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. REPLY 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: December 7, 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. TABLE OF CONTENTS Page PRELIMINARY STATEMENT ............................................................................... 1 SUMMARY OF ARGUMENT ................................................................................. 3 ARGUMENT ........................................................................................................... 11 I. BEAR STEARNS’ LOSS WAS COVERED AND DID NOT CONSIST OF THE RELINQUISHMENT OF BEAR STEARNS’ ILL-GOTTEN GAINS .............................................................. 11 A. Bear Stearns’ Loss Was within the Core of the Coverage the Insurers Sold .................................................................................. 12 B. Bear Stearns Would Not Be Unjustly Enriched by Being Indemnified for Its Loss ...................................................................... 16 II. COVERAGE FOR BEAR STEARNS’ LOSS SHOULD NOT BE NULLIFIED FOR THE SAKE OF “DETERRENCE” .......................... 21 III. BEAR STEARNS DID NOT ADMIT TO CONDUCT WARRANTING THE NULLIFICATION OF ITS INSURANCE COVERAGE ......................................................................... 28 A. Under the SEC Order and the Offer of Settlement, Bear Stearns Retained the Ability to Prove the Actual Facts Regarding Its Conduct in Litigation with Third Parties, Including in This Coverage Case ........................................................ 29 B. Findings Made in Administrative Orders and Settlements Are Not Given Preclusive Effect, Including in Insurance Coverage Cases ................................................................................... 33 1. It Makes No Difference That the SEC Was Required to Make Findings to Conclude Its Proceeding ................................................................................. 33 2. Bear Stearns Retained the Right, for Coverage Purposes, to Prove That It Did Not Engage in Intentionally Harmful Conduct ................................................. 39 -ii- IV. THE DOCUMENTARY EVIDENCE DOES NOT CONCLUSIVELY ESTABLISH THAT BEAR STEARNS COMMITTED INHERENTLY HARMFUL ACTS .................................... 44 A. Violations of the Securities Laws Are Not “Inherently Harmful” Conduct ............................................................................... 44 B. The SEC’s Findings Do Not Establish That Bear Stearns Engaged in Intentionally or Inherently Harmful Activity ................... 47 V. THE SEC ORDER DOES NOT CONCLUSIVELY ESTABLISH THAT THE PERSONAL PROFIT EXCLUSION APPLIES ....................................................................................................... 50 A. The Purpose of the Exclusion, New York Insurance Law and Public Policy Require That the Exclusion Be Construed Strictly against the Insurers ............................................... 52 B. The SEC Claim Was Not “Based upon or Arising Out of” Bear Stearns’ Personal Profit .............................................................. 53 C. There Is No Claim That Bear Stearns Obtained Funds to Which It Was Not Legally Entitled ..................................................... 57 D. Nothing Has Been Determined against Bear Stearns “in Fact” .................................................................................................... 58 VI. THE SEC ORDER DOES NOT CONCLUSIVELY ESTABLISH THAT THE KNOWN WRONGFUL ACTS EXCLUSION APPLIES ............................................................................... 60 A. The Insurers’ Abandonment Claim Is Meritless ................................. 60 B. The Documentary Evidence Does Not Conclusively Establish That the Known Wrongful Acts Exclusion Applies ................................................................................................. 62 1. The SEC Order Does Not Conclusively Establish That a Bear Stearns Officer Knew as of March 21, 2000 That a Wrongful Act Had Occurred ................................ 64 2. The SEC Order Does Not Conclusively Establish that the Unnamed Individuals Mentioned in that Order Were Bear Stearns “Officers” ........................................ 68 -iii- 3. The SEC Order Does Not Conclusively Establish That a Bear Stearns Officer Knew or Could Have Reasonably Foreseen That a Claim Could Result .................... 70 CONCLUSION ........................................................................................................ 73 TABLE OF AUTHORITIES Page(s) CASES A.D. Julliard & Co. v. Johnson, 259 F.2d 837 (2d Cir. 1958) ............................................................................... 35 Accessories Biz., Inc. v. Linda & Jay Keane, Inc., 533 F. Supp. 2d 381 (S.D.N.Y. 2008) ................................................................ 46 AG Capital Funding Partners, L.P. v. State St. Bank & Trust Co., 5 N.Y.3d 582 (2005) ........................................................................................... 11 AIU Ins. Co. v. Superior Court, 799 P.2d 1253 (Cal. 1990) .................................................................................. 13 Alanco Tech., Inc. v. Carolina Cas. Ins. Co., 2006 WL 1371633 (D. Ariz. May 17, 2006) ...................................................... 17 Allstate Ins. Co. v. Mugavero, 79 N.Y.2d 153 (1992) ............................................................................. 45, 47, 48 Alstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376 (D. Del. 2002) .............................................................. 52, 54 Am. Century Servs. Corp. v. Am. Int’l Specialty Lines Ins. Co., 2002 WL 1879947 (S.D.N.Y. Aug. 14, 2002) ............................................. 56, 57 Atl. Mut. Ins. Co. v. Terk Techs. Corp., 309 A.D.2d 22 (1st Dep’t 2003) ................................................................... 46, 63 Austro v. Niagara Mohawk Power Corp., 66 N.Y.2d 674 (1985) ......................................................................................... 44 Avondale Indus., Inc. v Travelers Indem. Co., 887 F.2d 1200 (2d Cir. 1989) ............................................................................. 13 Baldi v. Fed. Ins. Co. (In re McCook Metals, L.L.C.), 2007 WL 1687262 (N.D. Ill. June 7, 2007) ........................................................ 55 Bank of America Corp. v. SR Int’l Bus. Ins. Co., S.E., 2007 WL 4480057 (Super. Ct. N.C. Dec. 19, 2007) .......................................... 57 -v- Bank of the West v. Superior Ct., 833 P.2d 545 (Cal. 1992) .............................................................................. 17, 25 Belt Painting Corp. v. TIG Ins. Co., 100 N.Y.2d 377 (2003) ........................................................................... 53, 68, 69 Bingham v. Atl. Mut. Ins. Co., 215 A.D.2d 315 (1st Dep’t 1995) ....................................................................... 46 Boeing Co. v. Aetna Cas. & Sur. Co., 784 P.2d 507 (Wash. 1990) ................................................................................ 14 Breed v. Ins. Co. of N. Am., 46 N.Y.2d 351 (1978) ......................................................................................... 53 Buechel v. Bain, 97 N.Y.2d 295 (2001) ......................................................................................... 64 C.R.A. Realty Corp. v. Crotty, 878 F.2d 562 (2d Cir. 1989) ............................................................................... 69 Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598 (S.D.N.Y. 1980) ..................................................................... 35 Cent. Dauphin Sch. Dist. v. Am. Cas. Co., 426 A.2d 94 (Pa. 1981) ................................................................................. 17, 25 Charlebois v. J.M. Weller Assocs., Inc., 72 N.Y.2d 587 (1988) ......................................................................................... 27 Coregis Ins. Co. v. Baratta & Fenerty, Ltd., 264 F.3d 302 (3d Cir. 2001) ............................................................................... 70 DeSantis Enters. v. American & Foreign Ins. Co., 241 A.D.2d 859, 861 (3d Dep’t 1997) ................................................................ 46 Dodge v. Legion Ins. Co., 102 F. Supp. 2d 144 (S.D.N.Y. 2000) ................................................................ 45 Excess Ins. Co. Ltd. v. Factory Mut. Ins. Co., 3 N.Y.3d 577 (2004) ..................................................................................... 30, 58 -vi- Exec. Risk Indem., Inc. v. Pac. Educ. Servs., Inc., 451 F. Supp. 2d 1147 (D. Haw. 2006) ................................................................ 17 Exec. Risk Indem. Inc. v. Pepper Hamilton LLP, 13 N.Y.3d 313 (2009) ......................................................................................... 70 FCC v. AT&T, Inc., 131 S. Ct. 1177 (2011) ........................................................................................ 51 Fed. Ins. Co. v. Kozlowski, 18 A.D.3d 33 (1st Dep’t 2005) ........................................................................... 55 Fed. Ins. Co. v. Sheldon (In re Donald Sheldon & Co..), 186 B.R. 364 (S.D.N.Y. 1995) ............................................................... 39, 51, 55 Gerrish Corp. v. Universal Underwriters Ins. Co., 947 F.2d 1023 (2d Cir. 1991) ............................................................................. 13 Halyalkar v. Bd. of Regents, 72 N.Y.2d 261 (1988) ......................................................................................... 34 Hartford Accident & Indem. Co. v. Village of Hempstead, 48 N.Y.2d 218 (1979) ......................................................................................... 23 Home Ins. Co. v. Am. Home Prods. Corp., 75 N.Y.2d 196 (1990) ................................................................................... 23, 26 In re Garner v. New York State Dep’t of Corr. Servs., 10 N.Y.3d 358 (2008) ......................................................................................... 61 In re San Juan Dupont Plaza Hotel Fire Litig., 802 F. Supp. 624 (D.P.R. 1992), ........................................................................ 25 Int’l Tel. & Tel. Corp., Commc’ns Equip. & Sys. Div. v. Local 134, Int’l Bhd. of Elec. Workers, AFL-CIO, 419 U.S. 428 (1975) ............................................................................................ 37 Jarvis Christian College v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 197 F.3d 742 (5th Cir. 1999) .............................................................................. 58 Liberty Ins. Underwriters Inc. v. Corpina Piergrossi Overzat & Klar LLP, 78 A.D.3d 602 (1st Dep’t 2010) ......................................................................... 71 -vii- Lindsay Mfg. Co. v. Hartford Accident & Indem. Co., 118 F.3d 1263 (8th Cir. 1997) ............................................................................ 13 Lipsky v. Commonwealth United Corp., 551 F.2d 887 (2d Cir. 1976) ............................................................. 33, 34, 36, 37 Little v. MGIC Indem. Corp., 836 F.2d 789 (3d Cir. 1987) ............................................................................... 38 Marafioti v. Hartford, 91 A.D.2d 974 (2d Dep’t 1983) .......................................................................... 69 MBIA, Inc. v. Fed. Ins. Co., 652 F.3d 156 (2d Cir. 2011) ............................................................................... 15 Menorah Nursing Home v. Zukov, 153 A.D.2d 13 (2d Dep’t 1989) .................................................................... 61, 62 Messersmith v. Am. Fid. Co., 232 N.Y. 161 (1921) ............................................................................... 21, 22, 24 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) .................................................... 16, 40, 41 Miller v. Continental Ins. Co., 40 N.Y.2d 675 (1976) ......................................................................................... 21 Mishkin v. Peat, Marwick, Mitchell & Co., 1988 WL 391648 (S.D.N.Y. Nov. 7, 1988) ........................................................ 36 Mortenson v. National Fire Insurance Co. of Pittsburgh, Pa., 249 F.3d 667 (7th Cir. 2001) .............................................................................. 25 Mount Vernon Fire Ins. Co. v. Creative Hous. Ltd., 88 N.Y.2d 347 (1996) ......................................................................................... 53 Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. AARPO, Inc., 1999 WL 14010 (S.D.N.Y. Jan. 14, 1999) ......................................................... 45 Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Continental Ill. Corp., 666 F. Supp. 1180 (N.D. Ill. 1987) ..................................................................... 53 -viii- Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Xerox Corp., 25 A.D.3d 309 (1st Dep’t 2006) ......................................................................... 33 New England Mut. Life Ins. Co. v. Caruso, 73 N.Y.2d 74 (1989) ........................................................................................... 27 Nortex Oil & Gas Corp. v. Harbor Ins. Co., 456 S.W.2d 489 (Tex. Civ. App. 1970) .............................................................. 17 O’Neill Investigations, Inc. v. Ill. Employers Ins. of Wausau, 636 P.2d 1170 (Alaska 1981) ............................................................................. 17 Pendergest-Holt v. Certain Underwriters at Lloyd’s of London, 600 F.3d 562 (5th Cir. 2010) ........................................................................ 38, 58 Perdue Farms, Inc. v. Travelers Cas. & Sur. Co. of Am., 448 F.3d 252 (4th Cir. 2006) .............................................................................. 55 Pereira v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 2006 WL 1982789 (S.D.N.Y. July 12, 2006) ............................................... 17, 55 Pioneer Tower Owners Ass’n v. State Farm Fire & Cas. Co., 12 N.Y.3d 302 (2009) ............................................................................. 53, 57, 68 PMI Mort. Ins. Co. v. American Int’l Specialty Lines Ins. Co., 2006 WL 825266 (N.D. Cal. Mar. 29, 2006) ..................................................... 58 Pub. Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392 (1981) ............................................................................. 44, 45, 48 Raymond Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 5 N.Y.3d 157 (2005) ........................................................................................... 38 Reliance Grp. Holdings v. Nat’l Union Fire Ins. Co., 188 A.D.2d 47 (1st Dep’t 1993) ................................................................... 16, 20 Ross v. Med. Liab. Mut. Ins. Co., 75 N.Y.2d 825 (1990) ......................................................................................... 64 Ryan v. New York Tel. Co., 62 N.Y.2d 494 (1984) ......................................................................................... 34 -ix- Ryerson Inc. v. Fed. Ins. Co., 676 F.3d 610 (7th Cir. 2012) .............................................................................. 17 Seaboard Sur. Co. v. Ralph Williams’ Nw. Chrysler Plymouth, Inc., 504 P.2d 1139 (Wash. 1973) .............................................................................. 17 SEC v. Citigroup Global Mkts., 673 F.3d 158 (2d Cir. 2012) ............................................................................... 32 SEC v. Lorin, 869 F. Supp. 1117 (S.D.N.Y. 1994) ................................................................... 25 Servidone Constr. Corp. v. Sec. Ins. Co. of Hartford, 64 N.Y.2d 419 (1985) ................................................................................... 42, 43 Singleton Mgmt. Inc. v. Compere, 243 A.D.2d (1st Dep’t 1998) .............................................................................. 64 Sphere Drake Ins. Co. v. 72 Centre Ave. Corp., 238 A.D.2d 574 (2d Dep’t 1977) ........................................................................ 46 Steadfast Ins. Co. v. Stroock & Stroock & Lavan LLP, 277 F. Supp. 2d 245 (S.D.N.Y. 2003) ................................................................ 57 Syvertsen v. Great American Ins. Co., 267 A.D.2d 854 (3d Dep’t 1999) ........................................................................ 46 Tager v. SEC, 344 F.2d 5 (2d Cir. 1965) ................................................................................... 48 Town of Massena v. Niagara Mohawk Power Corp., 45 N.Y.2d 482 (1978) ......................................................................................... 