J.P. Morgan Securities Inc., et al., Appellants,v.Vigilant Insurance Company, et al., Respondents.BriefN.Y.May 1, 2013 To Be Argued By: JOSEPH G. FINNERTY III Time Requested: 20 Minutes New York County Clerk’s Index No. 600979/09 Court of Appeals STATE OF NEW YORK d J.P. MORGAN SECURITIES INC., J.P. MORGAN CLEARING CORP., and THE BEAR STEARNS COMPANIES LLC, Plaintiffs-Appellants, —against— VIGILANT INSURANCE COMPANY, THE TRAVELERS INDEMNITY COMPANY, FEDERAL INSURANCE COMPANY, NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA., LIBERTY MUTUAL INSURANCE COMPANY, CERTAIN UNDERWRITERS AT LLOYD’S, LONDON, and AMERICAN ALTERNATIVE INSURANCE CORPORATION, Defendants-Respondents. BRIEF FOR DEFENDANTS- RESPONDENTS JOSEPH G. FINNERTY III, ESQ. DLA PIPER LLP (US) 1251 Avenue of the Americas New York, New York 10020 Telephone: (212) 335-4500 Facsimile: (212) 335-4501 Of Counsel: MEGAN SHEA HARWICK, ESQ. Attorneys for Defendants-Respondents ERIC S. CONNUCK, ESQ. Vigilant Insurance Company and MILES D. NORTON, ESQ. Federal Insurance Company (Counsel continued on inside cover) Dated: November 16, 2012 MARSHA J. INDYCH, ESQ. DOUGLAS M. MANGEL, ESQ. DAVID F. ABERNETHY, ESQ. Of Counsel DRINKER BIDDLE & REATH LLP 1177 Avenue of the Americas, 41st Floor New York, New York 10036-2714 (212) 248-3140 Attorneys for Defendant-Respondent Travelers Indemnity Company LUKE D. LYNCH, JR. , ESQ. RICHARD F. RUSSELL, ESQ. LIZA A. CHAFIIAN, ESQ. D’AMATO & LYNCH, LLP Two World Financial Center New York, New York 10281 (212) 269-0927 Attorneys for Defendant-Respondent National Union Fire Insurance Company of Pittsburgh, Pa. SCOTT A. SCHECHTER, ESQ. SERGIO ALVES, ESQ. KAUFMAN BORGEEST & RYAN LLP 120 Broadway, 14th Floor New York, New York 10271 (212) 980-9600 Attorneys for Defendant-Respondent Liberty Mutual Insurance Company EDWARD J. KIRK, ESQ. ALLISON M. CALKINS, ESQ. CLYDE & CO. US LLP 405 Lexington Avenue New York, New York 10174 (212) 710-3900 Attorneys for Defendant-Respondent Certain Underwriters at Lloyd’s, London MICHAEL L. GIOIA, ESQ. LANDMAN CORSI BALLAINE & FORD P.C. 120 Broadway, 27th Floor New York, New York 10271 (212) 238-4800 Attorneys for Defendant-Respondent American Alternative Insurance Corporation Of Counsel OMMID C. FARASHAHI, ESQ. KRISTI S. NOLLEY, ESQ. R. PATRICK BEDELL, ESQ. BATES CAREY NICOLAIDES LLP 191 North Wacker Drive, Suite 2400 Chicago, IL 60606 (312) 762-3100 Attorneys for Defendant-Respondent American Alternative Insurance Corporation TABLE OF CONTENTS Page(s) i PRELIMINARY STATEMENT ...........................................................................1 STATEMENT OF FACTS .....................................................................................9 I. THE REGULATORY INVESTIGATIONS OF LATE TRADING, MARKET TIMING........................................................................................9 II. RESOLUTION OF THE REGULATORY INVESTIGATIONS................11 III. THE SEC ORDER AND THE NYSE DECISION......................................12 A. The SEC’s Factual Findings...............................................................12 B. The SEC Censures Bear Stearns For Its Willful Violations Of The Securities Laws And Orders Bear Stearns To Disgorge $160 Million Of The Profits Created By Its Illegal Scheme .............14 C. The NYSE Decision ...........................................................................15 IV. THE CIVIL LITIGATION AND SETTLEMENT ......................................16 V. BEAR STEARNS’ CLAIMS FOR INSURANCE COVERAGE AND THE UNDERLYING PROCEEDINGS.......................................................17 ARGUMENT .........................................................................................................21 I. THE FIRST DEPARTMENT CORRECTLY HELD THAT BEAR STEARNS’ DISGORGEMENT PAYMENT IS NOT AN INSURABLE LOSS AS A MATTER OF NEW YORK LAW AND PUBLIC POLICY.........................................................................................21 A. Bear Stearns’ $160 Million Payment Was Disgorgement Of Ill- Gotten Gains Generated By Its Illegal Conduct.................................21 B. The Decision Is Entirely Consistent With Well Established New York Law And Public Policy Prohibiting Insurance For Disgorgement .....................................................................................27 1. The Decision Is Consistent With Bear Stearns I .....................32 2. Bear Stearns Has Not Identified A Single Authority That Holds That Disgorgement Ordered Under The Circumstances Presented Here Is Insurable.............................34 C. This Court Has Long Applied Deterrence Principles To Prohibit Insurance Coverage As A Matter of Public Policy ............................37 TABLE OF CONTENTS Page(s) ii II. BEAR STEARNS IS BOUND BY THE CONSENTED-TO AND STIPULATED FINDINGS IN THE SEC ORDER AND NYSE DECISION....................................................................................................39 A. The First Department Properly Considered The Regulatory Findings When It Granted Insurers’ Motion To Dismiss ..................39 B. The Regulatory Findings Are Not Unilateral Findings, They Were Finally Adjudicated, And Bear Stearns Is Bound By Those Findings For Insurance Coverage Purposes ............................41 1. The Regulatory Findings Are Final As Between The Regulators And Bear Stearns ...................................................41 2. Bear Stearns Is Bound By The Validity Of The Regulatory Findings When It Submits Them To Insurers For Coverage............................................................................45 3. The Decision Does Not Involve Or Implicate In Any Way, The Ability Of Government Agencies To Enter Into Settlements........................................................................52 III. THE SEC FINDINGS SET FORTH BEAR STEARNS’ INHERENTLY HARMFUL AND FRAUDULENT CONDUCT ..............54 IV. THE POLICIES EXCLUDE COVERAGE FOR CLAIMS BASED UPON OR ARISING OUT OF ANY IMPROPER PROFIT OR ADVANTAGE OBTAINED BY BEAR STEARNS ..................................61 V. THE INSURERS DID NOT AGREE TO INDEMNIFY BEAR STEARNS FOR THE DISGORGEMENT OF ILL-GOTTEN GAINS CREATED BY ITS WILLFUL COLLABORATION IN AN ILLEGAL MUTUAL FUND TRADING SCHEME...................................68 A. Consistent With Public Policy, The Policy’s Express Terms Limit Coverage To Amounts Paid “As Damages” And Bear Stearns’ Payment Of Disgorgement Is Not A Payment Of Damages .............................................................................................69 B. Consistent With Public Policy, The Express Terms Of The Policy Bar Coverage For Bear Stearns’ Intentional Conduct ............71 VI. THE PRIOR WRONGFUL ACTS EXCLUSION APPLIES TO BAR COVERAGE UNDER UNDERWRITERS’ EXCESS POLICIES .............74 TABLE OF CONTENTS Page(s) iii A. Bear Stearns Abandoned Its Appeal Of The Ruling On Underwriters’ Motion To Dismiss .....................................................75 B. Bear Stearns Officers Knew As Of March 21, 2000 Of The Wrongful Acts Committed Prior To March 21, 2000........................77 C. Officers Knew Or Could Have Reasonably Foreseen That The Pre-March 21, 2000 Wrongful Acts Could Lead To A Claim...........80 VII. DEFENSE COSTS ARE UNINSURABLE WHERE, AS HERE, NO COVERAGE IS TRIGGERED BY THE CLAIM.......................................83 CONCLUSION......................................................................................................84 TABLE OF AUTHORITIES Page(s) iv Cases 212 Inv. Corp. v. Kaplan, 16 Misc. 3d 1125(A), 2007 WL 2363233 (Sup. Ct. N.Y. Cnty. 2007) ..............21 Accessories Biz, Inc. v. Linda & Jay Keane, Inc., 533 F. Supp. 2d 381 (S.D.N.Y. 2008) ..........................................................56, 57 A.D.Julliard & Co. v. Johnson, 166 F. Supp. 577 (S.D.N.Y. 1957) aff’d, 259 F.2d 837 (2d Cir. 1958), cert. denied, 359 U.S. 942 (1959).......................................................................51 Admiral Ins. Co. v. Weitz & Luxemberg, P.C., 2002 WL 31409450 (S.D.N.Y. Oct. 24, 2002)...................................................70 Alanco Tech., Inc. v. Carolina Cas. Ins. Co., 2006 WL 1371633 (D. Ariz. May 16, 2006) ......................................................28 Allstate Ins. Co. v. Mugavero, 79 N.Y.2d 153 (1992) ...................................................................................55, 58 Alstrin v. St. Paul Mercury Ins., 179 F. Supp. 2d 376 (D. Del. 2002)....................................................................64 Am. Century Servs. Corp. v. Am. Int’l Specialty Lines Ins. Co., 2002 WL 1879947 (S.D.N.Y. Aug. 14, 2002)....................................................64 AON Corp. v. Certain Underwriters at Lloyds, London, 2010 WL 8510173 (Ill. Cir. Ct. Cook Cnty. Dec. 3, 2010)................................84 Ark Bryant Park Corp. v. Bryant Park Restoration Corp., 285 A.D.2d 143 (1st Dep’t 2001) .......................................................................40 Atlantic Mut. Ins. Co. v. Terk Techs. Corp., 309 A.D.2d 22 (1st Dep’t 2003) ...................................................................58, 75 Austro v. Niagara Mohawk Power Corp., 66 N.Y.2d 674 (1985) .........................................................................................54 Bank of Am. Corp. v. SR Int’l Bus. Ins. Co., 2007 WL 4480057 (N.C. Super. Ct. Dec. 19, 2007) ..........................................36 TABLE OF AUTHORITIES Page(s) v Bank of the West v. Superior Ct., 833 P.2d 545 (Cal. 1992) ........................................................................28, 29, 39 Bankwest v. Fidelity & Deposit Co. of Maryland, 63 F.3d 974 (10th Cir. 1995) ..............................................................................48 Bassuk Bros., Inc. v. Utica First Ins. Co., 1 A.D.3d 470 (2d Dep’t 2003)............................................................................62 Bingham v. Atlantic Mut. Ins., 215 A.D.2d 315 (1st Dep’t 1995) .................................................................58, 59 Biondi v. Beekman Hill House Apt. Corp, 257 A.D.2d 76 (1st Dep’t 1999), aff’d, 94 N.Y.2d 659 (2000) .........................................................................37, 40 Cambridge Fund, Inc. v. Abella, 501 F.Supp. 598 (S.D.N.Y. 1980) ......................................................................51 Cent. Dauphin School Dist. v. American Cas. Co., 426 A.2d 94 (Pa. 1981).................................................................................28, 39 Clayton B. Obersheimer v. Travelers Cas. & Sur. Co. of America, 96 A.D.3d 1284 (3d Dep’t 2012)........................................................................77 CNL Hotels & Resorts, Inc. v. Houston Cas. Co., 505 F. Supp. 2d 1317 (M.D. Fla. 2007)..............................................................36 Continental Cas. Co. v. Pittsburgh Corning Corp., 917 F.2d 297 (7th Cir.1990) ...............................................................................73 Coregis Ins. Co. v. Lewis, Johs, Avallone, Aviles and Kaufman, LLP, 2006 WL 2135782 (E.D.N.Y. Jul. 28, 2006)......................................................83 CPA Mut. Ins. Co. v. Weiss & Co., 80 A.D.3d 431 (1st Dep’t 2011) .............................................................81, 82, 83 DeSantis Enters. v. Am. & Foreign Ins. Co., 241 A.D.2d 859 (3d Dep’t 1997)........................................................................57 TABLE OF AUTHORITIES Page(s) vi Dodge v. Legion Ins. Co., 102 F. Supp. 2d 144 (S.D.N.Y. 2000) ..........................................................54, 55 ERC Indus., Inc. v. Nat’l Union Fire Ins. Co., 136 B.R. 59 (S.D.N.Y. 1992) .............................................................................83 Excess Ins. Co. Ltd. v. Factory Mut. Ins., 3 N.Y.3d 577 (2004) ...........................................................................................67 Exec. Risk Indem. Inc. v. Pepper Hamilton LLP, 13 N.Y.3d 313 (2009) ...................................................................................81, 82 Exec. Risk Indemnity, Inc. v. Pacific Educ. Services, Inc., 451 F. Supp. 2d 1147 (D. Haw. 2006)................................................................28 Fed. Ins. Co. v. Kozlowski, 18 A.D.3d 33 (1st Dep’t 2005) ...........................................................................64 Federal Ins. Co. v. Sheldon, 186 B.R. 364 (S.D.N.Y. 1995). ..........................................................................64 FTC v. Bronson, 654 F.3d 359 (2d Cir. 2011) ...............................................................................22 Garner v. New York State Dep’t of Correctional Services, 10 N.Y.3d 358 (2008) superseded on other grounds..............................74, 76, 77 Genzyme v. Federal Ins. Co., 622 F.3d 62 (1st Cir. 2010).................................................................................35 Halyalkar v. Bd. of Regents, 72 N.Y.2d 261 (1988) .........................................................................................51 Hartford Acc. & Indem. Co v. Village of Hempstead, 48 N.Y.2d 218 (1979) .........................................................................................37 Hertz Corp. v. Gov’t Employees Ins. Co., 250 A.D.2d 181 (1st Dep’t 1998) .......................................................................54 Home Ins. Co. v. Am. Home Prod. Corp., 75 N.Y.2d 196 (1990) ...................................................................................37, 38 TABLE OF AUTHORITIES Page(s) vii Ikramuddin v. DeBuono, 256 A.D.2d 1039 (3d Dep’t 1998)......................................................................51 In re Mutual Funds Investment Litig., 384 F. Supp. 2d 845 (D. Md. 2005)..............................................................16, 17 In re Platinum & Palladium Commodities Litig., 828 F. Supp. 2d 588 (S.D.N.Y. 2011) ................................................................51 In re San Juan Dupont Plaza Hotel Fire Litig., 802 F. Supp. 624 (D.P.R. 1992) .........................................................................39 Int’l Tel. & Tel. Corp. Commc’ns Equip. & Sys. Div. v. Local 134, Int’l Bhd. of Elec. Workers, 419 U.S. 428, 95 S.Ct. 600 (1975)......................................................................44 J.P. Morgan Securities, Inc., et al. v. Vigilant Ins. Co., et al., 91 A.D.3d 226 (1st Dep’t 2011) .......................................................19, 20, 31, 61 Jahier v. Liberty Mut. Group, 64 A.D.3d 683 (2d Dep’t 2009)..........................................................................62 Jarvis Christian College v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 197 F.3d 742 (5th Cir. 1999) ........................................................................63, 64 Levitt v. Levitt, 97 A.D.3d 543 (2d Dep’t 2012)..........................................................................77 Levy v. SEC, 462 F. Supp. 2d 64 (D.D.C. 2006)......................................................................44 Lipsky v. Commonwealth United Corp., 551 F.2d 887 (2d Cir. 1976) ...............................................................................51 Maroney v. New York Cent. Mut. Fire Ins., 5 N.Y.3d 467 (2005) ...........................................................................................67 Matter of Tristram, 65 A.d.3d 894 (1st Dep’t 2009) ..........................................................................77 TABLE OF AUTHORITIES Page(s) viii McKee v. City of Cahoes Bd. of Educ., 99 A.D.2d 923 (3d Dep’t 1984)..........................................................................77 Menorah Nursing Home, Inc. v. Zukov, 153 A.D.2d 13 (2d Dep’t 1989)..........................................................................61 Messersmith v. Am. Fid. Co., 232 N.Y. 161 (1921) ...............................................................................54, 68, 69 Millennium Partners L.P. v. Select Ins. Co., 24 Misc. 3d 212, 216 (Sup. Ct. N.Y. Cnty. 2009), aff’d, 68 A.D.3d 420 (1st Dep’t 2009) .......................................................passim Miller v. Brereton, 98 A.D.3d 824 (3d Dep’t 2012)..........................................................................77 Mishkin v. Peat, Marwick, Mitchell & Co., 1988 WL 391648 (S.D.N.Y. Nov. 7, 1988)........................................................51 Mortenson v. Nat’l Fire Ins. Co. of Pittsburgh, Pa., 249 F.3d 667 (7th Cir. 2001) ..............................................................................39 Mutchnick v. John Hancock Mut. Life Ins. Co., 284 N.Y.S. 565 (N.Y. Mun. Ct. 1935)................................................................66 Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Continental Ill. Corp., 666 F. Supp. 1180 (N.D. Ill. 1987).....................................................................63 Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Xerox Corp., 25 A.D.3d 309 (1st Dep’t 2006) .........................................................................50 Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Xerox Corp., 6 Misc.3d 763 (Sup. Ct. N.Y. Cnty. 2004) ...................................................49, 50 Nat’l Union Fire Ins. of Pittsburgh, Pa. v. AARPO, Inc., 1999 WL 14010 (S.D.N.Y. Jan. 14, 1999) ...................................................56, 58 New Hampshire Ins. v. Jefferson Ins. of N.Y., 213 A.D.2d 325 (1st Dep’t 1995) .......................................................................67 TABLE OF AUTHORITIES Page(s) ix Nortex Oil & Gas Corp. v. Harbor Ins. Co., 456 S.W.2d 489 (Tex. Civ. App. 1970)..............................................................28 Northland Cas. Co. v. HBE Corp., 160 F. Supp. 2d 1348 (M.D. Fla. 2001)..............................................................48 O’Neill Investigations, Inc. v. Illinois Employers Ins. of Wausau, 636 P.2d 1170 (Alaska 1981) .............................................................................28 Official Committee of Unsecured Creditors of Worldcom, Inc. v. SEC, 467 F.3d 73 (2d Cir. 2006) ...........................................................................26, 70 Pan Pacific Properties, Inc. v. Gulf Ins. Co., 471 F.3d 961 (9th Cir. 2006) ........................................................................34, 35 Penna v. Peerless Ins. Co., 510 F. Supp. 2d 199 (W.D.N.Y. 2007)...............................................................66 Pereira v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 2006 WL 1982789 (S.D.N.Y. July 12, 2006).........................................35, 36, 64 Pub. Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392 (1981) ...................................................................................54, 68 Raychem Corp. v. Federal Ins. Co., 853 F. Supp. 1170 (N.D. Cal. 1994).............................................................51, 59 Raymond Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 5 N.Y.3d 157 (2005) ...........................................................................................73 Reliance Grp. Holdings, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburg, Pa., 188 A.D.2d 47 (1st Dep’t 1993) ...................................................................28, 29 Ryan v. New York Tel. Co., 62 N.Y.2d 494 (1984) .........................................................................................51 Ryerson Inc. v. Federal Ins. Co., 796 F. Supp. 2d 911 (N.D. Ill. 2010)............................................................72, 73 Ryerson Inc. v. Federal Ins. Co., 676 F.3d 610 (7th Cir. 2012) ..................................................................28, 36, 73 TABLE OF AUTHORITIES Page(s) x Seaboard Sur. Co. v. Ralph Williams’ Northwest Chrysler Plymouth, Inc., 504 P.2d 1139 (Wash. 1973) (en banc) ..............................................................28 SEC v. Anticevic, 2010 WL 3239421 (S.D.N.Y. Aug. 16, 2010)..............................................21, 23 SEC v. Boock, 2012 WL 3133638 (S.D.N.Y. Aug. 2, 2012)......................................................21 SEC v. Cavanagh, 445 F.3d 105 (2d Cir. 2006) ...............................................................................70 SEC v. Citigroup Global Markets, Inc., 827 F. Supp. 2d 328 (S.D.N.Y. 2011) ..........................................................52, 53 SEC v. Citigroup Global Markets Inc., 673 F.3d 158 (2d Cir. 2012) .........................................................................53, 54 SEC v. Commonwealth Chemical Sec., 574 F.2d 90 (2d Cir. 1978) .................................................................................70 SEC v. DiBella, 587 F.3d 553 (2d Cir. 2009) ...............................................................................22 SEC v. Drexel Burnham Lambert, Inc., 956 F. Supp. 503 (S.D.N.Y. 1997) .....................................................................70 SEC v. Durgarian, 477 F. Supp.2d 342 (D. Ma. 2007) .....................................................................79 SEC v. First City Financial Corp., Ltd, 890 F.2d 1215 (D.C. Cir. 1989)..........................................................................22 SEC v. First Jersey Sec., Inc., 101 F. 3d 1450 (2d Cir. 1996) ............................................................................21 SEC v. First Pacific Bancorp, 142 F.3d 1186 (9th Cir. 1998) ............................................................................26 SEC v. Fischbach Corp., 133 F.3d 170 (2d Cir. 1997) .............................................................22, 26, 29, 70 TABLE OF AUTHORITIES Page(s) xi SEC v. Patel, 61 F.3d 137 (2d Cir. 1995) .................................................................................22 SEC v. PIMCO Advisors Fund Mgmt., LLC, 341 F. Supp. 2d 454 (S.D.N.Y. 2004) ................................................................79 SEC v. Svoboda, 409 F. Supp. 2d 331 (S.D.N.Y. 2006) ................................................................21 SEC v. Tome, 833 F.2d 1086 (2d Cir. 1987) .............................................................................70 SEC v. Universal Express, Inc., 646 F. Supp. 2d 552 (S.D.N.Y. 2009) ................................................................21 SEC v. Verdiramo, 2011 WL 5546222 (S.D.N.Y. Nov. 10, 2011)..............................................21, 22 SEC v. Warde, 151 F.3d 42 (2d Cir. 1998) ...........................................................................22, 23 Servidone Constr. Corp. v. Sec. Ins. Co. of Hartford, 64 N.Y.2d 419 (1985) ...................................................................................47, 48 Sphere Drake Ins. Co. v. 72 Centre Ave. Corp., 238 A.D.2d 574 (2d Dep’t 1997)........................................................................58 SR Int’l Bus. Ins. Co., Ltd. v. World Trade Ctr. Props. LLC, 2006 WL 3073220 (S.D.N.Y. Oct. 31, 2006).....................................................73 Steadfast Ins. Co. v. Stroock & Stroock & Lavan LLP, 277 F. Supp. 2d 245 (S.D.N.Y. 2003) ................................................................64 Stonewall Ins. Co. v. Asbestos Claims Mgt. Corp., 73 F.3d 1178 (2d Cir. 1995) ...............................................................................83 Syversten v. Great Am. Ins. Co., 267 A.D.2d 854 (3d Dep’t 1999)........................................................................57 TIG Specialty Ins. Co. v. Pinkmonkey.com Inc., 375 F.3d 365 (5th Cir. 2004) ..............................................................................63 TABLE OF AUTHORITIES Page(s) xii Town of Massena v. Healthcare Underwriters Mut. Ins., 98 N.Y.2d 435 (2002) .........................................................................................54 Town of Massena v. Niagara Mohawk Power Corp., 45 N.Y.2d 482 (1978) .........................................................................................61 Travelers Ins. Co. v. Waltham Indus. Labs. Corp., 883 F.2d 1092 (1st Cir. 1989).............................................................................48 U.S. Fidelity & Guar. Co. v. Annunziata, 67 N.Y.2d 229 (1986) ...................................................................................62, 65 Unified Western Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106 (9th Cir. 2006) ............................................................................36 United Parcel Service, Inc. v. Tax Appeals Tribunal of the State of New York, 2012 WL 3481291 (3d Dep’t Aug. 12, 2012) ....................................................77 Vigilant Ins. Co. v. The Bear Stearns Cos., Inc., 34 A.D.3d 300 (1st Dep’t 2006), rev’d, 10 N.Y.3d 170 (2008)...................................................................24, 25, 33 Vigilant Ins. Co. v. Credit Suisse First Boston, 6 Misc. 3d 1020(A), 2003 WL 24009803 (Sup. Ct. N.Y. Cnty. 2003) ........29, 47 Vigilant Ins. Co. v. Credit Suisse First Boston, 10 A.D.3d 528 (1st Dep’t 2004) .............................................................28, 47, 83 Weedo v. Stone-E-Brick, Inc., 405 A.2d 788 (N.J. 1979) .............................................................................73, 74 Wilhelmina Models, Inc. v. Fleisher, 19 A.D.3d 267 (1st Dep't 2005)..........................................................................40 Wojtunik v. Kealy, 2011 WL 1211529 (D. Ariz. Mar. 31, 2011)......................................................36 XL Specialty Ins. v. Agoglia, 2009 WL 1227485 (S.D.N.Y. April 30, 2009) ...................................................75 TABLE OF AUTHORITIES Page(s) xiii Zurich Ins. v. Shearson Lehman, 84 N.Y.2d 309 (1994) .............................................................................37, 38, 39 OTHER AUTHORITIES 2 Allan Windt, Insurance Claims and Disputes § 6.31 (2012) ................................48 5 U.S.C. § 551(6) .....................................................................................................44 5 U.S.C. § 551(7) .....................................................................................................44 5 U.S.C. § 551 et seq................................................................................................43 15 U.S.C. § 78o(c)(4)...............................................................................................15 17 C.F.R. § 201.240 .................................................................................................43 17 C.F.R. § 201.240(c)(7)......................................................................12, 44, 50, 70 17 C.F.R. § 202.5(e).................................................................................................43 Black’s Law Dictionary (9th ed. 2009) ...................................................................69 Kenneth B. Winer & Samuel J. Winer, Securities Enforcement: Counseling and Defense § 17.07 (2012)................................................................................43 Merriam-Webster Collegiate Dictionary (11th ed. 2007) .......................................69 N.Y. Jur. 2d Damages § 9 ........................................................................................69 1 PRELIMINARY STATEMENT For more than four years, Bear Stearns operated an illegal late trading and market timing scheme for the benefit of its clients “that generated hundreds of millions of dollars” of ill-gotten gains at the expense of other mutual fund investors. After a lengthy investigation, the Securities and Exchange Commission (“SEC”) concluded in over 40 pages and 184 paragraphs of detailed factual findings that Bear Stearns “willfully violated” and “willfully aided and abetted and caused” violations of a litany of federal securities laws, and that its role as the architect and “hub” of the illegal scheme rendered it liable to disgorge $160 million of the ill-gotten gains generated by the scheme. (R.116-45.)1 A Hearing Panel of the New York Stock Exchange (“NYSE”) similarly concluded that Bear Stearns’ illegal scheme violated the securities laws and identical NYSE rules. (R.160-203.) Bear Stearns consented to the entry of the regulators’ findings in an offer of settlement that it submitted to the SEC and in a stipulation of facts with the NYSE. Bear Stearns also agreed to be bound by the findings, to never dispute their validity, and to withdraw all prior submissions and defenses to the extent inconsistent with those findings. Finally, Bear Stearns offered and agreed to pay a 1 Citations to “R.” refer to the Record on Appeal. Citations to “BB” refer to the Brief for Plaintiffs-Appellants, dated August 27, 2012. 2 $250 million sanction—comprised of $160 million in disgorgement and a $90 million penalty—and was censured by the SEC. In this appeal, Bear Stearns admits that it was ordered to pay and paid disgorgement, that its disgorgement payment was calculated based on the gains generated as a result of what the SEC deemed an illegal mutual fund late trading scheme, and, finally, that the SEC is authorized to obtain from one collaborator, like Bear Stearns, all of the ill-gotten gains generated as a result of the illegal conduct. Bear Stearns also concedes that disgorgement of ill-gotten gains is not insurable under New York law and public policy. Bear Stearns nevertheless argues that it is entitled to recover its disgorgement payment from the Insurers because it did not retain for itself the ill-gotten gains that it was ordered to disgorge. Bear Stearns is wrong. As shown below, the SEC and NYSE properly compelled Bear Stearns to disgorge the ill-gotten gains created by its collaboration with its customers in an unlawful trading scheme. The securities laws make no distinction between those that retain ill-gotten gains and those that make them possible. The reason for this is to make securities violations unprofitable and to deter future violations. Indeed, the SEC recognized these very principles here, confirming that Bear Stearns’ disgorgement payment was meant both to “deprive Bear Stearns of the gains it reaped by its conduct” and to “prevent similar misconduct from recurring.” (R.156.) Consistent with these deterrence principles, 3 established New York law and public policy prohibit one who is required to repay ill-gotten gains as a result of its unlawful conduct from being reimbursed with insurance. Bear Stearns is asking this Court to create a carve-out from this well established law to allow it to be reimbursed through insurance for a payment that it admits reflects the return of ill-gotten gains that the SEC found were generated by its illegal conduct. Allowing Bear Stearns to collect insurance proceeds in these circumstances would directly undermine the deterrence principles driving New York law and public policy, and incentivize wrongdoers like Bear Stearns to engage in collaborative illegal conduct safe in the assurance that the gains from the illegal enterprise, for which they are liable, are guaranteed by insurance. Indemnification of such illegal gains was not a risk that was, or legally could be, underwritten by the Insurers. The First Department properly concluded that Bear Stearns’ disgorgement payment was uninsurable because the findings in the SEC Order and the NYSE Decision conclusively linked Bear Stearns’ disgorgement payment with the illegal gains generated by its collaboration in the illegal trading scheme. The First Department thus correctly applied the critical deterrence objectives underlying the SEC’s disgorgement remedy—and corresponding public policy considerations— by not allowing Bear Stearns to recoup through insurance its disgorgement of ill- gotten gain. This Court should affirm. 4 Bear Stearns’ separate argument that the First Department was obligated to ignore, for purposes of insurance, the findings that Bear Stearns proposed and agreed to as the basis for the regulatory settlements and instead accept Bear Stearns’ wholly contrary allegations in its Amended Complaint, is not only mistaken, it highlights the bait and switch Bear Stearns has played vis-a-vis its Insurers, and now plays with this Court. On the one hand, Bear Stearns consented to detailed regulatory findings that it willfully facilitated illegal trading activities and agreed to pay a quarter of a billion dollars to resolve them. But when it presents those very same regulatory findings and orders to its Insurers for coverage, Bear Stearns insists that the detailed findings do not mean what they say and that it is entitled to insurance based on directly contradictory allegations in its Amended Complaint and unsuccessful defenses asserted in the Wells Submission Bear Stearns abandoned by express agreement with the SEC. For example, Bear Stearns argues here that it did not “knowingly accept late trades” because the entry of an order after the 4 p.m. close of trading does not evidence that the customer was a late trader. (BB 3.) But the SEC and the NYSE found and ordered precisely the opposite—that Bear Stearns affirmatively and knowingly facilitated its customers’ late trading by advising brokers and timing desk employees to “record 3:59 or 4:00 p.m. as the order taken time, regardless of the time when the mutual fund order was in fact received from a customer,” and 5 then forwarding those post 4 p.m. orders to the mutual funds “to receive that day’s NAV, as if they had been received before 4 p.m.” (R.117 (¶2), R.125 (¶48), R.128-29 (¶76).) With regard to deceptive market timing, Bear Stearns alleges here that it “attempted to block all trades from accounts known to be market timers” if a mutual fund “indicated that it did not want trades from market timer accounts,” (BB 14), but again the SEC and NYSE found and ordered just the opposite—that Bear Stearns ignored thousands of complaints it received from mutual funds to stop allowing timing in their funds, and instead, actively helped its customers evade mutual fund blocks so that those customers could continue their timing activity. (R.117-18 (¶¶2-4), R.122 (¶¶29-30), R.164 (¶¶6-8), R.169 (¶32).) Bear Stearns also alleges here that any evasion of the mutual funds’ blocking systems “was not the result of any scheme or policy of Bear Stearns but at most the result of unauthorized actions by individual brokers,” (BB 50), but again the SEC and NYSE found and ordered just the opposite—that the illegal trading scheme was carried out by, or with the awareness of, the “senior managers” and other individuals at “the highest levels” of Bear Stearns. (R.140 (¶138), R.145 (¶175).) The NYSE similarly acknowledged the widespread complicity among the ranks at Bear Stearns: “It is disturbing how so many people in so many different units [at Bear Stearns] worked to circumvent the blocks and restrictions set up by the 6 mutual funds. . . . This type of behavior is completely outrageous and unacceptable.” (R.1844.) In short, the detailed factual findings in orders by the SEC and NYSE— which Bear Stearns proposed and agreed to be bound by—plainly contradict the self-serving allegations in Bear Stearns’ Amended Complaint, and they delineate the precise nature of Bear Stearns’ unlawful conduct and the bases for the sanctions imposed. Bear Stearns agreed to withdraw the same allegations it now attempts to reassert in this case as the basis for its insurance claim, and more than that, expressly agreed that it would take no action to deny or undermine the factual findings by the regulators—which is exactly what it now attempts to do here. The regulatory findings are final and conclusive as between Bear Stearns and the regulators, and the First Department followed established New York law when it held that Bear Stearns was bound by the validity of those findings for the purposes of its claim for insurance coverage. Insurers must be able to rely upon arms- length, bona fide terms in agreements resolving liability exposure to finally determine whether payment obligations incurred as a result are properly insured. These bedrock principles of New York law are sufficient in themselves to affirm the First Department’s decision, but the decision also should be affirmed for additional independent reasons. First, New York law and public policy bar insurance coverage for any claim when harm is inherent in the intentional 7 misconduct of the insured, such that the insured must be regarded as intending the harm itself. Bear Stearns knowingly and intentionally facilitated illegal late trading and deceptive market timing—acts it knew would inflict massive harm upon other mutual fund shareholders. Bear Stearns cannot use insurance proceeds to sidestep its responsibility for its adjudicated willful, inherently harmful conduct. Second, the Policies expressly exclude coverage for Claims based upon or arising out of any improper profit or advantage gained by the insured, and the findings that bind Bear Stearns establish that Bear Stearns was motivated to and in fact did gain significant profit or advantage from its facilitation of the illegal trading scheme. Third, the Policies cover only “Loss” paid “as damages,” which does not include the payment of disgorgement that Bear Stearns has made here. Fourth, the Policies do not cover deliberately fraudulent dishonest acts where there is an adjudication of those acts—here, in the form of SEC findings agreed to by Bear Stearns in an administrative order expressly defined by the relevant law as an “adjudication.” Finally, Bear Stearns has abandoned its right to challenge the First Department’s determination to grant the separate motion to dismiss by Certain Underwriters at Lloyd’s and American Alternative Insurance Corporation (collectively, “Underwriters”), based on the “Prior Wrongful Acts Exclusion” in 8 the excess policies issued by Underwriters. Even if the Court concludes that the issue has not been abandoned, the First Department’s decision should be affirmed. The Prior Wrongful Acts Exclusion applies here as a matter of law to preclude coverage under the excess insurance policies issued by Underwriters because the SEC Order and NYSE Decision conclusively establish that Bear Stearns committed numerous willful and intentional acts beginning in 1999, and that, as of March 2000, Bear Stearns officers knew or could have reasonably foreseen that the wrongful conduct could lead to a Claim. For all of these reasons, the First Department decision dismissing Bear Stearns’ complaint against Insurers for insurance coverage for its disgorgement payment, civil settlement and defense costs, should be affirmed. 9 STATEMENT OF FACTS I. THE REGULATORY INVESTIGATIONS OF LATE TRADING, MARKET TIMING In September 2003, the SEC and the NYSE commenced parallel investigations of Bear Stearns’ operation of an illegal mutual fund trading scheme based on practices known as “late trading” and “deceptive market timing.” (R.116 (¶1), R.119 (¶13), R.139 (¶130).) Late trading is the per se illegal practice of placing orders to buy or sell mutual fund shares after trading is closed and after the mutual funds have calculated their daily net asset value (“NAV”)—typically 4 p.m.2 (R.52 (¶16), R.119 (¶9), R.120 (¶17).) “Late trading enables the trader improperly to obtain profits from market events that occur after 4 p.m., such as earnings announcements and futures trading, that are not reflected in that day’s [net asset value].” (R.119 (¶9).) With this after-close market information, late traders obtain unfair “trading advantages over the other shareholders of the targeted mutual funds.” (Id.) Put another way, “late trading” amounts to betting today on yesterday’s horse race. “Market timing” involves frequent buying and selling of shares of the same mutual fund, and often goes hand-in-hand with late trading. (R.52 (¶6), R.118 (¶8).) Market timing is illegal where “deception is used to induce a mutual fund to 2 Rule 22c-1(a), the “forward pricing rule,” requires a broker such as Bear Stearns “to sell and redeem [mutual] fund shares at a price based on the current [net asset value] next computed after receipt of an order to buy or redeem.” (R.120 (¶17).) 10 accept trades that it otherwise would not accept under its own market timing policies.” (R.118-19 (¶8).) Market timing enables late traders to sell shares before illicit gains can be erased and harms other shareholders because it “dilute[s] the value of their shares,” “disrupt[s] the management of the mutual fund’s investment portfolio” and “cause[s] the targeted mutual fund to incur considerable extra costs associated with excessive trading.” Id. The SEC and NYSE investigations of Bear Stearns’ facilitation of illegal mutual fund trading spanned two and a half years during which the SEC issued more than 20 subpoenas and document requests, interviewed and deposed approximately 35 current and former Bear Stearns employees and reviewed hundreds of thousands of pages of documents from Bear Stearns’ files. (R.65 (¶62), R.74 (¶96).) During the course of the investigation, the staff of the SEC informed Bear Stearns that it intended to recommend that the SEC commence civil proceedings against Bear Stearns, charging Bear Stearns with violations of the federal securities laws and seeking injunctive relief and sanctions of $720 million. (R.76 (¶104).) The SEC staff reviewed with Bear Stearns the evidence upon which the SEC would rely to support its charges, and Bear Stearns submitted to the SEC a detailed Wells Submission attempting to refute the SEC’s charges. (R.75 (¶98).) - 11 II. RESOLUTION OF THE REGULATORY INVESTIGATIONS The SEC staff informed Bear Stearns that the SEC had authorized the commencement of proceedings against Bear Stearns, but that the “SEC would be willing to discuss a resolution of the investigation if the SEC had an understanding of the amount of fees the market-timing business generated for Bear Stearns, and the amount of profits Bear Stearns’ customers enjoyed.” (R.75 (¶100) (emphasis in original); see also id. (¶101).) Bear Stearns argued to the SEC, as it does here, that it had received only $16.9 million from its illegal activity and, based on those purported gains, Bear Stearns proposed to settle the SEC’s charges for $20 million. (R.76 (¶103).) As Bear Stearns admits, the “SEC rejected Bear Stearns’ proposal.” (Id.) The SEC agreed to settle its charges against Bear Stearns for $250 million—$160 million of which Bear Stearns alleges was “based upon the alleged gains to Bear Stearns’ customers from late trading.” (R.178 (¶111); see also R.77 (¶109), R.80 (¶122).) Bear Stearns submitted an offer of settlement (the “Offer of Settlement”) in which it consented to detailed factual findings that the SEC would issue as part of an administrative order, and agreed to pay sanctions totaling $250 million, comprised of “Disgorgement and Civil Money Penalties.” (R.1648-91; see also R.54 (¶14), R.80 (¶120), R.82-83 (¶132), R.1686 (§ IV.D).) 