J.P. Morgan Securities Inc., et al., Appellants,v.Vigilant Insurance Company, et al., Respondents.BriefN.Y.May 1, 2013To Be Argued By: JOHN H. GROSS Time Requested: 20 minutes New York County Clerk’s Index No. 600979/09 Court of Appeals STATE OF NEW YORK J.P. MORGAN SECURITIES INC., J.P. MORGAN CLEARING CORP., and THE BEAR STEARNS COMPANIES LLC, Plaintiffs-Appellants, -against- VIGILANT INSURANCE COMPANY, THE TRAVELERS INDEMNITY COMPANY, FEDERAL INSURANCE COMPANY, NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA., LIBERTY MUTUAL INSURANCE COMPANY, CERTAIN UNDERWRITERS AT LLOYD’S, LONDON, and AMERICAN ALTERNATIVE INSURANCE CORPORATION, Defendants-Respondents. BRIEF FOR PLAINTIFFS-APPELLANTS JOHN H. GROSS, ESQ. PROSKAUER ROSE LLP Eleven Times Square New York, New York 10036-8299 Telephone: (212) 969-3000 Facsimile: (212) 969-2900 Attorneys for Plaintiffs-Appellants J.P. Morgan Securities Inc., J.P. Morgan Clearing Corp. and The Bear Stearns Companies LLC Dated: August 27, 2012 Of Counsel: STEVEN E. OBUS SETH B. SCHAFLER FRANCIS D. LANDREY MATTHEW J. MORRIS DISCLOSURE PURSUANT TO 22 NYCRR 500.1(F) J.P. Morgan Securities Inc., J.P. Morgan Clearing Corp., and the Bear Stearns Companies LLC have no parents other than JPMorgan Chase & Co., which owns stock in each of them. They each have no subsidiaries, and no affiliates other than one another and JPMorgan Chase Bank, N.A. i TABLE OF CONTENTS Page JURISDICTIONAL STATEMENT ..........................................................................1 STATEMENT OF THE QUESTIONS PRESENTED FOR REVIEW ....................1 PRELIMINARY STATEMENT ...............................................................................4 STATEMENT OF FACTS ......................................................................................10 PROCEEDINGS IN THE COURTS BELOW........................................................19 ARGUMENT ...........................................................................................................23 I. BEAR STEARNS INCURRED A COVERED LOSS, AND NEITHER RECEIVED ILL-GOTTEN GAINS NOR WAS UNJUSTLY ENRICHED .............................................................................23 A. Bear Stearns Incurred a “Loss” as Defined in the Policy ...................23 B. Bear Stearns Is Not Seeking Coverage for Ill-Gotten Gains It Was Required to Relinquish................................................................25 1. Coverage for Payments of Ill-Gotten Gains Is Barred to Prevent Unjust Enrichment, but No Such Bar Applies When the Insured Has Not Been Unjustly Enriched ................26 2. Bear Stearns Was Not Unjustly Enriched.................................30 II. THE APPELLATE DIVISION CONTRAVENED NEW YORK PUBLIC POLICY WHEN IT HELD THAT COVERAGE FOR BEAR STEARNS’ LOSS SHOULD BE NULLIFIED, WHETHER OR NOT THE LOSS CONSTITUTED THE RETURN OF BEAR STEARNS’ OWN ILL-GOTTEN GAIN, TO PRESERVE THE DETERRENT EFFECT OF THE SEC’S DISGORGEMENT ACTION........................................................................................................33 A. New York Public Policy Strongly Supports the Enforcement of Contractual Obligations As Written....................................................34 B. The Only Remedy for Which New York Public Policy Nullifies Coverage Is Punitive Damages, Which Are Uninsurable ii Because They Punish Wrongful Conduct and Have No Compensatory Purpose........................................................................39 C. New York Law Permits Indemnification for the SEC Disgorgement Payment in This Case ..................................................42 1. The Payment Bear Stearns Made Was Not a Punitive Measure.....................................................................................43 2. The SEC Did Not Bar Indemnification, and There Is No Reason for New York to Adopt a Different Policy ..................46 III. THE APPELLATE DIVISION ERRONEOUSLY ASSUMED THAT BEAR STEARNS ENGAGED IN WRONGFUL CONDUCT WARRANTING THE NULLIFICATION OF ITS INSURANCE COVERAGE .................................................................................................47 A. There Are Extensive Facts in the Record Rebutting Any Inference That Bear Stearns Intended to Harm Investors ...................48 1. The Documentary Evidence Is Not Remotely Sufficient to Support the Dismissal of Bear Stearns’ Claim .....................48 2. Nullifying Coverage Based on the SEC’s Findings Is Contrary to the Terms of the SEC Order and the Terms of the Insurance Policy..................................................................50 3. By Nullifying the Provisions of the SEC Order and the Insurers’ Policies, the Appellate Division Undermined the Public Policy in Support of Settlements .............................55 B. The SEC’s Disgorgement Award Was Not Based on Allegations, Much Less an Adjudication, That Bear Stearns Acted with an Intent to Harm..............................................................57 CONCLUSION........................................................................................................65 iii TABLE OF AUTHORITIES Page(s) CASES 511 W. 232nd Owners Corp. v. Jennifer Realty Co., 98 N.Y.2d 144 (2002) .......................................................................23, 32, 48, 50 AG Capital Funding Partners, L.P. v. State St. Bank & Trust Co., 5 N.Y.3d 582 (2005) ...........................................................................................23 Allstate Insurance Co. v. Mugavero, 79 N.Y.2d 153 (1992) ...................................................................................57, 59 Bank of Am. Corp. v . S.R. Int’l Bus. Ins. Co., SE, 2007 WL 4480057 (N.C. Super. Ct. Dec. 19, 2007) ..........................................28 Bank of the West v. Superior Ct., 833 P.2d 545 (Cal. 1992)....................................................................................26 Booth v. 3669 Delaware, Inc., 92 N.Y.2d 934 (1998) .........................................................................................55 Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598 (S.D.N.Y. 1980) .....................................................................54 Carey v. Piphus, 435 U.S. 247 (1978)............................................................................................40 CFTC v. Vartuli, 228 F.3d 94 (2d Cir. 2000) .................................................................................43 Charlebois v. J.M. Weller Assocs., Inc., 72 N.Y.2d 587 (1988) ...................................................................................37, 46 CNL Hotels & Resorts, Inc. v. Houston Cas. Co., 505 F. Supp. 2d 1317 (M.D. Fla. 2007)..............................................................27 Enright v. Lilly & Co., 77 N.Y.2d 377 (1991) .........................................................................................40 Genzyme Corp. v. Fed. Ins. Co., 622 F.3d 62 (1st Cir. 2010).................................................................................27 iv Gerosa v. Savasta & Co., 329 F.3d 317 (2d Cir. 2003) .........................................................................28, 41 Halyalkar v. Bd. of Regents, 72 N.Y.2d 261 (1988) .........................................................................................53 Hartford Accident Co. v. Village of Hempstead, 48 N.Y.2d 218 (1979) .............................................................................39, 41, 44 Home Ins. Co. v. Am. Home Prods. Corp., 75 N.Y.2d 196 (1990) ...................................................................................39, 41 Howard v. SEC, 376 F.3d 1136 (D.C. Cir. 2004)..........................................................................60 In re Del-Val Fin. Corp. Sec. Litig., 868 F. Supp. 547 (S.D.N.Y. 1994) .....................................................................40 In re Mut. Funds Inv. Litig., 384 F. Supp. 2d 845 (D. Md. 2005)....................................................................60 In re Platinum & Palladium Commodities Litig., 828 F. Supp. 2d 588 (S.D.N.Y. 2011) ................................................................53 Joseph R. Loring & Assocs., Inc. v. Continental Cas. Co., 56 N.Y.2d 848 (1982) .........................................................................................38 Level 3 Commc’ns, Inc. v. Fed. Ins. Co., 272 F.3d 908 (7th Cir. 2001) ..............................................................................26 Lipsky v. Commonwealth United Corp., 551 F.2d 887 (2d Cir. 1976) ...............................................................................53 Little v. MGIC Indem. Corp., 836 F.2d 789 (3d Cir. 1987) ...............................................................................52 MBIA Inc. v. FDIC, 652 F.3d 152 (2d Cir. 2011) ...............................................................................24 McDougald v. Garber, 73 N.Y.2d 246 (1989) .........................................................................................40 v Messersmith v. American Fidelity Co., 232 N.Y. 161 (1921) ............................................................ 35, 36, 52, 58, 59, 62 Millennium Partners, L.P. v. Select Ins. Co., 24 Misc. 3d 212 (Sup. Ct. N.Y. Co.), aff’d, 68 A.D.3d 420 (1st Dep’t 2009)................................................................29 Miller v. Continental Ins. Co., 40 N.Y.2d 675 (1976) .......................................................................34, 37, 42, 52 Mishkin v. Peat, Marwick, Mitchell & Co., 1988 WL 391648 (S.D.N.Y. Nov. 7, 1988)........................................................53 Mondello v. N.Y. Blood Ctr., 80 N.Y.2d 219(1992) ..........................................................................................40 Morris v. Snappy Car Rental, Inc., 84 N.Y.2d 21 (1994) ...........................................................................................37 National Union Fire Ins. Co. of Pittsburgh, Pa. v. Xerox Corp., 25 A.D.3d 309 (1st Dep’t 2006) .........................................................................54 New England Mutual Life Ins. Co. v. Caruso, 73 N.Y.2d 74 (1989) .........................................................................36, 37, 42, 46 Oppenheimer & Co. v. Oppenheim, Appel, Dixon & Co., 86 N.Y.2d 685 (1995) .........................................................................................37 Pan Pac. Retail Props., Inc. v. Gulf Ins. Co., 471 F.3d 961 (9th Cir. 2006) ..................................................................27, 28, 41 Pendergest-Holt v. Certain Underwriters at Lloyd’s of London, 600 F.3d 562 (5th Cir. 2010) ..............................................................................52 Pereira v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 2006 WL 1982789 (S.D.N.Y. July 12, 2006).....................................................27 Public Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392 (1981) ................................................................................. passim vi Raychem Corp. v. Federal Ins. Co., 853 F. Supp. 1170 (N.D. Cal. 1994).............................................................54, 61 Reliance Grp. Holdings, Inc. v. Nat’l Union Fire Ins. Co., 188 A.D.2d 47 (1st Dep’t 1993) .........................................................................29 Ryerson Inc. v. Federal Ins. Co., 676 F.3d 610 (7th Cir. 2012) ..............................................................................27 SEC v. Absolutefuture.com, 393 F.3d 94 (2d Cir. 2004) .....................................................................30, 31, 61 SEC v. Anticevic, 2010 U.S. Dist. Lexis 83538 (S.D.N.Y. Aug. 11, 2010) ....................................31 SEC v. Champion Sports Mgmt., Inc., 599 F. Supp. 527 (S.D.N.Y. 1984) .....................................................................60 SEC v. Citigroup Global Mkts., 673 F.3d 158 (2d Cir. 2012) .........................................................................46, 56 SEC v. Citigroup Global Mkts. Inc., 2011 WL 5903733 (S.D.N.Y. Nov. 28, 2011)....................................................55 SEC v. Coven, 581 F.2d 1020 (2d Cir. 1978) .............................................................................43 SEC v. First Jersey Secs., Inc., 101 F.3d 1450 (2d Cir. 1996) .............................................................................31 SEC v. Fischbach, 133 F.3d 170 (2d Cir. 1997) ...............................................................................61 SEC v. Hughes Capital Corp., 124 F.3d 449 (3d Cir. 1997), ........................................................................54, 60 SEC v. Lorin, 869 F. Supp. 1117 (S.D.N.Y. 1994) ...................................................................43 SEC v. Palmisano, 135 F.3d 860 (2d Cir. 1998) ...............................................................................43 vii SEC v. Tex. Gulf Sulphur Co., 446 F.2d 1301 (2d Cir. 1971) .............................................................................43 SEC v. Whittemore, 659 F.3d 1 (D.C. Cir. 2011), cert. denied, 2012 U.S. Lexis 4796 (U.S. June 25, 2012) ..................................31 Servidone Constr. Corp. v. Sec. Ins. Co. of Hartford, 64 N.Y.2d 419 (1985) .........................................................................................51 Sirota v. Solitron Devices, Inc., 673 F.2d 566 (2d Cir. 1982) ...............................................................................60 Slayko v. Sec. Mut. Ins. Co., 98 N.Y.2d 289 (2002) .........................................................................................38 Soto v. State Farm Ins. Co., 83 N.Y.2d 718 (1994) .........................................................................................40 Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008)............................................................................................44 Tager v. SEC, 344 F.2d 5 (2d Cir. 1965) ...................................................................................59 Town of Massena v. Healthcare Underwriters Mut. Ins. Co., 98 N.Y.2d 435 (2002) .............................................................................58, 59, 62 Unified Western Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106 (9th Cir. 2006) ......................................................................27, 28 Vigilant Ins. Co. v. Bear Stearns Cos., 34 A.D.3d 300 (1st Dep’t 2006), rev’d, 10 N.Y.3d 170 (2008)...............................................................................28 Vigilant Ins. Co. v. Credit Suisse First Boston, 6 Misc. 3d 1020A, 2003 N.Y. Misc. Lexis 1984 (Sup. Ct. N.Y. Co. 2003), aff’d in part, modified in part, 10 A.D.3d 528 (1st Dep’t 2004)..................25, 29 Wojtunik v. Kealy, 2011 WL 1211529 (D. Ariz. Mar. 31, 2011)......................................................27 viii Wonsover v. SEC, 205 