60 Unified Western Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106 (9th Cir. 2006) ............................................................................ 13 Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 6 Misc. 3d 1020(A), 2003 WL 24009803 (Sup. Ct. N.Y. Co. July 8, 2003), 10 A.D.3d 528 (1st Dep’t 2004) ................................................................... 41, 42 Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 10 A.D.3d 528 (1st Dep’t 2004) ......................................................................... 16 -x- XL Specialty Ins. Co. v. Agoglia, 2009 WL 1227485 (S.D.N.Y. Apr. 30, 2009), aff’d, 370 F. App’x 193 (2d Cir. 2010)............................................................... 63 Zurich Ins. Co. v. Shearson Lehman Hutton, Inc., 84 N.Y.2d 309 (1994) ......................................................................................... 23 STATUTES 5 U.S.C. § 551 .......................................................................................................... 37 5 U.S.C. § 551 (6) and (7) ........................................................................................ 37 15 U.S.C. §§ 77t, 78u ............................................................................................... 14 Bus. Corp. L. § 726(e).............................................................................................. 24 RULES AND OTHER AUTHORITIES 17 C.F.R. § 201.240(c)(4), (5) and (7) ..................................................................... 37 17 C.F.R. 240.3b-2 ................................................................................................... 69 17 C.F.R. 270.22c-1 ................................................................................................. 66 N.Y. C.P.L.R. 3211(a)(1) ..................................................................................passim In re Mass. Fin. Servs., Co., Exchange Act Release Nos. 2213, 2004 WL 226714 (Feb. 5, 2004) ........................................................................ 71 In re Michael Flanagan, Exchange Act Release No. 160, 2000 WL 98210 (ALJ Jan. 31, 2000) ................................................................. 71 Loss, Seligman & Paredes, Securities Regulation § 13-C, Quasijudicial Proceeding (2012) ........................................................................ 34 Black’s Law Dictionary 1193 (9th ed. 2009) .......................................................... 69 PRELIMINARY STATEMENT The Insurers sold coverage to Bear Stearns, a securities broker dealer, specifically insuring it against “any investigation by any governmental body or self-regulatory organization (SRO)” (R. 103) – precisely the kind of liability Bear Stearns incurred here when it agreed to pay money to settle an SEC investigation. The Insurers would nonetheless have the Court relieve them of all obligations under the policies they sold to Bear Stearns on the purported ground that New York’s public policy effectively rendered the coverage they offered a complete nullity. Their core contention is that, because the SEC issued an order with findings of fact (as its regulations require it to do), and in which the payment for which Bear Stearns seeks indemnification was denominated as “disgorgement” (which, apart from uninsurable penalties, is the only monetary remedy the SEC may obtain), it can be determined – on a motion under CPLR 3211(a)(1) – that the payment was uninsurable, even though Bear Stearns does not seek indemnification for the disgorgement of ill-gotten gains it received, and Bear Stearns would not be unjustly enriched by an insurance recovery; even though the order specifically provided that Bear Stearns consented to it solely for the purpose of the SEC proceedings, and without admitting the SEC’s findings; even though Bear Stearns expressly reserved the right to dispute in other proceedings the facts stated in the SEC’s findings; even though those findings were never adjudicated and have not 2 been proven; and even though the SEC neither sought to preclude Bear Stearns from seeking coverage for the disgorgement payment, nor even alleged that Bear Stearns intended to cause harm. If the Insurers’ contentions were correct, they would not merely wipe out the coverage that Bear Stearns purchased here, but would wipe out a broad swath of regulatory coverage sold to broker dealers and other regulated businesses for their protection, and for the protection of their directors and officers, including coverage for any and all payments made to settle SEC investigations. But the Insurers’ contentions are not correct. Indeed, as we show below, practically every proposition stated in the Insurers’ brief is wrong. In trying to make their case, moreover, the Insurers repeatedly and materially distort the record. In particular, the Insurers’ repeated assertion (starting at page 4 of their brief) that Bear Stearns proposed the findings contained in the SEC Order, and hence cannot disown them, is, as the Insurers know, completely false. That Bear Stearns signed an Offer of Settlement that recites the same findings found in the SEC Order does not establish that Bear Stearns proposed those findings or that it believes them to be true. Rather, as the documents Bear Stearns produced to the Insurers during discovery demonstrate, the SEC proposed the findings and gave Bear Stearns the option either to acquiesce in the inclusion of those findings in the order to be issued upon settlement, without admitting them, or 3 to refuse to settle. The facts Bear Stearns believes to be true, and was prepared to prove if the case did not settle, are stated in its Wells Submission and the Amended Complaint, not in the SEC Order, and the basis for the SEC settlement cannot be understood without considering those documents. The Insurers’ statement that Bear Stearns “agreed . . . to never dispute” the SEC’s findings (Opp. at 1) is also flat out wrong. The SEC Order clearly provides that Bear Stearns consented to it “[s]olely for the purpose of these proceedings,” and “without admitting or denying the findings” the SEC made. (R. 116.) The Offer of Settlement likewise provided that it did not affect 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, Bear Stearns expressly reserved the absolute right to dispute any factual contentions based on the findings in proceedings with third parties such as the Insurers, and has in fact done so here. The allegations in Bear Stearns’ Amended Complaint reflect what Bear Stearns is prepared to prove at trial, and, on a motion to dismiss, they must be accepted as true. SUMMARY OF ARGUMENT As we show in Point I, the Insurers misplace reliance on cases holding disgorgement payments to be uninsurable where the insured was required to relinquish funds it was not entitled to receive in the first place, and thus would be 4 unjustly enriched by an insurance recovery when it did not actually incur a loss. There is no serious dispute here, however, that Bear Stearns did suffer an out-of- pocket loss when it paid to settle the SEC investigation. Bear Stearns consented to make a “disgorgement” payment based on allegations of ill-gotten gains received by others, and does not seek indemnification for disgorgement of ill-gotten gains it received. The SEC did not allege that Bear Stearns obtained ill-gotten gains, and did not dispute Bear Stearns’ showing that its revenues (not profits) related to the trades at issue were at most $16.9 million, so that upwards of $140 million of the $160 million disgorgement payment can have related only to funds received not by Bear Stearns, but directly by Bear Stearns’ customers. And the fact that the SEC claims the ability to force persons who have received no ill-gotten gains to pay as “disgorgement” amounts that were allegedly wrongfully obtained by others shows why the cases prohibiting indemnification for restitutionary payments in order to avoid unjust enrichment of the insured are inapplicable here. The question is not what the payment is called or whether the SEC has the power to force the insured to pay it, but whether insurance would unjustly enrich the insured, and here it plainly would not. As we show in Point II, the Insurers’ fall-back argument – that the coverage they sold to Bear Stearns should be nullified as a matter of New York public policy in order to preserve the deterrent effect of the SEC’s remedy – is equally meritless. 5 If the Court were to adopt such an unwarranted rule, it would work a sea change in New York public policy. The only remedy that this Court has ever held uninsurable on public policy grounds is punitive damages. The Court has done so because the purpose of punitive damages is not merely to deter, but to punish – i.e., to express societal outrage at highly immoral and harmful conduct – and because punitive damages, practically by definition, are never used for compensation. SEC disgorgement, by contrast, is not punitive in nature, and has nothing to do with the expression of societal outrage (or with conduct that is necessarily reprehensible). Moreover, it may be (and in this case was) used for compensatory purposes. The Insurers ignore these differences between punitive damages and disgorgement, and harp on a perceived general public interest in deterring misconduct. But if that were sufficient reason to nullify coverage, no remedy for alleged securities laws violations, public or private, would be insurable, and there would certainly be no point in buying insurance for government and SRO investigations (in which deterrence is a goal of the remedy). The Insurers have no answer to this or to Bear Stearns’ showing that the applicable public policy is to hold parties to the contractual obligations they incur, avoid windfalls and forfeitures, and not distort the law of contracts by using it to advance regulatory or penal goals that are already served by other laws. Indeed, the Insurers would walk away from their express agreement that even unequivocal allegations of dishonest or fraudulent 6 conduct would not be excluded from coverage absent a final adjudication in the underlying matter that the insured actually engaged in such conduct – an adjudication that never occurred here. Nor do the Insurers answer Bear Stearns’ showing that in this case the SEC itself determined how to enforce the securities laws and what parts of the settlement payment to designate as a penalty, and chose not to impede Bear Stearns from seeking coverage for the disgorgement payment or to use it to obtain an offset against the compensatory damages claimed in civil actions – a choice that the New York courts have no reason to override. As we show in Point III, the Insurers’ next argument – that because Bear Stearns agreed to the SEC Order, it should be barred in this coverage action from contesting any finding therein – is contrary to the text of the order itself and to all the relevant law. If the provisions stating that Bear Stearns consented to the order “[s]olely for the purpose of these proceedings,” and “without admitting or denying the findings” mean anything, they mean that Bear Stearns retained the right to demonstrate here that it incurred an insurable loss and that that loss is not based on Bear Stearns’ having done anything intentionally or inherently harmful. The core of the Insurers’ argument is that if a party enters into a settlement with the government in an administrative proceeding where the agency must make findings of fact, those findings become the agreed-upon determination of the facts for all purposes, even when the document itself provides just the contrary – that the 7 respondent does not admit the findings and reserves the right to contest them in other proceedings. The Insurers’ view renders the actual language of the order meaningless. It also runs counter to settled law under which non-adjudicated administrative orders are not given preclusive effect. Under those cases – and contrary to the Insurers’ argument – it makes no difference whether the agency makes findings or not, or whether the third party that seeks to give the order preclusive effect is an insurance company or somebody else. Indeed, the Insurers’ argument turns the law upside down: if the law will not give preclusive effect to findings in a consent judgment based on allegations made by the SEC when it seeks an injunction, which must be approved by a court, it surely will not give preclusive effect to findings made in an order entered on consent in an agency proceeding, where the procedures are less protective of the private litigant’s rights and court approval is not required. The Appellate Division cases the Insurers cite for their proposed rule do not support it, but merely hold that if the insured is unable to raise an issue of fact as to whether it obtained ill-gotten gains, it cannot obtain coverage. They do not hold (and this Court should not hold) that even where the terms of the administrative order permit the insured to present the facts in litigation with third parties, the presence of findings in the order negates those terms and precludes the insured from proving the actual facts. 8 In Point IV, we show that the Insurers’ argument that the securities law violations of which Bear Stearns was accused involve inherently harmful conduct, for which insurance is never available, grossly overreaches. The only conduct this Court has ever found “inherently harmful,” so that public policy bars coverage regardless of the insured’s actual intent, is child molestation; neither this Court nor any other has ever put violations of the securities laws in the “inherently harmful” category, and for good reason. It is possible to violate the securities laws without intending to harm anybody, and there is ample basis in the record to conclude that that is what happened here. The Insurers try to create a different impression with lurid references to Bear Stearns as the “hub” of a “scheme” to “defraud” investors, but the actual facts – indeed, even the allegations by the SEC in its order – are otherwise. Bear Stearns’ customers (not Bear Stearns) engaged in market timing (which is generally legal and often not objected to by mutual funds) and late trading (which Bear Stearns could only have prevented by prohibiting its customers from entering any trades after the close of trading, even where such entries were legal). All of this customer activity occurred without any benefit to Bear Stearns, and the SEC alleged that Bear Stearns did not have adequate controls in place to stop such conduct, and in some instances facilitated it. Those SEC allegations – even if credited and even if considered without reference to any other evidence favorable to Bear Stearns – do not conclusively establish that Bear 9 Stearns intended to harm investors or did anything inherently harmful as a matter of insurance law. And when the allegations in Bear Stearns’ Amended Complaint and its Wells Submission are considered, as they must be, the impropriety of the Insurers’ argument on a motion to dismiss is all the more clear. As we show in Point V, the Insurers’ argument that coverage is barred by the personal profit exclusion is also wrong because the SEC Order does not conclusively establish that Bear Stearns – which had just $16.9 million in revenue as a result of the allegedly wrongful trades – received any profit or advantage at all, as the exclusion would require, much less that the SEC’s charges arose out of Bear Stearns’ receipt of such a gain. The exclusion is ambiguous at best, and inapplicable on this record to the SEC’s claim, which alleged securities law violations that were not dependent upon proof of receipt of ill-gotten gains by anyone and that resulted in activity profitable to Bear Stearns’ customers. Moreover, for the exclusion to apply, the Insurers would have to prove that Bear Stearns “in fact” obtained such profits, which is not possible on the record here, and could only conceivably apply to the extent of such profit (if any). If the exclusion applied here, it would apply in every SEC case, and indeed in every case alleging wrongdoing by a corporate entity engaged in a profit-making enterprise, and the result once again would be that the coverage the Insurers sold was a fraud on policyholders. 