12 In its Offer of Settlement, Bear Stearns also agreed: (1) “not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any finding in the [SEC] Order or creating the impression that the [SEC] Order is without factual basis”; and (2) to “withdraw any papers previously filed . . . to the extent they deny, directly or indirectly, any finding in the [SEC] Order.” (R.1687 (§ VI).) III. THE SEC ORDER AND THE NYSE DECISION A. The SEC’s Factual Findings Where, as here, the SEC resolves an investigation by administrative order, the SEC is required to make findings. (See 17 CFR § 201.240(c)(7).) In its administrative order, the SEC set forth 40 pages, and 184 paragraphs of findings detailing Bear Stearns’ complicity in an illegal mutual fund trading scheme (the “SEC Order”). (R.116-55.) These findings adopted verbatim the findings proposed by Bear Stearns itself in its Offer of Settlement. (R.1648-91.) As set forth in the SEC Order, the SEC concluded that for a period of four years beginning in 1999, Bear Stearns orchestrated and ran a “timing desk,” through which Bear Stearns purposefully facilitated illegal mutual fund trading. Among other things, the SEC found that Bear Stearns: knowingly processed late trades as if they had been submitted hours earlier and “falsified internal order tickets” to misrepresent that it had received late trading orders prior to the 4 p.m. deadline, (R.125 (¶¶ 46-48)); 13 explicitly “touted their late trading capabilities” to customers because “[t]he ability to enter late trades was an important benefit” to those customers, (R.122-23 (¶¶ 32-33)); offered to assist its hedge fund clients in “cancelling unprofitable trades the next day,” (R.129 (¶ 76).) The SEC Order also detailed Bear Stearns’ active facilitation of deceptive market timing in direct disregard of thousands of demands it received from mutual funds requesting that Bear Stearns stop allowing timing in their funds. (R.122 (¶¶29-30).) Rather than prevent the timing activity, Bear Stearns took “affirmative steps” to help its clients “evade the blocks and restrictions imposed by the mutual funds.” (R.117 (¶¶2, 4).) It accomplished this by “hid[ing]” from mutual funds the identity of its customers and traders that were known market timers by assigning multiple account numbers and registered representative numbers. For example, the SEC found that Bear Stearns gave 150 different account numbers to a single trader and well over 300 account numbers to a group of 14 market timing customers. (R.137 (¶117), R.144 (¶170).) In addition, despite Bear Stearns’ efforts to convince its regulators that it was simply reckless in failing to “supervise” a few rogue employees (BB 13, n.1), the SEC concluded that “senior management” and other individuals “at the highest levels” of Bear Stearns operated with knowledge that this illegal late trading and deceptive market timing was regularly ongoing at Bear Stearns. (R.140 (¶138), 14 R.141 (¶151), (R.145 (¶¶175-177).) The NYSE likewise found that “many people” in “many different units” at Bear Stearns “worked to circumvent the blocks and restrictions set up by the mutual funds.” (R.204.) In sum, Bear Stearns in fact proposed (and the SEC accepted) findings that establish beyond any dispute that Bear Stearns was not the innocent, unknowing and unwitting bystander to illegal conduct described in its brief in this Court. Quite to the contrary, the SEC concluded and found that “Bear Stearns was the hub that connected the many spokes of market timing and late trading,” (R.156), and its conduct “enabled [its customers] to generate hundreds of millions of dollars in profits from these trading tactics at the expense of mutual fund shareholders.” (R.118 (¶5).) Bear Stearns not only proposed and then consented to the SEC’s detailed findings, it agreed to be bound by them: “The findings herein . . . are not binding on any other person or entity in this or any other proceeding.” (R.117, n.1 (emphasis added).) B. The SEC Censures Bear Stearns For Its Willful Violations Of The Securities Laws And Orders Bear Stearns To Disgorge $160 Million Of The Profits Created By Its Illegal Scheme Based on the detailed factual findings in the SEC Order, the SEC concluded that Bear Stearns had “willfully violated” and “willfully aided and abetted” several provisions of the federal securities laws. (R.145-46 (¶¶ 179-83) (emphasis 15 added).) The SEC accordingly censured Bear Stearns—a remedy that the SEC may impose only if it finds “on the record after notice and opportunity for hearing” that a broker-dealer, such as Bear Stearns, has willfully violated or willfully aided and abetted violations of the federal securities laws. See 15 U.S.C. § 78o(c)(4). The SEC Order directs Bear Stearns to pay “Disgorgement and Civil Money Penalties,” comprised of “disgorgement in the total amount of $160,000,000” and “civil money penalties in the amount of $90,000,000.” (R.154 (§ IV.D); see also R.54 (¶14), R.82 (¶132).) According to the SEC’s Enforcement Division Director, the purpose of Bear Stearns’ settlement with the SEC was to “deprive Bear Stearns of the gains it reaped by its conduct,” and to “put in place procedures to prevent similar misconduct from recurring.” (R.156.) Bear Stearns’ total payment to the SEC—the $90 million penalty and the $160 million disgorgement payment—was placed in a Fair Fund under the Sarbanes-Oxley Act of 2002 and used to compensate investors harmed by Bear Stearns’ illegal mutual fund trading practices. Id. C. The NYSE Decision A Hearing Panel of the NYSE issued two decisions (collectively, the “NYSE Decision”) censuring and fining Bear Stearns for the same illegal conduct described in the SEC Order. (R.160-203.) Bear Stearns first executed a “Stipulation of Facts and Consent to Penalty” in which it consented to the entry of 16 factual findings by the NYSE Hearing Panel that are substantively identical to the SEC’s findings. (R.1692-1739.) Based on these factual findings, the NYSE Hearing Panel adjudged Bear Stearns “guilty” of late trading and deceptive market timing. (R.171 (¶39).) The NYSE levied a total “penalty” of $250,000,000, deemed satisfied by Bear Stearns’ payment of the same amount agreed to be disgorgement and a civil money penalty in the SEC Order. (R.160-203.) IV. THE CIVIL LITIGATION AND SETTLEMENT Following Bear Stearns’ payment of $250 million to resolve the SEC and NYSE investigations, Bear Stearns agreed to pay $14 million to settle thirteen shareholder class action lawsuits alleging similar conduct (the “Civil Litigation”). (R.55 (¶17), R.88 (¶155).) Bear Stearns had moved to dismiss the civil complaints, arguing that the allegations, which paralleled the SEC’s and NYSE’s factual findings, were insufficient to hold Bear Stearns liable under the securities laws as a “primary actor.” In re Mutual Funds Investment Litig., 384 F. Supp. 2d 845, 863 (D. Md. 2005). In denying Bear Stearns’ motion, the district court held that plaintiffs had adequately asserted claims that Bear Stearns was a “co designer” or “committed a manipulative or deceptive act in furtherance of” the illegal mutual fund trading scheme and “did not merely assist in facilitating late trades and market timed 17 transactions.” Id. at 862. The court also held that “it is reasonably inferable that [Bear Stearns] participated in initiating, instigating, and orchestrating the scheme” and that the plaintiffs sufficiently established that Bear Stearns was a “primary actor” for purposes of establishing liability for fraud under the federal securities laws. Id. V. BEAR STEARNS’ CLAIMS FOR INSURANCE COVERAGE AND THE UNDERLYING PROCEEDINGS On March 31, 2009, Bear Stearns commenced this insurance coverage action against Insurers. The provisions of the Policies relevant to Bear Stearns’ coverage claim are set forth below. The Policies only cover “Loss” and define that term to include only amounts paid “as damages”: compensatory damages, multiplied damages, punitive damages where insurable by law, judgments, settlements, costs, charges and expenses or other sums the Insured shall legally become obligated to pay as damages resulting from any Claim or Claim(s); (R.103 (§ II(B)(2)(v)) (emphasis added).) The Policies also exclude certain matters from this operative definition of Loss, including “matters which are uninsurable under the law pursuant to which this policy shall be construed.” (Id., § II(B)(2)(v).) The Policies also contain a Profit or Advantage Exclusion that provides: This Policy shall not apply to any Claim(s) made against the Insured(s) . . . based upon or arising out of the Insured gaining in 18 fact any personal profit or advantage to which the Insured was not legally entitled . . . . (R.106 (§ IV(9)).) Similarly, the Policies contain a Dishonest Acts Exclusion that provides: This policy shall not apply to any Claim(s) made against the Insured(s) . . . based upon or arising out of any deliberate, dishonest, fraudulent or criminal act or omission by such Insured(s), provided, however, such Insured(s) shall be protected under the terms of this policy with respect to any Claim(s) made against them in which it is alleged that such Insured(s) committed any deliberate, dishonest, fraudulent or criminal act or omission, unless judgment or other final adjudication thereof adverse to such Insured(s) shall establish that such Insured(s) were guilty of any deliberate, dishonest, fraudulent or criminal act or omission . . . (R.105-107 (§ IV(1).) Insurers moved to dismiss Bear Stearns’ Amended Complaint on the following grounds: (1) Bear Stearns’ $160 million disgorgement payment is not insurable as a matter of New York law and public policy; (2) public policy prohibits insurance for these claims because they arise out of Bear Stearns’ inherently harmful conduct; (3) the Policies exclude coverage because the claims are based upon or arise out of profit or advantage to which Bear Stearns was not legally entitled; and (4) the excess policies issued by Underwriters contain a Prior Wrongful Acts Exclusion that applies to bar coverage because the SEC Order and NYSE Decision conclusively establish that Bear Stearns committed numerous willful and intentional acts beginning in 1999, and that, as of March 21, 2000, 19 senior management and other officers at Bear Stearns knew or could have reasonably foreseen that the wrongful conduct could lead to a Claim. The trial court denied Insurers’ motions by Order dated September 13, 2010. (R.15-46.) Insurers appealed to the Appellate Division, First Department on January 3, 2011. In their appeal, Insurers argued that the trial court erred in holding that it may look behind the express findings in the SEC Order and NYSE Decision to determine whether it agrees with the regulators that the $160 million payment that the regulators and Bear Stearns agreed was disgorgement—and expressly identified as “disgorgement”—was disgorgement of ill-gotten gains, and further erred in rejecting the other arguments offered in support of their motions to dismiss. The First Department unanimously reversed the trial court and ordered that Bear Stearns’ Amended Complaint be dismissed. J.P. Morgan Securities, Inc., et al. v. Vigilant Ins. Co., et al., 91 A.D.3d 226, 234 (1st Dep’t 2011). It held that the SEC Order was “not reasonably susceptible to any interpretation other than that Bear Stearns knowingly and intentionally facilitated illegal late trading for preferred customers, and that the relief provisions of the SEC Order required disgorgement of funds gained through that illegal activity.” Id. at 231. The court noted the SEC’s findings that Bear Stearns collaborated with its hedge fund customers to process illegal late trades through Bear Stearns’ timing desk and it 20 took active steps to disguise the hedge funds’ timing trades in “direct disregard” of the mutual funds demands. Id. Based on these findings and the express conclusion set forth in the agreed SEC Order that Bear Stearns had willfully violated federal securities laws, the First Department held that “it cannot be seriously argued that Bear Stearns was merely found guilty of inadequate supervision and a failure to place adequate controls on its electronic entry system.” Id. at 232. The First Department acknowledged the SEC’s broad authority not only to calculate disgorgement but also to demand disgorgement from close collaborators on a joint and several basis, and held that Bear Stearns’ $160 million disgorgement payment clearly constituted ill-gotten gains. Id. at 233. In particular, the First Department identified the inescapable nexus between Bear Stearns’ own revenue, its customers’ gains, and the amount disgorged. Id. (Bear Stearns “admittedly generat[ed] at least $16.9 million in revenues for itself [and] knowingly and affirmatively facilitated an illegal scheme which generated hundreds of millions of dollars for collaborating parties”). On June 26, 2012, this Court granted Bear Stearns leave to appeal the First Department’s decision. 21 ARGUMENT I. THE FIRST DEPARTMENT CORRECTLY HELD THAT BEAR STEARNS’ DISGORGEMENT PAYMENT IS NOT AN INSURABLE LOSS AS A MATTER OF NEW YORK LAW AND PUBLIC POLICY A. Bear Stearns’ $160 Million Payment Was Disgorgement Of Ill-Gotten Gains Generated By Its Illegal Conduct Bear Stearns concedes the SEC could compel it to disgorge the $160 million the SEC calculated to be gains generated by Bear Stearns’ illegal trading scheme regardless of whether Bear Stearns “in fact received the ill-gotten gains.” (BB 31.) This plainly is so because, in furtherance of the deterrence objectives of the federal securities laws, the SEC may obtain from any one collaborator in an illegal trading scheme all of the ill-gotten gains generated by the scheme. SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1475-76 (2d Cir. 1996) (party that “collaborates” with and is “intimately involved” in violations of securities laws is liable to disgorge full amount of ill-gotten gain); SEC v. Boock, 2012 WL 3133638, at *4, (S.D.N.Y. Aug. 2, 2012); SEC v. Verdiramo, 2011 WL 5546222, at *4 (S.D.N.Y. Nov. 10, 2011); SEC v. Anticevic, 2010 WL 3239421, at *5 (S.D.N.Y. Aug. 16, 2010); SEC v. Svoboda, 409 F. Supp. 2d 331, 346 (S.D.N.Y. 2006); SEC v. Universal Express, Inc., 646 F. Supp. 2d 552, 563 (S.D.N.Y. 2009); 212 Inv. Corp. v. Kaplan, 16 Misc. 3d 1125(A), 2007 WL 2363233, at *10 (Sup. Ct. N.Y. Cnty. 2007). The SEC is required only to show that the amount sought is a “reasonable approximation of profits causally connected to the violation.” SEC v. First City 22 Financial Corp., Ltd, 890 F.2d 1215, 1231 (D.C. Cir. 1989); see also SEC v. Warde, 151 F.3d 42, 50 (2d Cir. 1998) (as long as the measure of disgorgement is reasonable, the wrongdoer must bear the risk of uncertainty regarding the precise amount); SEC v. Patel, 61 F.3d 137, 140 (2d Cir. 1995) (same). Disgorgement serves the fundamental purpose of deterrence even if the disgorging party did not retain the ill-gotten gains. As the Second Circuit recently explained: disgorgement does not require the district court . . . to identify specific funds in the defendant’s possession that are subject to return. . . . [W]hen a public entity seeks disgorgement it does not claim any entitlement to particular property; it seeks only to “deter violations of the [] laws by depriving violators of their ill-gotten gains.” FTC v. Bronson, 654 F.3d 359, 373 (2d Cir. 2011) (citing SEC v. Fischbach Corp., 133 F.3d 170, 175 (2d Cir. 1997)); SEC v. DiBella, 587 F.3d 553, 572 (2d Cir. 2009) (rejecting argument that “disgorgement is limited to profits reaped through [defendant’s] securities law violations”). To serve this deterrent purpose, courts in New York routinely order defendants like Bear Stearns who violate the securities laws to disgorge the ill- gotten gains generated by the illegal conduct, even if the defendant did not itself retain any of those gains. In Verdiramo, defendant argued that he should not be liable for disgorgement because, unlike his co-defendants, he “did not receive a single dime as a consequence of the challenged transactions.” 2011 WL 5546222 23 at *4. The court rejected this argument and held defendant jointly and severally liable to disgorge the ill-gotten gains received by his co-defendants because “without [his] actions, his co-defendants would not have received the [] shares that they illegally sold.” Id. Similarly, in Anticevic, the defendant was ordered to disgorge profits earned by others who traded on inside information he provided. See 2010 WL 3239421, at *5-6. The court explained that disgorgement was appropriate because otherwise “the rule against insider trading ‘would be virtually nullified if those in possession of such information, although prohibited from trading in their own accounts, were free to use the insider information on trades to benefit [others].’” Id. at *5 (quoting SEC v. Warde, 151 F.3d 42, 49-50 (2d Cir. 1998)). Applying these principles here, there is no basis for Bear Stearns’ assertion that its disgorgement payment is somehow not disgorgement but more akin to compensatory damages because it did not reflect Bear Stearns’ own gains, but rather the “gains the SEC alleged were received by Bear Stearns’ customers.” (BB 4.) Bear Stearns’ illegal collaboration with its customers to generate those gains rendered Bear Stearns liable to disgorge all of them. The SEC was required only to ensure that the disgorgement ordered was a “reasonable approximation” of the gains generated by Bear Stearns’ illegal conduct. The SEC found, with Bear Stearns’ agreement, that Bear Stearns’ conduct generated “hundreds of millions” of 24 dollars in ill-gotten gains, and it properly ordered Bear Stearns to disgorge $160 million of those gains. Bear Stearns admits in its Amended Complaint that the amount of its disgorgement payment was the amount unlawfully generated by the illegal trades that Bear Stearns’ own timing desk made possible and executed. (R.77 (¶109).) Whether Bear Stearns held all of the ill-gotten gains generated by its illegal conduct, or it made them possible for its collaborators to earn those gains, does not change the nature, or the fundamental deterrent purpose of the disgorgement remedy. Indeed, the SEC confirmed that Bear Stearns’ disgorgement payment was meant both to deprive Bear Stearns of its ill-gotten gains and to deter future violations of the securities laws: This settlement will not only deprive Bear Stearns of the gains it reaped by its conduct, but also require Bear Stearns to put in place procedures to prevent similar misconduct from recurring. (R.156.) In short, Bear Stearns agreed to pay, and in fact paid $160 million as disgorgement and cannot now argue for the purposes of its claim for insurance that this payment was compensatory damages or anything other than disgorgement of ill-gotten gains. Indeed, Bear Stearns advanced a similar argument in an appeal to this Court in a different insurance coverage action, captioned Vigilant Ins. Co. v. The Bear Stearns Cos., Inc., 34 A.D.3d 300 (1st Dep’t 2006), rev’d, 10 N.Y.3d 170 25 (2008) (“Bear Stearns I”), arguing there that its payment of disgorgement to resolve a different SEC regulatory investigation was really a payment of damages falsely “labeled” disgorgement. The SEC filed an amicus brief in Bear Stearns I that rejected Bear Stearns’ attempt to re-characterize a disgorgement payment ordered by the SEC as a payment of compensatory damages for purposes of insurance coverage. (R.1396-1418.) The SEC explained to the Court that “the key documents in the settlement . . . all called for Bear Stearns to pay ‘disgorgement,’” and there can be no “triable issue of fact as to whether these documents mean anything other than what they say, namely that Bear Stearns agreed to, was ordered to, and did, pay disgorgement.” (R.1404.) The SEC also warned that “[a]cceptance of Bear Stearns’[] erroneous argument could raise questions in future cases about whether the [SEC] is seeking relief that is outside of its authority” and “could interfere with the [SEC’s] ability to settle cases in an efficient manner, as it would prevent the [SEC] from settling without further investigation even though both the [SEC] and the defendant are willing to settle for disgorgement of a particular amount in light of the available evidence and the [SEC’s] regulatory objectives.”3 (R.1402.) Here, Bear Stearns abandoned any challenge to the SEC’s