F.3d 408 (D.C. Cir. 2000)............................................................................59 XL Specialty Ins. Co. v. Loral Space & Commc’n, Inc., 82 A.D.3d 108 (1st Dep’t 2011) .........................................................................30 Zurich Ins. Co. v. Shearson Lehman Hutton, Inc., 84 N.Y.2d 309 (1994) ...................................................................................40, 41 STATUTES 15 U.S.C. § 77t.........................................................................................................25 15 U.S.C. § 78u........................................................................................................25 15 U.S.C. § 78u(d)(5)...............................................................................................61 N.Y. Bus. Corp. L. § 726(a)(3) ................................................................................52 N.Y. Bus. Corp. L. § 726(b) ....................................................................................52 N.Y. Bus. Corp. L. § 726 ...................................................................................38, 52 N.Y. Bus. Corp. L. § 726(e).....................................................................................38 N.Y. C.P.L.R. § 5602.................................................................................................1 RULES N.Y. C.P.L.R. 3211(a)(1)...................................................................8, 19, 20, 47, 48 N.Y. C.P.L.R. 3211(a)(7).........................................................................................19 OTHER AUTHORITIES Henry G. Manne, What Mutual Fund Scandal?, Wall St. J., Jan. 8, 2004, at A22......................................................................................................................14 Tom Lauricella, Mutual Funds See No Injuries From “Timing,” Wall St. J., Mar. 3, 2004, at C1 .............................................................................................14 U.S. SEC FY 2011 Performance and Accountability Report, at 2, available at www.sec.gov/about/secpar/secpar2011.pdf#performance (last visited Aug. 23, 2012) ....................................................................................................45 ix Harvey L. Pitt, SEC Chairman, Remarks before the U.S. Department of Justice Corporate Fraud Conference (Sept. 26, 2002), available at www.sec.gov/news/speech/spch585.htm (last visited Aug. 23, 2012) ..............45 Plaintiffs-Appellants J.P. Morgan Securities Inc., J.P. Morgan Clearing Corp., and the Bear Stearns Companies LLC (collectively, “Bear Stearns”) respectfully submit the following memorandum of law in support of their appeal from the decision and order of the Appellate Division, First Department entered December 13, 2011 (the “Decision,” R. 1833-47) dismissing Bear Stearns’ Amended Complaint. JURISDICTIONAL STATEMENT This Court granted Bear Stearns’ motion for leave to appeal by Order dated June 28, 2012. (R. 1831.) Therefore, this Court has jurisdiction to entertain Bear Stearns’ appeal under CPLR 5602. The issues presented were preserved for review, as Bear Stearns raised them in its Amended Complaint (R. 52-54); in its briefs and at oral argument before the IAS Court (e.g., R. 1765, 1772-73); and in its brief to the Appellate Division, as is apparent from the Decision. STATEMENT OF THE QUESTIONS PRESENTED FOR REVIEW 1. Whether an express insurance contract obligation to cover loss sustained by an insured in making a payment should be nullified as a matter of New York public policy, because the payment was labeled “disgorgement,” notwithstanding that the payment did not constitute the return of an ill-gotten gain the insured received. 2 The Appellate Division, citing a rationale never approved by this Court, rejected by every court to address the issue in circumstances analogous to those pertaining here, and applicable only where, as was not the case here, the insured’s payment constituted the return of its own ill-gotten gain, held that coverage should be barred as a matter of public policy. 2. Whether New York public policy should be invoked to nullify common and longstanding insurance contract obligations and rights, notwithstanding New York’s strong public interest in the enforcement of contracts as written, and in contravention of the clear limitations heretofore imposed on contract nullification, on the ground that such nullification may deter alleged wrongful conduct. The Appellate Division, venturing far beyond any statement of public policy by this Court, and also beyond the policy choice made by the SEC in the underlying investigation and settlement, held that the insurance contract obligation should be nullified in the interest of deterrence. 3. Whether coverage may be nullified, on a motion to dismiss, on the ground that the insured intentionally facilitated wrongful conduct by others, where there is abundant evidence that that is not the case, the insurer relied entirely on unilateral non-adjudicated agency findings recited in a settlement document that expressly provides that such 3 findings are not admitted, the insured reserved the right in litigation with third parties to continue to disagree with the agency’s factual position, the insurance contract precludes the insurer from denying coverage on the basis of facts that have not been finally adjudicated against the insured, and the agency’s findings, even if credited, do not allege that the insured intended to cause harm. The Appellate Division held that statements by the SEC in an administrative order issued to effectuate a settlement, which the SEC characterized as “findings,” precluded Bear Stearns, as a matter of law, from any recovery, notwithstanding the SEC’s agreement that its findings were not admitted and should not have evidentiary value in other proceedings; notwithstanding allegations and evidence directly contrary to those findings in Bear Stearns’ Amended Complaint and in its submissions to the SEC and in opposition to the motion; notwithstanding that the findings do not in any case allege intent to cause harm; and despite policy language under which the insurers expressly agreed that allegations of the kind the SEC and the insurers made would not exclude coverage unless finally adjudicated. 4 PRELIMINARY STATEMENT The Appellate Division’s Decision, which dismissed at the pleading stage Bear Stearns’ insurance coverage action for $200 million plus interest, is an unwarranted expansion of New York public policy to nullify an express grant of coverage applicable to that loss, for which Bear Stearns duly paid substantial premiums. The Decision was based only on unproven allegations that would not have been sufficient to support the court’s flawed rationale even if they had in fact been adjudicated. Bear Stearns settled a disputed claim by the Securities and Exchange Commission (“SEC”) that its clearing procedures had facilitated certain trades by Bear Stearns’ customers that had resulted in gains to those customers at the expense of certain mutual fund investors. In these circumstances, Bear Stearns is entitled to recover under the insurance contracts it purchased from the Defendants (the “Insurers”) because Bear Stearns had an out-of-pocket covered loss arising from payments that did not constitute the return of ill-gotten gains it received, and that did not in any other respect constitute an uninsurable loss. Notwithstanding that $140 million of Bear Stearns’ payment to the SEC was based on gains the SEC alleged were received by Bear Stearns’ customers, the Appellate Division improperly nullified the Insurers’ express coverage obligations on the ground that Bear Stearns’ payment was classified under the SEC’s 5 enforcement authority as “disgorgement.” But “disgorgement” as used in SEC proceedings encompasses payments well beyond those that constitute the return by the respondent of a gain it improperly received. Thus, the cases on which the Appellate Division relied, which bar coverage where an insured would be unjustly enriched if it were able to use insurance to recover funds it should never have had in the first place, are manifestly inapplicable here, where Bear Stearns was charged with legal responsibility for gains received by others. Courts around the country have recognized this distinction and required insurers in analogous circumstances to honor their contractual obligations to their insureds. Thus, the fact that Bear Stearns agreed to pay “disgorgement” as the SEC uses the term does not in any way constitute an acknowledgment that the payment is not a covered Loss suitable for indemnification under the Insurers’ policies. (See Point I.) The Insurers further contended below, and the Appellate Division erroneously agreed, that their insurance contracts should be nullified as a matter of public policy, whether or not an insurance recovery would result in Bear Stearns’ unjust enrichment, in order to deter alleged wrongdoing. But neither the Legislature nor this Court has ever determined that New York public policy countenances the nullification of insurance contract obligations merely on the ground that denial of coverage for losses may deter wrongful conduct. To the contrary, as shown by Public Service Mutual Insurance Co. v. Goldfarb, 53 6 N.Y.2d 392 (1981), among other cases, this Court is reluctant to invoke a general public interest in deterrence to nullify insurance coverage even for highly culpable conduct. Indeed, the approach taken by the Appellate Division would undermine the very purpose of liability coverage and leave insureds, including officers and directors, without coverage any time they are charged with responsibility for third party gains. If the public interest in deterrence alone justified nullifying coverage, practically no liabilities would be insurable, as virtually any legal remedy includes at least some deterrent component. New York public policy, as articulated by this Court, allows courts to nullify a contract of insurance in order to deter wrongful conduct by the insured in only two narrow circumstances: first, when the liability for which indemnification is sought serves solely as punitive damages (see Point II), and second, when the insured has engaged in conduct specifically intended to cause injury (see Point III). Neither of these circumstances is a precondition to a disgorgement payment under the SEC’s standards, and neither applies here. In all other circumstances, this Court’s precedents are clear that the controlling public policy principle is freedom of contract, which mandates that insurers be held to the bargain they struck with their insured - neither visiting a forfeiture upon the insured nor conferring a windfall on the insurer. 7 Additionally, the SEC itself made a choice about the extent to which the settlement should contain provisions intended to preserve the deterrent effect of the remedies it contained. The SEC, citing the need to “preserve the deterrent effect” of a $90 million penalty that Bear Stearns agreed to pay (and for which no coverage is sought), prohibited Bear Stearns from benefitting from an offset of that payment in civil litigation. In contrast, the SEC agreed not to preclude Bear Stearns from using its disgorgement payment to offset compensatory damages otherwise incurred in civil actions, or from proving facts that would entitle it to coverage. Thus, the agency charged with enforcing the federal securities laws has made its own judgment as to how best to vindicate its public policy concerns, and neither prohibited Bear Stearns from obtaining an offset for the sake of deterrence nor barred Bear Stearns from seeking coverage. Under these circumstances, there is no reason why this Court should constrain the SEC’s enforcement alternatives in other cases and remove a source of funds to make investors whole by creating in this case a heretofore unheard of across-the-board bar to insurance coverage for alleged violations of the securities laws. (See Point II.) As shown in Point III, this case also does not fit within the narrow class of cases in which the Court has allowed an insurance contract to be nullified based on proof that the insured intended to cause the injury giving rise to the liability for which it seeks coverage. First, such a circumstance has neither been alleged nor 8 proven. The Appellate Division erred when it found Bear Stearns “guilty” of willful misconduct (R. 1844) notwithstanding that there had been no trial, no adjudication of any kind, and no admission by Bear Stearns, and despite the SEC’s agreement that its “findings” would not be considered as evidence in a case between Bear Stearns and third parties, including its insurers. In so finding, the Appellate Division ignored CPLR 3211(a)(1), under which the non-movant on a motion to dismiss is entitled to every favorable factual inference - not the reverse. The only undisputed facts here are that, based on allegations that Bear Stearns facilitated the improper trades of its customers, from which the customers, not Bear Stearns, profited, the SEC sought to require Bear Stearns to make a “disgorgement” payment consisting principally of the gains received by Bear Stearns’ customers (not Bear Stearns), and that Bear Stearns made such a payment to settle the matter. Bear Stearns alleged in its Amended Complaint, and demonstrated in a submission to the SEC (the “Wells Submission,” included in the record here) that it did not intentionally facilitate late trading or market timing, much less do anything intended to harm investors. On that record, the Decision would be unsupportable even if the SEC had alleged, but had not proven, that Bear Stearns acted with an intent to cause harm (which it did not). By treating unproven findings by the SEC in this case as established facts for purposes of nullifying Bear Stearns’ right to coverage under its insurance 9 contracts with third parties, the Appellate Division ignored decisions of this and other courts upon which public agencies and private parties have long relied, providing that when parties enter into arms’ length settlements with no adjudication or admission of liability, courts will honor their expressed intention that unilateral findings recited by the public agency will not be treated as proven facts in cases between the settling party and a third party. Under those principles, Bear Stearns should not be precluded from obtaining coverage, especially in view of policy terms providing that allegations of the kind the SEC made would not exclude coverage unless adjudicated, and of the facts in the record showing that Bear Stearns did not intend to facilitate violations of the securities laws by its customers or to cause injury to mutual funds; did not receive any part of the profits from its customers’ transactions; and instead sought to stop them. In disregarding those facts and nullifying coverage based on