10 And as we show in Point VI, the argument of two of the Insurers, Lloyd’s and AAIC (together, “Underwriters”) that the known wrongful acts exclusion in their excess policy bars coverage is equally unavailing. First, their contention that Bear Stearns “abandoned” the right to dispute this argument is absurd. The Appellate Division did not rely on or address the argument, so there was no occasion for Bear Stearns to address it in its opening brief on appeal. On the merits, the exclusion could only apply if Underwriters prevailed on several disputed issues of fact, including what Bear Stearns’ officers knew before March 21, 2000 concerning deceptive market timing or late trading; who at Bear Stearns knew such facts and whether they were “officers” of Bear Stearns within the meaning of the exclusion; and whether the facts known to Bear Stearns’ officers before March 21, 2000 were sufficient for those officers to know or reasonably foresee that Bear Stearns’ actions could lead to the claims for which coverage is sought. All of those issues are disputed and none are resolved by the terms of the SEC Order, which did not even address them. In short, Underwriters’ attempt to prevail based on that exclusion in the present procedural posture is, at best, completely premature. (Point VI.) 11 ARGUMENT The Insurers turn the applicable CPLR 3211(a)(1) standard on its head when they contend that if a plaintiff’s allegations merely “are contradicted by documentary evidence, the Court need not presume that those allegations are true.” (Opp. at 39-40.) The resolution of any such contradictions is what trials are for. The test on a motion to dismiss is whether the documentary evidence “conclusively refutes” the plaintiff’s allegations. AG Capital Funding Partners, L.P. v. State St. Bank & Trust Co., 5 N.Y.3d 582, 591 (2005). The Insurers’ further assertion that the “totality of the record” supports the Appellate Division’s conclusion (Opp. at 41) is effectively an admission that the Insurers cannot prevail under the actual CPLR 3211(a)(1) standard, but instead would have the Court extract from the record only a selective mix of information and inferences unfavorable to Bear Stearns, while disregarding the rest. That approach is a complete inversion of what CPLR 3211(a)(1) in fact requires. I. BEAR STEARNS’ LOSS WAS COVERED AND DID NOT CONSIST OF THE RELINQUISHMENT OF BEAR STEARNS’ ILL-GOTTEN GAINS Bear Stearns showed in its opening brief (at 23-32) that it incurred a loss within the core of the coverage the Insurers sold, and that requiring the Insurers to indemnify Bear Stearns for that loss would not result in Bear Stearns’ unjust enrichment. It thus showed that a recovery by Bear Stearns would not implicate 12 the concern expressed in cases cited by the Appellate Division where the court denied insurance recovery when the insured was required to relinquish as restitution or disgorgement gains to which it was not legally entitled. The Insurers hardly attempt to address the first point at all, and, as to the second, they misstate the case law, which does not show that allowing coverage for the payment Bear Stearns made would result in its unjust enrichment. A. Bear Stearns’ Loss Was within the Core of the Coverage the Insurers Sold First, it is effectively undisputed that the $160 million Bear Stearns paid to settle the SEC investigation was a Loss Bear Stearns was legally obligated to pay as a result of Claims for its alleged Wrongful Acts. The Insurers’ contention that Bear Stearns did not make the payment “as damages” (Opp. at 69-71) – which they did not even argue to the Appellate Division – is wrong because “damages,” for insurance purposes, is much broader than compensatory damages (which is the only monetary remedy for which coverage would be available under the Insurers’ argument). As defined in the Policy, “Loss” includes “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,” as well as “costs, charges and expenses or other damages incurred in connection with any investigation by any governmental body or self-regulatory organization.” (R. 103.) 13 Obviously this is not limited to “compensatory damages.” The Insurers make absolutely no attempt to show why the payment Bear Stearns made does not qualify either as a “settlement” or as a “cost, charge [or] expense,” because they cannot. As Bear Stearns showed in its opening brief (at 27-28), many courts have recognized that coverage is not determined by the label on the remedy but by the real nature of the relief sought. See, e.g., Unified Western Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106, 1115 (9th Cir. 2006);1 Lindsay Mfg. Co. v. Hartford Accident & Indem. Co., 118 F.3d 1263, 1271 (8th Cir. 1997) (liability policy that covered payments made “as damages” included coverage for environmental cleanup costs incurred by the insured in settlement of government investigation); Gerrish Corp. v. Universal Underwriters Ins. Co., 947 F.2d 1023, 1030 (2d Cir. 1991) (holding that insurer agreed to pay all sums insured was required to pay in cleanup costs, “regardless of the technical, legal characterization of the particular judgment”); Avondale Indus., Inc. v Travelers Indem. Co., 887 F.2d 1200, 1206 (2d Cir. 1989) (“damages” included payments made as equitable relief); AIU Ins. Co. v. Superior Court, 799 P.2d 1253, 1266 (Cal. 1990) (the “mere 1 The Insurers attempt to distinguish Unified Western Grocers by arguing that there, the underlying plaintiff sought both compensatory and restitutionary relief. (Opp. at 36, n. 6.) That argument misses the point, which is that the relief the plaintiff sought was called “restitution,” but the court recognized that the name of the remedy did not determine whether the insured had an insurable loss. 14 characterization of relief under federal law . . . is not dispositive of the proper construction of insurance policies”); Boeing Co. v. Aetna Cas. & Sur. Co., 784 P.2d 507, 510-15 (Wash. 1990) (“damages” includes cleanup costs). The Insurers also make no attempt to address Bear Stearns’ showing (Opening Brief at 24-25) that barring coverage for any payment labeled “disgorgement” eviscerates the insurance they sold for government or SRO investigations like the one here, because the only monetary remedy available in such matters (aside from penalties) is disgorgement. See 15 U.S.C. §§ 77t, 78u.2 It should be obvious that a broker dealer like Bear Stearns buys such coverage because it anticipates investigations by its primary regulators, notably the SEC and (at that time) NYSE. If the Insurers were right, SEC investigations would be uninsurable and the coverage for “costs, charges and expenses or other damages incurred in connection with any investigation by any governmental body or self- regulatory organization (SRO)” (R. 103), for which the Insurers collected premiums, would be nullified. 2 The Insurers play a word game when they assert (Opp. at 27, n. 4) that the NYSE order characterized the entire $250 million as a “penalty.” The NYSE order had a remedial section labeled “penalty,” within which it described the components of the remedy, including the $90 million penalty, the $160 disgorgement, the censure, and the undertakings to implement reforms and other measures. (R. 198.) Obviously this section label could not transform the “disgorgement” into a “penalty” for coverage purposes. 15 The Insurers’ contention, as the final point of their brief, that Bear Stearns is not even entitled to recover its costs incurred in defense of the regulatory proceedings confirms that on their view, the coverage grant for SEC investigations is a sham, and they cannot ground their contention on the unjust enrichment rationale of the cases they cite. Even if indemnifying the insured for a disgorgement payment would unjustly enrich the insured (which is not the case here), that rationale would not apply to nullify the grant of coverage for the cost of the defense. Thus, in MBIA, Inc. v. Federal Insurance Co., 652 F.3d 152, 159-62 (2d Cir. 2011), the Second Circuit held that defense costs were covered in connection with regulatory proceedings that resulted in disgorgement and penalty payments. The nullification of coverage the Insurers are advocating would not be limited to Bear Stearns. As Bear Stearns showed in its opening brief (at 54-55), and the Insurers never rebut, corporate directors and officers may be held jointly and severally liable for disgorgement of a gain received by others even where they are found to have acted negligently. The Insurers’ assertion that they did not underwrite such risks and could not legally have done so (e.g., Opp. at 3) would, if accepted, mean that the coverage they sold to such insureds was and is nothing but an empty shell. 16 B. Bear Stearns Would Not Be Unjustly Enriched by Being Indemnified for Its Loss Bear Stearns showed in its opening brief (at 29) that Reliance Group Holdings v. National Union Fire Insurance Co., 188 A.D.2d 47 (1st Dep’t 1993) and its progeny, on which the Appellate Division heavily relied (R. 1840-41), are inapposite because in those cases, the insureds sought coverage for ill-gotten gains they possessed and were forced to disgorge, while Bear Stearns does not seek coverage for its own ill-gotten gains and would not be unjustly enriched by obtaining indemnification for the payment it made. In citing such cases, the Insurers ignore the crucial distinguishing fact that in each one, the insured was seeking to recover its own ill-gotten gains, which it had been obliged to give up. (Opp. at 28-30.) For instance, in Reliance the summary judgment record was clear that the insured had received tens of millions of dollars of greenmail profits and the settlement for which it sought coverage simply required it to return a portion of those profits. 188 A.D.2d at 54-55. The same is true for the other New York cases that follow Reliance, and every single out-of-state case the Insurers cite on this point.3 3 See Millennium Partners, L.P. v. Select Ins. Co., 24 Misc. 3d 212, 217-18 (Sup. Ct. N.Y. Co.) (the insured itself – a hedge fund that profited from market timing, rather than a clearing broker like Bear Stearns – actually obtained tens of millions of dollars of “improperly acquired funds” from the illegal activity), aff’d, 68 A.D.3d 420 (1st Dep’t 2009); Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 10 A.D.3d 528, 529 (1st Dep’t 2004) (“the final judgment expressly state[d] that 17 Nor do the Insurers have any real answer to Bear Stearns’ showing in its opening brief (at 27-28) that when courts have been presented with the issue here – i.e., whether coverage should be barred where the insured is seeking to recover for a loss that did not consist of the return of its own ill-gotten gains – they have recognized that such a bar is not justified. See, e.g., Pereira v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 2006 WL 1982789, at *3 (S.D.N.Y. July 12, 2006) (under New York law, the bar on coverage for restitution would apply only to the extent that the underlying claim was for “return of monies wrongfully obtained” by the money ordered disgorged was ‘obtained improperly by CSFB’”); see also Ryerson Inc. v. Fed. Ins. Co., 676 F.3d 610, 614 (7th Cir. 2012) (coverage would be available to the extent that the insured “gained nothing from” the transaction underlying the “restitution” award, but was denied because the insured failed to allocate between covered losses and ill-gotten gains); Alanco Tech., Inc. v. Carolina Cas. Ins. Co., 2006 WL 1371633, at *2 (D. Ariz. May 17, 2006) (no coverage where remedy sought in underlying case was restitution of assets that the insured obtained by fraud); Bank of the West v. Superior Ct., 833 P.2d 545, 555 (Cal. 1992) (barring coverage where necessary to prevent the “wrongdoer” from “retain[ing] the proceeds of his illegal acts”); Exec. Risk Indem., Inc. v. Pac. Educ. Servs., Inc., 451 F. Supp. 2d 1147, 1162 (D. Haw. 2006) (“claims for the return of ill-gotten gains should not be insurable”); O’Neill Investigations, Inc. v. Ill. Employers Ins. of Wausau, 636 P.2d 1170, 1175 (Alaska 1981) (claim for which coverage was barred was for “restoration to individuals of monies or property acquired by the defendant”); Cent. Dauphin Sch. Dist. v. Am. Cas. Co., 426 A.2d 94, 96 (Pa. 1981) (underlying claim was for refund of taxes that insured school district was not entitled to collect); Seaboard Sur. Co. v. Ralph Williams’ Nw. Chrysler Plymouth, Inc., 504 P.2d 1139, 1141 (Wash. 1973) (en banc) (underlying claim was for insured to return to customers property of which it had improperly “gained possession”); Nortex Oil & Gas Corp. v. Harbor Ins. Co., 456 S.W.2d 489, 493-94 (Tex. Civ. App. 1970) (underlying claim was for insured to “restor[e] to its rightful owners” proceeds of oil it had “inadvertently acquired” while “having no right thereto”). 18 the insureds). The Insurers argue that cases like Pereira “involve situations in which an insured was obligated by a settlement or judgment to pay a sum of money to resolve a civil action – not a regulatory proceeding.” (Opp. at 34.) That distinction is meaningless. Nothing in the case law turns on whether the insured is investigated by a government agency, sued by the same agency, or sued by a private person, and the policy language does not differentiate between the above, but rather provides coverage for all of them. (R. 103.) The Insurers’ point is apparently that the SEC investigation concluded with an administrative order rather than a settlement between private parties or a judgment (Opp. at 36-37), but that merely confuses the issues. The issue of what effect to give to the language of an administrative order is discussed in Point III, below. The rest of the Insurers’ argument on this point consists of a series of evasions and misstatements. First, they assert that “Bear Stearns concedes” that “the SEC rejected its contention that it made no profit from its illegal activity. (R.76 (¶103).)” (Opp. at 31.) A simple look at the cited paragraph of Bear Stearns’ Amended Complaint is enough to show that Bear Stearns made no “concession.” Bear Stearns alleged that on “November 18, 2004, Bear Stearns advised the SEC that it had, at most, received revenue” – not profit – “of only $16,903,560 from the alleged late trading and market timing practices of its customers”; that it offered to settle for $20 million; that in “making that offer, Bear 19 Stearns did not admit that any revenue it had received was in fact ill-gotten gains”; and that the “SEC rejected Bear Stearns’ proposal” of settlement. (R. 76, ¶ 103.) That allegation is not a “concession” that the SEC “rejected” Bear Stearns’ contention that it did not profit from the trading at issue. The Amended Complaint merely states that the SEC rejected a settlement offer; it does not say that the SEC commented in any way on what gains Bear Stearns received or did not receive.4 Moreover, even the actual fact – that the SEC rejected at one point Bear Stearns’ settlement offer – is beside the point. The point is that the SEC never disputed that Bear Stearns’ revenues were under $20 million and never came up with an alternative number of its own, and instead sought to recover a larger payment based on alleged customer gains. (R. 78, ¶ 111.) Over $140 million of Bear Stearns’ loss was unquestionably based solely on funds received by its customers. Aside from distorting the record, the Insurers rely on securities cases holding that violators of the securities laws may be compelled to disgorge funds even if they do not possess them or the SEC cannot establish the amounts they possess. (Opp. at 21-23, 31-32.) But those cases merely prove Bear Stearns’ point. The 4 The Insurers are equally careless when they repeatedly cite an SEC press release for the proposition that Bear Stearns had “ill-gotten gains.” (Opp. at 2, 24, citing R. 156.) As Bear Stearns pointed out in its opening brief (at 32, n. 10), what the SEC unilaterally says to the press has no evidentiary or preclusive value and obviously is not documentary evidence within the scope of CPLR 3211(a)(1). Having no such evidence, the Insurers continue to cite a press release instead, without even acknowledging what it is. 20 fact that the SEC can obtain such payments is exactly why the rationale of cases in the Reliance line does not automatically apply in SEC matters and it is necessary instead to determine whether the insured in fact seeks coverage for the relinquishment of its own ill-gotten gains such that enforcing a coverage obligation would result in its unjust enrichment. Pretending that this hole in their argument does not exist, the Insurers assert that to permit coverage “would allow Bear Stearns and its co-conspirators to retain the benefit they received from their joint illegal activity.” (Opp. at 32.) Nothing in the record supports the suggestion that Bear Stearns “conspired” with anyone, or held the “benefits” of “illegal activity,” or, for that matter, that the SEC Order here had any impact on the introducing brokers and hedge funds who did receive the funds. The Insurers’ attempt to equate Bear Stearns with its customers who were unjustly enriched is empty bluster. The Insurers therefore fall back on the contention