and NYSE’s regulatory authority when it 3 This Court ultimately denied Bear Stearns’ claim for insurance coverage for its disgorgement payment in Bear Stearns I, but the Court’s decision addressed and disposed of Bear Stearns’ claim for insurance coverage based on Bear Stearns’ failure to obtain its insurers’ consent to the settlement at issue in that case. (10 N.Y.3d at 178-79) 26 explicitly agreed to pay, and paid, $160 million as disgorgement. To hold otherwise would interfere with the SEC’s regulatory objectives by calling into question its authority to seek and obtain Bear Stearns’ disgorgement payment. The nature of Bear Stearns’ disgorgement payment also is not, as Bear Stearns suggests, altered by the fact that it ultimately was placed in a Fair Fund for distribution to mutual fund investors, or by the fact that the SEC did not prevent Bear Stearns from using its disgorgement payment to offset its civil liability. The use of disgorged funds to benefit investors is entirely consistent with the SEC’s statutory authority, and “does not change the nature of the remedy.” See SEC v. First Pacific Bancorp, 142 F.3d 1186, 1192 (9th Cir. 1998); see also Official Committee of Unsecured Creditors of Worldcom, Inc. v. SEC, 467 F.3d 73, 81 (2d Cir. 2006) (“compensation of fraud victims is a ‘secondary goal’” of disgorgement); SEC v. Fischbach Corp., 133 F.3d 170, 175 (2d Cir. 1997) (“[a]lthough disgorged funds may often go to compensate securities fraud victims for their losses, such compensation is a distinctly secondary goal”). Indeed, Bear Stearns’ $90 million penalty payment also was distributed to injured investors through the Fair Fund, and Bear Stearns cannot and does not argue that distribution of the penalty to investors changes the nature of its penalty payment or makes it insurable. The same is true of the disgorgement Bear Stearns paid. 27 Finally, even if there was not crystal clarity as to the nature of Bear Stearns’ payment, the SEC’s statutory authority is restricted to penalties and equitable relief (which includes disgorgement) and does not include the authority to seek compensatory damages. (R.1403.) Any argument that Bear Stearns’ payment of disgorgement was compensatory damages therefore would require the Court to hold that the SEC sought and obtained from Bear Stearns an ultra vires recovery. There is no basis, nor has Bear Stearns argued there is a basis, for such a collateral attack on the SEC Order or the NYSE Decision ordering Bear Stearns to pay disgorgement. Given that the SEC’s statutory authority is limited to seeking and obtaining disgorgement and penalties, and the absence of any ground to assert that the SEC acted outside its proper regulatory authority, Bear Stearns’ payment here can only be properly understood to reflect the payment of disgorgement or penalties.4 And Bear Stearns’ opportunity to make any such challenge has long since passed. B. The Decision Is Entirely Consistent With Well Established New York Law And Public Policy Prohibiting Insurance For Disgorgement In denying Bear Stearns’ claim for insurance, the First Department applied well established principles of New York law and public policy that “one may not 4 Indeed, the NYSE Decision characterized the entire $250 million sanction as a “penalty.” (R.160.) There is no dispute that penalties are not covered under the Policies, and Bear Stearns expressly agreed that it would not seek or accept any payment under any insurance policy for its payment of penalties. (R.103 (§ II(B)(2)(i)).) 28 insure against the risk of being ordered to return money or property that has been wrongfully acquired.” Reliance Grp. Holdings, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburg, Pa., 188 A.D.2d 47, 55 (1st Dep’t 1993) (internal quotation marks and citation omitted); see also Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 10 A.D.3d 528, 528-29 (1st Dep’t 2004); Millennium Partners L.P. v. Select Ins. Co., 24 Misc. 3d 212, 216 (Sup. Ct. N.Y. Cnty. 2009), aff’d, 68 A.D.3d 420 (1st Dep’t 2009).5 New York courts have applied this principle consistently for nearly twenty years, dating back to the Reliance decision in which the First Department recognized that a recovery of disgorged ill-gotten gains through insurance would eliminate any incentive for obeying the law. In Reliance, the First Department adopted the reasoning of the California Supreme Court which held that: When the law requires a wrongdoer to disgorge money or property acquired through a violation of the law, to permit the wrongdoer to transfer the cost of disgorgement to an insurer would eliminate the incentive for obeying the law. Otherwise, the wrongdoer would retain the proceeds of his illegal acts, merely shifting his loss to an insurer. 5 The public policy prohibiting insurance for disgorgement of ill-gotten gains is applied consistently in other jurisdictions as well. See, e.g., Ryerson Inc. v. Federal Ins. Co., 676 F.3d 610, 612-13 (7th Cir. 2012); Alanco Tech., Inc. v. Carolina Cas. Ins. Co., 2006 WL 1371633, at *2 (D. Ariz. May 16, 2006); Bank of the West v. Superior Ct., 833 P.2d 545, 555 (Cal. 1992); Exec. Risk Indemnity, Inc. v. Pacific Educ. Services, Inc.,451 F. Supp. 2d 1147, 1162 (D. Haw. 2006); O’Neill Investigations, Inc. v. Illinois Employers Ins. of Wausau, 636 P.2d 1170, 1175 (Alaska 1981); Cent. Dauphin School Dist. v. American Cas. Co., 426 A.2d 94, 96 (Pa. 1981); Seaboard Sur. Co. v. Ralph Williams’ Northwest Chrysler Plymouth, Inc., 504 P.2d 1139 (Wash. 1973) (en banc); Nortex Oil & Gas Corp. v. Harbor Ins. Co., 456 S.W.2d 489, 493-94 (Tex. Civ. App. 1970). 29 Bank of the West v. Superior Court 833 P.2d 545, 555 (Cal. 1992) (cited with approval in Reliance, 188 A.D.2d at 55.) The courts in Credit Suisse and Millennium also acknowledged that the purpose of disgorgement is “to deprive a party of ill-gotten gains and to deter improper conduct,” and applied these principles to preclude insurance coverage for disgorgement. Vigilant Ins. Co. v. Credit Suisse First Boston, 6 Misc. 3d 1020(A), 2003 WL 24009803 (Sup. Ct. N.Y. Cnty. 2003) (emphasis added); see also Millennium, 24 Misc. 3d at 217 (citing SEC v. Fischbach Corp., 133 F.3d 170, 175 (2d Cir. 1997) (the “primary purpose of disgorgement orders is to deter violations of the securities laws by depriving violators of their ill-gotten gains”)). In Millennium, a hedge fund sought insurance coverage for defense costs incurred in settling regulatory claims that alleged an illegal mutual fund trading scheme identical to the scheme at issue here. 24 Misc. 3d at 213. Millennium’s settlement with the SEC, like the SEC Order here, was memorialized in an SEC administrative order in which Millennium neither admitted nor denied the factual findings it stipulated to, and was required to pay $148 million in disgorgement. Id. at 214-15. Millennium argued that there was a triable question of fact whether the amount it was required to disgorge reflected ill-gotten gains because the settlement documents did not specify precisely that Millennium’s disgorgement payment repaid the improperly acquired funds. See id. at 217. The court rejected that 30 argument and held that the regulatory settlement documents established that Millennium had violated federal securities laws and had generated millions of dollars in ill-gotten gains, and “conclusively link[ed] the disgorgement to improperly acquired funds.” Id. The court concluded that the regulatory settlement documents were “not reasonably susceptible to any other interpretation than that the relief provisions require disgorgement of funds gained through improper market timing activities.” Id. at 218. The First Department unanimously affirmed the trial court, agreeing that the SEC’s findings were sufficient to “‘conclusively link the disgorgement to improperly acquired funds’ notwithstanding that [the insured] consented and agreed to these orders ‘without admitting or denying the findings [t]herein.’” 68 A.D.3d at 420 (citing Credit Suisse). The First Department also held that in deciding the claim for insurance coverage “the fact that no judgments resulted from the negotiated settlements in which these findings were made does not affect the validity of the findings.” Id. Consistent with this line of cases, the First Department properly concluded in this case that Bear Stearns’ disgorgement payment was not insurable because the findings in the SEC Order and NYSE Decision conclusively linked Bear Stearns’ disgorgement payment with the ill-gotten gains generated by its illegal activity: Here too, read as a whole, the offer of settlement, the SEC Order, the NYSE order and related documents are not reasonably susceptible to 31 any interpretation other than that Bear Stearns knowingly and intentionally facilitated illegal late trading for preferred customers, and that the relief provisions of the SEC Order required disgorgement of funds gained through that illegal activity. J.P. Morgan Sec. Inc., et al. v. Vigilant Ins. Co., et al., 91 A.D.3d 226, 231 (1st Dep’t 2011). Bear Stearns’ assertion that the First Department impermissibly extended or misapplied New York law and public policy is wrong. Bear Stearns does not dispute that it was ordered by the SEC to forfeit gains generated by its illegal conduct. Bear Stearns argues instead that its payment should be treated as an insurable loss because Bear Stearns claims it made little or no direct trading profits from its involvement in the illegal scheme. This argument fails for at least two reasons. First, as Bear Stearns concedes, the SEC rejected its contention that it made no profit from its illegal activity. (R.76 (¶103).) Second, even if it were plausible that Bear Stearns engaged in its illegal trading scheme with no expectation of profit—and had no interest in financial gain from retaining and furthering profitable relationships with its customers—the SEC in fact found that Bear Stearns’ own conduct generated “hundreds of millions of dollars” in gains, (R.118(¶5)), and that Bear Stearns was such an integral collaborator in the illegal generation of those ill-gotten gains that it was liable under the securities laws to disgorge them. As demonstrated above, the law of disgorgement makes no 32 distinction among the co-conspirators who collaborate to create an ill-gotten gain. All of the ill-gotten gains are imputed as a matter of law to all collaborators—Bear Stearns and its customers alike—and all are equally liable to disgorge those ill- gotten gains. (See supra, § I. A.) Bear Stearns cannot divorce itself from these ill-gotten gains for purposes of its claim for insurance coverage. To hold otherwise would allow Bear Stearns and its co-conspirators to retain the benefit they received from their joint illegal activity, eliminate the deterrent effect of the disgorgement remedy and incentivize securities law violators such as Bear Stearns to engage undeterred in such illegal conduct with their customers safe in the knowledge that insurance will guarantee the cost of returning the ill-gotten gains if they are forced under the applicable law to disgorge them. This guarantee of illegal gains clearly was not the risk underwritten by the Insurers, or for which Bear Stearns can claim any reasonable expectation of coverage. 1. The Decision Is Consistent With Bear Stearns I Bear Stearns’ suggestion that the First Department decision here conflicts with its earlier decision in Bear Stearns I, is wrong. (BB 28.) Bear Stearns I was reversed by this Court, and—to the extent it has any continuing validity—is factually distinct and inapposite here. In Bear Stearns I, the First Department identified a question of fact as to whether the disgorgement ordered in that case 33 represented “ill-gotten gains or improperly acquired funds,” because, unlike here, the settlement documents in that earlier case did not include any explanation of the basis for the payment. 34 A.D.3d at 302. Bear Stearns also presented evidence in Bear Stearns I that the regulators calculated its settlement payment based on Bear Stearns’ share of the investment banking market rather than making a calculation of the ill-gotten gains generated by Bear Stearns’ unlawful conduct. Id. at 303. The court did not conclude that disgorgement was covered loss, but decided only that, under the unique factual circumstances of that case, there was a question of fact whether the payment was in fact disgorgement. Unlike in Bear Stearns I, the SEC and NYSE expressly found in this case that Bear Stearns’ illegal scheme generated “hundreds of millions of dollars” in ill- gotten gains and those gains were the basis for the calculation of the disgorgement amount. (R.118 (¶5), R.165(¶9).) Thus, the First Department’s decision is entirely consistent with its prior decisions in Millennium and Credit Suisse. Bear Stearns’ disgorgement payment is uninsurable because the regulators expressly linked the disgorgement payment to the hundreds of millions of dollars generated by the illegal trading scheme. 34 2. Bear Stearns Has Not Identified A Single Authority That Holds That Disgorgement Ordered Under The Circumstances Presented Here Is Insurable Bear Stearns asserts that “every court” that has considered the issue presented here—i.e., whether public policy prohibiting insurance for disgorgement applies where the insured is forced to disgorge ill-gotten gains retained by others— has held that the disgorgement payment was insurable. The cases Bear Stearns on relies on, however, are all plainly inapplicable. (BB 2, 26-28.) None are New York precedent, and none address regulatory enforcement proceedings like this one in which the insured expressly offered to pay and paid disgorgement of ill-gotten gains generated by its unlawful conduct. They 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—and the question in each was whether that payment reflected an insurable payment of compensatory damages or an uninsurable restitution of wrongly taken property, or some combination of both. For example, Pan Pacific Properties, Inc. v. Gulf Ins. Co., 471 F.3d 961 (9th Cir. 2006), involved the settlement of a shareholder class action in which the underlying plaintiffs claimed that they were damaged because the defendants failed to negotiate the “highest possible price” for their shares in a merger transaction. The Ninth Circuit affirmed the “well established” principal that “one may not insure against the risk of being ordered to return money or property that has been 35 wrongfully acquired.” Id. at 966 (citations omitted). The Ninth Circuit determined, however, that there was a disputed issue of fact surrounding the extent to which Pan Pacific’s settlement payment “reflected restitutionary damages” as opposed to “non-restitutionary compensation for injuries suffered by the shareholders, which would be covered under the insurers’ Policies.” Id. at 967. Genzyme v. Federal Ins. Co., 622 F.3d 62 (1st Cir. 2010), likewise addressed whether Genzyme’s payment to settle a shareholder class action seeking damages from Genzyme and certain its directors and officers “represents restitution by Genzyme of ill-gotten gains or benefits to which Genzyme was not entitled and is therefore uninsurable.” Id. at 70. The First Circuit concluded that Genzyme’s settlement payment was not “restitutionary” because it did not “represent the restoration to the plaintiffs of some amount Genzyme had improperly taken and withheld.” Id. Pereira v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 2006 WL 1982789 (S.D.N.Y. July 12, 2006), addressed a similar question whether an award of damages in a civil judgment in a bankruptcy proceeding reflected restitution of ill- gotten gain or a payment of compensatory damages. The court concluded that the portion of the judgment “representing the return of monies wrongfully obtained” by two of the defendants in the adversary proceeding was uninsurable, but the “monetary relief” entered against the other defendants for breach of fiduciary duty 36 were compensatory and not restitutionary in nature. Id. at *3; see also Ryerson Inc. v. Federal Ins. Co., 676 F.3d 610, 613 (7th Cir. 2012) (monetary “judgment or settlement in a fraud case could involve a combination of restitution and damages”); Wojtunik v. Kealy, 2011 WL 1211529, at *10 (D. Ariz. Mar. 31, 2011) (damages paid pursuant to stipulated judgment in securities fraud litigation an insurable “Loss” where plaintiffs asserted claims for compensatory and punitive damages and potential recovery not limited to “restitutionary or disgorgement-type damages”); CNL Hotels & Resorts, Inc. v. Houston Cas. Co., 505 F. Supp. 2d 1317 (M.D. Fla. 2007) (addressing question whether payment by insured to settle civil securities law claims was restitutionary in nature); Bank of Am. Corp. v. SR Int’l Bus. Ins. Co., 2007 WL 4480057 (N.C. Super. Ct. Dec. 19, 2007) (same).6 Here, unlike in the civil cases Bear Stearns’ relies on, there is no question as to the nature of Bear Stearns’ $160 million disgorgement payment. The SEC Order and the NYSE Decision expressly link Bear Stearns’ disgorgement payment to the ill-gotten gains generated by its illegal conduct, and Bear Stearns admits that its payment reflected those gains. Disgorgement of ill-gotten gains is not insurable 6 Bear Stearns also relies upon Unified Western Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106 (9th Cir. 2006). Unified Western Grocers did not involve the payment by an insured of a settlement or judgment but instead raises the question whether insurance coverage is available for defense costs in an underlying civil action in which the plaintiff sought to recover both compensatory and restitutionary relief. Since the SEC and NYSE did not seek or recover any compensatory relief here (and indeed had no authority to do so), Unified Western Grocers has no bearing on the issues presented here. 37 as a matter of law, and thus the issues of fact presented in Bear Stearns’ cases are not present here. C. This Court Has Long Applied Deterrence Principles To Prohibit Insurance Coverage As A Matter Of Public Policy Bear Stearns’ assertion that this Court has never barred insurance coverage “in the name of general deterrence” (BB 38), ignores the long line of cases in which this Court has held that punitive damages are not insurable for precisely the same reason why disgorgement is not insurable—namely, that insurance would eviscerate the deterrent effect of punitive damages. See, e.g., Zurich Ins. v. Shearson Lehman, 84 N.Y.2d 309 (1994); Home Ins. Co. v. Am. Home Prods., 75 N.Y. 2d 196 (1990); Hartford Acc. & Indem. Co v. Village of Hempstead, 48 N.Y.2d 218, 226 (1979); see also Biondi v. Beekman Hill House Apt. Corp., 94 N.Y.2d 659, 663-64 (2000). As this Court explained, because “punitive damages are imposed not as compensation but as punishment and as a deterrent, the policy behind their imposition would be defeated were an individual insured permitted to avoid the burden of such damages by passing it on to an insurance carrier.” Hartford Acc., 48 N.Y.2d at 225. Similarly, disgorgement has a fundamental deterrent purpose, which would be defeated if the party that should be deterred from future violations by the burden of the disgorgement payment can simply pass it along to an insurer and be made entirely whole for the consequences of its illegal conduct. 38 Bear Stearns argues that punitive damages are imposed as punishment and disgorgement is imposed as a forfeiture, but this distinction makes no real difference here. The end purpose of both disgorgement and punitive damages is the same—deterrence. Disgorgement deters by requiring the party to forfeit gains generated by its illegal conduct. Punitive damages deter by imposing monetary liability as punishment. It makes no difference how the end of deterrence is advanced; the important point is that insuring the financial consequences nullifies the deterrent effect. This Court’s decision in Shearson Lehman illustrates this point. The Court was presented with the question whether New York public policy precluded coverage of punitive damages awarded in defamation cases in Texas and in Georgia. 84 N.Y.2d at 313. The Court ruled that New York public policy controlled coverage even though the punitive damages were awarded in other states that would allow insurance coverage.7 Id. at 314. The Court held that under New York public policy, insurance coverage was available for the Georgia award because Georgia law permitted juries to award “punitive” damages for compensatory purposes, but unavailable for the Texas award because there was 7 Bear Stearns’ suggestion that the SEC permitted Bear Stearns to seek insurance coverage for its disgorgement payment here is wrong; the SEC was silent on the point. In any event, insurability of disgorgement is a question of state law for this Court to decide. Shearson Lehman, 84 N.Y.2d at 321; see also Home Ins. Co. v. Am. Home Prod. Corp., 75 N.Y.2d 196, 200 (1990) (applying New York public policy to determine insurability of out-of-state award of punitive damages). 