last 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 as related to ill-gotten gains or personal profit type matters, and these contracts aren't geared to insure those types of elements.

“Frankly, insurance companies are reading about this in the papers like everyone else. There are just so many different elements to this so that, unfortunately, there are probably going to be some real battles over whether this is insured or not,” the senior manager predicted.

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

He also added that the settlement and evidence of alleged misconduct by these banks–thousands of pages of documents and e-mails issued by regulators–could fuel plaintiffs' attorneys to file individual private actions against these banks. But this may pose less of a problem than meets the eye, he suggested.

“Frankly, the worse these e-mails look, the more I think you get into this scheme or pattern of intentional misconduct that might lead to further reason why it shouldn't be an insurable situation.”

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

“In fact, errors-and-omissions policies are not and have never been intended to fund independent research establishments. And what brought these banks to the settlement table to begin with doesn't fall under the definition of errors and omissions.”

“These were intentional, willful acts, not errors or omissions.”

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

“I understand that there are positions being taken both by the carriers 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 went public during the tech-boom in late 1990s. The case is still ongoing, with a judge presiding over the case largely denying the motion to dismiss, he noted.

(In general, IPO laddering cases allege wrongdoing in the process that lead securities underwriters who handle initial public offerings to allocate IPO shares to their customers. See NU, Nov. 12, 2001, page 10 for more on laddering.)

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

He observed that the settlement and the investigation by the New York State Attorney General Elliot Spitzer's office has provided further 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 investing in 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 be policy-specific, depending on how the coverage is even phrased.

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

But Mr. Watts added that an errors-and-omissions policy is not designed to cover intentional, willful activities that some banks may have been involved in.

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

“Whether this settlement involves that kind of situation or not is 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 public policy” if these banks are allowed to pass these costs onto insurance companies, policyholders and taxpayers.

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

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

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

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Insurance Debate Looms On Investment Banks' Settlement, Lawsuits

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