that Bear Stearns should be penalized with forfeiture of its insurance coverage merely for the sake of “deterrence.” (Id.) That argument, which should not be confused with the unjust enrichment argument that the Insurers cannot support, is also wrong, for the reasons shown in Point II. Finally, the Insurers attack a strawman when they argue at length that the fact that the $160 million at issue was placed in a Fair Fund for distribution to investors does not qualify it as “compensatory damages.” (Opp. at 24-27.) Bear 21 Stearns is not arguing that the payment consists of “compensatory damages,” although it is significant for the public policy issues discussed in Point II that, unlike punitive damages, the payment here was capable of being used, and was used, for a compensatory purpose. The issue is whether the payment consists of the insured’s own ill-gotten gains, and the answer is that SEC-mandated disgorgement cannot automatically be equated with the relinquishment of ill-gotten gains for insurance purposes. Bear Stearns’ point is that nothing depends on the name of the remedy, and that Bear Stearns is not seeking indemnification for having returned its own ill-gotten gains. That point is unrebutted. II. COVERAGE FOR BEAR STEARNS’ LOSS SHOULD NOT BE NULLIFIED FOR THE SAKE OF “DETERRENCE” Bear Stearns showed in its opening brief (at 33-46) that the Appellate Division’s holding, lacking any basis in the case law involving the unjust enrichment rationale discussed in Point I, unquestionably rested solely on a perceived “public policy” under which coverage is denied in the interest of “deterring” misconduct by the insured. Second, Bear Stearns showed that the supposed policy of “deterrence” runs counter to the well-established New York public policy of holding parties to the contractual obligations they freely incur. See, e.g., Miller v. Continental Ins. Co., 40 N.Y.2d 675, 679 (1976); Messersmith v. Am. Fid. Co., 232 N.Y. 161, 163-66 (1921). Here too, the Insurers do not (and cannot) dispute the public policy principle of freedom of contract that runs through 22 so many of this Court’s insurance coverage cases.5 Third, Bear Stearns showed that the public policy the Appellate Division announced, requiring forfeiture of coverage in the interest of deterrence, has never been stated by the Legislature or – except in punitive damages cases – by this Court. This, too, is uncontested. Fourth, Bear Stearns showed that the public policy this Court has stated foreclosing coverage for punitive damages should not be extended to the facts here, because the SEC remedy differs in material respects from punitive damages and the SEC itself did not seek to bar coverage. That is the only part of the argument that the Insurers dispute, and they do so solely by asserting that because both punitive damages and disgorgement are intended to deter misconduct, they should be treated alike for coverage purposes. (Opp. at 38-39.) That argument is wrong because, as shown in our opening brief, both the remedies and the implicated public policy interests at issue differ materially from one another. Crucially, when this Court has said that coverage should not be available for punitive damages, it has not based those holdings merely on the deterrent effect of the remedy, but also on the recognition that punitive damages serve to punish. 5 The Insurers’ answer to Messersmith and its progeny is merely to assert that, unlike the insurers in those cases, they “never agreed to cover” the liability at issue here. (Opp. at 68.) But that is circular. As shown above, they agreed to cover payments made to settle regulatory investigations – which would inevitably be labeled “disgorgement” – and are now explicitly asking the Court to determine that “public policy precludes such coverage.” (Id.) 23 Zurich Ins. Co. v. Shearson Lehman Hutton, Inc., 84 N.Y.2d 309, 316 (1994) (indemnification for punitive damages is precluded because they serve “solely to punish the offender and to deter similar conduct on the part of others”); Home Ins. Co. v. Am. Home Prods. Corp., 75 N.Y.2d 196, 203-205 (1990) (same); Hartford Accident & Indem. Co. v. Village of Hempstead, 48 N.Y.2d 218, 226 (1979) (same).6 If the fact that a remedy served to deter undesirable conduct were in itself a sufficient ground for holding that it should not be insurable, then practically all liability insurance would be against public policy, since every remedy has a deterrent component.7 More specifically, it is common ground that all of the remedies available in enforcement proceedings brought by the SEC are aimed at deterring violations of the securities laws. If the fact that a remedy is aimed at deterrence were reason enough to hold it uninsurable, then any monetary payment made to resolve an SEC proceeding would be uninsurable. If that is the Insurers’ position, then their 6 The Insurers try to distort Zurich by quoting out of context a sentence where the Court mentioned only the deterrent effect of punitive damages. (Opp. at 39, quoting Zurich, 84 N.Y.2d at 317.) But the Court later made clear that the rule against indemnification for non-compensatory punitive damages is based on the “deterrent as well as the condemnatory character of the award.” Id. at 320. This is in keeping with the entire line of precedent from Hartford on, in which the Court has repeatedly grounded the uninsurability of punitive damages on the fact that they are designed to punish. 7 Bear Stearns demonstrated in its opening brief (at 40, n. 14) that this is true with respect to damages awarded under the securities laws as well as for negligence and other torts. The Insurers have made no attempt to contest that demonstration. 24 agreement to provide indemnification for such payments (R. 103) was a sham. And, in light of the ramifications of that position for directors and officers who may be held liable for monetary remedies under the securities laws even if they are merely negligent, the Insurers’ argument is directly contrary to the legislative statement (nowhere addressed by the Insurers) that it is “the public policy of this state to spread the risk of corporate management.” Bus. Corp. L. § 726(e). In this connection, the Insurers prove nothing in their long footnote (Opp. at 39, n. 8) discussing cases where courts have identified “moral hazard” – the danger that an insured will be more apt to engage in risky or harmful behavior knowing that insurance may cover a resulting loss – as a reason to deny coverage in some circumstances. Insurance for any remedy, including for compensatory damages paid for negligence, involves some potential that the insured may be indemnified for damages incurred as a result of conduct that law or public policy otherwise would discourage – and hence that the insured might be less careful to avoid such conduct – but that possibility is not a reason to bar coverage. See Messersmith, 232 N.Y. at 163 (“To restrict insurance to cases where liability is incurred without fault of the insured would reduce indemnity to a shadow.”). Indeed, barring coverage wherever there is an asserted societal interest in deterring the conduct that led to the liability would undermine the societal interest in having funds available to compensate the injured persons. The cases in the Insurers’ footnote do 25 not set deterrence in front of other policy goals; they merely hold that coverage is unavailable for payments of funds the insured was not entitled to possess in the first place.8 Such cases are irrelevant because Bear Stearns’ loss did not arise from such a payment. They do not support the proposition that coverage should be forfeited whenever such a forfeiture may have a deterrent effect. Bear Stearns showed in its opening brief (at 43-46) that the SEC disgorgement remedy here differs materially from punitive damages because (1) numerous federal courts have held that SEC disgorgement is “remedial” rather than “punitive,” see, e.g., SEC v. Lorin, 869 F. Supp. 1117, 1123-24 (S.D.N.Y. 1994), and (2) disgorgement, unlike punitive damages, can be (and in this case was) used to compensate investors. On the first point, the Insurers have no answer; they simply ignore Lorin and the other cases Bear Stearns cited and assert, without authority, that it “makes no real difference” whether a payment is of punitive damages or disgorgement and whether the purpose of the remedy is deterrence or 8 As previously shown, in Bank of the West, 833 P.2d at 555, and Central Dauphin, 426 A.2d at 96, the insured sought coverage for repayment of funds it was never entitled to obtain. In re San Juan Dupont Plaza Hotel Fire Litigation, 802 F. Supp. 624, 641-42 (D.P.R. 1992) merely cites Bank of the West for the proposition that claims under a California consumer protection statute are not insurable. Finally, in Mortenson v. National Fire Insurance Co. of Pittsburgh, Pa., 249 F.3d 667, 671 (7th Cir. 2001), the issue was whether a payment the insured made pursuant to a tax statute was a penalty outside of coverage as defined in the policy, and the court, noting that the statute defined the payment as a “penalty,” denied coverage. None of these cases sheds any light on what New York public policy is or should be with respect to SEC disgorgement payments. 26 punishment. (Opp. at 38.) But, in fact, punitive damages differ from other remedies both in their purpose – which includes the expression of the “community attitude” toward the wrongdoer, Home, 75 N.Y.2d at 203 – and in the legal prerequisites for an award (generally only on the basis of “gross misbehavior,” id., or the like, and generally only after a jury verdict). The Insurers provide no legal basis for their attempt to mash the remedies together, and on this record there are no proven facts of gross misbehavior. This leads to the second point. As Bear Stearns showed in its moving brief (at 44-45), although the SEC is not required to use the proceeds of its enforcement proceedings to compensate investors, it usually does so, did so here, and publicizes its investor compensation activities with pride. By contrast, punitive damages are never used for compensation; they are awarded in addition to the damages necessary to compensate the plaintiff, and, almost by definition, are a windfall to the plaintiff who receives them. Home, 75 N.Y.2d at 203 (“Punitive damages are allowed on the ground of public policy and not because the plaintiff has suffered any monetary damages for which he is entitled to reimbursement; the award goes to him simply because it is assessed in his particular suit.”). Accordingly, one important factor that supports finding the remedy insurable – the societal interest in ensuring that injured persons are compensated – is present when the remedy is SEC disgorgement but absent in the case of punitive damages. The Insurers 27 respond by citing cases saying that compensation is just a “secondary goal” of SEC disgorgement (Opp. at 26), but whether primary, secondary or tertiary, the goal meaningfully differentiates SEC disgorgement from punitive damages and is a further reason that the former should be insurable, at least in circumstances like those of this case.9 Bear Stearns also demonstrated in its opening brief (at 46) that by designating $90 million of Bear Stearns’ $250 million settlement payment as a penalty and barring the use of that payment to offset liability for compensatory damages, the SEC did all that it considered appropriate to “preserve the deterrent effect” of the penalty (R. 154), and there is no reason the New York courts should try to deter violations of the securities laws more zealously than the SEC. Indeed, this Court has observed that the presence of penal and/or regulatory deterrents is a good reason not to use the law of insurance coverage as a means to create additional deterrence for the regulated conduct, with resulting forfeitures by the insureds. See New England Mut. Life Ins. Co. v. Caruso, 73 N.Y.2d 74, 82 (1989); Charlebois v. J.M. Weller Assocs., Inc., 72 N.Y.2d 587, 595 (1988). Here, the 9 It is also unrebutted that if the payment Bear Stearns made had been paid in the first instance as damages to settle the civil actions – rather than first paid to the SEC as disgorgement, then used as part of the Fair Fund to compensate investors and then used to offset the damages claimed in the civil actions (R. 55) – the Insurers would be unable to make their “disgorgement” argument at all. This shows how artificial and insubstantial that argument is. 28 Insurers – who in other contexts are very keen to remind the Court of statements the SEC has made (e.g., Opp. at 25) – merely assert that the choices the SEC made do not matter because “insurability of disgorgement is a question of state law for this Court to decide.” (Opp. at 38, n. 7.) Thus, the Insurers utterly ignore cases like Caruso, where the Court has steadfastly declined insurers’ invitations to give them windfalls in the name of “public policy” and in derogation of the State’s true public policy of holding parties to the contractual bargains they strike. III. BEAR STEARNS DID NOT ADMIT TO CONDUCT WARRANTING THE NULLIFICATION OF ITS INSURANCE COVERAGE Bear Stearns showed in its opening brief that – once it is recognized that Bear Stearns should not be barred from obtaining coverage merely because the payment at issue consisted of SEC disgorgement – the remaining issue under New York law is whether the SEC Order conclusively establishes that Bear Stearns’ loss arose from intentionally harmful conduct (or conduct so inherently injurious that it is deemed intentionally harmful), which are the only public policy grounds this Court has recognized for barring coverage based on the insured’s conduct. Bear Stearns further showed that the Appellate Division decided that issue wrongly, both because New York law and the terms of the SEC Order permit Bear Stearns to dispute and disprove the SEC’s findings (see Opening Brief at 47-57), and because the findings – even if credited – in any event do not establish the kind of intentionally harmful conduct that precludes coverage (see id. at 57-64). The 29 Insurers’ response to the first point, discussed in this section, disregards the language of the SEC Order, and relies on untenable efforts to distinguish the relevant case law. A. Under the SEC Order and the Offer of Settlement, Bear Stearns Retained the Ability to Prove the Actual Facts Regarding Its Conduct in Litigation with Third Parties, Including in This Coverage Case The starting point must be the SEC Order, which provides, in Section II, that: In anticipation of the institution of these proceedings, Respondents have submitted an Offer of Settlement (the “Offer”), which the Commission has determined to accept. Solely 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, except as to the Commission’s jurisdiction over them and the subject matter of these proceedings, which are admitted, Respondents consent to the entry of this Order. . . . (R. 116-17, emphasis added.) Thus, Bear Stearns made it as clear as possible that its consent to the entry of the order (1) was for the purpose of the SEC proceedings only and (2) could not be deemed an admission of the findings regarding Bear Stearns’ conduct. The Insurers’ only response is to cite a footnote in the next section of the order that states that the SEC’s “findings . . . are not binding on any other person or entity,” (R. 117, n. 1), which they erroneously contend, in a complete non sequitur, means that the “findings are conclusive and binding on Bear Stearns” in proceedings against the Insurers (Opp. at 42, 45). If the Insurers’ 30 point is that the footnote somehow nullifies the paragraph quoted above, which makes clear that the findings are not binding on Bear Stearns in proceedings not involving the SEC, their argument fails to give effect to all of the agreed-upon language, as the law requires. See, e.g., Excess Ins. Co. v. Factory Mut. Ins. Co., 3 N.Y.3d 577, 582 (2004) (“the court should construe the agreement so as to give full meaning and effect to the material provisions”). The plain meaning of the order is that it bound Bear Stearns as against the SEC, but not “for the purpose” of any other “proceedings.” The Insurers put great store (e.g., Opp. at 11-12, 41) on their assertion that Bear Stearns “proposed” the SEC findings through its “Offer of Settlement.” (R. 1648-91.) The fact that the SEC findings are included in the Offer of Settlement as a matter of form does not, however, demonstrate that Bear Stearns was in fact the drafter of the findings or that they represent Bear Stearns’ view. In fact, as the Insurers are well aware from the documents Bear Stearns produced in this case after the motion to dismiss was submitted, and as any securities practitioner would expect, the