39 “no evidence that the award was for other than deterrent purposes.” Id. at 317. The dispositive issue was the purpose of the award under the relevant law. Because established principles of the federal securities laws make it clear that the purpose of the disgorgement remedy imposed upon Bear Stearns was deterrence, not compensation, the same public policy applies to render that payment uninsurable.8 II. BEAR STEARNS IS BOUND BY THE CONSENTED-TO AND STIPULATED FINDINGS IN THE SEC ORDER AND NYSE DECISION A. The First Department Properly Considered The Regulatory Findings When It Granted Insurers’ Motion to Dismiss Bear Stearns misstates the relevant legal standard when it argues this Court must “accept as true the facts alleged in the complaint.” (BB 23.) Where, as here, the plaintiff’s factual allegations and legal conclusions are contradicted by 8 Other courts throughout the country similarly recognize deterrence as a reason to bar insurance coverage based on the universally recognized principle of “moral hazard”—i.e., the concern that the availability of insurance could incentivize conduct otherwise prohibited by law. See, e.g., Mortenson v. Nat’l Fire Ins. Co. of Pittsburgh, Pa., 249 F.3d 667, 671 (7th Cir. 2001) (“The temptation that insurance gives the insured to commit the very act insured against is called by students of insurance ‘moral hazard’ and is the reason that fire insurance companies refuse to insure property for more than it is worth—they don’t want to tempt the owner to burn it down.”); Bank of the West v. Superior Court, 833 P.2d 545, 555 (Cal. 1992) (allowing “the wrongdoer to transfer the cost of disgorgement to an insurer would eliminate the incentive for obeying the law”); Cent. Dauphin, 426 A.2d at 259 (if school district were permitted to insure against “refunding of taxes collected through an unlawful taxing measure” a school district or any other taxing body would have little reason, if any, to enact only lawful taxing measures”); In re San Juan Dupont Plaza Hotel Fire Litig., 802 F. Supp. 624, 641 (D.P.R. 1992) (“[t]o find that insurance exists for the possible return of money or property wrongfully attained . . . would be contrary to public policy as the violator would simply shift the loss to the insurer while retaining the fruits of the unfair business practice, thereby eliminating any incentive for obeying the law”). 40 documentary evidence, the Court need not presume that those allegations are true or accord them “every favorable inference.” Ark Bryant Park Corp. v. Bryant Park Restoration Corp., 285 A.D.2d 143, 150 (1st Dep’t 2001); Wilhelmina Models, Inc. v. Fleisher, 19 A.D.3d 267, 269 (1st Dep’t 2005) The relevant inquiry is whether the plaintiff has a cause of action, not simply whether the complaint states one. See Ark Bryant, 285 A.D.2d at 150; Biondi v. Beekman Hill House Apt. Corp., 257 A.D.2d 76 (1st Dep’t 1999), aff’d, 94 N.Y.2d 659 (2000) (same). The allegations in Bear Stearns’ Amended Complaint mirror the very defenses Bear Stearns admits were rejected by the SEC and NYSE. (Compare R.52-53(¶8), with R.76(¶103) In addition, Bear Stearns agreed: (1) “not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any finding in the [SEC] Order or creating the impression that the [SEC] Order is without factual basis”; and (2) to “withdraw any papers previously filed . . . to the extent they deny, directly or indirectly, any finding in the [SEC] Order.” (R.1687 (§ VI).) In other words, Bear Stearns agreed not to dispute the validity of the SEC findings and it formally withdrew any and all prior defenses, including its Well Submission, which were inconsistent with those findings. Those detailed findings establish that Bear Stearns’ intentional and inherently injurious violations of the securities laws created “hundreds of millions of dollars” of ill- gotten gains that Bear Stearns was required to disgorge. The documentary record 41 of those regulatory findings directly contradicts the allegations in Bear Stearns’ Amended Complaint, and the First Department properly examined the totality of the record to conclude that Bear Stearns did not present a legally cognizable claim for insurance coverage for those settlements. B. The Regulatory Findings Are Not Unilateral Findings, They Were Finally Adjudicated, And Bear Stearns Is Bound By Those Findings For Insurance Coverage Purposes Bear Stearns argues that because it neither admitted nor denied the regulatory findings, they are nothing more than “unilateral” and “non-adjudicated” allegations from which it is free to walk away when it seeks insurance for the very payments it made to resolve those findings. (BB 9, 15.) Bear Stearns is wrong. The findings are not unilateral—Bear Stearns itself submitted them in its offers of settlement, consented to their entry, and agreed to be bound by them. The SEC Order and NYSE Decision are final adjudications of Bear Stearns’ involvement in an illegal late trading and market timing scheme. Bear Stearns is bound by the validity of those findings when it submits the SEC Order and NYSE Decision to its insurers for reimbursement. 1. The Regulatory Findings Are Final As Between The Regulators And Bear Stearns After the SEC’s two and a half year investigation, which included the interviews and depositions of 35 Bear Stearns employees, and the review of hundreds of thousands of documents, Bear Stearns submitted its Offer of 42 Settlement in which it consented to the SEC’s detailed findings and it agreed to be bound by them. The SEC Order expressly states that “the findings . . . are not binding on any other person or entity in this or any other proceeding.” (R.117 n.1 (emphasis added).) The meaning is clear; the findings are conclusive and binding on Bear Stearns. (R.116-17.) Bear Stearns is barred from taking positions inconsistent with “any finding in the Order” and it agreed to withdraw any prior defenses that might contradict any of its regulators’ factual findings, including the Wells Submission it relies upon extensively in this appeal. (R.1687.) The NYSE Decision is equally conclusive. Before the NYSE rendered its decision, Bear Stearns submitted an executed “Stipulation of Facts and Consent to Penalty.” (R.1692-1739.) In the adjudication by the NYSE that followed this submission, the NYSE and Bear Stearns “stipulate[d] to certain facts,” all of which were expressly detailed in the findings in the NYSE Decision. (R.162.) The NYSE issued a “Decision” that was based upon the NYSE’s conclusive findings and stated as follows: The Hearing Panel, in accepting the Stipulation of Facts and Consent to Penalty, found [Bear Stearns] guilty as set forth above by unanimous vote. (R.198.) Bear Stearns wrongly suggests that the SEC Order and NYSE Decision are something less than a final adjudication because they were resolved via a 43 consensual settlement. A settlement of regulatory proceedings with the SEC is, as a matter of law, an “adjudication” and is fundamentally different than a settlement in a civil litigation, in which a party denies all allegations and liability. The SEC chose to pursue an administrative enforcement proceeding against Bear Stearns. It was governed by the federal Administrative Procedure Act (the “APA”) and related federal regulations. 5 U.S.C. § 551 et seq. Under the relevant statute and regulations governing SEC administrative proceedings, SEC charges may be resolved by agreement only upon a formal offer of settlement by the defendant which must include irrevocable waivers of all defenses and an express agreement never to dispute the factual findings in the resulting SEC Order. See 17 C.F.R. § 201.240. The SEC’s stated policy is “not to permit a defendant or respondent to consent to a judgment or order that imposes a sanction while denying the allegations in the complaint or order for proceedings” because “it is important to avoid creating, or permitting to be created, an impression that a decree is being entered or a sanction imposed, when the conduct alleged did not, in fact, occur.” 17 C.F.R. § 202.5(e). The SEC accordingly has sought to vacate settlements “after the settling defendant made statements to the public that the SEC construed as denials.” Kenneth B. Winer & Samuel J. Winer, Securities Enforcement: Counseling and Defense § 17.07 (2012). 44 The SEC is required to issue an order which includes findings of fact. See 17 C.F.R. § 201.240(c)(7) (“[f]inal acceptance of any offer of settlement will occur only upon the issuance of findings and an order by the Commission”). The APA specifically defines an “adjudication” as the “agency process for the formulation of an order.” 5 U.S.C. § 551(7). An “order” is “the whole or a part of a final disposition whether affirmative, negative, injunctive, or declaratory in form, of an agency other than rule making but including licensing.” 5 U.S.C. § 551(6). A “final disposition” is one that resolves a dispute between parties to administrative proceedings. See Int’l Tel. & Tel. Corp. Commc’ns Equip. & Sys. Div. v. Local 134, Int’l Bd. of Elec. Workers, 419 U.S. 428, 444, 95 S.Ct. 600, 610 (1975); see also Levy v. SEC, 462 F. Supp. 2d 64, 67 (D.D.C. 2006). Thus, the laws relevant here dictate that the SEC Order constitutes the final adjudication of the SEC’s administrative proceeding against Bear Stearns. The NYSE Decision also was an adjudication. The NYSE expressly made a “Decision” in the proceedings against Bear Stearns in which it “found Respondent guilty.” Bear Stearns consented to the NYSE Decision, which includes detailed factual findings that mirror the SEC’s findings. Bear Stearns admitted the findings which lead ineluctably to the “Violations of the Federal Securities Laws and Exchange Rules” that the NYSE delineated in its Decision. (R.196.) 45 In sum, the SEC and NYSE finally adjudicated all issues arising from Bear Stearns’ illegal late-trading and deceptive market timing practices in the proceedings in which those violations were charged. 2. Bear Stearns Is Bound By The Validity Of The Regulatory Findings When It Submits Them To Insurers For Coverage Bear Stearns’ assertion that the First Department’s reliance on the regulatory findings “nullifies express terms at the heart of the settlement”—namely, Bear Stearns’ purported reservation of rights to dispute the regulatory findings in future litigation with third parties—is wrong. (BB 50-51.) First, the SEC did not “agree” that its findings would have no preclusive effect in any other proceedings. Nothing in the Order says that. The SEC Order in fact states only that it is not binding on any party other than Bear Stearns. (R.117.) Second, any reservation of rights Bear Stearns may have itself included in its Offer of Settlement to dispute the findings in the SEC Order in future litigation with third parties (which notably was not included in the final SEC Order and NYSE Decision), does not allow Bear Stearns to deny them when it submits those very findings and the very settlements based on those findings to its Insurers for insurance coverage. New York law is clear that despite an insured’s supposed reservation of rights to deny detailed factual findings set forth in an SEC administrative order, those findings are valid and binding with respect to the insured’s claim for 46 insurance coverage for that regulatory settlement. Millennium Partners, L.P. v. Select Ins. Co., 24 Misc. 3d 212, 217-18 (Sup. Ct. N.Y. Cnty. 2009) (findings in SEC order establish lack of coverage for settled claims) aff’d, 68 A.D.3d 420 (1st Dep’t 2009). In Millennium as here, the insured purported to reserve the right to dispute the detailed factual findings in an SEC administrative order, but the court concluded those findings were binding on the insured with respect to its claim for insurance coverage for that very regulatory settlement. 68 A.D.3d at 420. Millennium involved an SEC administrative proceeding similar to the proceeding against Bear Stearns here. Millennium, like Bear Stearns here, argued that because its settlement with the SEC, which was memorialized in an SEC administrative order, did not result in a final judgment, it could disregard the SEC’s findings that plainly required Millennium to disgorge ill-gotten gains that it had obtained through market timing activities, and re-litigate whether its disgorgement payment represented ill-gotten gains. 24 Misc. 3d at 218. The trial court in Millennium rejected this argument and held that Millennium’s regulatory settlements “essentially [are] equivalent to a determination, reached through agreement of the parties.” Id. at 218. The First Department affirmed, holding that “[t]he fact that no judgments resulted from the negotiated settlements in which these findings were made does not affect the validity of the findings.” 68 A.D.3d 420, 420 (1st Dep’t 2009). 47 Similarly, in Credit Suisse, the insured sought insurance coverage for the disgorgement payment it was ordered to pay to resolve an SEC regulatory investigation. Credit Suisse argued, as Bear Stearns does here, that “there was no final adjudication of wrongdoing on its part, and therefore, permitting coverage would not result in [its] retaining a benefit that it may have obtained wrongfully.” 2003 WL 24009803, at *3. The trial court rejected that argument, noting that the SEC set forth detailed allegations of Credit Suisse’s wrongdoing, and “the Final Judgment specifically links the disgorgement payment to the improper activity that the SEC complaint alleged.” Id. The First Department affirmed noting: Although the final judgment directing the disgorgement here at issue was based on a settlement and not on an adjudication after trial that CSFB wrongfully obtained the funds, the final judgment expressly states that the money ordered disgorged was ‘obtained improperly by CSFB as a result of the conduct alleged in the Complaint,’ and CSFB executed a ‘Consent and Undertakings of CSFB to Final Judgment of Permanent Injunctive and Other Relief’ with the SEC, and a “Letter of Acceptance, Waiver and Consent’ with the NASDR, in which it agreed not to contest the allegations of the complaint. 10 A.D.3d 528, 529. Millennium and Credit Suisse are consistent with the well settled principle that a court must consider the actual conduct reflected in the findings or terms of the underlying settlement which established the basis for the insured’s liability in order to determine if the claim is insurable. See Servidone Constr. Corp. v. Sec. Ins. Co. of Hartford, 64 N.Y.2d 419, 424 (1985) (insurer’s “duty to pay is 48 determined by the actual basis for the insured’s liability to a third person” and plenary trial is not required when the basis for liability is established by the underlying record); accord Bankwest v. Fidelity & Deposit Co. of Maryland, 63 F.3d 974, 978 (10th Cir. 1995) (“duty to indemnify is determined by the facts as they are established at trial or as they are finally determined by some other means (e.g., summary judgment or settlement)”); Travelers Ins. Co. v. Waltham Indus. Labs. Corp., 883 F.2d 1092, 1099 (1st Cir. 1989) (“duty to indemnify is determined by the facts, which are usually established at trial,” but where the underlying case is settled “the duty to indemnify must be determined in the basis of the settlement”); Northland Cas. Co. v. HBE Corp., 160 F. Supp. 2d 1348, 1360 (M.D. Fla. 2001) (“duty to indemnify is measured by the facts as they unfold at [an underlying] trial or are inherent in the settlement agreement”); see generally 2 Allan Windt, Insurance Claims and Disputes § 6.31, at 6-244 (2012) (the “existence of coverage should depend on what claims were settled, that is, it should depend on why the money was paid”) (collecting cases). Here, Bear Stearns consented to forty pages of detailed factual findings and regulatory charges that it “willfully violated” and “willfully aided and abetted and caused” violations of federal securities laws, and agreed to disgorge $160 million based on those agreed findings. There can be no question that the findings in the SEC Order and the NYSE Decision are the agreed basis for those regulatory 49 settlements—both documents expressly state that Bear Stearns agreed to the findings for the specific purpose of settling the proceedings brought by those regulators. (R.117, R.162.) Bear Stearns is bound by the SEC and NYSE findings when it seeks insurance coverage for the disgorgement it agreed to and was ordered to pay, and the First Department properly relied on them in holding that coverage was unavailable. Bear Stearns’ position that insurers cannot rely upon the insured’s own agreed basis for a settlement in determining coverage would reflect a radical change in the handling of insurance claims and, as shown, New York law on this issue. Bear Stearns argues that regulatory findings made pursuant to settlements may not be used against an insured “as a basis for denying coverage.” (BB 53-54.) The cases on which Bear Stearns relies, however, are inapposite because they all involve a third party’s attempted use of findings from a prior unrelated civil or regulatory settlement (not involving an SEC administrative order) to establish the settling party’s liability in the subsequent action. For example, in Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Xerox Corp., 6 Misc. 3d 763, 769 (Sup. Ct. N.Y. Cnty. 2004), the insurer sought to rescind its policy against its insured based on fraudulent inducement. The SEC alleged that Xerox fraudulently misstated its financial condition in its 10-K reports. Unlike here, however, the SEC did not commence an administrative proceeding and did not enter any factual findings 50 against Xerox. It only made allegations in a civil complaint in federal court, then settled with Xerox not admitting those allegations, but agreeing to restate its financial statements. Id. at 766. Xerox’s insurer then sought affirmative relief rescinding the insurance policy it issued to Xerox, arguing that Xerox intentionally filed false financial statements upon which the insurer relied in issuing the insurance policy to Xerox. Xerox’s insurer sought to use Xerox’s settlement with the SEC to establish an element of the fraudulent inducement claim—i.e., that Xerox filed false financial statements. The trial court did not allow it, and the First Department affirmed, explaining that Xerox “did not admit the falsity of their financial statements for purposes of this litigation” and the consent agreements in the SEC settlement “did not preclude defendants from taking positions contrary to the settlements in any litigation in which the SEC was not a party.” Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Xerox Corp., 25 A.D.3d 309, 309-10 (1st Dep’t 2006). There are clear and critical distinctions between Xerox and this case. The regulatory proceeding against Bear Stearns in this case was an administrative proceeding in which the SEC was required to issue a final order with specific factual findings. See 17 C.F.R. § 201.240(c)(7). Xerox was an injunctive proceeding that did not require findings. Further, the insurer in Xerox was 51 attempting affirmatively to establish liability for a separate claim against Xerox based exclusively upon the fact of its settlement with the SEC.9 The Insurers here are not asserting any affirmative claims for relief against Bear Stearns; they are only defending against Bear Stearns’ claim for insurance coverage for its regulatory settlements with the SEC and NYSE, and relying properly on the settlements themselves. New York law is clear that the Insurers are entitled to rely on the validity of the very findings Bear Stearns has submitted for coverage to determine the nature of the claims settled and the nature of the payment made to resolve those claims. 9 The other cases cited by Bear Stearns for this proposition are inapplicable for the same reasons. See, e.g., Halyalkar v. Bd. of Regents, 72 N.Y.2d 261, 269-70 (1988) (finding that the New York Board of Regents improperly relied on a prior consent order from New Jersey to suspend a physician’s license); Lipsky v. Commonwealth United Corp., 551 F.2d 887, 893 (2d Cir. 1976) (plaintiff not permitted to use a consent decree affirmatively against the defendant who had entered into the decree with the SEC, in order to prove a claim for damages liability in a separate action); Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598, 617-18 (S.D.N.Y. 1980) (plaintiff could not rely on SEC consent decree in prior proceeding (in which it was not involved) to challenge a board of directors’ decision to indemnify the officers who entered that consent decree); Mishkin v. Peat, Marwick, Mitchell & Co., 1988 WL 391648, at *2 (S.D.N.Y. Nov. 7, 1988) (liquidation trustee of securities firm not collaterally estopped by findings in SEC consent judgment in earlier proceeding against securities firm to which trustee was not a party); In re Platinum & Palladium Commodities Litig., 828 F. Supp. 2d 588, 593-94 (S.D.N.Y. 2011) (plaintiff in civil litigation not entitled to rely upon findings in CFTC order to establish liability in subsequent civil action); Raychem Corp. v. Federal Ins. Co., 853 F. Supp. 1170 (N.D. Cal. 1994) (settlement by insureds of securities class action did not include any factual findings). And New York Courts have found that regulatory findings have binding effect in the appropriate circumstances. E.g., Ryan v. New York Tel. Co., 62 N.Y.2d 494, 503 (1984); A.D. Julliard & Co. v. Johnson, 166 F. Supp. 577, 585 (S.D.N.Y. 1957), aff’d, 259 F.2d 837 (2d Cir. 1958), cert. denied, 359 U.S. 942 (1959); Ikramuddin v. DeBuono, 256 A.D.2d 1039, 1040-41 (3d Dep’t 1998) (distinguishing Halyalkar). 