Q&A: Liability Insurance Implication for Admitting Wrongdoing in SEC Settlements

Earlier this year, the U.S. Securities and Exchange Commission reached a settlement with New York-based hedge fund adviser Philip A. Falcone and his advisory firm Harbinger Capital Partners.

The agreement was the first to require a defendant to admit wrongdoing since the SEC announced a tougher policy in June that would require such admissions more often, according to a Reuters report. (Falcone, who agreed to be barred from the securities industry for five years under the SEC settlement, has also been banned by New York officials from decision-making roles at Fidelity & Guaranty Life Insurance, a unit of his firm, for seven years.)

John Hughes, a Boston-based partner in law firm Edwards Wildman’s insurance and reinsurance department, provided the following answers to questions on whether such admissions could provide liability insurers with coverage defenses which previously eluded them. Hughes says it’s unlikely that courts will find admissions of wrongdoing in SEC settlements to be determinative on whether intentional misconduct for purposes of liability insurance coverage has occurred.

Q: Does the Falcone-Harbinger Capital settlement really represent a significant departure from consent judgments and orders which respondents agreed to in past settlements of enforcement proceedings brought by the SEC?

A: Yes. The consent of Falcone and Harbinger Capital prohibited them from either making or permitting to be made any public statements to the effect that they did not admit the allegations of the SEC’s complaint or that the consent did not contain admissions with respect to the SEC’s allegations of wrongdoing.

Previously, SEC settlements did not contain this striking prohibition. Nevertheless, the consent still permitted the Falcone and Harbinger defendants to reserve the right to take legal or factual positions in legal proceedings involving other parties besides the SEC. It remains to be seen how these two apparently inconsistent conditions will be reconciled.

Q: Will courts find such admissions to be conclusive with respect to particularly the misconduct exclusion found in liability policies?

A: Although every case turns on its facts, it is unlikely that courts will find admissions of wrongdoing in SEC settlements resolving alleged violations of the federal securities laws to be determinative on whether intentional misconduct for purposes of liability insurance coverage has occurred.

The federal securities laws prohibit misrepresentations which are made either knowingly or recklessly. The federal securities laws do not also require that the defendant intend to financially harm his or her victim when knowingly or recklessly making these misrepresentations. Many courts considering the public policy of prohibiting insurance coverage for intentional misconduct have held that for that public policy to apply, the insured must have intended to harm his or her victim. Thus, these two legal issues are not perfectly aligned.

Q: In coverage litigation does it matter at what stage of the proceedings these issues are presented?

A: Absolutely. We saw in the case of JP Morgan Securities, Inc., et al v. Vigilant Insurance Company, et al. 21 N.Y. 3d 324 (June 11, 2013), that the New York Court of Appeals felt that the insured had been unfairly deprived of its ability to establish that, notwithstanding the terms of a prior regulatory settlement, it in fact had not paid $160 million in “disgorgement.” Rather, of that amount, the insured insisted that approximately $130 million actually was “damages,” representing the harm to mutual fund investors caused by the market timing trading of the insured’s hedge fund customers.

The New York Court of Appeals noted that there were even provisions in the regulatory settlement that supported the insured’s position in this respect. Accordingly, the court felt compelled to allow the case to proceed beyond the motion to dismiss stage so that the insured might have the opportunity to prove its case. Clearly, if these issues were presented to the court for resolution either in cross motions for summary judgment or indisputably at trial, their resolution might have been quite different.

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