impermissible adverse inferences drawn from the SEC’s unadjudicated findings, the Appellate Division not only committed legal error, but also contravened public policy by undermining the ability of the SEC and private parties to settle in reliance on settlement provisions like those that were agreed upon here. (See Point III.A.) Finally, the SEC did not allege, much less prove, that Bear Stearns acted with the intent to harm anyone, but rather alleged that Bear Stearns violated securities laws under which allegations of “willful” or “knowing” violations 10 merely mean that the defendant intentionally performed the act that constitutes the violation. Under those statutes, reckless acts may form the basis for liability. New York law unquestionably allows coverage for liabilities arising from conduct that is intentional in the sense of being voluntary, but not motivated by intent to harm, including reckless conduct. The SEC’s findings relate to an alleged failure by Bear Stearns to implement measures to prevent customer misconduct; they are at most compatible with a recklessness standard; and they say nothing about an intent to harm. Thus, even if the SEC’s findings in the SEC order were credited (as explained below, they may not be), they still would not put this case within the narrow class of cases where coverage has been barred based on the insured’s intent to harm. (See Point III.B.) STATEMENT OF FACTS The SEC Investigation Bear Stearns alleged in its Amended Complaint (R. 50-92), that the Insurers provided $200 million in bankers professional liability coverage to Bear Stearns. (R. 61-62.) Bear Stearns seeks coverage for a payment of $160 million, labeled as “disgorgement,” it made to settle an investigation by the SEC into whether Bear Stearns employees facilitated violations of the securities laws by its customers, as well as approximately $40 million in defense costs and $14 million Bear Stearns paid to settle compensatory damages claims in related civil litigation. As alleged 11 in the Amended Complaint, the SEC and Bear Stearns did not agree to the $160 million “disgorgement” payment to settle the SEC’s proposed charges based upon an estimation that Bear Stearns itself had received gains in that amount. Instead, that negotiated figure was comprised of $140 million claimed to have been received by Bear Stearns’ customers (but which the SEC asserted it had a right to compel Bear Stearns to pay), plus an approximation, on the high side, of $20 million of total fees and commissions - not profit - received by Bear Stearns. (R. 76-78.) This allegation, which is not refuted by anything in the March 13, 2006 consent order pursuant to which Bear Stearns settled with the SEC (the “SEC Order,” R. 116-55), must be accepted as true on this motion to dismiss. Indeed, the SEC Order nowhere even alleges that Bear Stearns profited, but only that its customers did. (R. 118, ¶ 5.) The securities laws violations that Bear Stearns allegedly facilitated consisted of late trading and deceptive market timing. Late trading is the practice of making orders to buy, redeem or exchange mutual fund shares after the 4:00 close of trading, but receiving the price based upon the prior net asset value determined before the close of trading. (R. 1437, n. 3.) Market timing involves frequent buying or selling of shares of the same mutual fund, or buying or selling shares in order to exploit inefficiencies in mutual fund pricing; it may be deceptive 12 if, for instance, it induces a mutual fund to accept trades it would not otherwise accept under its own market timing policies. (Id.; R. 118-19.) Bear Stearns was a clearing broker. Its role was to settle and clear transactions; perform cashiering functions; maintain proper custody of customer funds; prepare and transmit trade confirmations; extend credit in margin accounts; and perform other ministerial duties. (E.g., R. 1448.) As such, it did not make late trades or engage in market timing on its own account, was not accused of doing so, and did not derive greater compensation for late trading or market timing transactions than it did on any other mutual fund trades it cleared. (E.g., R. 1447, n. 14.) Bear Stearns’ customers’ profits from their late trading and market timing activities were received directly by the customers, and Bear Stearns, whose function was to clear the trades for a fee designed to cover Bear Stearns’ costs, had no right to share in any such profits. (R. 1440.) In 2003, the SEC began an investigation into allegations of late trading and deceptive market timing by introducing broker-dealers in connection with mutual fund transactions. (R. 63-64, 1439.) Because Bear Stearns cleared such transactions, it, too, became a subject of the SEC investigation. In 2005, Bear Stearns submitted a detailed Wells Submission countering the SEC’s proposed charges. (R. 1434-1507.) As shown in the Wells Submission, Bear Stearns introduced an electronic order entry system (the Mutual Fund Routing System, or 13 “MFRS”) in the mid-1990s to increase efficiency by affording Bear Stearns’ customers the ability to enter their own trades. (R. 1440, 1452.) The MFRS was kept open after the market closed because it was not possible for traders to enter trades made just before the 4:00 closing time until after that time. (R. 1452-54.) Trades were also entered after closing to correct errors made earlier, or to deal with emergencies arising from systems problems. (R. 1454.) All of these entries were permissible under the then-applicable industry standards and rules. (Id.) Thus, contrary to the SEC’s charges, the fact that an order was entered in the MFRS after the 4:00 close of trading provides no evidence that the customer was a late trader. (Id.) The SEC’s investigation uncovered no evidence of a deliberate effort by Bear Stearns to design a system that would allow its customers to evade the rules governing late trading. (R. 1454; 1465-75.)1 And as Bear Stearns showed in its Wells Submission, the evidence was that Bear Stearns did not knowingly accept late trades. (R. 1487-88.) The Wells Submission also showed that the overwhelming majority of market timing transactions processed through Bear Stearns were with mutual funds 1 Although the SEC Order suggests that the SEC investigation involved a large number of transactions, in fact the conduct at issue involved fewer than 1% of the trades Bear Stearns processed; just 3 of the 562 correspondent firms for which Bear Stearns cleared trades; and at most five brokers (and a handful of other personnel) out of the 11,000 employees of Bear Stearns. (R. 1494.) 14 that liberally accepted such transactions. (R. 1457.)2 Where, however, a mutual fund indicated that it did not want trades from market timer accounts, Bear Stearns so informed the representatives at the correspondents handling those accounts, and attempted to block all trades from accounts known to be market timers, which led numerous customers to stop trading through Bear Stearns. (R. 1458-61.) Bear Stearns’ interest lay in preventing abusive mutual fund trading, since mutual funds were among its customers. (R. 1441.) In its Wells Submission, Bear Stearns also addressed whether it had profited from the alleged market timing and late trading activities of its customers. Bear Stearns’ calculation, which was intentionally overbroad and substantially overstated the fees it earned (R. 1489, n. 56), showed revenues of no more than $16.9 million, from which Bear Stearns earned virtually no profits (R. 1462-63). The SEC never challenged that calculation. After submitting the Wells Submission, Bear Stearns conducted extensive negotiations with the SEC (R. 74-81) and made a formal offer of settlement (R. 1648-91). Although Bear Stearns disputed its liability for the gains of its 2 As Bear Stearns pointed out in its Wells Submission (R. 1437), research suggests that market timing may benefit investors. See, e.g., Tom Lauricella, Mutual Funds See No Injuries From “Timing,” Wall St. J., Mar. 3, 2004, at C1 (noting that long- term shareholders may benefit from market timing when there is a decline in share price); Henry G. Manne, What Mutual Fund Scandal?, Wall St. J., Jan. 8, 2004, at A22 (arguing that market-timing practices “actually helped investors” in part by creating more efficient markets). 15 customers, it settled the SEC’s claim for disgorgement by Bear Stearns of such customer profits - which the SEC claimed exceeded $500 million (R. 76; 1442) - based on Bear Stearns’ own calculation showing that such customer profits, properly calculated, did not exceed $140 million. (R. 77-78.) The SEC accepted this calculation, proposing a $160 million disgorgement payment to resolve its claims. (R. 78.) The SEC Order entered pursuant to Bear Stearns’ offer of settlement makes no claim that Bear Stearns received any gain, but, instead, solely alleges that its customers had profited. (R. 118, ¶ 5.) The SEC Order included non-adjudicated, unilateral findings by the SEC that Bear Stearns’ customers engaged in late trading and deceptive market timing and that Bear Stearns “facilitated” those activities. (R. 117.) Many of the SEC’s findings focused specifically on Bear Stearns’ alleged failure to implement more effective controls to regulate the conduct of its customers. (E.g., R. 121, ¶ 22; R. 122, ¶¶ 29, 30; R. 126, ¶ 54; R. 131, ¶ 83; R. 131-32, ¶¶ 87, 92; R. 134, ¶¶ 98, 99; R. 136, ¶ 108.) Such a failure could be reckless rather than deliberate, as the same allegations indicate. (E.g., R. 122, ¶¶ 30, 31.) The SEC Order contained no allegation or finding that Bear Stearns intended to harm mutual fund investors. The SEC Order further made explicit that Bear Stearns’ consent to its issuance was “[s]olely for the purpose of these proceedings,” and that, in providing that consent, Bear Stearns was neither “admitting or denying the findings herein.” 16 (R. 116-17.) Further, the SEC Order was entered pursuant to the SEC’s acceptance of Bear Stearns’ offer of settlement, which expressly provided that “[n]othing in this provision affects” Bear Stearns’ “right to take legal or factual positions in litigation or other legal proceedings in which the Commission is not a party.” (R. 1687.) Thus, the settlement preserved Bear Stearns’ right to disagree with the SEC’s findings in legal proceedings with parties other than the SEC, such as Bear Stearns’ insurers. In accordance with the settlement, the SEC used Bear Stearns’ $160 million “disgorgement” payment as part of the Fair Fund, pursuant to section 308(a) of the Sarbanes-Oxley Act of 2002, to compensate allegedly harmed mutual fund investors seeking damages from Bear Stearns in pending civil actions involving the same allegations as the SEC made. (R. 54, ¶ 15.) The SEC permitted Bear Stearns to obtain an offset against the damages claimed in the civil actions. (R. 55, ¶ 17.) Notably, the SEC elected not to preclude Bear Stearns from seeking insurance coverage for that payment or from proving in a coverage action that the calculation of that payment was not based on alleged ill-gotten gains received by Bear Stearns. (R. 53, ¶ 12.) In contrast, citing the need to “preserve the deterrent effect” of a separate $90 million civil penalty that was also part of the regulatory settlement (R. 154), the SEC mandated that the payment be treated “as penalties paid to the government for all purposes” and prohibited Bear Stearns from benefitting from 17 any offset on account of the penalty payment in the parallel civil actions. (R. 154, 1688.)3 Mutual fund investors also commenced a series of class actions against Bear Stearns under the federal securities laws, seeking compensatory damages for their alleged losses resulting from the late trading and market timing activities of Bear Stearns’ customers. Because the class members benefitted from the distribution of the disgorgement payment Bear Stearns made in its settlement with the SEC, its damages liabilities were correspondingly reduced (R. 84-85), permitting Bear Stearns to negotiate a settlement of claims involving hundreds of millions of dollars in alleged liability for damages caused to mutual fund investors for a payment of $14 million. (R. 55, ¶ 17.) Bear Stearns incurred approximately $40 million in costs in defense of the civil actions and regulatory investigations. (R. 69-71.) The Policy Terms Bear Stearns sought (and was denied) coverage for the settlements under a primary bankers professional liability policy issued by Vigilant Insurance Company (the “Policy,” R. 102-115) and a series of excess policies, issued by the other Insurers, that follow form to the Policy. (R. 60-61.) The Policy terms 3 Bear Stearns also entered into a settlement with the New York Stock Exchange (“NYSE”) based on the same terms as the SEC settlement (R. 160-203), again without admitting or denying any wrongdoing (R. 161), and with no allegation that Bear Stearns received illegal payments. 