SEC, not Bear Stearns, drafted the findings and presented them to Bear Stearns as the findings that needed to be included in the offer if Bear Stearns wished to proceed with the settlement. Those findings reflect the SEC’s, not Bear Stearns’, views. The facts according to Bear Stearns are instead set forth in its Wells Submission (R. 1437-1507) and differ starkly from the 31 Offer of Settlement, which obviously reflects the SEC’s perspective on selected evidence. The stark contrast between these documents (and any dispute about which should be given credence or who really drafted the Offer) merely emphasizes that disposition of this case under CPLR 3211(a)(1) was improper. The Insurers’ further argument that Bear Stearns agreed in the Offer of Settlement not to make public statements “denying, directly or indirectly, any finding in the Order or creating the impression that the Order is without factual basis” (Opp. at 40), and agreed to withdraw the Wells Submission from the SEC’s administrative record (Opp. at 42), likewise does not avail them, because the very same paragraph of the offer states 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.) Like the language in Section II of the SEC Order, this provision – which the Insurers simply ignore – makes clear that the settlement, and its required consent to the entry of the SEC Order, was not intended to bind or limit Bear Stearns in proceedings with third parties, such as its present litigation with the Insurers. And even if Bear Stearns were explicitly required to admit every allegation in the SEC Order (it unquestionably was not), that would still have left it with ample room to show that in the context of other facts set forth in the Wells Submission and even in the SEC 32 Order – such as the fact that it blocked market timing on request (R. 1458-63; R. 122, ¶ 29) – its conduct was not such that coverage should be precluded. Finally, it remains significant that the policy the SEC has embraced by entering into neither-admit-nor-deny settlements with parties like Bear Stearns is not only good policy from the perspective of the agency, but also from that of the federal courts. As Bear Stearns showed in its moving brief, this is confirmed by SEC v. Citigroup Global Markets, 673 F.3d 158, 165 (2d Cir. 2012), where the Second Circuit, citing the need to defer to the SEC’s policy choices and to facilitate settlements, was critical of Judge Rakoff’s attempt to require admissions of liability as a condition to approval of a settlement. The Insurers respond that Citigroup is irrelevant because court approval was not required here (Opp. at 53), but that merely shows why the SEC findings here are even less entitled to be given preclusive effect than they would be in a matter where court approval was required. The point is that both the SEC and the federal courts recognize that it is good public policy to enable participants in the securities industry to continue to settle cases without admitting liability, or the factual predicates of the SEC charges. Finding that the loss Bear Stearns incurred here is not insurable because it must be saddled with the SEC’s findings – even though it bargained for the right to take different positions in litigation with third parties like the Insurers – would put 33 New York public policy directly at odds with federal public policy. The Insurers have not offered any good reason for the Court to do that. B. Findings Made in Administrative Orders and Settlements Are Not Given Preclusive Effect, Including in Insurance Coverage Cases Bear Stearns showed in its opening brief (at 53-55) that the Appellate Division’s Decision is contrary to settled law under which findings by an administrative agency made in a consent judgment or settlement may not be given preclusive effect, see, e.g., Lipsky v. Commonwealth United Corp., 551 F.2d 887, 893 (2d Cir. 1976), and specifically may not be used to negate coverage, see National Union Fire Ins. Co. of Pittsburgh, Pa. v. Xerox Corp., 25 A.D.3d 309, 310 (1st Dep’t 2006). In response, the Insurers seem to argue (Opp. at 44-51) that the present case is different because (1) here, the findings were made in an SEC administrative order that required the SEC to make findings, and (2) here, the issue is what effect to give the findings in litigation between Bear Stearns and its insurers, rather than between Bear Stearns and investors or other third parties. Neither distinction has merit. 1. It Makes No Difference That the SEC Was Required to Make Findings to Conclude Its Proceeding It makes no difference whatsoever that in this case, the SEC Order was entered in the context of a proceeding in which the SEC was required to make findings (as opposed to a lawsuit in district court, where it sets forth its allegations 34 in a complaint). In the first place, the Insurers’ argument gets the policy underlying the case law backwards. The reasons courts do not give preclusive effect to orders that are not “truly adjudicated” are that (1) doing so would “discourage compromises” and “accord them consequences which the parties neither intended nor foresaw,” and (2) when the prior matter is before an administrative tribunal, “significant differences between the constitutional and other protections guaranteed” in litigation and “administrative procedures” make it all the more inadvisable to apply preclusion. Halyalkar v. Bd. of Regents, 72 N.Y.2d 261, 268-69 (1988). If these considerations support not giving preclusive effect to consent judgments entered by a federal court, as in Lipsky, then they should weigh even more strongly against giving preclusive effect to findings made in an administrative order to resolve an SEC investigation, where no court approval is required and the procedures are less protective of the respondent’s rights than in court. For instance, the respondent in an SEC proceeding is not entitled to trial by jury (or to a trial of any kind presided over by an article III judge), and the rules regarding discovery, evidence and other procedural matters are less formal than in federal court cases. See generally Loss, Seligman & Paredes, Securities Regulation § 13-C, Quasijudicial Proceedings (2012).10 10 The Insurers point to Ryan v. New York Telephone Co., 62 N.Y.2d 494, 503-504 (1984), which shows that fully-litigated administrative adjudications may have preclusive effect in some circumstances (Opp. at 51), but that is a far cry from 35 Furthermore, the claimed distinction between SEC consent judgments and administrative orders entered by consent is not supported by the case law. Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598 (S.D.N.Y. 1980) is directly on point. The SEC commenced an administrative proceeding against investment advisors serving the plaintiff Fund, which was settled “pursuant to an Order and Findings.” Id. at 608. The Fund argued that, for public policy reasons, it should not be required to indemnify the investment advisors because in the SEC consent order they had “consented to findings that they willfully aided and abetted violations” of the securities laws, but the court rejected that argument because there had been “no adjudication of willfulness – only the entry of a consent order with such findings.” Id. at 618, 619. There is no material difference between Cambridge Fund and this case with respect to the form of the SEC proceeding, the findings the SEC entered, or any other material fact. The Insurers’ attempt to distinguish it on those grounds (Opp. at 51, n. 9) is simply a misreading. Moreover, contrary to the Insurers’ argument, the principles stated in Cambridge Fund are equally valid and apposite when stated in other cases where establishing that consent judgments may be given such effect. Equally unhelpful to the Insurers is A.D. Julliard & Co. v. Johnson, 259 F.2d 837, 844 (2d Cir. 1958), where the court simply denied a motion to set aside a district court judgment in order to introduce evidence of an error in a prior administrative proceeding, but explicitly noted that its decision was based on the principle of finality and not on the “collateral estoppel” effect of the administrative determination. 36 courts refused to give preclusive effect to consent judgments entered into in other kinds of proceedings. For instance, in Mishkin v. Peat, Marwick, Mitchell & Co., 1988 WL 391648 (S.D.N.Y. Nov. 7, 1988), the issue was whether the plaintiff should be collaterally estopped from contesting that he violated the securities laws based on a consent judgment that a district court had so-ordered. The court, citing Lipsky, held that the “general rule that stipulated facts are not given preclusive effect must be followed.” Id. at *2. There is no legal authority suggesting that it makes any difference that the stipulated factual findings in Mishkin and cases like it were so-ordered in a district court action rather than found by the SEC in one of its own administrative proceedings. Either way, there is no trial or decision on the merits, and either way, the findings cannot be given preclusive effect. If anything, the fact that a federal court so-ordered the findings in a consent judgment should entitle them to more deference than administrative findings not approved by any court, rather than less. The Insurers inexplicably attach great weight to the proposition that the SEC Order was an “adjudication” under the Administrative Procedure Act. This argument misconstrues the APA. The term “adjudication” as defined in the APA does not mean that particular findings issued by the SEC were “adjudicated” in any sense that would support giving them preclusive effect, but only that the agency followed its “process for the formulation of an order,” and hence that the issuance 37 of the “order” qualifies as an “adjudication,” in APA parlance, as opposed to “rulemaking.” 5 U.S.C. § 551 (6) and (7).11 With respect to settlement of an administrative proceeding, the statutory framework to which the Insurers refer makes clear that in making a settlement offer, the offeror waives its right to a hearing or to any proceeding before a hearing officer. 17 C.F.R. § 201.240(c)(4), (5) and (7). As in the case of a consent judgment, the order results from private bargaining, with no hearing or rulings or any form of decision on the merits by a trier of fact. It is also highly significant that the insurance policies involved here provide broad coverage subject to an exclusion for claims “arising out of any deliberate, dishonest, fraudulent or criminal act or omission” in which “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 11 International Telephone & Telegraph Corp., Communications Equipment and Systems Division v. Local 134, International Brotherhood of Electrical Workers, AFL-CIO, 419 U.S. 428, 443-44 (1975), which the Insurers cite for the proposition that a “‘final disposition’ is one that resolves a dispute between parties to administrative proceedings” (Opp. at 44), does not even say that, but even if it did, it would not mean that the Second Circuit was wrong a year later when it stated 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, 551 F.2d at 893. The definitions stated in 5 U.S.C. § 551 and discussed in IT&T for the purpose of classifying agency actions as a matter of administrative law simply do not alter the fact that agency findings entered on consent without admitting their truth are not given preclusive effect. 38 omission.” (R. 105.) There would be no reason for the policies to contain this exclusion if the Insurers were not assuming the risk of having to pay losses incurred without such an adjudication. In fact, the very purpose of this provision is to provide coverage for settlements. See Pendergest-Holt v. Certain Underwriters at Lloyd’s of London, 600 F.3d 562, 573 (5th Cir. 2010); Little v. MGIC Indem. Corp., 836 F.2d 789, 794 (3d Cir. 1987). Although the Insurers argue that the presence of the exclusion does not provide guidance to the scope of the coverage grant in the insuring clause – a vain exercise, in this context12 – they seem not to believe their argument, as they devote half of their discussion of this point to an attempt to argue that the exclusion applies. (Opp. at 71-72.) That argument fails because, as shown above, the SEC Order is not a “judgment or other final adjudication,” and it does not “establish” anything, as the exclusion requires. (R. 105.) 12 The Insurers cite Raymond Corp. v. National Union Fire Insurance Co. of Pittsburgh, Pa., 5 N.Y.3d 157, 163 (2005) for the proposition that “exclusionary language” cannot be used “to expand by negative inference the scope of coverage” (Opp. at 73), but Bear Stearns is not trying to “expand” coverage here. The Policy’s coverage grant here expressly includes regulatory proceedings (R. 103), and thus no expansion by negative inference is required. The exclusionary language, which expressly confirms that Bear Stearns “shall be protected” under the Policy in the face of unadjudicated allegations of dishonesty (R. 105), instead demonstrates the parties’ clear intent to provide indemnification for claims of alleged dishonesty. 39 Furthermore, “the exclusion requires that actual dishonest purpose and intent be ‘established’ by adjudication,” so that “the exclusion certainly is susceptible to the interpretation, well-developed in the law of collateral estoppel, that the judgment establishes dishonesty under the exclusion only if a finding of dishonesty was necessary to the judgment.” Fed. Ins. Co. v. Sheldon (In re Donald Sheldon & Co.), 186 B.R. 364 (S.D.N.Y. 1995) (holding exclusion inapplicable in case where the insured had lost at trial on a breach of fiduciary duty claim). As discussed in our opening brief (at 59-60) and again in Point IV.B., below, the SEC’s claim here did not depend on proof of dishonesty. The SEC Order did not “establish” anything about Bear Stearns’ intentions, and would not support the application of collateral estoppel. Thus, the SEC Order does not support application of the exclusion. 2. Bear Stearns Retained the Right, for Coverage Purposes, to Prove That It Did Not Engage in Intentionally Harmful Conduct Equally meritless is the Insurers’ contention that this case is different because Bear Stearns is seeking coverage from its insurers rather than defending a claim by a third party (Opp. at 45-48) or because the Insurers “are not asserting any affirmative claims for relief against Bear Stearns” (Opp. at 51). It is, of course, pure sophistry to argue that depriving Bear Stearns of the coverage it bought and paid for is somehow defensive rather than an attempt to obtain 40 “affirmative” relief. Moreover, when Bear Stearns reserved its “right to take legal or factual positions in litigation or other legal proceedings in which the Commission is not a party” (R. 1687) and stipulated that it did not admit or deny the findings in the SEC Order and consented to the order solely for the purpose of the SEC proceedings (R. 116), neither it nor the SEC said anything to suggest that they intended to carve out a tacit exception to those provisions for the benefit of Bear Stearns’ liability insurers. For insurance coverage purposes, and in light of the requirements of CPLR 3211(a)(1), the only facts that are conclusively established by the SEC Order are that the SEC investigated Bear Stearns and Bear Stearns made a payment to settle the investigation, which consisted of $90 million labeled as a penalty and $160 million labeled as disgorgement. Nothing about Bear Stearns’ conduct preceding the claim is established, or could be under Lipsky and its progeny. The Insurers rely on Millennium, 24 Misc. 3d at 218, for a contrary rule under which “regulatory settlements ‘essentially [are] equivalent to a determination, reached through agreement of the parties’” (Opp. at 46), but it is revealing that the Insurers do not go on to discuss exactly what is and is not determined by such agreements, and in fact the case does not provide a rule with any application here. It merely holds that when the insured fails to raise an issue of fact concerning the existence of a loss, it makes no difference whether the payment 41 was made pursuant to an administrative consent order rather than a judgment entered in court. In Millennium it was undisputed on summary judgment that the insured had obtained ill-gotten gains – it “did not submit any evidence that the amount to be disgorged was not attributable to profits made as a result of its market timing.” 24 Misc. 3d at 219. In that context, because the insured did not raise an issue of fact concerning the existence of a loss, its objection that there was no final judgment was irrelevant. The Insurers also rely on Credit Suisse, where it was “undisputed that the Final Judgment required CSFB to disgorge itself of money that the SEC alleged CSFB obtained improperly.” Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 6 Misc. 3d 1020(A), 2003 WL 24009803, at *4 (Sup. Ct. N.Y. Co. July 8, 2003), aff’d, 10 A.D.3d 528 (1st Dep’t 2004). In Credit Suisse, the SEC alleged with great particularity the illegal payments that Credit Suisse received. (R. 1587-95.) In that context, and in the absence of factual dispute, Credit Suisse was unable to demonstrate how it made a difference that the underlying case was not adjudicated. Neither case, however, addressed circumstances like those here, where the insured has shown that the recovery it is seeking is not for the return of its own ill- gotten gains. Much less did either case suggest that the fact that the underlying investigations ended in settlements meant that agency findings could be deemed to establish beyond dispute that the insured engaged in intentionally (or inherently) 42 harmful conduct, despite the language by which the insured reserved its rights in proceedings with other parties, and despite the rule stated in cases in the Lipsky line. In short, Millennium and Credit Suisse do not hold that when an insured settles with a government agency, it is barred from presenting facts regarding the nature of its loss and the reason why it settled, other than to the extent that the order actually expresses such a bar. What they hold is that if the insured is unable on summary judgment to present an issue of fact regarding the existence of a loss, the mere circumstance that the underlying matter was resolved in an order issued by the SEC or a consent judgment does not alter the result. The Insurers cite Servidone Construction Corp. v. Security Insurance Co. of Hartford, 64 N.Y.2d 419, 424 (1985) for the proposition that the insurer’s “duty to pay is determined by the actual basis for the insured’s liability to a third person” (Opp. at 47-48), but the documentary evidence the Insurers presented here does not conclusively refute Bear Stearns’ allegation that the basis for the settlement was that Bear Stearns, although it was not facing a claim for its own ill-gotten gains and had done nothing intentionally harmful, settled the SEC investigation by making payments under the only remedial designations the SEC has the ability to collect. Indeed, the Insurers’ contention merely brings into focus how inadequate and superficial the record on this motion to dismiss necessarily is to determine 43 what the basis for the settlement was. The reason any case settles for a given amount at a given moment is that both sides – taking into consideration not only the merits of the claims, but also the cost of litigation (monetary and otherwise) and their institutional or business goals – determine that the settlement is preferable to continued litigation. That obviously presents fact issues, and although “a plenary trial” of such issues “is not always necessary,” id. at 425, those issues certainly cannot be determined on the basis of the settlement agreement alone. Here, the SEC presumably settled in part because it knew that Bear Stearns might be able to prove the facts in its Wells Submission, which undeniably was part of the basis of the settlement – and continued to be even when Bear Stearns withdrew it from the administrative record as part of the process of finalizing the settlement. The fact that the SEC required Bear Stearns, as a formality, to withdraw its Wells Submission from the administrative record as a condition of the settlement does not change the fact that it showed what Bear Stearns was prepared to prove if the case did not settle, and was as much the basis for settlement as the SEC’s findings, which reflected its contrary view of the case. When the Appellate Division based its Decision solely on the SEC Order and other agency documents (but evidently not the Wells Submission) that it “read as a whole” (R. 1841), it improperly selected and weighed the evidence, making inferences against Bear 44 Stearns, in violation of CPLR 3211(a)(1). That is reason enough in itself to reverse the Decision. IV. THE DOCUMENTARY EVIDENCE DOES NOT CONCLUSIVELY ESTABLISH THAT BEAR STEARNS COMMITTED INHERENTLY HARMFUL ACTS Bear Stearns showed in its opening brief (at 57-64) that the only conduct for which New York public policy bars insurance coverage is intentionally harmful conduct (or acts that are inherently injurious), and that the findings the SEC made to the effect that Bear Stearns committed “willful” violations of the securities laws do not establish intentionally or inherently harmful conduct. The Insurers respond, predictably, by attempting to expand the definition of inherently harmful acts far beyond anything this Court has ever countenanced, and inviting the Court to draw inferences against Bear Stearns that the record does not support (and that could not possibly be supported in this procedural posture). A. Violations of the Securities Laws Are Not “Inherently Harmful” Conduct There is no dispute that insurance and other “[i]ndemnification agreements are unenforceable as violative of public policy only to the extent that they purport to indemnify a party for damages flowing from the intentional causation of injury.” Austro v. Niagara Mohawk Power Corp., 66 N.Y.2d 674, 676 (1985) (citing Pub. Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392, 400 (1981)). It is also beyond dispute that the SEC did not allege anywhere in its order, much less conclusively 45 establish, that Bear Stearns intended to cause injury to anyone and that, even if such an issue of direct intent were presented in this coverage case, it would require considerable factual development prior to adjudication. Therefore, the Insurers are reduced to arguing (Opp. at 55-57) that violations of the securities laws are “inherently harmful” and hence uninsurable conduct under New York law. That argument is ridiculous. The only conduct this Court has ever found inherently harmful is child molestation, and it did so because in that limited case the harmful effect of the conduct is inevitable, invariable and immediate. Allstate Ins. Co. v. Mugavero, 79 N.Y.2d 153, 161 (1992) (“molesting a child without causing harm is a virtual impossibility”). The general rule is that the law recognizes that intentional (even risky) acts may have unintended harmful consequences and that insurance for resulting losses is compatible with public policy. See, e.g., Goldfarb, 53 N.Y.2d at 398. None of the cases the Insurers cite on this issue actually supports their attempt to broaden the class of inherently harmful acts to include alleged violations of the securities laws. Dodge v. Legion Insurance Co., 102 F. Supp. 2d 144, 157 (S.D.N.Y. 2000) was another sexual predation case. In National Union Fire Insurance Co. of Pittsburgh, Pa. v. AARPO, Inc., 1999 WL 14010, at *4-5 (S.D.N.Y. Jan. 14, 1999), the underlying claims were for fraud, and coverage was barred by a dishonest acts exclusion. Although the court cited Mugavero in dictum 46 while explaining why the eleventh-hour addition of an ostensible negligent misrepresentation claim did not change the result, the analysis and holding were driven by the perception that the negligence was alleged in name only, for the apparent purpose of creating coverage where none would otherwise exist. Id. That is a far cry from supporting an extension of the public policy regarding “inherently harmful” conduct to securities claims. Similarly, Accessories Biz., Inc. v. Linda & Jay Keane, Inc., 533 F. Supp. 2d 381, 386-87 (S.D.N.Y. 2008) merely holds that there was no covered “accident” where the loss arose when the insured deliberately converted the underlying plaintiff’s property; Syvertsen v. Great American Insurance Co., 267 A.D.2d 854, 856 (3d Dep’t 1999) likewise holds that fraud and other intentional tort claims arising from the insured’s alleged concealment of defects in a house could not be considered accidental; and DeSantis Enterprises v. American & Foreign Insurance Co., 241 A.D.2d 859, 861 (3d Dep’t 1997) holds that the errors and omissions policy at issue did not cover a claim arising from the insured’s intentional termination of its employees’ benefit plan.13 These cases 13 Further cases cited on page 58 of the Insurers’ brief are off point for the same reason. See Atl. Mut. Ins. Co. v. Terk Techs. Corp., 309 A.D.2d 22 (1st Dep’t 2003) (“knowledge of falsity” exclusion barred coverage for Lanham Act claim where insured was accused of deliberately selling counterfeit goods); Sphere Drake Ins. Co. v. 72 Centre Ave. Corp., 238 A.D.2d 574, 576 (2d Dep’t 1977) (assault and battery exclusion excluded claim for assault); Bingham v. Atl. Mut. Ins. Co., 215 A.D.2d 315, 316 (1st Dep’t 1995) (expected or intended exclusion excluded coverage for defamation claim). 47 come nowhere near holding that the Mugavero public policy rule deeming certain sex crimes inherently harmful applies when the underlying claim is for violation of the securities laws. B. The SEC’s Findings Do Not Establish That Bear Stearns Engaged in Intentionally or Inherently Harmful Activity Bear Stearns showed in its opening brief (at 62-64) that it did not engage in any intentionally or inherently harmful conduct. Aside from distorting the standard, as discussed above, the Insurers respond once again by misstating the facts. The relevant facts, as previously noted, are that (1) the SEC did not allege anywhere in its order that Bear Stearns intended to harm investors; (2) thus, by consenting to entry of the order, Bear Stearns did not consent to such a finding; (3) the record, including the Wells Submission, easily admits of the conclusion that Bear Stearns did not intend to harm any investors; and (4) there was no adjudication to the contrary. Those facts require a finding of coverage. That is why the Insurers have argued that the SEC alleged inherently harmful conduct within the Mugavero paradigm. If indeed an insured is accused solely of child molestation (or similar conduct), then his actual intent not to harm is deemed irrelevant. Mugavero, 79 N.Y.2d at 161. In such cases, it likewise does not matter whether the underlying plaintiff alleged that the conduct was willful or negligent; the facts alleged in the underlying complaint determine the outcome. But, conversely, where the conduct 48 alleged is not inherently harmful, if the insurer claims coverage should be prohibited because the harm was intentional, that issue is determined based on the facts, not the conclusory labels the parties may have applied to them. Goldfarb, 53 N.Y.2d at 400-402. This principle is significant because the Appellate Division, at the Insurers’ instigation, devoted a substantial part of its Decision to reciting the SEC’s findings of “willful” misconduct, and misapprehended the legal import of those findings. (R. 1843.) Bear Stearns demonstrated in its opening brief (at 59-60) that when the SEC alleges or finds that a defendant “willfully” violated the securities laws (as it did in the SEC Order here), it does not follow that the defendant intended to cause injury, or performed inherently harmful acts, because “willful” under the securities laws merely means that the act that constitutes the violation was intentional. See, e.g., Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965) and other cases cited in Bear Stearns’ opening brief at 59-60 (and never addressed by the Insurers). Thus, even if Bear Stearns were deemed to have agreed in some sense to the SEC’s characterization of its conduct as “willful,” that agreement would not be an admission that Bear Stearns’ conduct giving rise to the liability was uninsurable. The Insurers do not and cannot take issue with Bear Stearns’ explanation of what “willful” means, or with any of the authorities supporting it. Instead, they disregard the point and try to take Bear Stearns to task for supposedly forgetting 49 that the “actual conduct” rather than “general standards for liability” determine coverage. (Opp. at 58.) It is true that the actual conduct determines coverage, but not remotely true that the SEC’s use of the word “willful” (or any other label) proves that Bear Stearns’ actual conduct was intentionally injurious, as a matter of law, for coverage purposes. The SEC did not allege or find that Bear Stearns intended to injure anyone or that its conduct was inherently harmful, and that conclusion also is not a fair inference – let alone the only possible inference – from the findings the SEC did make. To the contrary, the SEC’s findings actually say nothing about how mutual funds or their customers were allegedly harmed by the market timing and late trading conducted by certain Bear Stearns customers, much less about how Bear Stearns intended such harm. Many of the findings either allege that Bear Stearns acted recklessly, or simply fault Bear Stearns with failing to police the conduct of its customers more proactively. (E.g., R. 117-18, ¶ 4; R. 121, ¶ 22; R. 122, ¶¶ 29- 31; R. 131, ¶¶ 83-84; R. 132, ¶¶ 88, 92; R. 134, ¶ 100; R. 144, ¶ 167.) And, as shown in Bear Stearns’ opening brief (at 49-50), the Wells Submission contains abundant evidence (which the Insurers do not address at all) that Bear Stearns endeavored to comply with the law and at most fell out of compliance at times due to the unauthorized actions of a small number of employees. 50 The Insurers’ response here (Opp. at 59-60) is long on inflammatory labels (“defraud,” “scheme,” “steal”) but short on substance. The paragraphs the Insurers cite refer mainly to Bear Stearns’ assistance of market timing by its customers. (R. 122, ¶¶ 29-30; R. 137, ¶ 117; R. 144, ¶ 170.) As Bear Stearns has shown, and the Insurers nowhere deny, market timing is not necessarily unlawful (as even the SEC acknowledges) (R. 118-19, ¶ 8); may benefit investors (R. 1437); is permitted by many mutual funds (R. 1457); and was curtailed by Bear Stearns in many instances when mutual funds objected to it (R. 122, ¶ 29; R. 1458-61). In light of these facts, and the Insurers’ utter failure to explain how market timing harmed investors in the instances where Bear Stearns allegedly promoted it, the Insurers’ conclusory assertion that Bear Stearns had a “purposeful intent to violate the law and defraud innocent mutual fund shareholders” (Opp. at 59) is simply without support in the very SEC Order paragraphs the Insurers single out. The Insurers also cite a few paragraphs where, although focusing mainly on market timing, the SEC also made references to late trading (R. 117, ¶ 2; R. 117-18, ¶ 4; R. 121, ¶ 24), but here too, there is no support for the proposition that Bear Stearns intended to encourage the late trades its customers made, or any resulting harm. V. THE SEC ORDER DOES NOT CONCLUSIVELY ESTABLISH THAT THE PERSONAL PROFIT EXCLUSION APPLIES The Personal Profit Exclusion does not apply because – in keeping with the analysis of the IAS Court (R. 29-30), which the Appellate Division did not address 51 – the record does not support, much less conclusively establish, any of the multiple elements necessary for the exclusion to apply. The exclusion bars coverage for claims “based upon or arising out of the Insured gaining in fact any personal profit or advantage to which the Insured was not legally entitled, including but not limited to any actual or alleged commingling of funds or accounts.” (R. 106.) As a matter of text, the exclusion would only apply if the Insurers established that (1) the SEC’s claim against Bear Stearns was based upon or arose out of Bear Stearns’ gaining a personal profit or advantage (and not its customers’ doing so); (2) the personal profit or advantage was one to which Bear Stearns was not legally entitled; and (3) the issue was determined “in fact.”14 Here, by contrast, the SEC’s claim was for violation of securities laws that did not require a showing of receipt of ill-gotten gains by anyone, let alone by Bear Stearns; there was no allegation or evidence that Bear Stearns was not legally entitled to the commissions and fees it earned; and nothing was determined against Bear Stearns in fact. 14 The exclusion also requires that the profit or advantage be “personal.” The claimed profits or advantages on which the Insurers rely accrued only to corporate entities and thus were not “personal,” a term used to mean individuals, not corporations. See, e.g., FCC v. AT&T, Inc., 131 S. Ct. 1177, 1182-84 (2011) (as a matter of “ordinary meaning,” the term “[p]ersonal ordinarily refers to individuals,” not corporations); Sheldon, 186 B.R. at 369 (rejecting insurers’ claim that the personal profit exclusion applied where the gain was received by a corporation, not individuals). At the very least, the term “personal” must be accorded some meaning, and does not unambiguously encompass corporate gains and thus cannot be