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Court of Appeals Holds SEC Disgorgement Payment Does Not Constitute Excludable “Penalty” for Purposes of Insurance Coverage Dispute

Recently, the New York Court of Appeals issued another ruling in a long-running insurance coverage dispute concerning $140 million in disgorgement paid by Bear Stearns pursuant to an SEC settlement over fifteen years ago. 

The issue in J.P. Morgan Securities Inc. v. Vigilant Insurance Company[1] was whether Bear Stearns’ disgorgement payment constituted a “penalt[y] imposed by law” such that it would be excluded from coverage under the company’s “wrongful act” liability policy.[2]  In a 6-1 decision, the Court of Appeals reversed the First Department and concluded that the insurers had not met their burden in demonstrating that the disgorgement payment “clearly and unambiguously” fell within the policy exclusion for “penalties.”  In so holding, the Court of Appeals distinguished the 2017 U.S. Supreme Court decision in Kokesh v. SEC—holding that SEC-ordered disgorgement is a “penalty”[3]—on the ground that the decision did not control the interpretation of insurance contracts executed almost two decades earlier.[4]


The dispute between Bear Stearns and its insurers dates back to 2006, when Bear Stearns entered into a settlement with the SEC after an investigation into allegations that the company facilitated late trading and deceptive market timing practices in connection with the purchase and sale of shares of mutual funds.  Under the terms of that settlement, and “[w]ithout admitting or denying the [investigation’s] findings,” Bear Stearns agreed to a $160 million “disgorgement” payment and a $90 million payment for “civil money penalties.”[5]  The settlement order directed that the $90 million payment should be treated as a “penalty” for tax purposes and could not offset any sums owed to private litigants injured by the alleged practices.  However, the order gave no similar restrictions for the $160 million disgorgement payment.

Bear Stearns sought coverage for nearly all of the disgorgement payment amount ($140 million), as well as other defense costs and expenses, under insurance policies it had purchased in 2000.  The policies provided coverage for any “loss” that Bear Stearns became liable to pay in connection with any civil proceeding or governmental investigation into violations of law or regulations.  The policies defined “loss” to include various types of damages, including compensatory and punitive damages.  However, the policies also carved out one notable exception from that definition: that “loss” shall not include “fines or penalties imposed by law.”[6]  Under that carve out, the insurers disclaimed coverage for the disgorgement paid under Bear Stearns’ settlement with the SEC.

In 2009, J.P. Morgan (which had acquired Bear Stearns the year before) commenced an action against Bear Stearns’ insurers, alleging they had breached their obligations under the insurance contracts.  Since then, the case has been litigated at all levels of the New York court system, including one prior appeal to the Court of Appeals. 

The instant appeal concerns the parties’ cross motions for summary judgment.  The Supreme Court granted summary judgment to J.P. Morgan, concluding that the disgorgement payment constituted an insurable loss.  The First Department reversed and granted summary judgment for the insurers, concluding that Bear Stearns was not entitled to coverage for the SEC disgorgement payment.  In so holding, the First Department relied on the intervening U.S. Supreme Court decision in Kokesh.  The issue then went up to the Court of Appeals.


In an opinion authored by Chief Judge Janet DiFiore, the Court of Appeals decided 6-1 to reverse the First Department.  Integral to that decision was the posture of the case: because the coverage dispute presented a question of contract interpretation, under New York law it must be decided “‘according to common speech and consistent with the reasonable expectation of the average insured’ at the time of contracting, with any ambiguities construed against the insurer and in favor of the insured.”[7]  Moreover, the insurers bore the burden of establishing that the “exclusion applies to defeat coverage” and that such exclusion is “subject to no other reasonable interpretation.”[8]

Under this framework, the Court of Appeals concluded that the insurers had not met their burden in demonstrating “that a reasonable insured purchasing this wrongful act policy in 2000 would have understood the phrase ‘penalties imposed by law’ to preclude coverage for the . . . SEC disgorgement payment.”[9]  Surveying case law and secondary sources (including dictionary definitions) from around that time, the Court of Appeals reasoned that the term “penalty” reasonably referred to “non-compensatory, purely punitive monetary sanctions.”[10] 

In the Court’s view, Bear Stearns’ disgorgement payment to the SEC in 2006 did not meet that standard.  Among other things, the Court cited unrebutted record evidence that the disgorgement amount was calculated by reference to Bear Stearns’ customers’ gains and the corresponding injury suffered by investors as a consequence of the challenged trading practices—estimated to be roughly $140 million.[11]  The Court further noted that, unlike the $90 million civil penalty, the disgorgement payment was eligible to offset private claims against Bear Stearns under the terms of the SEC settlement.  The Court concluded that these factors taken together showed that the disgorgement payment “was intended—at least in part—to compensate those injured” by the alleged wrongdoing and, therefore, “could not fairly have been understood as a ‘penalty’” under the policies.[12]

In reaching this conclusion, the Court distinguished the U.S. Supreme Court decision in Kokesh, which the First Department had relied on in finding for the insurers.  Kokesh concerned the statute of limitations applicable to SEC actions seeking disgorgement.  In that context, the U.S. Supreme Court determined that SEC-ordered disgorgement is a “penalty” and, for that reason, held that the SEC was subject to the five-year limitations period for actions to enforce a “penalty.”  In the case of Bear Stearns, however, the New York Court of Appeals concluded that Kokesh—a statutory interpretation decision from 2017—did not control the proper interpretation of an insurance contract executed in 2000 under New York law.  The Court observed, among other things, that Kokesh was not around at the time Bear Stearns purchased its insurance policies to inform the meaning of the term “penalty”; that the meaning of a term “may vary based on context”; that the U.S. Supreme Court has since clarified that disgorgement may not constitute a “penalty” in certain contexts; and that the mere fact of recent U.S. Supreme Court jurisprudence shows that the issue has been “a matter of much debate and confusion.”[13]


The Court of Appeals’ decision offers an interesting illustration of the limits Kokesh may have under New York law, particularly when it comes to determining whether SEC disgorgement constitutes a “penalty” as a matter of contract interpretation.  But given that the Court framed its ruling in terms of what “a reasonable insured . . . in 2000 would have understood” the disputed language to mean, the Court leaves the door open to future litigation under different insurance policies, negotiated by different parties in different times. 

[1] 2021 BL 448934 (N.Y. Nov. 23, 2021).

[2] Id. at *1.

[3] 137 S. Ct. 1635, 1639 (2017).

[4] 2021 BL 448934, at *8.

[5] Id. at *2.

[6] Id. at *4.

[7] Id. at *3 (quoting Dean v. Tower Ins. Co. of N.Y., 19 N.Y.3d 704, 708 (2012)). 

[8] Id. at *4 (quoting Seaboard Sur. Co. v. Gillette Co., 64 N.Y.2d 304, 311 (1984)).

[9] Id.

[10] Id. at *6.

[11] Id.  The additional $20 million added to the total $160 million disgorgement payment represents Bear Stearns’ own revenues from the challenged practices.

[12] Id. at *7.

[13] Id. at *8.