18 manifestly are intended to provide coverage for, among other things, settlements of SEC and NYSE investigations arising from alleged violations of the securities laws by the insured, as well as costs incurred in defense of such claims. The Policy required the Insurers to “pay on behalf of the Insured all Loss which the Insured shall become legally obligated to pay as a result of any Claim or Claims first made against the Insured and reported in writing to the Insurer during the Policy Period for any Wrongful Act of the Insured.” (R. 103.) “Loss” is defined in the Policy as: (1) compensatory damages, multiplied damages, punitive damages where insurable by law, judgments, settlements, costs, charges and expenses or other sums the Insured shall legally become obligated to pay as damages resulting from any Claim or Claim(s); (2) costs, charges and expenses or other damages incurred in connection with any investigation by any governmental body or self-regulatory organization (SRO), provided however, Loss shall not include: (i) fines or penalties imposed by law, or . . . (v) matters which are uninsurable under the law pursuant to which this policy shall be construed . . . . (R. 103.) “Claim” is defined to include “a civil proceeding” and “any investigation into possible violations of law or regulation initiated by any governmental body or self-regulatory organization (SRO) . . . against an Insured for any Wrongful Act. . . .” (R. 104-105.) “Wrongful Act” means “any actual or alleged act, error, 19 omission, misstatement, misleading statement, neglect or breach of duty by the Insured(s) in providing services as a Security Broker/Dealer and/or Investment Advisor and/or Administrator.” (R. 103.) The Policy also contained an exclusion for Claims arising from “any deliberate, dishonest, fraudulent or criminal act or omission” by the Insured, but provided that the Insured “shall be protected” unless there was a “judgment or other final adjudication” establishing that the excluded conduct occurred. (R. 105.) That provision, which is common in the insurance market, makes it all the more clear that the parties contemplated that Bear Stearns would be covered for settlements of alleged securities law violations. PROCEEDINGS IN THE COURTS BELOW After the Insurers refused coverage, Plaintiffs, as successors-in-interest to the settling Bear Stearns entities, commenced this coverage action. The Insurers moved to dismiss pursuant to CPLR 3211(a)(1) and (a)(7), alleging that the SEC Order was documentary evidence that precluded Bear Stearns from establishing that any part of the $160 million “disgorgement” payment was a covered “Loss” under the policies. In an order dated September 13, 2010, the IAS Court (Ramos, J.) denied the Insurers’ motion. (R. 17-30.) The court held that despite its use of the “disgorgement” label, the SEC Order “does not contain an explicit finding that Bear Stearns directly obtained ill-gotten gains or profited by 20 facilitating” its customers’ “trading practices,” so that the SEC findings “alone do not establish as a matter of law that Bear Stearns seeks coverage for losses that include the disgorgement of improperly acquired funds.” (R. 23.) As the IAS Court added, to “find otherwise would be to resolve disputed issues of fact, which is improper on a motion to dismiss the complaint on the basis of documentary evidence.” (R. 26.) The IAS Court also rejected the Insurers’ arguments that the “known wrongful act” and “profit/advantage” exclusions in certain of their policies barred coverage. (R. 27-30.) The Insurers appealed and the Appellate Division reversed, on the law, and dismissed the Amended Complaint. Disregarding numerous allegations in the Amended Complaint, including that Bear Stearns was not the recipient of any ill- gotten gains (e.g., R. 52-53, 77, 83); disregarding the terms of the settlement agreement the SEC and Bear Stearns had made; and in contravention of settled precedent governing CPLR 3211(a)(1) motions and of settled federal and state law on the conditions under which findings in settlements and administrative orders may be given preclusive effect, the Appellate Division treated the SEC’s findings as proven facts rather than disputed contentions, and construed them against Bear Stearns: read as a whole, the offer of settlement, the SEC Order, the NYSE order and related documents are not reasonably susceptible to any interpretation other than that Bear Stearns knowingly and intentionally facilitated illegal late trading for preferred customers, 21 and that the relief provisions of the SEC Order required disgorgement of funds gained through that illegal activity. (R. 1841-42; see also R. 1844 (based on SEC’s findings, “it cannot be seriously argued that Bear Stearns was merely found guilty of inadequate supervision and a failure to place adequate controls on its electronic entry system”); R. 1846 (concluding, based on SEC’s findings, that Bear Stearns “knowingly and affirmatively facilitated an illegal scheme which generated hundreds of millions of dollars for collaborating parties”).)4 In making these holdings - which implicitly concede the undisputable legal point that Bear Stearns is entitled to coverage if it was in fact merely negligent or reckless - the Appellate Division improperly decided a motion to dismiss based on its perception that the disputed evidence weighed against the non-movant. Without acknowledging that the SEC allowed the payment to be used for purposes of offset, the Appellate Division further recited that there was no “issue as to whether the disgorgement payment was in fact compensatory” (R. 1844), and, based on the non sequitur that the SEC’s authority extended to seeking the payment that Bear Stearns made (R. 1845-46), erroneously deemed irrelevant that the payment itself did not represent the return of gains of Bear Stearns, but rather the gains of Bear Stearns’ customers. 4 In fact, the SEC Order never refers to Bear Stearns and its customers as “collaborating.” The evidence is that Bear Stearns had a strictly arms’-length contractual relationship. (R. 1445.) 22 By thus effectively drawing every inference in favor of the movants, rather than Bear Stearns, the Appellate Division stood motion to dismiss procedure on its head. Having done so, the Appellate Division grounded its Decision on the inapposite holding that “disgorgement of ill-gotten gains or restitutionary damages does not constitute an insurable loss,” explaining that the “public policy rationale for this rule is that the deterrent effect of a disgorgement action would be greatly undermined if wrongdoers were permitted to shift the cost of disgorgement to an insurer, thereby allowing the wrongdoer to retain the proceeds of his or her illegal acts.” (R. 1840-41.) The Decision disregarded the fact that Bear Stearns was not alleged in the SEC Order to have received any such proceeds; that Bear Stearns’ $160 million payment to the SEC reduced the compensatory damages otherwise payable in the related civil actions that had been brought against it and was allowed to be used for that specific purpose; that Bear Stearns paid $14 million to settle those civil actions - a payment that clearly could not be characterized as anything but compensatory damages; and that Bear Stearns incurred additional Loss, as defined in the Policy, of approximately $40 million in costs incurred in defense of civil actions and the regulatory investigations. 23 ARGUMENT In deciding a motion to dismiss, courts must “liberally construe the complaint”; “accept as true the facts alleged in the complaint and any submissions in opposition to the dismissal motion”; and “accord plaintiffs the benefit of every possible favorable inference.” 511 W. 232nd Owners Corp. v. Jennifer Realty Co., 98 N.Y.2d 144, 152 (2002). Dismissal under CPLR 3211(a)(1) is warranted only if the movant establishes that the documentary evidence “conclusively refutes” the plaintiff’s submissions. AG Capital Funding Partners, L.P. v. State St. Bank & Trust Co., 5 N.Y.3d 582, 591 (2005). As shown below, the Decision is utterly irreconcilable both with those standards and with controlling New York insurance law and public policy. I. BEAR STEARNS INCURRED A COVERED LOSS, AND NEITHER RECEIVED ILL-GOTTEN GAINS NOR WAS UNJUSTLY ENRICHED A. Bear Stearns Incurred a “Loss” as Defined in the Policy There can be no dispute that Bear Stearns incurred a “Loss,” triggering the Insurers’ obligation to indemnify, when Bear Stearns made payments to defend and settle the SEC and NYSE investigations and the civil actions. First, the $160 million “disgorgement” payment that Bear Stearns made to settle the regulatory investigations was a covered “settlement” that Bear Stearns was “legally obligated to pay as a result of [a] Claim,” which specifically includes 24 investigations by governmental bodies and self-regulating agencies. (R. 103, 104.) It also constituted “costs, charges and expenses or other damages” incurred in connection with investigations by a governmental body (the SEC) and an SRO (NYSE). (R. 103.) Second, Bear Stearns sought coverage for $14 million it paid to settle civil actions in which the primary remedy the investor plaintiffs sought was compensatory damages (R. 55, ¶ 17; R. 86-88; R. 92; R. 154-155), and $40 million in defense costs related to the civil actions and the investigations (R. 69-71). These, too, are squarely within the Policy’s definition of “Loss” (R. 103), and the Appellate Division provided no reason why they were not recoverable. Coverage for SEC investigations was at the core of the insurance Bear Stearns purchased and reasonably expected to receive. Businesses in industries where the regulators seek such remedies buy coverage for such losses precisely because they know that they may be accused of violating the securities laws (whether they have ill-gotten gains or not) and may need to defend against and settle them (whether they have acted wrongfully or not). See, e.g., MBIA Inc. v. FDIC, 652 F.3d 152, 155 (2d Cir. 2011) (upholding coverage for defense of SEC and New York Attorney General investigation). If such coverage could be nullified for the reasons stated by the Appellate Division in the Decision, the coverage Bear Stearns purchased would be eviscerated. 25 Indeed, if SEC-mandated “disgorgement” were uninsurable even where it constitutes Loss resulting from an SEC investigation under the explicit terms of the Policy, then - inasmuch as the SEC can only order disgorgement, penalties or injunctive relief, see 15 U.S.C. §§ 77t, 78u - New York law would treat virtually any SEC-imposed remedy as uninsurable, extending public policy preclusion of coverage well beyond its rationale, removing a source of funds to make injured investors whole, exposing officers and directors to uncovered personal liability, and rendering many such cases much harder to settle. That result would nullify the explicit grant of coverage for regulatory agency and SRO investigations in the policy here (R. 104), and many others like it. B. Bear Stearns Is Not Seeking Coverage for Ill-Gotten Gains It Was Required to Relinquish The public policy rationale upon which the Appellate Division based its denial of coverage for Bear Stearns’ loss is that “the deterrent effect of a disgorgement action would be greatly undermined if wrongdoers were permitted to shift the cost of disgorgement to an insurer, thereby allowing the wrongdoer to retain the proceeds of his or her illegal acts.” (R. 1841 (citing Vigilant Ins. Co. v. Credit Suisse First Boston, 6 Misc. 3d 1020A, 2003 N.Y. Misc. Lexis 1984 (Sup. Ct. N.Y. Co. 2003), aff’d in part, modified in part, 10 A.D.3d 528 (1st Dep’t 2004)).) But that rationale simply does not apply in this case, because the payment the SEC sought in its Order unquestionably did not consist of Bear Stearns’ own 26 ill-gotten gains. Moreover, the prohibition on insurance recovery for ill-gotten gains is premised on the avoidance of the insured’s unjust enrichment - not on the general deterrence of alleged wrongful conduct. 1. Coverage for Payments of Ill-Gotten Gains Is Barred to Prevent Unjust Enrichment, but No Such Bar Applies When the Insured Has Not Been Unjustly Enriched Numerous courts have held that when an insured is required to disgorge its own ill-gotten gains, it does not have a “loss”; rather, it is merely returned to the position in which it would have been but for its misconduct.5 Thus, coverage for disgorgement of an insured’s own ill-gotten gains is barred to prevent its unjust enrichment. Bear Stearns, however, was not unjustly enriched by the profits its customers earned on the trades at issue here. No court (other than the Appellate Division below) has held that public policy nullifies coverage for the settlement of a proceeding where disgorgement or other equitable monetary remedies were sought, where the insured is not returning an ill-gotten gain that it had received, and therefore there was no possibility that the insured would be unjustly enriched by recovery of insurance. In fact, every case to have considered the issue has ruled to the contrary, because if the payment 5 That is the rationale stated in the seminal out-of-state cases on this issue. See Level 3 Commc’ns, Inc. v. Fed. Ins. Co., 272 F.3d 908, 911 (7th Cir. 2001) (an “insured incurs no loss within the meaning of the insurance contract by being compelled to return property that it had stolen”); Bank of the West v. Superior Ct., 833 P.2d 545, 555 (Cal. 1992) (rationale is that “[o]therwise, the wrongdoer would retain the proceeds of his illegal acts, merely shifting his loss to an insurer”). 27 is not the return of ill-gotten gains, then it constitutes a covered loss, which should be insurable. See, e.g., Genzyme Corp. v. Fed. Ins. Co., 622 F.3d 62, 70 (1st Cir. 2010) (coverage is not precluded where the insured received no identifiable asset because “the settlement payment cannot represent the restoration to the plaintiffs of some amount [the insured] had improperly taken and withheld”); Unified Western Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106, 1115 (9th Cir. 2006) (“The label of ‘restitution’ or ‘damages’ does not dictate whether a loss is insurable. . . . The fundamental distinction is not whether the insured received ‘some benefit’ from a wrongful act, but whether the claim seeks to recover only the money or property that the insured wrong-fully acquired.”); Pereira v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 2006 WL 1982789, at *3 (S.D.N.Y. July 12, 2006) (preclusion of insurance applies only to the extent the insured seeks coverage for the portions of the judgment representing the return of ill-gotten gains received by the insured).6 As these cases illustrate, the question is not what the remedy is 6 See also Ryerson Inc. v. Federal Ins. Co., 676 F.3d 610, 614 (7th Cir. 2012) (reimbursement of transaction costs that did not constitute gains from which the insured benefitted is insurable); Pan Pac. Retail Props., Inc. v. Gulf Ins. Co., 471 F.3d 961, 970 (9th Cir. 2006) (finding a factual issue whether settlement consisted solely of reimbursement of funds insured wrongfully received, or included insurable component); Wojtunik v. Kealy, 2011 WL 1211529, at *10 (D. Ariz. Mar. 31, 2011) (bar on coverage for restitutionary or disgorgement payments did not apply “given that the Insureds could not have disgorged any ill-gotten gains because [a third party], not the Insureds, received the benefit” of the transaction that gave rise to the claim); CNL Hotels & Resorts, Inc. v. Houston Cas. Co., 505 F. Supp. 2d 1317, 1324 (M.D. Fla. 2007) (“if an entity makes a payment that 28 called, but whether the insured seeks coverage for ill-gotten gains it received. See Pan Pac. Retail Props., Inc. v. Gulf Ins. Co., 471 F.3d 961, 966 (9th Cir. 2006) (“In deciding whether a certain remedy is insurable, we must look beyond the labels of the asserted claims or remedies”); Unified Western Grocers, 457 F.3d at 1115.7 Indeed, even the First Department previously recognized that disgorgement payments are insurable where they do not constitute the return of an insured’s ill- gotten gains. Vigilant Ins. Co. v. Bear Stearns Cos., 34 A.D.3d 300, 302-03 (1st Dep’t 2006) (finding an “issue of fact as to whether the portion of the settlement attributed to disgorgement actually represented ill-gotten gains or improperly acquired funds”), rev’d on other grounds, 10 N.Y.3d 170 (2008) (denying coverage solely on the basis of the insured’s failure to obtain the insurers’ consent to settle) (“Bear Stearns I”). The Decision here did not attempt to harmonize its result with Bear Stearns I. Indeed, it did not address Bear Stearns I at all. constitutes something other than disgorgement of its own ill-gotten gains, it has suffered a loss”); Bank of Am. Corp. v . S.R. Int’l Bus. Ins. Co., SE, 2007 WL 4480057 (N.C. Super. Ct. Dec. 19, 2007) (finding coverage for claims under Sections 11 and 12 of the Securities Act of 1933 where investment bankers were not issuers and did not receive the proceeds of bond offerings). 