construed to bar coverage for that reason as well as the others set forth in the text. 52 A. The Purpose of the Exclusion, New York Insurance Law and Public Policy Require That the Exclusion Be Construed Strictly against the Insurers As its language suggests, the basis for the Personal Profit Exclusion is the public policy against allowing an insured to recover when the payment it made consists only of restitution of funds it never had the right to obtain. By contrast, the construction of the exclusion that the Insurers advocate – essentially that any allegation that the insured obtained benefits related to the conduct alleged in the underlying claim – would expand it so far that it would wipe out all the coverage in the Policy. As a federal district court perceptively commented: Almost all securities fraud complaints will allege that the defendants did what they did in order to benefit themselves in some way. If such an allegation were sufficient to invoke [the exclusion], the broad coverage for “Securities Claims” provided by the National Union policy would be rendered valueless by this exclusion. Alstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376, 400 (D. Del. 2002). In fact, construing the exclusion the way the Insurers advocate would nullify coverage for any claim involving corporate wrongdoing by a profit-making entity, as any activity would be motivated by profit and result in some actual or pretended corporate “advantage” or it would not be engaged in in the first place. Construing the exclusion narrowly is consistent not only with the observation of the Alstrin court, but also with settled New York law on exclusions. As with any exclusion, any ambiguity as to its scope must be construed in favor of 53 coverage. See Belt Painting Corp. v. TIG Ins. Co., 100 N.Y.2d 377, 383 (2003) (exclusions are given a “strict and narrow construction, with any ambiguity resolved against the insurer.”); see also Pioneer Tower Owners Ass’n v. State Farm Fire & Cas. Co., 12 N.Y.3d 302, 307 (2009) (“[w]e have enforced policy exclusions only where we found them to ‘have a definite and precise meaning, unattended by danger of misconception . . . and concerning which there is no reasonable basis for a difference of opinion.’” (quoting Breed v. Ins. Co. of N. Am., 46 N.Y.2d 351, 355 (1978)). B. The SEC Claim Was Not “Based upon or Arising Out of” Bear Stearns’ Personal Profit The SEC charges were not based upon and did not arise out of Bear Stearns’ supposed receipt of a gain. As this Court held in Mount Vernon Fire Ins. Co. v. Creative Hous. Ltd., 88 N.Y.2d 347, 352 (1996), for a claim to be based upon or arise out of certain conduct, such conduct must be the “operative act” giving rise to the claim. See also Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Continental Ill. Corp., 666 F. Supp. 1180, 1199 (N.D. Ill. 1987) (“Claims are simply not ‘based upon or attributable to’ certain conduct unless they allege such conduct.”). Applying the same principle to exclusions similar to the one here, courts have recognized that the exclusion is not triggered when a claim alleges some illegal activity by the insured and some gain by the insured; rather, the alleged 54 illegal gain by the insured must be the basis for the underlying claim. Again, the Delaware district court’s analysis is compelling: Exclusion 4(a), by its terms, requires a profit or gain that is illegal; not an illegal act that produces a profit or gain to the insured as a by- product. This exclusion, therefore, would be applicable in cases of theft, such as insider trading, but is inapplicable to illegalities such as securities misrepresentation to which a private gain might be incidental. Alstrin, 179 F. Supp. 2d at 400. In order to differentiate between claims within the exclusion and claims where the profit to the insured was “incidental” to the alleged illegal activity, the court went on to conclude that the “proper inquiry . . . must focus not only on the factual allegations, but on the elements of the causes of action that are alleged”: If an element of the cause of action that must be proved requires that the insured gained a profit or advantage to which he was not legally entitled, then, if proved, this exclusion would be applicable. Id. Based on that analysis, the court concluded that the underlying claims for securities law violations and breaches of fiduciary duty, although they “arguably” alleged conduct that benefited the insureds, did not fit within the exclusion. Id.15 15 The Insurers try to address Alstrin by saying that the court there “highlighted the fact that the allegations ‘do not seek disgorgement.’” (Opp. at 64.) What the court said was that the underlying plaintiffs “fail[ed] to allege” that the insureds’ “profit or gain was itself illegal” or to seek disgorgement of it. Alstrin, 179 F. Supp. 2d at 400. The point was not that there is any magic in the name of the remedy, but that the applicability of the exclusion depends on whether the substance of the claim arose from the unjust enrichment of the insured. In short, the Insurers’ argument 55 Similarly, in Sheldon, 186 B.R. at 369, the underlying claim was for mismanagement by corporate officers, and the insurer argued that the personal profit exclusion applied because the insureds gained advantages by remaining employed by the company, retaining the ability to expand it, and having the opportunity to increase the value of their stock. Finding it “at least reasonably arguable” that the “alleged personal profits to” the insureds “were not the basis of the liability for which recovery was sought,” the court held that the exclusion did not apply. Id. See also Perdue Farms, Inc. v. Travelers Cas. & Sur. Co. of Am., 448 F.3d 252, 256 n. 3 (4th Cir. 2006) (exclusion did not apply because underlying claim under ERISA “proscribe[d] specified conduct, not profit”); Baldi v. Fed. Ins. Co. (In re McCook Metals, L.L.C.), 2007 WL 1687262, at *4 (N.D. Ill. June 7, 2007) (exclusion did not apply where underlying claim “not necessarily based upon” the insured’s “receiving an illegal profit”; allegations of profit were “not necessary to maintain” the underlying “cause of action”); Pereira, 2006 WL 1982789, at *6 (ill-gotten gain obtained by one insured officer did not exclude coverage for claims against other officers who did not partake of the gain); Fed. Ins. Co. v. Kozlowski, 18 A.D.3d 33, 41 (1st Dep’t 2005) (Personal Profits Exclusion did not apply to the extent claims were based on activities from which here is just a rehash of the “unjust enrichment” argument disposed of in Point I above. 56 the insured did not directly profit); Am. Century Servs. Corp. v. Am. Int’l Specialty Lines Ins. Co., 2002 WL 1879947 (S.D.N.Y. Aug. 14, 2002) (coverage is not excluded under Personal Profits Exclusion to the extent settlement is payment for claims not based on insured’s own ill-gotten gain) (applying New Jersey law).16 Here, the SEC’s claim was not based upon and did not arise out of personal profit or advantage to Bear Stearns. Instead, the SEC’s claims were based on securities law violations that did not require proof of receipt of ill-gotten gains by anyone and did not in any way depend upon allegations of the receipt of profit or advantage to which Bear Stearns was not legally entitled. (R. 145-46.) Nor did the disgorgement remedy obtained by the SEC in settlement of its claims depend upon such allegations. As discussed in Point I, above, the SEC may obtain disgorgement from a party without alleging or proving that that party had any ill- gotten gain. And in its order the SEC did not even claim that Bear Stearns in fact achieved such a gain.17 Rather, the SEC alleged that the violations resulted in the enrichment of Bear Stearns’ customers, to which any revenues earned by Bear 16 The Insurers’ claim that American Century stands for the proposition that the Personal Profit Exclusion bars coverage for amounts beyond those labeled as disgorgement is a plain misreading of the case. Instead, the court held that the Personal Profits Exclusion was limited to the portion of a settlement payment that represented the insured’s restitution of misappropriated property. 2002 WL 1879947, at *8. 17 In support of the Insurers’ groundless assertion that the purpose of the SEC Order was to “deprive Bear Stearns of the gain it reaped by its conduct,” they do not even cite to the SEC Order, but only to an SEC press release. (Opp. at 2.) 57 Stearns were at most incidental. That being so, there is at least a “reasonable basis for a difference of opinion” as to whether the exclusion applies, Pioneer Tower, 12 N.Y.3d at 307, and therefore it does not apply. C. There Is No Claim That Bear Stearns Obtained Funds to Which It Was Not Legally Entitled The Insurers’ contention that the exclusion would apply even if Bear Stearns received profits that were lawful is also contrary to the requirement that the gain be one to which the insured is not legally entitled. (R. 106.) As the court held in Bank of America Corp. v. SR Int’l Bus. Ins. Co., S.E., 2007 WL 4480057 (Super. Ct. N.C. Dec. 19, 2007), the exclusion does not apply to claims for coverage by underwriters of bond offerings that were paid a fee but had not received the proceeds of those offerings, because, in such instances, there were “no facts of record . . . [that] prove that the Bank received anything to which it was not legally entitled.” 2007 WL 4480057, at *14. Here, Bear Stearns similarly performed lawful clearing services for which it obtained lawful fees.18 Indeed, the record is clear and undisputed that Bear Stearns had no right to share in its customers’ 18 Cases cited by the Insurers are not to the contrary. Steadfast Insurance Co. v. Stroock & Stroock & Lavan LLP, 277 F. Supp. 2d 245, 253 (S.D.N.Y. 2003) merely holds that funds received by the insured in violation of the prohibition on fraudulent transfers are subject to the personal profit exclusion, while American Century Services Corp. v. American International Specialty Lines Insurance Co., 2002 WL 1879947 (S.D.N.Y. Aug. 14, 2002) expressly acknowledges that the exclusion only applies to the extent the insured’s settlement reflects payment for the gain it had improperly achieved. 58 profits, and did not derive greater compensation for late trading or market timing transactions than it did for other mutual fund trades it cleared. (R. 1440, 1447, n. 14.)19 D. Nothing Has Been Determined against Bear Stearns “in Fact” The Insurers also completely ignore the requirement that the exclusion applies only if the insured “in fact” obtained an illegal profit or advantage that became the basis for the claim. This “in fact” requirement must be given distinct meaning and effect. See, e.g., Excess Ins. Co., 3 N.Y.3d at 582. The “in fact” proviso requires that the insurer obtain a judicial determination of the facts upon which the exclusion’s application depends and that the insurer may not simply rely on the allegations in the underlying action. E.g., Pendergest-Holt, 600 F.3d at 574; PMI Mort. Ins. Co. v. American Int’l Specialty Lines Ins. Co., 2006 WL 825266, at *5 (N.D. Cal. Mar. 29, 2006). Accordingly, even if the SEC Order alleged a Bear Stearns gain to which it was not legally entitled, which it does not, to satisfy the “in fact” requirement the Insurers would have to prove in this action through evidence, not the allegations of the SEC Order, that Bear Stearns in fact received 19 The Insurers cite Jarvis Christian College v. National Union Fire Insurance Co. of Pittsburgh, Pa., 197 F.3d 742 (5th Cir. 1999) for the proposition that an insured may not be legally entitled to funds even if it did nothing illegal to obtain them. (Opp. at 63.) The example the Jarvis court gave – of a bank customer who innocently receives an erroneous credit and is not legally entitled to keep it, 197 F.3d at 749 n. 8 – is no help to them, because the SEC did not even allege that Bear Stearns received its fees by mistake; Bear Stearns earned the fees. 59 such a gain and that the securities violations charged were in fact based upon Bear Stearns having received that gain. Finally, and as so often on this appeal, Bear Stearns must set the record straight because the Insurers have misstated it. Bear Stearns has not “acknowledged receiving some profit or advantage” (Opp. at 62); it has consistently maintained, both in this action and before the SEC, that the maximum gross revenues it received as a result of its customers’ trades under investigation was $16.9 million and that it achieved little or no profit.20 (R. 57, ¶ 24; R.76-77, ¶¶ 105-06; R. 1462-63). Whether Bear Stearns earned any profit at all from the trades at issue has yet to be established and is incidental at best. In any event, the SEC’s claim for the vast majority (over $140 million) of the payment clearly had nothing to do with any alleged profit accruing to Bear Stearns and could not possibly be within the exclusion. The Insurers’ claim that, in addition to these revenues, the SEC Order asserts that Bear Stearns obtained additional advantages in the form of new business (Opp. at 62) is a red herring. All revenues paid by those customers for their mutual fund trading activities are included in the Bear Stearns $16.9 million revenue calculation 20 Bear Stearns has never admitted that all of the trades included in this gross revenue calculation reflected either improper late trades or deceptive market timing and submitted this calculation to the SEC solely as a basis upon which to discuss a possible settlement of the SEC’s claims. (R. 1489.) 60 and the SEC never charged that Bear Stearns earned any revenues as a result of the market timing and late trading activities at issue beyond those directly attributable to the trades that were the subject of the investigation. Under the CPLR 3211(a)(1) standard, that should be the end of the discussion of this exclusion. VI. THE SEC ORDER DOES NOT CONCLUSIVELY ESTABLISH THAT THE KNOWN WRONGFUL ACTS EXCLUSION APPLIES A. The Insurers’ Abandonment Claim Is Meritless In reversing the IAS court’s denial of the Insurers’ motion to dismiss, the Appellate Division did not even address, much less overturn, the IAS court’s conclusion (R 27-28) that disputed issues of fact precluded a determination at the motion to dismiss stage that the Known Wrongful Acts Exclusion barred coverage under the policy issued by Certain Underwriters at Lloyd’s London (“Underwriters”). Instead, the Appellate Division based its ruling exclusively on the insurability of disgorgement and public policy issues discussed above. (R. 1836-47.) Bear Stearns thus was not obligated to address the applicability of the Known Wrongful Acts Exclusion in its opening brief to preserve its ability to counter Underwriters’ renewed assertion in its opposition, as an alternative ground for affirmance, that the exclusion bars coverage under Underwriters’ policy. Although it is well established that Underwriters may assert, as they have here, alternative grounds for affirmance that the Appellate Division did not address, see Town of Massena v. Niagara Mohawk Power Corp., 45 N.Y.2d 482, 61 488 (1978); Menorah Nursing Home v. Zukov, 153 A.D.2d 13, 19-20 (2d Dep’t 1989), Bear Stearns was not required to address in its opening brief issues that formed no part of the Appellate Division’s reasoning. Other than this Court’s decision in In re Garner v. New York State Department of Correctional Services, 10 N.Y.3d 358, 361 (2008), the cases on which Underwriters rely (Opp. at 77, n. 18) for the erroneous proposition that Bear Stearns had such an obligation each concerned an argument expressly addressed and resolved against the appellant by the court below and then abandoned by the appellant on appeal. In contrast to those cases, the Appellate Division here never addressed whether the IAS court correctly determined that disputed issues of fact precluded dismissal based on the Known Wrongful Acts Exclusion. And this Court’s opinion in Garner stands only for the proposition that it was Underwriters, not Bear Stearns, who were obligated to raise the alternative grounds not addressed by the Appellate Division or risk abandonment. In Garner, the Attorney General had prevailed on a statute of limitations defense in the motion court, but had obtained an affirmance in the Appellate Division on other grounds. On appeal to this Court, the appellant did not address the statute of limitations defense in its opening brief, as demonstrated by the points of counsel set out in the decision, see 10 N.Y.3d at 359-60, and the Attorney General chose not to address the statute of limitations defense in his brief in opposition. Abandonment thus 62 resulted from respondent’s, not appellant’s, failure to brief the issue. Id. at 361. Garner cannot be read to require an