52 3. The Decision Does Not Involve Or Implicate In Any Way, The Ability Of Government Agencies To Enter Into Settlements Bear Stearns also relies upon superficial comparisons to SEC v. Citigroup Global Markets, Inc., a case recently before Judge Rakoff in the Southern District of New York and then the Second Circuit. 827 F. Supp. 2d 328, 332 (S.D.N.Y. 2011). Bear Stearns asserts that “settlements would be discouraged” if Bear Stearns cannot disavow in insurance coverage litigation the adjudicated factual findings it proposed and its regulators entered. (BB 56.) Citigroup has no bearing on any of the issues presented here. In Citigroup, the SEC commenced an action in federal court, not an administrative proceeding like here. The SEC’s settlement required Judge Rakoff to approve the terms before the litigation could be dismissed. The absence of any factual findings or factual basis for the settlement led Judge Rakoff to withhold approval. 827 F. Supp. 2d at 332.10 The Second Circuit granted the SEC’s and Citigroup’s motion for a stay pending appeal, noting, in particular, that Judge Rakoff failed to show sufficient deference to the agency’s interpretation of the public interest and that his insistence on settlement terms that included an 10 According to Judge Rakoff, “the SEC’s long standing policy . . . of allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations, deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact.” Id. Judge Rakoff could not approve the Citigroup settlement because he had “not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment.” Id. at 330. 53 admission of liability could deter future settlements. SEC v. Citigroup Global Markets Inc., 673 F.3d 158, 163-66 (2d Cir. 2012). Citigroup has nothing to do with the regulatory settlement at issue here. Bear Stearns does not seek court approval for its settlements with the SEC and the NYSE, and the First Department’s decision does not address, much less impact, the validity of those settlements. Accordingly, the concern at play in Citigroup, namely, the ability of a governmental agency to enter into a settlement that it views is in the public interest, is not present here. The issue presented here—and not presented in Citigroup—is whether an insured is free to walk away from adjudicated consented-to factual findings when it submits the settlement based on those findings to its insurer for insurance coverage. The relevant authority is Millennium, in which the First Department held that the “neither-admit-nor-deny” provision in a similar SEC administrative order did not dilute at all the impact of the findings in that SEC Order for insurance coverage purposes. 68 A.D.3d 420, 420 (1st Dep’t 2009). The SEC’s findings were binding and conclusive and disposed of the insurance coverage issue “notwithstanding that plaintiff consented and agreed to these orders ‘without admitting or denying the findings therein.’” Id. 54 III. THE SEC FINDINGS SET FORTH BEAR STEARNS’ INHERENTLY HARMFUL AND FRAUDULENT CONDUCT New York law and public policy bar insurance coverage for any claim when the injury or harm to a third party is intended by the insured, or when injury or harm is inherent in the insured’s intentional misconduct itself. The First Department decision should be affirmed on this ground as well because the regulators found that Bear Stearns knowingly and intentionally orchestrated an illegal trading scheme for its clients, and its role was the driving force of this purposeful scheme directed inevitably to inflict massive harm to mutual fund shareholders. New York public policy prohibits insurance for intentionally harmful conduct. See, e.g., Town of Massena v. Healthcare Underwriters Mut. Ins., 98 N.Y.2d 435, 445 (2002); see also Austro v. Niagara Mohawk Power Corp., 66 N.Y.2d 674, 676 (1985); Hertz Corp. v. Gov’t Employees Ins. Co., 250 A.D.2d 181, 185 (1st Dep’t 1998). This public policy overrides the contractual terms of coverage. See id. As this Court has explained, the public policy barring insurance for intentional or inherently harmful wrongdoing is founded upon the well established and “fundamental principle that no one shall be permitted to take advantage of his own wrong.” Pub. Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392, 400 (1981) (quoting Messersmith v. Am. Fid. Co., 232 N.Y. 161, 165 (1921)). The denial of 55 insurance coverage for intentionally caused injuries serves as a “strong deterrent effect” because it prevents an insured from attempting to “evade responsibility for his actions” by “shifting the cost of the liability onto the insurer.” Dodge v. Legion Ins. Co., 102 F. Supp. 2d 144, 157 (S.D.N.Y. 2000). When harm is the natural result of certain misconduct—even if it is not the objective of the conduct—this type of “inherently harmful” conduct also is not insurable. Allstate Ins. Co. v. Mugavero, 79 N.Y.2d 153, 160 (1992). This Court has explained that, for certain types of conduct, “cause and effect cannot be separated” and “to do the act is necessarily to do the harm which is its consequence.” Id. at 160. “In such cases, if the act is intentional, so is the harm, and the courts will not inquire into the perpetrator’s subjective intent to cause the injury.” Dodge, 102 F. Supp. 2d at 151. Bear Stearns concedes that coverage properly is barred where harm is “inherent” in the conduct itself. (BB 57.) Bear Stearns instead argues that New York courts have “never expanded” the “class of conduct” that is inherently harmful beyond “the kind of horrific sex crime that Mugavero exemplifies.” (Id.) Bear Stearns is wrong. A number of New York courts have concluded that where solely economic harm is the inevitable result of an insured’s intentional misconduct, the consequences of deliberate injury must remain the responsibility of the wrongdoer, and not his insurer. For example, in Nat’l Union Fire Ins. v. 56 AARPO, Inc., 1999 WL 14010 (S.D.N.Y. Jan. 14, 1999), the Southern District of New York dismissed a claim for insurance coverage for a financial fraud on exactly these public policy grounds. In AARPO, an insurance broker sought coverage for the claim that it “knowingly conceived and deliberately executed a complex fraud.” Id. at *1. In particular, the broker lured insurance companies to “provide insurance at sharply lower rates than they would have otherwise . . . telling their customers that [the insurance companies] were charging much higher premiums than they actually were, and pocketing the difference.” Id. at *1. The court found that “public policy” barred insurance coverage for AARPO’s intentional and inherently harmful conduct. Id. at *4. In Accessories Biz, Inc. v. Linda & Jay Keane, Inc., 533 F. Supp. 2d 381 (S.D.N.Y. 2008), a jewelry wholesaler sought a defense and coverage for claims that it had intentionally failed to return certain jewelry samples to a manufacturer. Id. at 383. The insured argued that even though the underlying complaint alleged intentional conduct, the insured had withheld the underlying plaintiffs’ property only as a negotiating tactic and without subjective intent to cause economic harm. Id. at 387. The court held that the insured was not entitled to either a defense or coverage and that its subjective intent was not relevant when the injury was inherent in the defendant’s intentional conduct: In such cases, if the act is intentional, so is the harm, and the courts will not inquire into the perpetrator’s subjective intent to cause the 57 injury. . . . Even if L&J withheld the Samples from Accessories in order to create a profitable business agreement for both parties, L&J could have expected or anticipated that Accessories would suffer property damage because of this loss in value and the resulting inability to use those Samples to obtain business from other vendors. Such economic loss is an inherent result of L&J’s refusal to return Accessories’ Samples. Id. (emphasis added); see also DeSantis Enters. v. Am. & Foreign Ins. Co., 241 A.D.2d 859, 861 (3d Dep’t 1997) (“While plaintiffs may have terminated the plan based upon advice which itself was erroneous, the act of termination was an intentional act, not a mere oversight, and, accordingly, [insurer’s] motion for summary judgment should have been granted in its entirety”); Syversten v. Great Am. Ins. Co., 267 A.D.2d 854, 856-57 (3d Dep’t 1999) (citations omitted) (damages resulting from “allegations pertaining to fraudulent misrepresentation regarding concealment of the condition of the building” were “direct and natural consequence of intentional acts and therefore deemed, as a matter of law, ‘intentionally caused’ within the meaning of the policy”). Bear Stearns next argues that public policy has no application here because the SEC “could have” imposed liability on Bear Stearns for deceptive market timing based only on a showing of “recklessness, ” and “could have” imposed liability on Bear Stearns for illegal late trading without showing that Bear Stearns knew that the “trades themselves to have been initiated after the 4:00 p.m. market close.” (BB 59-60.) But there is no need to speculate about what the SEC “could 58 have” done with regard to its findings and charges against Bear Stearns. The SEC Order sets forth findings and charges, agreed to by Bear Stearns, detailing Bear Stearns’ intentional—not reckless—illegal conduct, and concludes that Bear Stearns’ “willfully violated” and “willfully aided and abetted and caused” violations of federal securities laws. In determining whether the conduct at issue is insurable, New York courts review the details of the actual conduct—and not, as Bear Stearns suggests—the general standards for liability under the governing law. E.g., Atlantic Mut. Ins. Co. v. Terk Techs. Corp., 309 A.D.2d 22 (1st Dep’t 2003) (“notwithstanding the fact that a violation of the Lanham Act can be unintentional, and that the complaint in the [underlying] action asserts that [the insured] acted with ‘reckless disregard,’” it was “impossible to envision how [the insured] could have unknowingly, and unintentionally” engaged in the conduct alleged in the complaint); see also Mugavero, 79 N.Y.2d at 162 (denying coverage, despite a negligence count, because “the analysis depends on the facts which are pleaded, not the conclusory assertions”); AARPO, 1999 WL 14010, at *4 (same); Sphere Drake Ins. Co. v. 72 Centre Ave. Corp., 238 A.D.2d 574, 576 (2d Dep’t 1997) (“The motion papers do not . . . provide an explanation of how the intrinsically intentional act of assault could be negligently performed.”); Bingham v. Atlantic Mut. Ins., 215 A.D.2d 315, 316 (1st Dep’t 1995) (“That allegations of mental suffering can be based on both 59 intentional and unintentional causes of action is not dispositive; what is material to the duty to defend is that the acts alleged in the counterclaims are all intentional”).11 The illegal trading scheme described in the factual findings by Bear Stearns’ regulators could not have been executed without Bear Stearns’ purposeful intent to violate the law and defraud innocent mutual fund shareholders. It automatically inflicted massive harm. There is no possible way—other than intentionally—that Bear Stearns could have devised, conducted (and touted) its scheme to manage illegal late trading, maintain a timing desk and actively disguise market timers to avoid detection of their deceptive trading by mutual funds. Bear Stearns consented to the entry of findings by the SEC and NYSE that it had (1) “knowingly processed” large numbers of late trades for “large hedge funds,” (2) cancelled customers’ “unprofitable trades” the next day, and (3) “helped” clients to “negotiate” and “evade” detection by mutual funds that were working to stop unlawful market timers. (R.117 (¶2), R.121 (¶124), R.117-18(¶4).) This illegal trading required intentional harmful conduct in order to proceed at all, and Bear 11 The decision by the California federal court in Raychem, supra, is inapposite here. Raychem involved a claim for insurance coverage for a settlement of a private securities class action. 853 F. Supp. at 1171. Unlike here, the insureds in Raychem settled simply by agreeing to pay a sum of money, without agreeing to any factual findings, and the plaintiffs’ allegations required only a showing of recklessness. Id. The Raychem court accordingly concluded that California public policy did not apply to bar coverage for the insureds’ civil settlement payment. Id. at 1180 60 Stearns continued to operate its “timing desk” and execute illegal late trades for four years until its scheme was uncovered. Not only was Bear Stearns’ conduct intentional, it was undertaken with full knowledge (gained directly from the mutual funds) that its conduct was inflicting massive harm on mutual funds. Bear Stearns received thousands of explicit demands from mutual funds ordering it to stop allowing its customers to “market time” their funds because the conduct was harming the mutual funds. (R.122 (¶¶29-30).) Rather than following those orders, Bear Stearns took affirmative steps to ensure that the illegal trading and resulting injuries continued. (R.117 (¶2).) Bear Stearns even deceived mutual funds into believing that it was blocking market timers when in reality, it was working with market timers to bypass the phony safeguards it purported to create and implement to enforce the funds’ restrictions on market timing. (R.122 (¶2), R.137 (¶117), R.144 (¶170).) Injury to mutual funds and their shareholders was the inherent and inevitable consequence of Bear Stearns’ intentional illegal trading scheme. Late trading and market timing: (1) steal profits from mutual funds by reducing the value of mutual fund shares in an amount at least equal to Bear Stearns’ and its customers’ profits from the illegal trades, (2) steal value from the mutual funds by forcing them to incur extra transaction costs, and (3) steal the return that would have been owned by innocent shareholders absent the illegal trades. (R.118-19(¶¶8-9).) 61 Insurance coverage for this intentional, illegal and inherently harmful conduct is barred as a matter of New York law.12 IV. THE POLICIES EXCLUDE COVERAGE FOR CLAIMS BASED UPON OR ARISING OUT OF ANY IMPROPER PROFIT OR ADVANTAGE OBTAINED BY BEAR STEARNS The unambiguous terms of the Policies’ Profit or Advantage Exclusion bars coverage for all of the relief sought by Bear Stearns in this action and provides an independent ground for affirming the First Department’s decision.13 The Profit or Advantage exclusion precludes coverage for any Claim “based upon or arising out of the Insured gaining in fact any personal profit or advantage to which the Insured was not legally entitled” (the “Profit or Advantage Exclusion”) (R.106 (§ IV(9)).) Like all policy provisions, this exclusion must be applied consistently with its plain and unambiguous language. U.S. Fidelity & 12 Bear Stearns argues that the First Department’s decision is unsupportable because it directed dismissal of the entire Amended Complaint, including Bear Stearns’ demand for reimbursement of $14 million it paid to settle the underlying civil actions by investor classes, and that payment, unlike the SEC payment, was not disgorgement excluded from coverage under New York law. (BB 32.) This argument misapprehends the scope of the bases for denial of coverage that have been asserted by the Insurers. Dismissal of Bear Stearns’ entire claim for coverage, including the demand for reimbursement of the civil settlements and all defense costs, is entirely consistent with the public policy prohibiting insurance coverage for inherently harmful conduct and, as discussed in Section IV, infra, with the express terms of the Policies which terms exclude coverage for claims based upon or arising out of any improper profit or advantage gained by the insured. This is because the investors’ claims are based on the same illegal trading scheme that Bear Stearns facilitated and that generated profits and advantages for Bear Stearns. 13 This issue was briefed below, see J.P. Morgan Securities Inc. v. Vigilant Ins. Co., 91 A.D.3d at 229, and may be relied upon by this Court to affirm the Decision even though the First Department did not expressly recite the exclusion as a basis for its Decision. See, e.g., Town of Massena v. Niagara Mohawk Power Corp., 45 N.Y.2d 482, 488 (1978); Menorah Nursing Home, Inc. v. Zukov, 153 A.D.2d 13, 19 (2d Dep’t 1989). 62 Guar. Co. v. Annunziata, 67 N.Y.2d 229, 232 (N.Y. 1986). It must be applied as written without distorting the language or straining to find an ambiguity where none exists. Bassuk Bros., Inc. v. Utica First Ins. Co., 1 A.D.3d 470, 471 (2d Dep’t 2003). Because the exclusion applies as a matter of law based upon facts admitted by the insured in its pleading or established by the documentary record of the settlements that Bear Stearns itself proposed, the insurers are entitled to judgment as a matter of law. Jahier v. Liberty Mut. Group, 64 A.D.3d 683, 685 (2d Dep’t 2009). Bear Stearns acknowledges in its Amended Complaint that it earned at least $16.9 million in revenue from the illegal trades it facilitated for its customers. (R.76 (¶103).) While Bear Stearns equivocates about whether that revenue produced any profit—using language like “little or no profit” to describe the result—it plainly acknowledged receiving some profit or advantage by offering to pay the SEC $20 million in a settlement based on that revenue calculation. (Id.) The SEC Order and NYSE Decision also establish that Bear Stearns gained other “advantages” from the illegal trading scheme, including new hedge fund customers, new business from existing hedge fund customers, new business from correspondent brokers and new brokers from other firms. (R.122-23 (¶¶ 33-35), R.124-25 (¶¶38-45), R.126-28 (¶¶52, 57-67), R.135-36 (¶¶106-109).) The “advantage” that triggers the exclusion need not be gained in the form of direct 63 monetary benefits. It “encompasses any gain or benefit, such as an opportunity to make a profit” or the opportunity “to gain credibility with other companies.” Jarvis Christian College v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 197 F.3d 742, 747-49 (5th Cir. 1999) (emphasis in original); see also TIG Specialty Ins. Co. v. Pinkmonkey.com Inc., 375 F.3d 365, 370 (5th Cir. 2004) (same); Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Continental Ill. Corp., 666 F. Supp. 1180, 1199 (N.D. Ill. 1987) (unsecured loans to the insured constituted profit or advantage to which the insured was not entitled). Bear Stearns argued in the court below that the Profit or Advantage Exclusion does not apply because the fees and commissions it earned on illegal trades and the revenue it gained from new business were not inherently illegal. Bear Stearns’ argument ignores the plain language of the exclusion, which does not require that the profit or advantage itself be illegal—only that the Insured is “not legally entitled” to it. “Not legally entitled” is not synonymous with “illegal.” Jarvis, 197 F.3d at 749. For example, as the Jarvis court explained, “a bank customer who receives an erroneous credit on his monthly statement is not ‘legally entitled’ to keep the mistaken deposit, since the bank or another customer has a superior right to that money; however, that customer is not guilty of illegal or illicit activity.” Id. at 749 n.8. 