7 See also Gerosa v. Savasta & Co., 329 F.3d 317, 321 (2d Cir. 2003) (characterization of the remedy must be based on the “real nature of the relief sought, not its label”). 29 In each of the cases on which the Decision relies - all of which, unlike this case, were decided on summary judgment - the insured did not raise an issue of fact as to whether it had received the proceeds of illegal transactions, or whether its settlement payment involved the return of such gains. For instance, in Millennium Partners, L.P. v. Select Ins. Co., 24 Misc. 3d 212 (Sup. Ct. N.Y. Co.), aff’d, 68 A.D.3d 420 (1st Dep’t 2009), the insured, a hedge fund, was required to disgorge profits it made by market timing. The court recounted that, in response to a motion for summary judgment, the insured “did not submit any evidence that the amount to be disgorged was not attributable to profits made as a result of its market timing.” Id. at 219. That is completely different from this case, where there is no evidence, or even allegation, that Bear Stearns earned profits from market timing. The same is true of the other cases the Appellate Division cited: in each, there was no factual dispute that the insured was merely returning by way of settlement ill- gotten gains to which it had no entitlement in the first place.8 Consequently, unlike here, the outcome could be justified as necessary to prevent the insured’s unjust 8 Cf. Reliance Grp. Holdings, Inc. v. Nat’l Union Fire Ins. Co., 188 A.D.2d 47, 54- 55 (1st Dep’t 1993) (undisputed on full factual record that insured had been unjustly enriched by receipt of tens of millions of dollars of greenmail profits, which were partially restored pursuant to settlement); Vigilant Ins. Co. v. Credit Suisse First Boston, 6 Misc. 3d 1020A, 2003 N.Y. Misc. Lexis 1984, at **11-12 (Sup. Ct. N.Y. Co. 2003) (underlying district court judgment specifically stated that the payment represented “disgorgement of monies obtained improperly” by the insured). 30 enrichment. See XL Specialty Ins. Co. v. Loral Space & Commc’n, Inc., 82 A.D.3d 108, 115 (1st Dep’t 2011) (holding that the rationale of Reliance and Credit Suisse did not apply when the insured was not being “forced to disgorge funds that it acquired wrongfully”). 2. Bear Stearns Was Not Unjustly Enriched Unlike in the above cases, Bear Stearns’ settlement payment was not tied to the receipt by it of ill-gotten gains. Thus, denial of coverage cannot properly be justified as necessary to prevent Bear Stearns’ unjust enrichment. As the Decision recognized (R. 1845-46), the SEC claimed the power to force Bear Stearns to pay amounts allegedly received by its customers. See, e.g., SEC v. Absolutefuture.com, 393 F.3d 94, 97 (2d Cir. 2004) (upholding broad discretion of SEC to formulate disgorgement remedies imposing joint and several liability on collaborating parties, which successively held proceeds of manipulative scheme). It was the assertion of that power, not the power to force Bear Stearns to return funds that it had received, that accounted for the payment agreed to here. (R. 1845.) Nor can it properly be inferred that Bear Stearns agreed it was unjustly enriched because it agreed to pay “disgorgement” to the SEC. The SEC Order alleged only that Bear Stearns’ customers had ill-gotten gains. (R. 118, ¶ 5.) It does not follow from the SEC’s use of the label “disgorgement” that Bear Stearns agreed that it, too, had an ill-gotten gain. Bear Stearns has alleged in its Amended 31 Complaint (R. 53, ¶¶ 11-12, R. 57, ¶ 24) and demonstrated in its Wells Submission (R. 1462-63) that it had virtually no profits. Bear Stearns agreed only to make a payment that the SEC demanded, and the SEC can demand and obtain payments from parties that have not in fact received ill-gotten gains. Courts crafting a remedy for violations of the securities laws have “‘broad discretion in subjecting the offending parties on a joint-and-several basis to the disgorgement order.’” SEC v. Whittemore, 659 F.3d 1, 9 (D.C. Cir. 2011) (citation omitted), cert. denied, 2012 U.S. Lexis 4796 (U.S. June 25, 2012); SEC v. First Jersey Secs., Inc., 101 F.3d 1450, 1475 (2d Cir. 1996)); Absolutefuture.com, 393 F.3d at 97. Thus, when an insured pays to settle a claim by the SEC, even if it agrees to call the payment “disgorgement,” it cannot be deemed to have agreed that it had ill-gotten gains.9 It 9 The proposition cited by the Appellate Division - that the SEC in seeking disgorgement “‘is not required to trace every dollar of proceed[s]’” (R. 1845 (quoting SEC v. Anticevic, 2010 U.S. Dist. Lexis 83538, at *14 (S.D.N.Y. Aug. 11, 2010))) - actually underscores a fallacy in the Appellate Division’s analysis. In Anticevic, an insider trading case, the tipper was held jointly and severally liable with his tippees for the proceeds of the insider trading, although the amount of his profits was not established. Anticevic is merely another case that shows why courts cannot assume that the funds the SEC makes an insured “disgorge” are the insured’s ill-gotten gains. Here, that assumption would be particularly mistaken, because the record shows that the SEC’s disgorgement calculation was based on $140 million in estimated revenues received by Bear Stearns’ customers, and on estimated Bear Stearns fees and commissions (not profits) of $16.9 million, rounded up to $20 million. (R. 76-78; R. 57.) That was the basis for the settlement. 32 merely agrees that it is making a payment the SEC arguably had the statutory power to require.10 In sum, Bear Stearns’ “disgorgement” payment gave rise to a covered “Loss” for which the Insurers agreed to provide indemnification in accordance with the express terms of the policies they sold to Bear Stearns. In nullifying that coverage obligation, the Appellate Division misapplied the public policy rationale it invoked, and in doing so committed error. Moreover, the Appellate Division’s denial without explanation of coverage even for the $14 million that Bear Stearns paid to settle civil actions in which the primary remedy the investor plaintiffs sought was compensatory damages (R. 86-88, 92, 206-1395), and for the $40 million that Bear Stearns incurred in defense costs (R. 69-71), shows that its Decision cannot be supported based on the rationale that an insured that merely disgorges ill-gotten gains has no loss. 10 The SEC’s passing reference, in a press release, to Bear Stearns’ “gains” (R. 156), which is without support in any of the SEC’s findings, obviously has no evidentiary, much less preclusive value, and certainly was not in any sense agreed to by Bear Stearns. The Appellate Division’s reliance on a press release as part of the documentary evidence supporting its dismissal of the Complaint (R. 1844-45, n.4) only shows how far it strayed from the proper standard on such a motion. See 511 W. 232nd Owners Corp., 98 N.Y.2d at 152. 33 II. THE APPELLATE DIVISION CONTRAVENED NEW YORK PUBLIC POLICY WHEN IT HELD THAT COVERAGE FOR BEAR STEARNS’ LOSS SHOULD BE NULLIFIED, WHETHER OR NOT THE LOSS CONSTITUTED THE RETURN OF BEAR STEARNS’ OWN ILL-GOTTEN GAIN, TO PRESERVE THE DETERRENT EFFECT OF THE SEC’S DISGORGEMENT ACTION The Appellate Division’s statement that the “public policy rationale” for disallowing coverage here is to preserve the “deterrent effect of a disgorgement action” (R. 1841) - even when, as discussed above, the payment the insured made did not constitute the return of the insured’s ill-gotten gains - erroneously expands New York public policy far beyond any rule ever articulated by this Court, and does so in derogation of New York’s strong public interest in the enforcement of contracts as written. This Court has repeatedly honored the important public policy of enforcing private contractual obligations, and has countenanced nullification of insurance contract obligations based on a public policy involving deterrence under only two limited circumstances. First, as discussed in this point, this Court has identified one (and only one) kind of remedy - punitive damages - as uninsurable, and it has done so based on considerations wholly inapplicable here. Second, as discussed in Point III, this Court has also identified one (and only one) class of conduct - intentionally harmful conduct - as uninsurable. But on this motion Bear Stearns has submitted its Wells Submission vigorously disputing all of the SEC’s allegations of culpable conduct, so there was no basis whatever for 34 granting the Insurers’ motion to dismiss on that purported public policy ground even if, as was not the case, the SEC had alleged an intent to harm. A. New York Public Policy Strongly Supports the Enforcement of Contractual Obligations As Written Nothing in the Insurance Law or the General Obligations Law, or any other statute, or any decision of this Court, supports the Insurers’ broad assertion that public policy requires that they be relieved of their contractual obligations, whether or not their insured had any ill-gotten gain or would otherwise be unjustly enriched, in the name of deterring alleged wrongful conduct. Indeed, this Court has often stated and applied a very pertinent and powerful public policy principle that requires exactly the opposite result: the principle that parties should be held to the contractual obligations they freely undertake. See Miller v. Continental Ins. Co., 40 N.Y.2d 675, 679 (1976) (“‘the right of private contract is no small part of the liberty of the citizen, and the usual and most important function of courts of justice is rather to maintain and enforce contracts, than to enable parties thereto to escape from their obligation on the pretext of public policy, unless it clearly appears that they contravene public right or the public welfare’”) (citation omitted). Public Service Mutual Insurance Co. v. Goldfarb, 53 N.Y.2d 392 (1981) shows that the public policy in favor of enforcing contracts outweighs a general interest in deterrence - even in deterring criminal conduct. In Goldfarb, the 35 insured, a dentist, was criminally convicted of sexually abusing a patient, who also brought a civil suit for which the insured sought coverage. His insurer, although it had sold a policy covering damages arising from claims of “undue familiarity” during dental treatment, contended that coverage for such a liability was contrary to public policy. Id. at 398. This Court disagreed, holding that the “mere fact that an act may have penal consequences does not necessarily mean that insurance coverage for civil liability arising from the same act is precluded by public policy.” Id. at 399. Although the Court recognized certain conditions under which coverage might be nullified (which, as discussed further below, are not applicable here), the touchstone of the analysis was that where those conditions do not apply, “the insurer must be held to the bargain which it struck with the insured.” Id. at 401. Messersmith v. American Fidelity Co., 232 N.Y. 161 (1921) (Cardozo, J.) makes much the same point. In Messersmith, the insured allowed a minor to drive his car, thereby committing a misdemeanor; there was an accident and then a civil suit; and the insurer disclaimed coverage based on public policy. This Court took a more restrained view. It observed that the “public policy of this state when the legislature acts is what the legislature says that it shall be,” id. at 163; that the law permits insurance against the consequences of many negligent acts, even when such acts are subject to criminal punishment; and that “[c]ourts are slow to 36 substitute their own varying views of policy for those which have found embodiment in settled institutions, in every-day beliefs and practices, which have taken root and flourished,” id. at 164-65. Against that backdrop of judicial restraint, the Court held that only an insured who intended to cause the injury for which indemnity was sought would forfeit coverage. Id. at 165, 166. The Court observed that “[t]o restrict insurance to cases where liability is incurred without fault of the insured would reduce indemnity to a shadow.” Id. at 163. The same would be true if “deterrence” alone were recognized as a basis to restrict insurance. As Goldfarb and Messersmith illustrate, this Court has identified several powerful countervailing public policy interests that militate against the Insurers’ arguments that their policy terms should be nullified for the sake of deterrence. In addition to freedom of contract, this Court has recognized that nullifying contractual obligations to deter conduct is inappropriate where other laws provide deterrence, and that public policy disfavors forfeitures (such as Bear Stearns would suffer) and windfalls (such as the Insurers would obtain). For example, in New England Mutual Life Insurance Co. v. Caruso, 73 N.Y.2d 74 (1989), the issue was whether a life insurance policy should be voided, even after the incontestability period expired, because the policyholder lacked an insurable interest in the life of its insured. The insurer argued that public policy rendered the contract void as a form of gambling on the life of another, but this 37 Court observed that “[f]reedom of contract itself is deeply rooted in public policy.” Id. at 81. Furthermore, the Court noted that “the policy concerns” raised by the insurer were “also protected by the penal statutes of this State,” in view of which “the need for further deterrents in this area to advance public safety would appear marginal.” Id. at 82. In that context, allowing the insurer to nullify the policy “would result in a forfeiture” to the insured “and an unnecessary advantage” to the insurer. Id.11 See also Miller, 40 N.Y.2d at 679 (rejecting insurer’s argument that illegal conduct of insured who died of a drug overdose justified nullifying coverage; applicable penal laws provide their own “explicit” punishment which 11 The Court has often stressed the same public policy considerations in favor of enforcing contracts as written in cases outside the insurance context as well. See, e.g., Oppenheimer & Co. v. Oppenheim, Appel, Dixon & Co., 86 N.Y.2d 685, 695 (1995) (“Freedom of contract prevails in an arm’s length transaction between sophisticated parties such as these. . . . If they are dissatisfied with the consequences of their agreement, ‘the time to say so [was] at the bargaining table’” (citation omitted)); Morris v. Snappy Car Rental, Inc., 84 N.Y.2d 21, 29 (1994) (upholding contract provision under which car lessor required lessee to indemnify it for damages due to lessee’s negligence; Court could not nullify the provision without disparaging the “right of freedom of contract, which is itself deeply rooted in public policy”); Charlebois v. J.M. Weller Assocs., Inc., 72 N.Y.2d 587, 595 (1988) (rejecting contention that engineer should not be paid because he violated licensing law; proposed nullification of contract “ignores the plain and concededly commercial realities of the arm’s length transaction” between the parties; “would impose a disproportionate and unnecessary remedy and price” given that “regulatory sanctions” already “protect the underlying public policy”; and was contrary to the principle that “forfeitures” are “strongly disfavored as a matter of public policy”). 