appellant to raise in its opening brief issues that were not the basis for the adverse ruling below. There, as here, it is the respondent, not the appellant, who must raise an issue not addressed by the court below as an alternative ground for affirmance, or risk abandonment. See also Menorah Nursing Home, 153 A.D.2d at 19 (appellate court addressed on the merits issues raised in, but not addressed by, the court below even though not addressed in appellant’s brief). B. The Documentary Evidence Does Not Conclusively Establish That the Known Wrongful Acts Exclusion Applies Underwriters’ efforts to have this Court apply the Known Wrongful Acts Exclusion to preclude coverage under their excess policy are wholly dependent on the erroneous assumption that the Court can resolve against Bear Stearns several quintessential questions of fact, all of which are disputed: (1) what was known before March 21, 2000 concerning deceptive market timing or late trading by Bear Stearns’ customers; (2) who knew such facts before March 21, 2000 and whether such persons were officers of Bear Stearns within the meaning of the exclusion; and (3) whether any facts known by a Bear Stearns officer prior to March 21, 2000 were sufficient for that officer to know or reasonably foresee that Bear Stearns’ actions could lead to the claims made in the regulatory investigations or civil actions. Neither the SEC nor the NYSE was called upon to address any of these 63 questions, and thus whatever findings they made – even if they were binding, in the proceedings against the Insurers, which they are not – cannot conclusively establish the facts necessary for the exclusion to apply. Underwriters’ assertion that, because Bear Stearns stipulated to the facts set forth in the SEC Order, it is barred from disputing those facts here (Opp. at 75) is plainly incorrect. The cases upon which Underwriters rely, Atlantic Mutual Ins. Co. v. Terk Tech. Corp., 309 A.D.2d 22 (1st Dep’t 2003), and XL Specialty Ins. Co. v. Agoglia, 2009 WL 1227485, at *7 (S.D.N.Y. Apr. 30, 2009), aff’d, 370 F. App’x 193 (2d Cir. 2010), do not support that argument. XL stands for the much different proposition that a guilty plea to orchestrating a fraudulent scheme devised before the date that triggered a known wrongful acts exclusion constitutes a judicial admission enabling the court to conclude that the insured had prior knowledge of acts that could lead to claims. Unlike the insured in XL, Bear Stearns has made no admissions, expressly reserved the right to dispute in this proceeding the facts upon which the SEC relied for its charges, and in fact disputes Underwriters’ factual assertions here. Nor does Atlantic Mutual support Insurers’ claim. That case stands for the unremarkable and inapplicable proposition that the existence of coverage can be determined based on the allegations in the underlying litigation where those allegations allow for no interpretation that could bring the claim within the grant of 64 coverage. Here, as shown below, the SEC Order does not conclusively establish the facts necessary to rule as a matter of law that the Known Wrongful Acts Exclusion bars coverage.21 In addition, as the court explained in Singleton Mgmt. Inc. v. Compere, 243 A.D.2d 213, 217 (1st Dep’t 1998): “Preclusive effect will not be given if the particular issue . . . was not ‘actually litigated, squarely addressed and specifically decided.’” Id. at 217 (quoting Ross v. Med. Liab. Mut. Ins. Co., 75 N.Y.2d 825, 826 (1990)). See also Buechel v. Bain, 97 N.Y.2d 295, 303-04 (2001). The SEC’s charges unquestionably did not depend upon a determination of whether Bear Stearns’ officers knew, as of March 21, 2000, of the conduct that led to the SEC’s claims and either knew or reasonably could have foreseen, as of that date, that those claims could be made. 1. The SEC Order Does Not Conclusively Establish That a Bear Stearns Officer Knew as of March 21, 2000 That a Wrongful Act Had Occurred While the SEC’s charges include allegations of conduct that occurred before March 21, 2000, such allegations, even if they were well-founded, would not 21 Underwriters’ further efforts to dismiss the factual showing Bear Stearns made in the Wells Submission, that senior management lacked any knowledge of wrongdoing, on the grounds that those arguments were “withdrawn” (Opp. at 79) misconstrue the nature of Bear Stearns’ settlement with the SEC. Bear Stearns did not admit the facts asserted by the SEC and expressly reserved the right in proceedings not involving the SEC to take legal or factual positions incompatible with the SEC order. (R. 1687.) 65 establish that a Bear Stearns officer, within the meaning of the Known Wrongful Acts Exclusion, knew of such conduct as of that date. Rather than quote the specific SEC Order allegations that purportedly conclusively establish that officers knew of Bear Stearns’ allegedly deceptive and wrongful conduct before March 21, 2000, Underwriters paraphrase the allegations in a manner designed to gloss over the inescapable fact that those allegations simply do not unequivocally support their claim. Many of the allegations on which Underwriters rely generally describe conduct without identifying whether it occurred before March 21, 2000 or whether someone who even arguably might qualify as an officer was aware of the conduct. Even in the isolated instances where Underwriters are able to cite to a pre-March 21, 2000 event recited in the SEC Order and connect that event to a Bear Stearns employee who was part of management, and thus in Underwriters’ view was an “officer,” the cited events do not establish knowledge of deceptive or illegal conduct, as shown next, point-by-point. Far from establishing that “late trading and market timing was an institutional business practice at Bear Stearns” (Opp. at 80), the SEC itself acknowledged that Bear Stearns established a timing desk for the entirely lawful purpose of managing, monitoring, and, where requested by the mutual funds, blocking market timing trades. (R. 117-18, ¶ 4.) This allegation manifestly does not establish an institutionalized business practice to deceive mutual funds and thus 66 cannot form a basis for Underwriters’ inference that officers must have known of deceitful conduct. That certain employees may have, as claimed by the SEC, subverted the purpose of the market timing desk to facilitate unlawful trading does not establish that such facilitation was the intended purpose of the desk or that Bear Stearns officers knew, prior to March 21, 2000, of this conduct. Nor does the fact that some of the securities law violations found in the SEC Order required a showing of scienter demonstrate that Bear Stearns’ officers engaged in or knew of wrongful conduct. As shown above, the securities violations at issue could have been established through a showing of recklessness, which could have been based simply on inadequate supervision and controls, as alleged in the SEC Order. Furthermore, the late trading charges required only that Bear Stearns have processed such trades whether or not it knew that the investment decision had been made after the market close. See Rule 22c-1, 17 C.F.R. 270.22c-1; R. 1475-77. As the Wells Submission demonstrates, in fact Bear Stearns’ officers had no knowledge of such violations, or of deceptive conduct by its customers or brokers (R. 1472-77), which alone demonstrates that Underwriters cannot, on the present record, establish the exclusion’s applicability. Underwriters citation to paragraphs 175-76 of the SEC Order (Opp. at 79) also does not conclusively establish knowledge of wrongful conduct. The only reference in either paragraph to the involvement of “senior management” is the 67 assertion that senior managers approved multiple account numbers where the stated reason was “mutual fund trading” with no indication or suggestion that the purpose was to deceive mutual funds. (R. 145, ¶ 175.) As Bear Stearns demonstrated in the Wells Submission, the mere fact that multiple accounts were established, given the fact that many entirely legitimate reasons existed for doing so, does not establish knowledge of a deceptive purpose. (R. 1481-87.) Underwriters’ reliance on the allegations of paragraphs 150 and 151 of the SEC Order is similarly misplaced. (Opp. at 79.) Missing from those paragraphs is any claim that the allegedly deceptive conduct at issue – the establishment of multiple account numbers in an effort to evade mutual fund market timing limitations – either occurred before March 21, 2000 or was known by a Bear Stearns officer. The SEC instead found that at some unspecified time after December 1999 numerous accounts were opened with the assistance of unspecified Bear Stearns personnel. (R. 141, ¶ 151.) Similarly, the allegations of paragraph 138 of the SEC Order do not support Underwriters’ claim. Missing from those allegations is any claim that the referenced use of accounts for deceptive market timing began before March 21, 2000, or that the alleged knowledge by Bear Stearns “management” of such an allegedly deceptive use of those accounts was 68 obtained before that date.22 (R. 140.) Such vague statements, which were never designed in the first place to establish the particular dates on which the identified activities occurred or whether they were known to an officer, cannot constitute the required conclusive proof for Underwriters to establish that the exclusion applies. 2. The SEC Order Does Not Conclusively Establish that the Unnamed Individuals Mentioned in that Order Were Bear Stearns “Officers” Underwriters have the burden to “establish that the exclusion is stated in clear and unmistakable language, is subject to no other reasonable interpretation, and applies in the particular case.” Belt Painting Corp., 100 N.Y.2d at 383 (internal quotation and citation omitted). In Pioneer Tower, 12 N.Y.3d at 307, this Court cautioned that an exclusion should be enforced only when “there is no reasonable basis for a difference of opinion” concerning the scope of its intended application. The term “officer” is not defined in either the primary policy issued by Vigilant or the excess policies issued by Underwriters. The term can hardly be said to “have a definite and precise meaning . . . concerning which there is no 22 Nor does Underwriters’ reliance on paragraphs 70 and 71 of the SEC Order (Opp. at 77) support application of the exclusion. Those paragraphs simply recite the fact that Bear Stearns, without identifying who at Bear Stearns, was aware that one of its customers was processing trades after 4:00 P.M. As Bear Stearns explained in the Wells Submission, the critical fact relevant to the regulation of late trading is when the investment decision was made, not when the trade was processed. (R. 1452-54.) Knowledge of trades processed after 4:00 P.M. thus does not establish knowledge of illegal late trading. 69 reasonable basis for a difference of opinion.”23 Id. Although Underwriters would go so far as to include any “supervisor” or, more generally, “the market timing desk” within the scope of the term “officer,” such an expansive definition is hardly the only, or even the most, reasonable one, particularly when construing an exclusion, which is to be given “a strict and narrow construction.” See Belt Painting, 100 N.Y.2d at 383. Indeed, standard definitions of the term “officer” restrict it to those at the highest levels of the corporation, with important functions of management. See Black’s Law Dictionary 1193 (9th ed. 2009) (“officer” means “a person elected or appointed by the board of directors to manage the daily operations of a corporation, such as a CEO, president, secretary, or treasurer.”); Rule 3b-2 of the 1934 Exchange Act (“officer” means “president, vice president, secretary, treasury or principal financial officer, comptroller or principal accounting officer, and any person routinely performing corresponding functions”), 17 C.F.R. 240.3b-2. Rather than attempt to demonstrate that the documentary evidence conclusively establishes that the individuals identified in the SEC Order by titles 23 Whether an individual is an “officer” is an issue of fact that is not to be decided based on that person’s title alone. See Marafioti v. Hartford, 91 A.D.2d 974 (2d Dep’t 1983); C.R.A. Realty Corp. v. Crotty, 878 F.2d 562, 565-67 (2d Cir. 1989). As the court noted in C.R.A. Realty, “[m]any businesses give the title of vice president to employees who do not have significant managerial or policymaking duties . . . .” Id. at 566 n.3. 70 and positions are in fact “officers” within the meaning of the exclusion, Underwriters falsely assert that Bear Stearns does not dispute that fact. (Opp. at 78.) Bear Stearns has made no such admission. In fact, Bear Stearns has consistently disputed this claimed fact in the lower courts.24 3. The SEC Order Does Not Conclusively Establish That a Bear Stearns Officer Knew or Could Have Reasonably Foreseen That a Claim Could Result Nor have Underwriters conclusively established that a Bear Stearns officer knew or could have reasonably foreseen prior to March 21, 2000 that the claims ultimately made several years later in the regulatory investigations and civil actions would be asserted. Indeed, there is no evidence to support Underwriters’ contention, and the cases upon which Underwriters rely are thus wholly inapposite. In Coregis Ins. Co. v. Baratta & Fenerty, Ltd., 264 F.3d 302 (3d Cir. 2001), for example, the court found that there was no question that the insured knew before the relevant date that a malpractice claim could be made because the insured knew both that the lawsuit the firm was handling had been dismissed for lack of prosecution for over a ten-year period and that the client had expressed his dissatisfaction. Id. at 306-07. No such undisputed facts are present here. Similarly, in Executive Risk Indem. Inc. v. Pepper Hamilton LLP, 13 N.Y.3d 313, 24 For example, in its brief in the Appellate Division, Bear Stearns included the same point heading set forth above (Bear Stearns App. Div. Br. at 50) and made the same points set forth here. 71 322 (2009), it was undisputed that the insured knew of its client’s fraud and in fact subjectively believed that a claim would be made. In contrast, Underwriters have not established here, and Bear Stearns denies, that Bear Stearns’ officers knew of the alleged wrongful conduct of its customers as of March 21, 2000, and there is no evidence that, as of that date, a Bear Stearns officer in fact subjectively believed that a claim could be made. The fact that mutual funds had complained about the market timing conduct of certain customers of Bear Stearns at most establishes that those funds sought to have Bear Stearns take some action to block the unwanted trading activity, not that a claim against Bear Stearns for violation of the securities laws would result from the conduct of its customers. The foreseeable consequence of a failure to block such unwanted trades was that the mutual fund would terminate Bear Stearns’ contract to clear trades in its shares. That such limited consequences may have been reasonably foreseeable does not establish the reasonable forseeability of the claims at issue here. See Liberty Ins. Underwriters Inc. v. Corpina Piergrossi Overzat & Klar LLP, 78 A.D.3d 602, 607 (1st Dep’t 2010). Market timing is not inherently unlawful. See In re Michael Flanagan, Exchange Act Release No. 160, 2000 WL 98210, at *5 (ALJ Jan. 31, 2000); In re Mass. Fin. Servs. Co., Exchange Act Release No. 2213, 2004 WL 226714, at *3 (Feb. 5, 2004). In fact, in March of 2000, market timing was accepted by several 72 mutual funds. Simply knowing that mutual funds complained of market timing, therefore, does not establish that any officer with such knowledge knew that Bear Stearns itself had engaged in actionable misconduct or that a regulatory investigation and class action claims could result. All of these unresolved factual issues bear on whether, under all the circumstances, a Bear Stearns’ officer in March 2000 could reasonably have foreseen the claims ultimately made more than three years later in the regulatory investigations and civil actions. In light of these disputed facts, Underwriters have failed to meet their heavy burden of establishing, through conclusive documentary evidence, that the Known Wrongful Acts Exclusions bars Bear Stearns’ claims with respect to their excess layer. 73 CONCLUSION For all the foregoing reasons, the Decision of the Appellate Division should be reversed. Dated: December 7, 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 is identical to the filed original printed materials, except that they need not contain an original signature. Dated: December 7, 2012 _______________________ Ramiro A. Honeywell /s/ Ramiro A. Honeywell