64 In any event, the SEC and NYSE found, in findings Bear Stearns proposed and consented to, that Bear Stearns facilitated an illegal trading scheme which generated this profit and advantage. New York law is clear that an insured is not legally entitled to profits or advantages gained through illegal activity even if the profits or advantages are not themselves inherently illegal. If the insured is not legally entitled to what otherwise would be lawful profits or advantages, the exclusion applies. See Steadfast Ins. Co. v. Stroock & Stroock & Lavan LLP, 277 F. Supp. 2d 245, 252-53 (S.D.N.Y. 2003) (collecting legal fees was not itself unlawful but firm was not legally entitled to fees paid in preference to claims of other creditors, so the exclusion applied); see also Am. Century Servs. Corp. v. Am. Int’l Specialty Lines Ins. Co., 2002 WL 1879947, at *7-9 (S.D.N.Y. Aug. 14, 2002) (profit or advantage exclusion bars coverage for amounts beyond those paid as disgorgement).14 14 The cases relied upon by Bear Stearns below are not on point. In Federal Ins. Co. v. Sheldon, 186 B.R 364, 368-69 (S.D.N.Y. 1995), the court found that the profit or advantage allegedly gained by two insured persons could be characterized as “incidental” to the wrongdoing committed by the insured entity. Here the profit or advantage gained by Bear Stearns was not incidental but rather the direct result of its wrongful conduct; it touted to potential clients its willingness to execute illegal late trades and its methods for evasion of mutual funds’ restrictions on market timing, showing that, from Bear Stearns’ vantage point, the gaining of profit or advantage was the central purpose of the scheme. In Fed. Ins. Co. v. Kozlowski, 18 A.D.3d 33, 41 (1st Dep’t 2005), the court held the insurer was obligated to advance defense costs because the pending actions against the insured encompassed not only claims barred by the exclusion, but also other claims for which coverage might be available. In Alstrin v. St. Paul Mercury Ins., 179 F. Supp. 2d 376, 400 (D. Del. 2002), the court highlighted the fact that the allegations “do not seek disgorgement” in finding that the exclusion did not apply, but the primary object of the claim against Bear Stearns in fact was obtaining disgorgement. Finally, in Pereira v. Nat’l Union Fire Ins. of Pittsburgh, Pa., 2006 WL 1982789, at *6 (S.D.N.Y. Jul. 12, 2006), the court held that 65 Contrary to Bear Stearns’ arguments the fact that others, specifically its customers, also gained profits or advantages from the illegal scheme is not relevant. The exclusion states that the “Policy shall not apply” to claims “arising out of” Bear Stearns’ gaining “any” profit or advantage to which it was not legally entitled. (R.106 (§ IV(9).) The exclusion means what it says—“any” not “all.” See Annunziata, 67 N.Y.2d at 232. Nothing in the exclusion suggests that all of the amounts for which coverage is sought must be profits gained by the insured, or that the exclusion does not apply because someone else also profited. Nor is it relevant if Bear Stearns’ profits or advantages comprise, as it claims, only a small proportion of the $160 million in disgorgement that Bear Stearns was required to pay and for which it now seeks coverage. The Profit or Advantage Exclusion contains no exception or limitation if the quantum of the profit or advantage does not relate in a prescribed mathematical way to the amount of the insurance claim. To the contrary, the exclusion states that the Policies “shall not apply” if the Claim arises from “any” profit or advantage to which the Insured is not legally entitled. To allow for coverage in cases in which the profit or advantage that has been gained by the Insured is less in dollar value than the amount for which coverage is sought would refuse application of the clear conduct triggering the exclusion could not be imputed from one insured to other insureds given the “severability” provision in that policy, but that point is irrelevant here because the exclusion applies to Bear Stearns based upon its own illegal conduct. 66 language of the exclusion. The exclusion does not say that it applies “unless the amount of the profit or advantage is less than what would otherwise be covered loss” or anything like that. Bear Stearns’ limited reading of the clear language of the exclusion adds terms that are not contained in the parties’ contract. A highly sophisticated insured such as Bear Stearns—which argues vigorously in its brief that “freedom of contract” between insured and insurer must be respected—cannot be excused from the contract it made, and the effect of its clear and unambiguous language, on the basis that it is “unfair” or “illogical” to apply the contract’s plain language to a case in which the insured asserts that its profit from illegal trading is less than the profits it facilitated for its customers. The contract language must be applied as written even if the result is disadvantageous to the insured. See, e.g., Penna v. Peerless Ins. Co., 510 F. Supp. 2d 199, 209 (W.D.N.Y. 2007) (where insurance policy unambiguously required plaintiffs to commence suit within two years after date of loss, plaintiffs’ failure to do so would not be excused “however harsh the result may be”); Mutchnick v. John Hancock Mut. Life Ins. Co., 284 N.Y.S. 565, 573 (N.Y. Mun. Ct. 1935) (“Whether the results to the insured are harsh or beneficial does not warrant interpreting deliberate language in other than its natural meaning”). Bear Stearns argued below that the exclusion only applies to disgorgement, but that argument cannot be reconciled with the plain language. The exclusion 67 contains no language limiting its application based on the remedy sought by the Claim—it says that the Policy “does not apply to the Claim,” not that the Policy “does not apply to disgorgement.” Furthermore, disgorgement is not insurable under applicable law, and therefore is not covered “Loss” in the first place, so treating the exclusion as applicable only to a claim for disgorgement would render it meaningless surplusage, as disgorgement is already outside the scope of coverage under the “Loss” definition. See Excess Ins. Co. Ltd. v. Factory Mut. Ins., 3 N.Y.3d 577, 582 (N.Y. 2004) Finally, it is clear that the late trading and deceptive market timing claims against Bear Stearns are “based upon” or “aris[e] out of” Bear Stearns having gained profit or advantage to which it is not legally entitled. This language is unambiguous and requires only “some causal connection” between the claim and the profit or advantage gained by the insured. See Maroney v. New York Cent. Mut. Fire Ins., 5 N.Y.3d 467, 472 (2005); New Hampshire Ins. v. Jefferson Ins. of N.Y., 213 A.D.2d 325, 330 (1st Dep’t 1995). The causal connection in this case is clear; the profit or advantage is central to the scheme which gave rise to the Claim. Bear Stearns alleges in its Amended Complaint, and the SEC Order and NYSE Decision found, that Bear Stearns generated substantial profits and advantages from the illegal conduct that is the subject of the claims. (See R.52-53(¶8), R.76(¶103), R.118(¶5).) The SEC Order and NYSE Decision further establish 68 that, from Bear Stearns’ standpoint, the gaining of profits or advantages for itself was the object of the scheme that was the basis of the claims against Bear Stearns. (See R.122-23 (¶¶ 32-33).) The claims therefore are “based upon” and “aris[e] out of” these profits or advantages and are excluded entirely, including any defense costs, as a matter of law. V. THE INSURERS DID NOT AGREE TO INDEMNIFY BEAR STEARNS FOR THE DISGORGEMENT OF ILL-GOTTEN GAINS CREATED BY ITS WILLFUL COLLABORATION IN AN ILLEGAL MUTUAL FUND TRADING SCHEME Bear Stearns argues that the First Department Decision, if affirmed, would somehow “nullify” the contractual obligations under the Policies and violate countervailing principles of “freedom of contract.” (BB 36.) As explained above, freedom of contract is not absolute and does not permit insurance coverage for disgorgement of ill-gotten gains or conduct that is inherently harmful; public policy precludes such coverage even if intended by the parties. In any event, Bear Stearns’ purported concern with freedom of contract is unwarranted because Insurers never agreed to cover the disgorgement of ill-gotten gains or to pay for the consequences of its deliberate, dishonest and inherently harmful conduct.15 As 15 By contrast, the insurers in the cases Bear Stearns relies on affirmatively agreed to insure the conduct in question. See Public Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392, 396-398 (1981) (insurer found to have agreed to defend criminally convicted dentist in civil suit because insurance policy provided coverage for liability arising out of “assault” and “undue familiarity”); Messersmith v. American Fidelity Co., 232 N.Y. 161, 163 (1921) (automobile insurer found to have agreed to indemnify insured even though the automobile was operated by underage driver with plaintiff’s knowledge because insurance policy provided for indemnification against 69 detailed below, the Policies only cover amounts paid “as damages.” This coverage does not include the repayment of disgorgement that Bear Stearns made to regulators here. And the Policies also expressly exclude coverage for the deliberate, dishonest and fraudulent acts that Bear Stearns has been adjudged to have committed here. A. Consistent With Public Policy, The Policies Express Terms Limit Coverage To Amounts Paid “As Damages” And Bear Stearns’ Payment Of Disgorgement Is Not A Payment Of Damages The Policies only cover “Loss,” which is defined to include only amounts paid “as damages.” “Loss” is defined to mean: compensatory damages, multiplied damages, punitive damages where insurable by law, judgments, settlements, costs, charges and expenses or other sums the Insured shall legally become obligated to pay as damages resulting from any Claim or Claim(s); (R.103 (§ II(B)(2)(v)) (emphasis added).) Damages are measured by the loss to the injured party and are awarded as compensation to make that party whole. See N.Y. Jur. 2d Damages § 9; see also Black’s Law Dictionary, 9th ed. (2009) (defining damages as “[m]oney claimed by, or ordered to be paid to, a person as compensation for loss or injury”); Merriam-Webster Collegiate Dictionary 314 (11th ed. 2007) (defining damages as “[l]oss or harm resulting from injury to person, property, or reputation”). “liability for injuries accidentally suffered by any one through the maintenance or use of his automobile”). 70 Disgorgement is not a form of damages. See, e.g., Admiral Ins. Co. v. Weitz & Luxemberg, P.C., 2002 WL 31409450, at *5 (S.D.N.Y. Oct. 24, 2002) (“New York law recognizes that the word ‘Damages’ does not include a claim for restitution of money that was wrongfully obtained by an insured”). It is calculated solely by reference to the amount of ill-gotten gains generated by the conduct of the wrongdoer and without regard to the amount needed, if any, to compensate an injured party. See Official Comm. Of Unsecured Creditors of WorldCom v. SEC, 467 F.3d 73, 81 (2d Cir. 2006) (“size of a disgorgement order ‘need not be tied to the losses suffered by defrauded investors’”) (quoting Fischbach, 133 F.3d at 176); SEC v. Cavanagh, 445 F.3d 105, 117 (2d Cir. 2006) (“‘disgorgement’ is not available primarily to compensate victims”); SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987) (“[w]hether or not any investors may be entitled to money damages is immaterial”); SEC v. Commonwealth Chemical Sec., 574 F.2d 90, 102 (2d Cir. 1978) (“the primary purpose of disgorgement is not to compensate investors”); SEC v. Drexel Burnham Lambert, Inc., 956 F. Supp. 503, 507 (S.D.N.Y. 1997) (same). Disgorgement is designed to separate the wrongdoer from the illegal gains obtained from his wrongdoing—and is calculated to do that whether or not it is later paid over to injured investors, and indeed, whether or not it is adequate or even more than is needed to do so. 71 Bear Stearns paid $160 million to its regulators as disgorgement. (R.154 (§ IV.D).) That payment reflected a calculation of illegal gains generated by Bear Stearns’ illegal mutual fund trading scheme. (BB 10-11; see also R.54 (¶14), R.118( ¶5).) Ill-gotten gains ordered to be disgorged are not damages. By agreeing to cover only amounts paid by Bear Stearns “as damages,” the Insurers plainly did not agree to cover Bear Stearns’ disgorgement payment. B. Consistent With Public Policy, The Express Terms Of The Policies Bar Coverage For Bear Stearns’ Intentional Conduct The Policies’ Dishonest Acts Exclusion is entirely consistent with the application of the public policy against insurance coverage for Bear Stearns’ intentionally harmful conduct at issue here. That exclusion bars coverage for “any Claim(s) made against the Insured(s): based upon or arising out of any deliberate, dishonest, fraudulent or criminal act or omission by such Insured(s), provided, however, such Insured(s) shall be protected under the terms of this policy with respect to any Claim(s) made against them in which it is alleged that such Insured(s) committed any deliberate, dishonest, fraudulent or criminal act or omission, unless judgment or other final adjudication thereof adverse to such Insured(s) shall establish that such Insured(s) were guilty of any deliberate, dishonest, fraudulent or criminal act or omission . . . (R.105 (§ IV(1)).) The SEC Order and NYSE Decision satisfy both elements of this exclusion. First, Bear Stearns’ claims for coverage plainly arise from deliberate, dishonest and fraudulent acts and omissions. Both the SEC and the NYSE charged 72 Bear Stearns with willfully violating the federal securities laws based on detailed findings of Bear Stearns’ knowing and intentional facilitation of illegal trading with the full knowledge of senior management. Second, as set forth above, see § II.B.1, the SEC Order and NYSE Decision constitute “judgment[s] or other final adjudication[s]” of all issues arising from Bear Stearns’ late trading and deceptive market timing practices. There is and can be no further adjudication of these issues between the regulators and Bear Stearns.16 Consistent with the language of this exclusion and the findings in the final adjudications by the SEC and NYSE, Bear Stearns’ intentional orchestration of the illegal trading scheme constitutes conduct excluded under the Policies’ Dishonest Acts Exclusion, and the Policies bar coverage for the claims and any associated defense costs. Bear Stearns’ assertion that the Policies’ Dishonest Acts Exclusion constitutes an express “promise[] to provide coverage” absent a final adjudication (BB 51), is inconsistent with two principles of policy interpretation. First, only a policy’s insuring agreements—not its exclusions—can be a source of coverage. See Ryerson Inc. v. Federal Ins. Co., 796 F. Supp. 2d 911, 914 n.4 (N.D. Ill. 2010) 16 A review of the Policies’ “No Action” clause demonstrates how the Policies specify when a trial on the merits is necessary: “No action shall lie against the Insurer unless, as a condition precedent thereto, the Insured(s) shall have fully complied with all of the terms of this policy, nor until the amount of the Insured’s obligation to pay shall have been fully and finally determined either by judgment against them after actual trial or by written agreement between them, the claimant and the Insurer.” (R.110 (§ XIII) (emphasis added).) In contrast, the Dishonest Acts Exclusion requires only that the insured’s deliberate, dishonest and fraudulent conduct be established by “other final adjudication” as opposed to “after actual trial.” 73 (“[A]n exclusion is only relevant if the claim first falls within the insuring agreement. . . . Because there was no insurable ‘loss,’ [insured’s] claim did not fall within the insuring agreement, making the exclusions irrelevant.”) (citing Continental Cas. Co. v. Pittsburgh Corning Corp., 917 F.2d 297, 300 (7th Cir.1990) (“an exclusion from insurance coverage cannot create coverage”)). Here, the Dishonest Acts Exclusion provides that Bear Stearns “shall be protected under the terms of this policy” unless there is a final adjudication of its deliberately dishonest acts. As stated above, the terms of the Policies do not cover (1) matters deemed uninsurable as a matter of law, (2) claims that are based upon or arise out of any improper profit or advantage gained by the insured, (3) amounts paid by the insured that do not constitute “damages” and (4) deliberately fraudulent dishonest acts where there has been an adjudication of those acts. Second, Bear Stearns cannot rely on exclusionary language to expand by negative inference the scope of coverage under the Policies. See Raymond Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 5 N.Y.3d 157, 163 (2005); SR Int’l Bus. Ins. Co., Ltd. v. World Trade Ctr. Props. LLC, 2006 WL 3073220, at *10, n.37 (S.D.N.Y. Oct. 31, 2006) (“exclusion cannot create coverage by ‘negative inference’”) (citing Raymond Corp.); see also Weedo v. Stone-E-Brick, Inc., 405 A.2d 788, 795 (N.J. 1979) (argument that carve-out in policy exclusion affirmatively creates coverage “runs directly counter to the basic principle that 74 exclusion clauses subtract from coverage rather than grant it”). Bear Stearns’ claim does not constitute an insurable “Loss” under the Policies, but even if the Court were to hold otherwise, the Dishonest Acts Exclusion applies to bar coverage because the SEC Order and NYSE Decision constitute binding and final adjudications of Bear Stearns’ fraudulent conduct. VI. THE PRIOR WRONGFUL ACTS EXCLUSION APPLIES TO BAR COVERAGE UNDER UNDERWRITERS’ EXCESS POLICIES The Prior Wrongful Acts Exclusion to the excess policies issued by Underwriters precludes coverage for Loss “in connection with any Claim”: 2. (i) for any alleged Wrongful Act(s) committed prior to 12:01 a.m. Local Standard Time on 21st March, 2000, if any officer of the Assured, at such date, knew or could have reasonably foreseen that such Wrongful Act(s) could lead to a Claim; or (ii) any other Wrongful Act whenever occurring, which, together with a known Wrongful Act as set forth in 2(i) above, would constitute Interrelated Wrongful Acts. (R.1427.) Bear Stearns has abandoned its right to challenge the First Department’s ruling on Underwriters’ Motion to Dismiss based on the Prior Wrongful Acts Exclusion by failing to raise the issue before this Court. See Garner v. New York State Dep’t of Correctional Services, 10 N.Y.3d 358, 361 (N.Y. 2008), superseded by statute on other grounds by Penal Law § 70.85. 75 Even if the Court were to conclude that the issue has not been abandoned, the SEC Order and the NYSE Decision conclusively establish that the Prior Wrongful Acts Exclusion applies and allows for no interpretation that could bring the regulatory and civil actions within Underwriters’ excess insurance policies. Terk, 309 A.D.2d at 29-30; XL Specialty Ins. v. Agoglia, 2009 WL 1227485, *7 (S.D.N.Y. Apr. 30, 2009). Bear Stearns does not dispute that it seeks coverage for a Claim allegedly arising out of Wrongful Acts committed prior to March 21, 2000 and Interrelated Wrongful Acts after that date. The consented-to factual findings in the SEC Order conclusively establish that senior management and other Bear Stearns officers knew of such pre-March 21, 2000 Wrongful Acts and that the officers knew or could have reasonably foreseen that such Wrongful Acts could lead to a Claim as of that date. A. Bear Stearns Abandoned Its Appeal Of The Ruling On Underwriters’ Motion To Dismiss Underwriters joined and adopted the underlying insurers’ motion to dismiss and separately moved for dismissal of Bear Stearns’ Amended Complaint based on the Prior Wrongful Acts Exclusion (R.95-97), and the trial court denied Underwriters’ motion. (R.33-46.) Underwriters appealed the trial court’s decision to the First Department (R.12-14, 31-46), and the First Department unanimously 76 reversed the trial court and, among other things, granted Underwriters’ motion to dismiss.17 (R.1833-47). Bear Stearns, however, has not appealed the First Department’s determination to grant Underwriters’ motion to dismiss based on the Prior Wrongful Acts Exclusion. On April 25, 2012, Bear Stearns submitted a Memorandum of Law in support of its Motion for Leave to Appeal to this Court. Nowhere in that Memorandum does Bear Stearns address the Prior Wrongful Acts Exclusion or the First Department’s decision with respect to that exclusion. This Court granted Bear Stearns’ Motion for Leave to Appeal and, on July 5, 2012, Bear Stearns filed a Preliminary Appeal Statement that did not list the Prior Wrongful Acts Exclusion among the issues to be addressed on appeal. On August 27, 2012, Bear Stearns filed its brief before this Court. Further, nowhere in its brief to this Court does Bear Stearns raise the Prior Wrongful Acts Exclusion or address the First Department’s ruling with respect to the same. A party that fails to present an issue to the appellate court abandons its right to challenge a prior ruling on that issue. See Garner, 10 N.Y.3d at 361 17 The First Department’s decision primarily addresses issues raised in the separate motion to dismiss by all Insurers, including Underwriters, but the First Department plainly considered and ruled upon Underwriters’ separate motion to dismiss. (See R.1836 (“[W]e reverse and grant defendants’ motions to dismiss the complaint”), R.1839 (“The Lloyd’s of London excess policy also includes a ‘Known Wrongful Acts Exclusion’ which excluded claims for Wrongful Acts committed before March 21, 2000 ‘if any officer of the Assured, at such date, knew or could have reasonably foreseen that such Wrongful Act(s) could lead to a Claim’”), R.1846-47 (reversing trial court decision denying “defendants’ motions to dismiss the complaint” and ordering defendants’ “motions granted”) (emphasis added).) 