38 does not include “forfeiture of life insurance rights so that insurance carriers become substitute beneficiaries”). In sum, this Court has been very reluctant to invoke public policy to bar enforcement of freely negotiated coverage provisions upon which insurance companies and insureds rely, has never done so in the name of general deterrence, and should not do so here. See also Slayko v. Sec. Mut. Ins. Co., 98 N.Y.2d 289, 295 (2002) (“when statutes and Insurance Department regulations are silent, we are reluctant to inhibit freedom of contract by finding insurance policy clauses violative of public policy”); Joseph R. Loring & Assocs., Inc. v. Continental Cas. Co., 56 N.Y.2d 848, 850 (1982) (“Inasmuch as the particular [insurance policy] clause in question did not violate any statutory mandate or prohibition or any regulation of the Superintendent of Insurance, this court cannot say that the clause was violative of public policy.”).12 Thus, even if the Appellate Division had not 12 The most relevant legislative statement of public policy is Business Corporation Law § 726(e), which provides that it “is the public policy of this state to spread the risk of corporate management, notwithstanding any other general or special law of this state or of any other jurisdiction including the federal government.” Section 726 authorizes corporations to purchase insurance to indemnify their directors and officers even where the law would prohibit direct indemnification with corporate funds. The Decision undermines New York’s public policy of “spread[ing] the risk of corporate management,” because, if the Decision is upheld, corporate officers and directors will not be able to procure coverage for claims against them seeking to impose personal liability for failure to prevent third parties from obtaining ill-gotten gains, even if they themselves did not receive any such gains. 39 erred in treating the SEC’s allegations as proven facts on the Insurers’ motion to dismiss, there would be no basis for expanding New York public policy to undermine contractual obligations in the manner that the Decision did here. B. The Only Remedy for Which New York Public Policy Nullifies Coverage Is Punitive Damages, Which Are Uninsurable Because They Punish Wrongful Conduct and Have No Compensatory Purpose This Court has identified only one kind of remedy - punitive damages - for which public policy generally bars insurance coverage. As the Court has explained, the “strongest arguments against coverage are that it defeats the purpose of punitive damages, which is to punish and deter others from acting similarly, and that allowing coverage serves no useful purpose since such damages are a windfall for the plaintiff who, by hypothesis, has been made whole by the award of compensatory damages.” Hartford Accident & Indem. Co. v. Village of Hempstead, 48 N.Y.2d 218, 226 (1979). Similarly, in Home Ins. Co. v. Am. Home Prods. Corp., 75 N.Y.2d 196, 203 (1990), the Court explained that “punitive damages are intended to act as a deterrent to the offender” and as “‘punishment for gross misbehavior’”; they express “‘the community attitude towards one who wilfully [sic] and wantonly causes hurt or injury.’” (Citations omitted.) But they are not intended to reimburse the plaintiff. Id. Based on these considerations, indemnification would be contrary to “public policy.” Id. at 205. It is only in such limited circumstances 40 that this Court has ever said that a public policy of punishment and deterrence nullifies coverage.13 This Court has never said that deterrence alone justifies such nullification. Indeed, if the public interest in deterring the conduct giving rise to liability alone justified nullifying coverage, practically no liabilities would be insurable, as virtually any legal remedy includes at least some deterrent component.14 Conversely, even where an award consists of punitive damages, if it can serve a compensatory purpose, this Court has held that coverage is available. See Zurich Ins. Co. v. Shearson Lehman Hutton, Inc., 84 N.Y.2d 309 (1994). In Zurich, the insured incurred liability for slander against different underlying plaintiffs in two states, Texas and Georgia, and was required to pay punitive damages to both, and the issue was whether indemnification for such damages was permitted under New York law. After reviewing the principles set forth in Soto, 13 See also Soto v. State Farm Ins. Co., 83 N.Y.2d 718, 724 (1994) (public policy bars indemnification for punitive damages awards, as they “are not designed to compensate an injured plaintiff” and their “only real purpose is to punish and deter the wrongdoer”). 14 Many remedies serve a “deterrence” purpose, including compensatory damages awarded for violations of the securities laws, see, e.g., In re Del-Val Fin. Corp. Sec. Litig., 868 F. Supp. 547, 558 (S.D.N.Y. 1994) and for negligence, McDougald v. Garber, 73 N.Y.2d 246, 254 (1989), and in cases involving product liability, Enright v. Lilly & Co., 77 N.Y.2d 377, 386 (1991); vicarious liability, Mondello v. N.Y. Blood Ctr., 80 N.Y.2d 219, 226-27 (1992); and constitutional claims, Carey v. Piphus, 435 U.S. 247, 256-57 (1978). If “deterrence” were a sufficient basis to bar insurance, little coverage would be left. 41 Home and Village of Hempstead, the Court noted that under Georgia law, a jury may award punitive damages to compensate the plaintiff. Id. at 316. The Court stated as a firmly established principle that “only when the damage award is of a ‘punitive nature’ is indemnification precluded by New York policy.” Id. at 317. Because the Georgia punitive damages award “also had a compensatory purpose,” the insurer was required to “indemnify its insured for them.” Id. In Texas, by contrast, there was “no evidence that the award was for other than deterrent purposes,” and therefore “New York public policy preclude[d] indemnification” for it. Id. Thus, even the rule against indemnification for punitive damages does not apply when such damages do not serve “solely to punish the offender and to deter similar conduct on the part of others,” but instead also has a compensatory purpose. Id. at 316 (emphasis added).15 In sum, this Court has taken a restrained view of public policy as a basis for upsetting otherwise clear contractual obligations, and has not allowed insurance contract obligations to be nullified on public policy grounds based on the classification of the payment made, except where the purpose of the award was solely to punish. Prior to the Decision, the lower New York courts generally had 15 Zurich also illustrates the important point, noted above, that the analysis of these coverage issues should be based on the facts giving rise to the claim for coverage, not on the label attached to the remedy for which insurance is sought. See also Pan Pac., 471 F.3d at 966; Gerosa, 329 F.3d at 321. 42 exercised similar restraint. The principles this Court has stated afford no public policy basis to nullify the Insurers’ coverage obligations in this case. C. New York Law Permits Indemnification for the SEC Disgorgement Payment in This Case The disgorgement remedy here was not imposed as a punishment. Instead, the SEC pursued the disgorgement remedy to hold Bear Stearns legally responsible for the profits of its customers and the concomitant harm to investors. (R. 78.) Additionally, funds paid to settle regulatory investigations like the one here often are used for a compensatory purpose, and in this case the disgorgement payment that Bear Stearns made was specifically designated to be used by the SEC to compensate investors and thereby to offset civil liabilities to which Bear Stearns would otherwise be exposed. (R. 54.) Had the mutual fund investors alone sued, and had the SEC taken no action, the same amounts Bear Stearns paid as disgorgement to settle the SEC proceedings would instead have been paid to settle the compensatory damages claims in the civil actions. (R. 85.) That the SEC did take action, in the Appellate Division’s view, thus transforms what would otherwise have been an insurable payment of compensatory damages into an uninsurable disgorgement remedy. The resulting windfall to the Insurers is improper. New England Mutual, 73 N.Y.2d at 82; Miller, 40 N.Y.2d at 679. Moreover, the SEC itself agreed to settlement terms under which Bear Stearns is free to seek insurance coverage. In light of these facts, this Court’s precedents 43 discussing the limited circumstances where indemnity is prohibited for public policy reasons provide no support for the Decision, and, indeed, conflict with it. 1. The Payment Bear Stearns Made Was Not a Punitive Measure The purpose of SEC enforcement proceedings and the equitable remedies available therein dictates that those remedies should be treated differently, with respect to insurability, from punitive damages. “The essential nature of an SEC enforcement action is equitable and prophylactic; its primary purpose is to protect the public against harm, not to punish the offender.” SEC v. Coven, 581 F.2d 1020, 1027-28 (2d Cir. 1978). SEC proceedings serve “important nonpunitive goals, such as encouraging investor confidence, increasing the efficiency of financial markets, and promoting the stability of the securities industry.” SEC v. Palmisano, 135 F.3d 860, 866 (2d Cir. 1998). Accordingly the disgorgement remedy available in such proceedings is “nonpunitive.” Id. See also CFTC v. Vartuli, 228 F.3d 94, 113 (2d Cir. 2000) (agency-mandated disgorgement is a “nonpunitive equitable remedy”); SEC v. Tex. Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir. 1971) (holding “that the SEC may seek other than injunctive relief in order to effectuate the purposes of the [Securities Exchange] Act, so long as such relief is remedial relief”); SEC v. Lorin, 869 F. Supp. 1117, 1123-24 (S.D.N.Y. 1994) (SEC “disgorgement serves as a remedial, and not as a punitive, measure”). The Insurers effectively invite the 44 Court to rewrite federal law to treat SEC disgorgement as a penalty, in order to bring it within the narrow class of payments for which New York public policy nullifies coverage. But this Court has never suggested that public policy nullifies coverage for a remedy that is not punitive in nature, and the law is clear the SEC disgorgement payments are not punitive. Although many courts have said that SEC disgorgement is intended to deter violations of the securities laws by depriving violators of the proceeds, and the Appellate Division cited such cases (R. 1840), those cases never speak of punishment as the rationale for the disgorgement remedy. Thus, the only rationale this Court has ever recognized for barring indemnification as a matter of public policy for a particular kind of remedy - namely, that coverage should not be available for punitive damages because the purpose of that remedy is “to punish and to deter,” Hartford, 48 N.Y.2d at 226 - is inapplicable here, where the purpose of the remedy is not to punish. Moreover, it is common for the proceeds of an SEC enforcement action to be used to compensate investors. See, e.g., Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 166 (2008) (“Since September 30, 2002, SEC enforcement actions have collected over $10 billion in disgorgement and penalties, much of it for distribution to injured investors” (citing SEC, 2007 45 Performance & Accountability Report, at 26)).16 Former SEC Chairman Harvey Pitt has described the agency’s “principal goal” as “taking care of innocent investors and trying to make them whole when they have been defrauded.”17 The SEC pursued its goal of investor compensation here: the payment was used as part of the Fair Fund, pursuant to section 308(a) of the Sarbanes-Oxley Act of 2002, to compensate investors who claimed to have been harmed by the late trading and deceptive market timing of Bear Stearns’ customers. (R. 54.)18 Although it is possible for the SEC to procure disgorgement without seeking to compensate investors, the reality is that the remedy is generally used for a compensatory purpose, as it was here, to facilitate the payment of compensatory damages, which unquestionably are insurable. Prohibiting coverage whenever an insured is required to pay an award of SEC disgorgement would in some cases eliminate a source of funds to compensate investors. 16 The SEC often proudly points out the compensatory uses of payments it exacts. See, e.g., U.S. SEC FY 2011 Performance and Accountability Report, at 2 (in 2011, “$1.97 billion in penalties, disgorgement and other monetary relief has been ordered, most of which has been or will be returned to harmed investors”); available at www.sec.gov/about/secpar/secpar2011.pdf#performance (last visited Aug. 23, 2012). 17 See Harvey L. Pitt, SEC Chairman, Remarks before the U.S. Department of Justice Corporate Fraud Conference (Sept. 26, 2002), available at www.sec.gov/news/speech/spch585.htm (last visited Aug. 23, 2012). 18 As previously noted, the payment was used as an offset against the damages claimed in the civil actions, reducing Bear Stearns’ civil settlement payment to $14 million. (R. 55.) 46 2. The SEC Did Not Bar Indemnification, and There Is No Reason for New York to Adopt a Different Policy The SEC itself clearly calibrated the deterrent effect of its multiple remedies in this case. It explicitly barred the use of Bear Stearns’ separate $90 million penalty payment (for which no coverage is sought) as an offset to its liability for compensatory damages, on the ground that that bar was necessary to “preserve the deterrent effect” of the penalty. (R. 154.) It just as clearly imposed no such bar when it chose to allow Bear Stearns to use the “disgorgement” payment for purposes of offset in pending civil actions, and not to preclude Bear Stearns from seeking insurance coverage for it. (R. 55.) In concluding that coverage should be nullified in order to preserve the deterrent effect of disgorgement, the Appellate Division thus conjured a New York public policy bar that went far beyond the stated deterrence goals of the federal agency charged with enforcing the securities laws - an agency that acts based on an “assessment of how the public interest is best served.” SEC v. Citigroup Global Mkts., 673 F.3d 158, 164 (2d Cir. 2012). And in doing so, the Appellate Division also contravened New York public policy, under which courts do not effectuate forfeitures of insurance coverage and other contractual rights in order to buttress deterrence of conduct that is already regulated by other means. New England Mut., 73 N.Y.2d at 82; Charlebois, 72 N.Y.2d at 595. 47 III. THE APPELLATE DIVISION ERRONEOUSLY ASSUMED THAT BEAR STEARNS ENGAGED IN WRONGFUL CONDUCT WARRANTING THE NULLIFICATION OF ITS INSURANCE COVERAGE There are no proven facts on this record upon which it would have been permissible for the Appellate Division to conclude that Bear Stearns engaged in any wrongful conduct, much less conduct warranting the nullification of Bear Stearns’ insurance coverage. To reach the contrary result, the Appellate Division turned CPLR 3211(a)(1) upside down, drawing numerous negative inferences about Bear Stearns’ acts and intentions. The Appellate Division compounded that error by treating the SEC findings as undisputed, which is contrary both to the SEC Order itself (in which the SEC acknowledged that Bear Stearns was not admitting the SEC’s allegations) and to abundant authority that unadjudicated agency findings may not be treated as proven facts. In reality, there are numerous facts in the record that negate the allegations of wrongful conduct that the Insurers made and the Appellate Division erroneously accepted. (Point III.A.) Moreover, the SEC findings, even if it were proper to credit them, do not support the nullification of the Insurers’ coverage obligations, because they are not based on a claim that Bear Stearns intended to injure investors. (Point III.B.) 48 A. There Are Extensive Facts in the Record Rebutting Any Inference That Bear Stearns Intended to Harm Investors 1. The Documentary Evidence Is Not Remotely Sufficient to Support the Dismissal of Bear Stearns’ Claim The Appellate Division improperly treated non-adjudicated, non-admitted and indeed vigorously disputed “findings” as undisputed facts when it reasoned that given the findings in the SEC Order, “it cannot be seriously argued that Bear Stearns was merely found guilty of inadequate supervision and a failure to place adequate controls on its electronic entry system.” (R. 1844.) First, by weighing what could “be seriously argued” based on the documents before it, the Appellate Division turned CPLR 3211(a)(1) on its head. Under CPLR 3211(a)(1), it is the non-movant, not the movant, that is entitled to every favorable inference when opposing a motion to dismiss based on documentary evidence. 511 W. 232nd Owners Corp. v. Jennifer Realty Co., 98 N.Y.2d 144, 152 (2002). The Appellate Division’s conclusion is incompatible with that standard and with the requirement that such a motion may be granted only if the documentary evidence conclusively establishes a defense as a matter of law. Id. In reality, only two facts are undisputed by Bear Stearns: that the SEC made a claim against Bear Stearns for “disgorgement,” which it linked, in the SEC Order, only to Bear Stearns’ customers’ gains (R. 118, ¶ 5), and that Bear Stearns 49 made a payment to settle that claim. Everything else the SEC found has been disputed by Bear Stearns by submission of its Wells Submission on this motion. Specifically, the facts show that Bear Stearns did not make late trades or engage in market timing on its own account - indeed, the SEC did not allege that it did - and Bear Stearns did not derive greater compensation for late trading or market timing transactions than it did on any other mutual fund trades it cleared, or derive greater compensation when its customers’ trades were profitable than when they were not. (R. 1440, 1447, n. 14.) Bear Stearns introduced the MFRS (which a small number of introducing brokers eventually used for late trading) in order to improve efficiency - not in order to enable customers to evade the rules - and there were many circumstances, fully authorized under the then-applicable industry standards and rules, under which a customer could enter a trade in the MFRS after 4:00 for purposes other than late trading. (R. 1452-54.) These facts, which must be credited on a motion to dismiss, rebut any contention that Bear Stearns intended for its customers to conduct illegal late trading, much less that Bear Stearns intended any resulting injury to the mutual funds. The same is true with respect to market timing. The record contains ample evidence that many mutual funds welcome market timing, which is not necessarily illegal and may be beneficial to the markets. (R. 1437, 1457.) The evidence also shows that when mutual funds indicated that they did not welcome market timing 50 trades, Bear Stearns so informed its customers and tried to block the offending trades, thereby losing the business of numerous customers. (R. 1458-63.) The SEC itself admitted that Bear Stearns blocked such trades. (R. 122, ¶ 29.) It is possible that, as the SEC alleged, an even more “effective” system to block deceptive market timing could have been implemented, but it cannot be concluded on that basis that Bear Stearns intended to facilitate deceptive market timing. Certainly the documentary evidence on this record does not conclusively refute Bear Stearns’ claim for coverage. As Bear Stearns explained in the Wells Submission, any evasion of these blocking systems by Bear Stearns’ customers was not the result of any scheme or policy of Bear Stearns but, at most, the result of unauthorized actions by individual brokers. (R. 1456-59; 1483-86.) In light of these facts and the CPLR 3211(a)(1) standard, the Appellate Division’s denial of coverage based on its finding that it could not be “seriously argued that Bear Stearns was merely found guilty of inadequate supervision and a failure to place adequate controls on its electronic entry system” (R. 1844) was clearly wrong. 2. Nullifying Coverage Based on the SEC’s Findings Is Contrary to the Terms of the SEC Order and the Terms of the Insurance Policy In treating the SEC’s findings as undisputed facts, the Decision nullifies express terms at the heart of the settlement, under which Bear Stearns consented to 51 entry of the Order and findings “[s]olely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein” (R. 116) and was not precluded from disputing the SEC’s findings in litigation with third parties (R. 1687).19 The Insurers’ response below was that whatever right Bear Stearns reserved in the SEC Order to dispute the contentions of other “third parties,” Bear Stearns could not assert that right in a coverage action against the Insurers. But the settlement agreement provisions do not differentiate insurers from other third parties. (R. 116.) The Insurers’ attempt to nullify coverage based on unadjudicated allegations of intentional misconduct is also irreconcilable with the language of the Policy’s dishonest act exclusion, in which the Insurers expressly promised to provide coverage to Bear Stearns unless there was a final adjudication in the underlying action conclusively establishing that excluded conduct occurred. The Policy provided that the “Insured(s)”: 19 The Decision also runs counter to a fundamental principle of insurance law set forth by this Court in Servidone Construction Corp. v. Security Insurance Co. of Hartford, 64 N.Y.2d 419, 423-25 (1985), that coverage for settlements can only be determined on the basis of the actual facts regarding the nature of the “loss compromised.” The nature of the loss is clear here: it arises from a payment by Bear Stearns, based on alleged ill-gotten gains received by Bear Stearns’ customers (R. 118), and used to compensate mutual funds investors. 52 shall be protected under the terms of this policy with respect to any Claim(s) made against them in which it is alleged that such Insured(s) committed any deliberate, dishonest, fraudulent or criminal act or omission, unless judgment or other final adjudication thereof adverse to such Insured(s) shall establish that such Insured(s) were guilty of any deliberate, dishonest, fraudulent or criminal act or omission . . . . (R. 105.) The very purpose of such a provision, which is common in the insurance market, is to provide coverage for settlements such as the one at issue here.20 By crediting the SEC’s non-adjudicated allegations, the Appellate Division rewrote the exclusion and applied it against Bear Stearns - effectively concluding that “public policy” overrode the bargained-for adjudication requirement. That is completely contrary to public policy as stated by this Court. See Goldfarb, 53 N.Y.2d at 401; Miller, 40 N.Y.2d at 679; Messersmith, 232 N.Y. at 163-65.21 20 See Pendergest-Holt v. Certain Underwriters at Lloyd’s of London, 600 F.3d 562, 573 (5th Cir. 2010) (“a final adjudication exclusion limits the insurer’s recourse if the parties settle - the most likely outcome - or if the insured is otherwise absolved of liability or guilt in the underlying action”); Little v. MGIC Indem. Corp., 836 F.2d 789, 794 (3d Cir. 1987) (in light of the final adjudication exclusion, the “policy expressly contemplates that claims against the insured may end in settlement, in which event the issue of dishonesty would never be adjudicated”). 21 Here again, Business Corporation Law § 726 is revealing. It permits a corporation to purchase insurance to indemnify its directors and officers even “in instances in which they may not otherwise be indemnified by the corporation,” Bus. Corp. L. § 726(a)(3), but adds that such insurance may not provide for any payment “(1) if a judgment or other final adjudication adverse to the insured director or officer establishes that his acts of active and deliberate dishonesty were material to the cause of action so adjudicated, or that he personally gained in fact a financial profit or other advantage to which we was not legally entitled, or (2) in relation to any risk the insurance of which is prohibited under the insurance law of this state,” Bus. Corp. L. § 726(b). Thus, in the context of authorizing corporations 53 The Appellate Division’s Decision is also contrary to the principle that findings by an administrative agency are insufficient to negate coverage. The law is settled that “a consent judgment between a federal agency and a private corporation which is not the result of an actual adjudication of any of the issues . . . . can not be used as evidence in subsequent litigation between that corporation and another party.” Lipsky v. Commonwealth United Corp., 551 F.2d 887, 893 (2d Cir. 1976) (disposition of claim “was the result of private bargaining, [with] no hearing or rulings or any form of decision on the merits” and thus may not be used in other proceedings); In re Platinum & Palladium Commodities Litig., 828 F. Supp. 2d 588, 594 (S.D.N.Y. 2011) (following Lipsky and striking from class action complaint references to findings in a Commodities Futures Trading Commission settlement); Mishkin v. Peat, Marwick, Mitchell & Co., 1988 WL 391648, at *2 (S.D.N.Y. Nov. 7, 1988) (SEC consent judgment including “findings of fact” based solely on the parties’ stipulation had no preclusive effect). This, in itself, means that the Decision’s reliance on the findings in the SEC Order was erroneous.22 to purchase D&O insurance, the Legislature recognized that certain deliberate misconduct by the insured may preclude coverage, but only if it has been finally adjudicated that such misconduct actually occurred. The same principle should apply here. 22 The Decision likewise conflicts with settled New York law under which courts do not apply collateral estoppel based on consent orders entered in administrative proceedings. See Halyalkar v. Bd. of Regents, 72 N.Y.2d 261, 268 (1988). 54 The law is also clear that when a private party settles a securities action or investigation without admitting wrongdoing, its choice not to admit wrongdoing must be given full effect, and coverage is available for such settlements. See, e.g., Raychem Corp. v. Federal Ins. Co., 853 F. Supp. 1170, 1177 (N.D. Cal. 1994) (where insured settled underlying case without admitting liability, the securities laws permitted indemnification by its insurer); Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598, 609, 617 (S.D.N.Y. 1980) (SEC administrative order containing findings of “willful aiding and abetting” did not preclude corporate indemnification where such “findings” were part of settlement and were neither admitted nor denied). The Decision is irreconcilable with these principles. Indeed, in barring coverage based on agency findings that the insured neither admitted nor denied, the Appellate Division failed to follow its own precedent in National Union Fire Insurance Co. of Pittsburgh, Pa. v. Xerox Corp., 25 A.D.3d 309, 310 (1st Dep’t 2006), which recognized that facts recited as part of a “neither admitted nor denied” settlement with the SEC may not be used affirmatively against an insured as a basis for denying coverage. Moreover, as discussed further in Point III.B., below, Bear Stearns’ agreement to pay “disgorgement” in no way establishes that Bear Stearns engaged in wrongful conduct, much less that it intended harm. See, e.g., SEC v. Hughes Capital Corp., 124 F.3d 449, 455 (3d Cir. 1997) (finding corporate officer jointly and severally liable for disgorgement even 55 though she had been found to have acted negligently, and not with scienter, regarding the fraud). In sum, the Appellate Division erred when it relied on unadjudicated findings to negate Bear Stearns’ coverage rights, and when, concomitantly, it nullified the settlement terms under which Bear Stearns did not admit those findings and retained the right to dispute them in proceedings with third parties. 