77 (“[D]efendant’s failure to raise the Statute of Limitations issue in its brief ‘is tantamount to an abandonment of that issue”) (quoting McKee v. City of Cahoes Bd. of Educ., 99 A.D.2d 923, 925 n.473 (3d Dep’t 1984).18 In failing to raise the Prior Wrongful Acts Exclusion before this Court, Bear Stearns has abandoned any right to appeal the First Department’s ruling on Underwriters’ motion to dismiss. B. Bear Stearns Officers Knew As Of March 21, 2000 Of The Wrongful Acts Committed Prior To March 21, 2000 Even if the Court determines that Bear Stearns has not abandoned the issue, the SEC Order conclusively establishes that the Prior Wrongful Acts Exclusion applies to preclude coverage under Underwriters’ excess insurance policies. The nature of the claims and findings by the SEC establish that Bear Stearns officers knew on or before March 21, 2000 that Bear Stearns facilitated improper and deceptive trading by its clients and made efforts to conceal such Wrongful Acts from detection by its regulators, the targeted funds and their investors. (R.128 (¶¶70-71), R.140 (¶138), R.141-42 (¶¶151-156), R.145 (¶¶175-178).) 18 See also Miller v. Brereton, 98 A.D.3d 824, 826 n.1 (3d Dep’t) (“[P]etitioner did not argue that issue in his brief on appeal to this Court and, accordingly, the issue was abandoned”); United Parcel Service, Inc. v. Tax Appeals Tribunal of the State of New York, 2012 WL 3481291, *5 n.3 (3d Dep’t Aug. 12, 2012) (same); Levitt v. Levitt, 97 A.D.3d 543, 545 (2d Dep’t 2012) (“By taking an appeal from only a part of a judgment or order, a party waives its right to appeal from the remainder thereof”); Clayton B. Obersheimer v. Travelers Cas. & Sur. Co. of America, 96 A.D.3d 1284, 1285 (3d Dep’t 2012) (“Having failed to advance any argument in its brief regarding the denial of its cross motion, defendant has abandoned any challenge to that portion of Supreme Court’s order”); Matter of Tristram, 65 A.D.3d 894, 894 (1st Dep’t 2009). 78 Bear Stearns does not dispute and, in fact, acknowledged in the Amended Complaint that the Claim involves Wrongful Acts committed prior to March 21, 2000 and Interrelated Wrongful Acts after that date. (R.62 (¶50), R.70 (¶80), R.82 (¶130), R.84-85 (¶¶140-141), R.86 (¶149).) Bear Stearns argued below that the SEC Order does not adequately demonstrate that any officer knew of those Wrongful Acts as of March 21, 2000. This argument ignores the stipulated factual findings and nature of the claims in the SEC Order, which establish that, as of March 21, 2000, various Bear Stearns officers knew of and engaged in the facilitation of fraudulent trading by its clients, and that Bear Stearns acted to conceal such improper trades after targeted mutual funds demanded that the harmful trading cease. (R.128 (¶¶70-71), R.140 (¶138), R.141-42 (¶¶150-55) R.145 (¶¶175-78).) Bear Stearns does not dispute that the individuals described in the SEC Order as the “head of broker-dealer services for [BSSC’s Global Clearing Services]”, the “MFOD Head’s supervisor”, “senior managers”, individuals at the “highest levels of BSSC”, “BSSC management” or “relationship managers” qualify as “officers” of Bear Stearns. The SEC Order provides specific and detailed examples of Wrongful Acts that these individuals had knowledge of and/or engaged in before March 21, 2000, including their knowledge and approval of the assignment of multiple accounts, new registered representative numbers and 79 other “deceptive devices” designed to disguise the identities of brokers and clients engaged in late trading and deceptive market timing despite repeated complaints by targeted funds about the harmful trading. (R.117-18 (¶¶1-2, 4) R.141 (¶¶150-51), R.145-46 (¶¶175-76, 179-83).) The nature of the violations further demonstrates that officers of Bear Stearns knew of the Wrongful Acts as of March 21, 2000. Bear Stearns consented to findings that resulted in charges that it “willfully” violated anti-fraud provisions of federal securities laws, including § 10(b) of the Exchange Act. (R.145-46 (¶¶179-83).) Bear Stearns does not and cannot dispute that the claims asserted by the SEC required a showing of scienter or that corporate intent is established by the knowledge and conduct of senior management.19 SEC v. Durgarian, 477 F. Supp. 2d 342, 357 (D. Mass. 2007); SEC v. PIMCO Advisors Fund Mgmt., LLC, 341 F. Supp. 2d 454, 470 (S.D.N.Y. 2004) (“[s]cienter of the corporate entities is ascertained through the mental state of its management”). Instead, Bear Stearns relied below exclusively on its now withdrawn Wells Submission and speculated that intent “could have been established through a showing of recklessness, which could have been established simply through inadequate supervision and controls.” As discussed above, coverage is determined by the findings of the SEC Order and 19 Notably, Bear Stearns unsuccessfully argued in its Wells Submission that its senior management did not have the requisite fraudulent intent. (R.1439, 1441, 1443, 1483-84, 1488, 1495-97). 80 the actual basis of the settlement, and not Bear Stearns’ conjecture about alternative theories of liability or the self-serving arguments in its rejected Wells Submission. (See supra at Section II.B.1-II.B.2.) As laid bare in the detailed findings by the SEC, the willful violations were based on senior management’s knowing participation in a fraudulent scheme running from 1999 through 2003, and not on inadequate supervision or controls. The SEC Order also makes plain that, by March 21, 2000, late trading and market timing was an institutionalized business practice at Bear Stearns and that its officers had to have known of and condoned such conduct. (R.117-23.) Bear Stearns claims that the SEC merely found that certain employees may have undermined the lawful purpose of the timing desk. To the contrary, the SEC actually concluded that between 1999 and 2003 Bear Stearns regularly utilized the timing desk to enter late trades, improperly cancel unprofitable trades, advise timers on how to evade detection, and promote market timing. (R.117-18 (¶¶1-5), R.121-22 ( ¶¶ 23-30).) C. Officers Knew Or Could Have Reasonably Foreseen That The Pre- March 21, 2000 Wrongful Acts Could Lead To A Claim The SEC Order also establishes that, on or before March 21, 2000, officers of Bear Stearns knew or could have reasonably foreseen that these Wrongful Acts could lead to a Claim. 81 The Prior Wrongful Acts Exclusion applies if, on or before March 21, 2000, an officer of Bear Stearns either (1) subjectively “knew,” or (2) objectively “could have reasonably foreseen,” that Wrongful Acts could lead to a Claim. The detailed findings by the SEC satisfy both the subjective and objective prongs of the mixed standard applied by New York courts in considering similar prior knowledge exclusions. Exec. Risk Indem. Inc. v. Pepper Hamilton LLP, 13 N.Y.3d 313, 322 (2009). The subjective prong is met because the stipulated facts in the SEC Order establish that, before March 21, 2000, officers of Bear Stearns had subjective knowledge of facts pertaining to a fraudulent scheme engaged in by their clients, which involved or implicated Bear Stearns. (R.117-118 (¶¶1-5), R.141 (¶¶150-51), R.145 ( ¶¶175-76)); see also CPA Mut. Ins. Co. v. Weiss & Co., 80 A.D.3d 431 (1st Dep’t 2011). As the improper trading facilitated by Bear Stearns violated numerous laws, rules and regulations and harmed mutual fund investors, officers of such a sophisticated financial institution would have known that such conduct could lead to investigations and actions by regulators, as well as lawsuits by the targeted mutual funds and their investors. Moreover, the fact that Bear Stearns took measures beginning as early as 1999 to conceal the harmful trading scheme from mutual funds that asked it to stop establishes that its officers knew prior to March 21, 2000 that a Claim could result from the Wrongful Acts. (R.122 (¶¶29- 30), R.141 (¶150).) 82 It is also beyond dispute that the objective prong is satisfied where, as here, prior to March 21, 2000, a reasonable officer in possession of these facts could have reasonably foreseen that the facilitation of customers’ late trading, which is illegal, and manipulative market timing, which violates numerous regulations governing its business and harmed mutual funds, could lead to a Claim by targeted mutual funds, their investors and/or regulators. Bear Stearns argued below that Underwriters have not established as “undisputable fact” that as of March 21, 2000 an officer knew or could have reasonably foreseen that the Wrongful Acts could lead to a Claim. That argument is a red herring. The Prior Wrongful Acts Exclusion has no such “in fact” requirement. Similarly unavailing is Bear Stearns’ contention below that the “sole foreseeable consequence” of its conduct was the termination of its contracts with the targeted funds. As in Pepper Hamilton and CPA Mutual, in view of Bear Stearns’ active and knowing participation in its clients’ fraudulent scheme, its officers could have reasonably foreseen the Claims that were ultimately made. Finally, Bear Stearns suggested in its arguments below that its officers could not have anticipated future Claims because “prior to the Fall of 2003, market timing was virtually ignored by federal and state regulators.” Bear Stearns’ belief that it would not get caught does not mean that it could not have reasonably 83 foreseen that the fraudulent scheme could lead to a Claim. Coregis Ins. Co. v. Lewis, Johs, Avallone, Aviles and Kaufman, LLP, 2006 WL 2135782, at *10 (E.D.N.Y. July 28, 2006) (holding insured’s subjective beliefs regarding whether the potential claimant would file suit irrelevant); see also CPA Mut., 80 A.D.3d at 432. VII. DEFENSE COSTS ARE UNINSURABLE WHERE, AS HERE, NO COVERAGE IS TRIGGERED BY THE CLAIM As a matter of settled New York law, under a liability insurance policy that does not include a duty to defend (as here), when there is no coverage for a claim, there is no coverage for any costs or expenses incurred in defending that claim. As the First Department explained in Credit Suisse, where, as here, “the Policy defines defense costs as a component of ‘Loss’ . . . defense costs are only recoverable for covered claims.” 10 A.D.3d 528, 528, 782 N.Y.S.2d 19, 20 (1st Dep’t 2004); see also Millennium, 24 Misc. 3d at 216; Stonewall Ins. Co. v. Asbestos Claims Mgt. Corp., 73 F.3d 1178, 1219 (2d Cir. 1995) (policies at issue did not “contemplate unconditional payment of defense costs for potentially covered claims, but only payment of costs if indemnification is required”); ERC Indus., Inc. v. Nat’l Union Fire Ins. Co., 136 B.R. 59, 64 (S.D.N.Y. 1992) (“Unlike duty to defend policies, which require the insurer to defend claims even if they are only arguably entitled to coverage, policies requiring the insurer to reimburse damages and defense costs related to wrongful acts entitle the insured to costs only when the underlying 84 claims are covered by the policy.”); AON Corp. v. Certain Underwriters at Lloyds, London, 2010 WL 8510173, * at 25 (Ill. Cir. Ct. Cook Cnty. Dec. 3, 2010) (order granting summary judgment) (“[D]efense costs are only recoverable for covered claims”). As shown, there is no coverage for any of Bear Stearns’ claims for coverage. Accordingly, New York law dictates that there can be no coverage for the expenses incurred to defend the claims. CONCLUSION For the foregoing reasons, the order by the First Department granting the Insurers’ motions to dismiss should be affirmed. 85 Dated: New York, New York November 16, 2012 DLA PIPER LLP (US) Attorneys for Vigilant Insurance Company and Federal Insurance Company By: /s/ Joseph G. Finnerty III Joseph G. Finnerty III Megan Shea Harwick Eric S. Connuck Miles D. Norton 1251 Avenue of the Americas New York, New York 10020-1104 (212) 335-3500 D’AMATO & LYNCH, LLP Attorneys for National Union Fire Insurance Company of Pittsburgh, Pa. By: /s/ Luke D. Lynch, Jr. Luke D. Lynch, Jr. Richard F. Russell Liza A. Chafiian Two World Financial Center New York, New York 10281 (212) 269-0927 KAUFMAN BORGEEST & RYAN LLP Attorneys for Liberty Mutual Insurance Company By: /s/ Scott A. Schechter Scott A. Schechter Sergio Alves 120 Broadway, 14th Floor New York, New York 10271 (212) 980-9600 DRINKER BIDDLE & REATH LLP Attorneys for Travelers Indemnity Company By: /s/ Marsha J. Indych Marsha J. Indych Douglas M. Mangel David F. Abernethy Of Counsel 1177 Avenue of the Americas, 41st Floor New York, New York 10036-2714 (212) 248-3140 86 CLYDE & CO US LLP Attorneys for Certain Underwriters at Lloyd’s, London By: /s/ Edward J. Kirk Edward J. Kirk Allison M. Calkins 405 Lexington Avenue New York, New York 10174 (212) 710-3900 LANDMAN CORSI BALLAINE & FORD P.C. Attorneys for American Alternative Insurance Corporation By: /s/ Michael L. Gioia Michael L. Gioia 120 Broadway, 27th Floor New York, New York 10271 (212) 238-4800 Of Counsel: BATES CAREY NICOLAIDES LLP Ommid C. Farashahi Kristi S. Nolley R. Patrick Bedell 191 North Wacker Drive, Suite 2400 Chicago, IL 60606 (312) 762-3100 87 CORPORATE DISCLOSURE STATEMENT Pursuant to 22 N.Y.C.R.R. §§ 500.1(f) and 500.13(a), Defendants- Respondents make the following disclosures: Vigilant Insurance Company and Federal Insurance Company Vigilant Insurance Company is a wholly-owned, indirect subsidiary of The Chubb Corporation. Federal Insurance Company is a wholly-owned subsidiary of The Chubb Corporation. The Chubb Corporation is a publicly-traded corporation. Additional subsidiaries and affiliates of The Chubb Corporation are listed in the attached appendix. Travelers Indemnity Company The Travelers Indemnity Company is the successor in interest by merger to Gulf Insurance Company. National Union Fire Insurance Company of Pittsburgh, Pa. National Union Fire Insurance Company of Pittsburgh, Pa. is a direct, wholly-owned (100%) subsidiary of Chartis U.S., Inc., which is a wholly-owned (100%) subsidiary of Chartis Inc., which is a wholly-owned (100%) subsidiary of AIUH LLC, which is a wholly-owned (100%) subsidiary of American 88 International Group, Inc., which is a publicly-held corporation. With the exception of the United States Department of the Treasury, no parent entity or publicly held entity owns 10% or more of the stock of American International Group, Inc. Liberty Mutual Insurance Company Liberty Mutual Insurance Company states that it is a wholly owned subsidiary of Liberty Mutual Group Inc., which in turn is wholly owned by LMCH Massachusetts Holdings Inc., which in turn is wholly owned by Liberty Mutual Holding Company Inc. Additional subsidiaries and affiliates of Liberty Mutual Insurance Company are listed in the attached appendix. Certain Underwriters at Lloyd’s London The defendant denominated as “Certain Underwriters at Lloyd’s, London” includes Syndicates 1241, 1007, 435, 2488, 456, 1211, 861 and 1209, which together subscribe to 80% of Excess Professional Liability Insurance Policy No. 501/FF00AC4B (the “Lloyd’s Excess Policy”). Pursuant to the applicable claims scheme, the claim at issue in the litigation is handled by leading Lloyd’s underwriter Syndicate 1241 on behalf of Syndicates 1241 and 1007. Xchanging Claims Services Limited acts on behalf of every other Lloyd’s syndicate subscribing to the Lloyd’s Excess Policy. 89 Syndicates 1241 and 1007 are managed by Novae Syndicates Limited (formerly known as SVB Syndicates Limited), which is wholly-owned by Novae Holdings Limited. The Novae Group plc is the ultimate parent of Novae Holdings Limited. Syndicate 435 is managed by Faraday Underwriting Limited, which is wholly-owned by Faraday Holdings Limited. Berkshire Hathaway Inc. is the ultimate parent of Faraday Holdings Limited. Syndicate 2488 is managed by ACE Underwriting Agencies Limited, which is wholly-owned by ACE Limited. Syndicate 456 is managed by Limit Underwriting Limited, which is wholly- owned by QBE Insurance Group Limited. Syndicate 1211 is managed by Travelers Syndicate Management Limited, which is wholly-owned by Travelers Companies Inc. Syndicates 861 and 1209 are managed by XL London Market Limited, which is wholly-owned by XL London Market Services Ltd. XL Group plc is the ultimate parent of XL London Market Services Ltd. Xchanging Claims Services Limited is a subsidiary of Xchanging plc. 90 American Alternative Insurance Corporation AAIC is a wholly owned subsidiary of Munich Reinsurance America, Inc. Munich Reinsurance America, Inc. is a wholly owned subsidiary of the Munich Re Group/Münchener Rüeckversicherungs (“Munich Re”). Munich Re is a German corporation that issues shares which are traded only on the Deutsche Böerse [German Stock Exchange] (“DAX”). No other parent companies, subsidiaries or affiliates of AAIC issue shares to the public. A-1 APPENDIX TO CORPORATE DISCLOSURE STATEMENT The following are subsidiaries and affiliates of The Chubb Corporation: Bellemead Development Corporation Bhakdikij Company, Ltd. CC Canada Holdings Ltd. Chubb 1882 (a Lloyds Syndicate) Chubb & Son Inc. Chubb Argentina de Seguros, S.A. Chubb Atlantic Indemnity Ltd. Chubb Capital Ltd. Chubb Computer Services, Inc. Chubb Custom Insurance Company Chubb Custom Market Inc. Chubb de Chile Compania de Seguros Generales, S.A. Chubb de Colombia Compania de Seguros, S.A. Chubb de Mexico Compania Afianzadora, S.A. de C.V. Chubb de Mexico Compania De Seguros, S.A. de C.V. Chubb do Brasil Companhia de Seguros Chubb Europe Finance Ltd. Chubb Europe Services Ltd. Chubb European Investment Holdings, SLP Chubb Executive Risk Inc. Chubb Financial Solutions (Bermuda) Ltd. Chubb Financial Solutions, Inc. Chubb Global Financial Services Corporation Chubb Indemnity Insurance Company Chubb Insurance (China) Company Limited A-2 Chubb Insurance Company (Thailand) Ltd. Chubb Insurance Company of Australia Ltd. Chubb Insurance Company of Canada Chubb Insurance Company of Europe SE Chubb Insurance Solutions Agency, Inc. Chubb Insurance Company of New Jersey, Inc. Chubb Insurance Investment Holdings Ltd. Chubb Investment Holdings Inc. Chubb Investment Holdings (Hong Kong) Ltd. Chubb Investment Services Limited Chubb Lloyds Insurance Company of Texas (a Texas Lloyd’s Company) Chubb Managing Agent Ltd. Chubb Multinational Manager Inc. Chubb National Insurance Company Chubb Pacific Underwriting Management Services PTE, Ltd. Chubb Re, Inc. Chubb Services Corporation DHC Corporation Executive Risk Capital Trust Executive Risk Indemnity Inc. Executive Risk Management Associates Executive Risk Specialty Insurance Company Federal Insurance Company Escritorio de Representacao No Brasil Ltd. Great Northern Insurance Company Harbor Island Indemnity Ltd. Masterpiece Netherlands B.V. MI Insurance Brokers Ltd. Northwestern Pacific Indemnity Company A-3 Pacific Indemnity Company PT Asuransi Chubb Indonesia Sullivan Kelly of Arizona, Inc. Sullivan Kelly, Inc. Texas Pacific Indemnity Company Transit Air Services, Inc. The following are subsidiaries and affiliates of Liberty Mutual Insurance Company: Liberty Mutual Insurance Company Liberty Mutual Fire Insurance Company Employers Insurance Company Of Wausau Liberty Insurance Corporation Wausau Business Insurance Company Wausau Underwriters Insurance Company LM Insurance Corporation LM General Insurance Company The First Liberty Insurance Corporation Bridgefield Casualty Insurance Company Bridgefield Employers Insurance Company Liberty County Mutual Insurance Company Liberty Insurance Underwriters Inc. Liberty Lloyds Of Texas Insurance Company Liberty Mutual Mid-Atlantic Insurance Company Liberty Mutual Personal Insurance Company Liberty Personal Insurance Company Liberty Surplus Insurance Corporation LM Property And Casualty Insurance Company Insurance Company Of Illinois A-4 Wausau General Insurance Company San Diego Insurance Company Peerless Insurance Company The Ohio Casualty Insurance Company Safeco Insurance Company Of America General Insurance Company Of America American States Insurance Company American Economy Insurance Company Indiana Insurance Company Golden Eagle Insurance Corporation Peerless Indemnity Insurance Company Safeco Insurance Company Of Illinois The Netherlands Insurance Company American States Preferred Insurance Company First National Insurance Company Of America American Fire And Casualty Company America First Insurance Company America First Lloyds Insurance Company American States Insurance Company Of Texas American States Lloyds Insurance Company Colorado Casualty Insurance Company Consolidated Insurance Company Excelsior Insurance Company Hawkeye-Security Insurance Company Liberty Northwest Insurance Corporation Mid-American Fire And Casualty Company Montgomery Mutual Insurance Company National Insurance Association North Pacific Insurance Company A-5 Ohio Security Insurance Company Oregon Automobile Insurance Company Safeco Insurance Company Of Indiana Safeco Insurance Company Of Oregon Safeco Lloyds Insurance Company Safeco National Insurance Company Safeco Surplus Lines Insurance Company The Midwestern Indemnity Company West American Insurance Company CERTIFICATE FOR IDENTICAL COMPLIANCE I, Keisha Boynton, certify that this electronic Brief for Defendants- Respondents is identical to the filed original printed materials, except that they need not contain an original signature. Dated: November 16, 2012 _______________________ Keisha Boynton /s/ Keisha Boynton