3. By Nullifying the Provisions of the SEC Order and the Insurers’ Policies, the Appellate Division Undermined the Public Policy in Support of Settlements By undermining the parties’ bargain that the SEC findings are not admitted and will not have any evidentiary value, the Decision makes it more difficult for public agencies to settle cases, and impedes New York’s public policy favoring settlement. See, e.g., Booth v. 3669 Delaware, Inc., 92 N.Y.2d 934, 935 (1998). This Court undoubtedly is aware of Judge Rakoff’s highly-publicized rejection of a proposed settlement between the SEC and Citigroup, under which Citigroup did not admit or deny the SEC’s allegations. SEC v. Citigroup Global Mkts. Inc., 2011 WL 5903733 (S.D.N.Y. Nov. 28, 2011). In response, the SEC and Citigroup sought to set aside the decision, and, pending resolution of that application, sought a stay of the trial Judge Rakoff had ordered. The Second Circuit granted the stay, for reasons that show how starkly the Appellate Division’s unprecedented “public policy” Decision conflicts with recent formulations of 56 public policy on the national level. SEC v. Citigroup Global Mkts. Inc., 673 F.3d 158 (2d Cir. 2012). In its decision, the Second Circuit “question[ed] the district court’s apparent view that the public interest is disserved by an agency settlement that does not require the defendant’s admission of liability.” Id. at 165. As the court observed, “[r]equiring such an admission would in most cases undermine any chance for compromise.” Id. Exactly the same is true here: if courts were free to nullify the bargained-for provisions of consent orders whereby settling parties do not admit or deny SEC (or other agency) findings, and retain the right to seek insurance coverage for the part of their settlement payment labeled as “disgorgement,” settlements would be discouraged. Like the district court’s decision in Citigroup, the Decision nullifies the arms’ length, bargained-for effect of the provisions of the SEC settlement here, and of many other settlements on consent with public agencies. As in Citigroup, there was never any hearing or adjudication with respect to the SEC’s findings in this case. To the contrary, the SEC Order makes explicit that the “findings” should have no preclusive effect in any other proceeding. (R. 116.) There is no question that Bear Stearns’ consent to the issuance of the SEC Order was predicated on these provisions, the express purpose of which was to afford Bear Stearns the legal right to contest the findings in proceedings with third 57 parties, which it exercised in this proceeding by relying on the Wells Submission. In nevertheless treating the findings as true for purposes of determining the availability of insurance coverage on the Insurers’ motion to dismiss, the Decision violates basic rules of New York law and will chill settlement of securities cases. It is an unwarranted expansion of public policy that should be rejected. B. The SEC’s Disgorgement Award Was Not Based on Allegations, Much Less an Adjudication, That Bear Stearns Acted with an Intent to Harm Knowing that the allegations against Bear Stearns were not adjudicated, the Insurers have argued that this case fits within the very narrow class of cases holding that coverage may be nullified, regardless of the nature of the award, and regardless of the actual facts, where the conduct of the insured for which it became liable was inherently injurious. But those cases are wholly inapposite here. The paradigmatic case the Insurers pointed to below is Allstate Insurance Co. v. Mugavero, 79 N.Y.2d 153 (1992), where the insured was accused of child molestation. The Court held that the harm resulting from the alleged conduct was “inherent” in the conduct itself and thus precluded coverage under the intentional acts exclusion in his homeowner’s policy. Id. at 161. The class of conduct that is “inherently” harmful is, however, quite narrow; New York courts have never expanded it beyond the kind of horrific sex crime that Mugavero exemplifies. To find “inherent” harm in other kinds of conduct would erode the fundamental 58 concept that an insured may be accused of, or even perform, intentional (but negligent or reckless) acts without intending any resulting harm. See, e.g., Goldfarb, 53 N.Y.2d at 399; Messersmith, 232 N.Y. at 165, 166. Thus, in Town of Massena v. Healthcare Underwriters Mutual Insurance Co., 98 N.Y.2d 435, 445 (2002), this Court held that public policy will not be found to bar coverage based on a claimant’s allegations so long as liability could have been imposed on the basis of recklessness. The facts of Town of Massena are instructive. The claimant (Franzon) alleged a clearly intentional course of conduct - a “concerted campaign of harassment designed to punish him for exercising his right to free speech,” including “overt and malicious acts” designed to “excommunicate him from, and ruin him in, the Massena medical community” - and that the insured hospital had “intentionally and maliciously made false statements to Franzon’s patients, potential patients, and the community at large in an effort to damage his reputation as a doctor.” 98 N.Y.2d at 442-44. As a limited public figure, however, the claimant could have established liability for defamation based on the hospital’s “reckless disregard” for the truth. Id. at 445 (emphasis in original). Under these circumstances, the Court concluded, “[s]uch defamatory statements would be covered by [the Hospital’s] policy and would not be precluded by public policy.” Id. 59 Under the principles stated in Town of Massena, Goldfarb, and Messersmith - and in contrast to the narrow class of cases exemplified by Mugavero - Bear Stearns cannot be deprived of coverage on public policy grounds because (apart from the fact that intent to harm has never been adjudicated) the SEC did not even allege that Bear Stearns intended to cause harm to anyone, and its alleged conduct was not inherently harmful. Thus, even if the SEC’s findings were to be credited (and they cannot), Bear Stearns would still be entitled to coverage. Although the Insurers try to make much of the references in the SEC Order to “willful” violations of the securities laws, those references cannot bear the weight the Insurers and the Appellate Division put on them. In SEC parlance, an assertion of “willfulness” merely connotes that the respondent is being charged with “intentionally committing the act which constitutes the violation.” Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). For instance, in Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000), the court upheld a finding of “willfulness” based on the defendant’s failure to conduct an adequate investigation into the sources of unregistered securities - a failure that obviously falls far short of establishing that the defendant intended to harm investors. The same is true of the SEC’s allegations that Bear Stearns failed to institute adequate controls to prevent late trading and market timing here. Indeed, the federal district court overseeing the civil litigation on these claims recognized the broad scope of scienter under the 60 securities laws when it denied a motion to dismiss in one of the cases in which investors sued Bear Stearns based on the allegations in the mutual funds investigation at issue here. In re Mut. Funds Inv. Litig., 384 F. Supp. 2d 845, 865 (D. Md. 2005) (“plaintiffs have adequately pled facts sufficient to show that . . . Bear Stearns . . . acted knowingly or recklessly”) (emphasis added).23 The SEC charges were based in part on alleged violations of Section 22(c) of the Investment Company Act, and Rule 22c-1(a) promulgated thereunder. According to the SEC, simply by clearing its customers’ trades after the 4:00 p.m. market close, whether or not it knew the trades themselves to have been initiated after the market close, Bear Stearns violated Section 22(c) and Rule 22c-1(a). (R. 1475-77.) This allegation clearly provides no basis for an inference of intent to harm, and the possibility that the SEC could have prevailed based on evidence supporting this allegation alone is enough, in itself, to establish that the SEC’s claims are insufficient to conclusively demonstrate that Bear Stearns’ conduct was uninsurable. See Goldfarb, 53 N.Y.2d at 399. 23 See also Howard v. SEC, 376 F.3d 1136, 1143 (D.C. Cir. 2004) (a secondary actor may be held liable for aiding and abetting securities laws violation even if he is unaware the conduct is illegal); Hughes, 124 F.3d at 455 (finding liability although defendant acted negligently, and not with scienter, regarding the fraud); Sirota v. Solitron Devices, Inc., 673 F.2d 566, 575 (2d Cir. 1982) (“proof of reckless conduct meets the requirement of scienter in a section 10(b) claim”); SEC v. Champion Sports Mgmt., Inc., 599 F. Supp. 527, 534 (S.D.N.Y. 1984) (recklessness meets the scienter requirements under Securities Act § 17(a)(1)). 61 The fact that the remedy the SEC sought was disgorgement changes nothing, as the SEC, in seeking that remedy, did not allege, or need to allege, that Bear Stearns intended to injure investors. “The crafting of a remedy for violations of the 1934 Act lies within the district court’s broad equitable powers,” which include the power to order disgorgement. SEC v. Fischbach, 133 F.3d 170, 175 (2d Cir. 1997); see also 15 U.S.C. § 78u(d)(5) (the court may order “any equitable relief that may be appropriate or necessary for the benefit of investors”). The only additional element the SEC must prove to obtain the remedy of disgorgement, beyond the violation of the securities laws, is a reasonable approximation of the gains to be disgorged. Absolutefuture.com, 393 F.3d at 97 (as long as total disgorgement amount does not exceed combined profits of defendants, “the trial court retains its traditional discretion to formulate a disgorgement remedy”). Because an insured can incur liability under the securities laws without intending to harm investors, coverage for such claims cannot be nullified based on presumed intent to harm. Thus, in Raychem, shareholders accused the management of a company of violating Securities Exchange Act § 10(b) and Rule 10b-5, which are among the laws the SEC invoked here. (E.g., R. 146.) The case settled, the defendants sought coverage, and the insurer disclaimed coverage based on a California statute that prohibits insurance for losses where the insured acted with a “preconceived design to inflict injury.” Raychem, 853 F. Supp. at 1180. 62 The court held that because “recklessness may satisfy the element of scienter in a civil action for damages under § 10(b) and Rule 10b-5,” coverage was not barred. Rather, only if the insurer could prove that the insureds “made knowing misrepresentations” might they be able to establish such a defense. Id. at 1179, 1180. Thus, because it is possible to establish § 10(b) liability without proving that the defendant intended to cause injury, allegations under § 10(b) cannot possibly bring the matter within the narrow class of cases where the insured’s intentionally harmful conduct precludes recovery. Exactly the same principle applies in this case under the New York authorities discussed above. See, e.g., Town of Massena, 98 N.Y.2d at 445; Goldfarb, 53 N.Y.2d at 399; Messersmith, 232 N.Y. at 165. Here, too, the SEC did not allege that Bear Stearns acted with an intent to harm, and no such claim inheres in the facts alleged. Rather, the SEC Order repeatedly refers to Bear Stearns’ alleged recklessness (R. 118, ¶ 4; R. 122, ¶¶ 30, 31), and it makes these references in the context of faulting Bear Stearns for its alleged failure to establish or enforce proper controls to prevent its customers’ alleged late trading and deceptive market timing practices. (See R. 117-18, ¶¶ 1-5; R. 121-22, ¶¶ 22-31; R. 131, ¶¶ 82-83.) These allegations include facts that show that Bear Stearns sought to control unauthorized market timing, and the SEC was taking it to task for its alleged failure to make those measures more “effective.” For example, the SEC alleged that: 63 29. In the over four-year period of the activity described in this Order, BSSC [Bear Stearns] received thousands of stop notices from mutual funds. BSSC forwarded these stop notices to timers and, as discussed in greater detail below, blocked the accounts identified in particular mutual funds’ stop notices from trading in those funds. BSSC did not, however, implement effective measures to stop the violative trading except when the complaining mutual fund threatened to cancel its dealer agreement with BSSC. In that circumstance, the firm was able to, and did, put a swift end to all unwanted trading in the affected funds. (R. 122, ¶ 29 (emphasis added); see also id., ¶ 31; R. 118, ¶ 4; R. 144, ¶ 167.) The SEC’s admission that Bear Stearns tried to block unauthorized market timing confirms that the SEC was seeking recovery on a legal theory under which Bear Stearns could be liable without intending to harm investors, even if - contrary to the law reviewed in Point III.A., above - it were permissible for a court to disregard the extensive evidence in Bear Stearns’ Wells Submission disputing the SEC’s factual allegations. The SEC Order did not charge that Bear Stearns had adopted policies designed to facilitate the deceptive market timing practices of its customers. Nor did it allege that Bear Stearns established a timing desk to function as a facilitator of deceptive market timing. To the contrary, the SEC acknowledged that Bear Stearns had established the timing desk for the lawful and appropriate purpose of monitoring the market timing of its customers, much of which was permitted by the mutual funds, and to block timing in those mutual funds that prohibited such trading. (R. 117-18, ¶ 4.) Even apart from the explanation Bear Stearns provided 64 (e.g., R. 1456-59, 1483-86), that is not intentional and inherently harmful conduct. This in itself is reason enough to reject the Insurers’ intentional harm argument. With respect to late trading, the SEC asserted that Bear Stearns facilitated such trading by giving some of its customers access to an order entry system (called “MFRS”) that allowed those customers to enter trades directly and to do so after the market close. Again, even putting aside Bear Stearns’ explanation of the facts,24 it cannot be said - and the SEC did not find - that this conduct was intentionally harmful. (R. 145-46.) In short, for the purpose of a coverage defense based on the allegation that Bear Stearns intended the harm that allegedly resulted from the conduct alleged in the SEC’s findings, the only undisputed facts are that Bear Stearns was accused of violating the securities laws and made a payment to settle that claim. Bear Stearns did not admit the findings and they cannot be treated as proven facts establishing the intent to harm defense. The Appellate Division’s apparent conclusion to the contrary was irreconcilable with state and federal law. 24 In its Wells Submission, Bear Stearns demonstrated that affording its customers the ability to enter orders directly into MFRS was designed to improve efficiency and was wholly unrelated to any design to facilitate late trading. (R. 1451-54.) Bear Stearns’ order entry system was kept open after the market close due to logistical difficulties in processing trades made shortly before the market close. (R. 1452-53.) As noted in the Wells Submission, the SEC’s investigation uncovered no evidence of a deliberate effort by Bear Stearns to design a system that would allow its customers to evade the rules governing late trading. (R. 1454; 1465-75.) 65 CONCLUSION For all the foregoing reasons, the Decision of the Appellate Division should be reversed. Dated: August 27, 2012 New York, New York PROSKAUER ROSE LLP By: /s/ John H. Gross John H. Gross Eleven Times Square New York, NY 10036 (212) 969-3000 Attorneys for Plaintiffs-Appellants Of Counsel: Francis D. Landrey Steven E. Obus Seth B. Schafler Matthew J. Morris CERTIFICATE FOR IDENTICAL COMPLIANCE I, Ramiro A. Honeywell, certify that this electronic Brief for Plaintiffs- Appellants is identical to the filed original printed materials, except that they need not contain an original signature. Dated: August 27, 2012 _______________________ Ramiro A. Honeywell /s/ Ramiro A. Honeywell