Category Archives: Securities Broker Exclusion

Nine Thirty FEF Investments: New York Appellate Division applies Financial Institution Bond’s Securities Broker Exclusion to Madoff Ponzi Losses

By David S. Wilson and Chris McKibbin

In United States Fire Insurance Company v. Nine Thirty FEF Investments, LLC, the New York Supreme Court, Appellate Division, held that Financial Institution Bonds did not cover losses sustained in a Ponzi scheme orchestrated by Bernie Madoff.  Drawing on its own recent decision in Jacobson Family Investments, Inc. v. National Union Fire Insurance Company of Pittsburgh, Pa. (which we discussed in our June 23 post), the Court held that the Securities Broker exclusion brought the loss outside the Bonds’ Outside Investment Advisor coverage, notwithstanding  the insureds’ argument that the coverage and the exclusion could not both operate without resulting in an ambiguity.

The Facts

Nine Thirty FEF Investments, LLC (“FEF”) and Nine Thirty VC Investments, LLC (“VC”) were formed to invest and trade in securities.  In 2005 and 2006, VC opened accounts with Bernard L. Madoff Investment Securities LLC (“BLMIS”) pursuant to Customer Agreements referring to BLMIS as the “Broker”.  In 2008, VC and FEF obtained Financial Institution Bonds from United States Fire Insurance Company (“USFI”).  During the time that VC was a BLMIS client, Madoff was running a massive Ponzi scheme through BLMIS that is now considered to be the largest financial fraud in American history.  On December 11, 2008, the SEC filed a complaint against BLMIS and Madoff.  The complaint alleged that BLMIS had operated as both a broker-dealer and an investment advisor.

Outside Investment Advisor Coverage / Securities Broker Exclusion

Each of the Bonds contained an Outside Investment Advisor rider (rider 9), whereby USFI agreed to indemnify VC and FEF for:

Loss resulting directly from the dishonest acts of any Outside Investment Advisor, named in the Schedule below, solely for their duties as an Outside Investment Advisor, on behalf of the Insured.

The rider named BLMIS as an Outside Investment Advisor.

The Bonds contained Exclusion x, which provided that coverage did not extend to:

Loss resulting directly or indirectly from any dishonest or fraudulent act or acts committed by any non-Employee who is a securities … broker

VC and FEF submitted a claim to USFI under the Outside Investment Advisor rider coverage.  USFI concluded that BLMIS was acting as a broker in its dealings with VC and FEF and, consequently, Exclusion x applied.

The Decision

USFI commenced an action for declaratory relief to confirm the validity of its coverage position.  On USFI’s motion for summary judgment, the motions court concluded that, although the Outside Investment Advisor rider was clear on its own terms, it “became” ambiguous when read together with Exclusion x.  As such, the matter could not be determined summarily and USFI’s motion was dismissed.

The Supreme Court, Appellate Division reversed the decision and granted summary judgment in favour of USFI.  Drawing on its own recent decision in Jacobson Family Investments, the Court observed that Exclusion x only required that the non-employee be a securities broker, not that it act as a securities broker in causing the loss:

Exclusion x excludes coverage for losses “resulting directly or indirectly from any dishonest or fraudulent act or acts committed by any non-Employee who is a securities … broker” …. It does not provide that the non-Employee must have been “acting as” a securities broker.  It is undisputed that Bernard Madoff was not defendants’ employee (as that term is defined in the bonds) and that [BLMIS] was a registered broker-dealer during the entire period in which it dealt with defendants.

Turning to the issue of whether Exclusion x rendered the Outside Investment Advisor rider ambiguous, the Court rejected this contention, holding that the rider and exclusion could stand together and that there was still significant scope for the rider to operate:

The Outside Investment Advisor Rider (Rider 9) does not mention exclusion x and does not contradict or alter the exclusion’s clear and unambiguous terms.  Further, our interpretation of exclusion x does not leave Rider 9 “without force and effect”.  The bonds could still provide coverage for losses resulting directly from the dishonest acts of outside investment advisers who are not brokers.  Defendants did not show that all — or even the majority — of the outside investment advisers listed on Rider 9 were also brokers. Accordingly, our interpretation of the bonds does not render them illusory. [citations omitted]

In reaching this conclusion, the Court took note of the surrounding context of the Bonds, observing that VC and FEF had had significant input into the underwriting process, and had ensured that several of the other riders contained provisions deleting certain exclusions:

It bears mentioning that defendants knew how to delete an exclusion. For example, riders 2, 8, and 19–20 provide that certain exclusions do not apply to the coverages created by those riders. If defendants had wanted the broker exclusion to be inapplicable to outside investment advisers (rider 9), they should have said so.

Consequently, Exclusion x applied to the loss and there was no coverage available to VC or FEF.

Conclusion

Like its predecessor Jacobson Family Investments, Nine Thirty FEF Investments is useful in clarifying the intended parameters of the Outside Investment Advisor rider under the Financial Institution Bond.  The Court arguably went further than in Jacobson Family Investments, reinforcing that coverages and exclusions can be drafted on either an “activity” or “status” basis, or both.  Here, the Outside Investment Advisor rider focused on the loss-causing actions, whereas Exclusion x focused on the status of the defaulter as a securities broker, notwithstanding that the loss might not be attributable to its conduct as a broker.

In reaching this conclusion, the Court also drew on the fact that the insureds had negotiated numerous other riders and had ensured that certain exclusions would not apply to the coverages provided thereunder.  In so doing, the Court refused to mechanically apply principles of policy interpretation which may be applicable when a policy is a true contract of adhesion, but which do not make sense where a policy is a product of negotiation and joint authorship.

United States Fire Insurance Company v. Nine Thirty FEF Investments, LLC, 2015 WL 5794368 (N.Y.A.D. 1st Dept.)

Advertisements

Leave a comment

Filed under Outside Investment Advisor Rider, Securities Broker Exclusion

Jacobson Family Investments: New York Appellate Division interprets Scope of Financial Institution Bond’s Investment Advisor Coverage and Securities Broker Exclusion

By David S. Wilson and Chris McKibbin

On June 18, 2015, the New York Supreme Court, Appellate Division released its decision in Jacobson Family Investments, Inc. v. National Union Fire Insurance Company of Pittsburgh, Pa. This decision examines the interplay between a Financial Institution Bond’s Outside Investment Advisor coverage rider and the Securities Broker exclusion, in the context of a loss resulting from Bernie Madoff’s Ponzi scheme.

The Facts

Jacobson Family Investments (JFI) managed the assets of several companies, including MDG 1994 Grat LLC (MDG). In 2008, JFI submitted a claim to National Union for losses, including losses to MDG, allegedly sustained as a result of the dishonest acts of Bernie Madoff. MDG alleged that:

  • Madoff provided fraudulent investment advice to MDG;
  • Madoff serviced a securities brokerage account that MDG created in 2006, via the execution of a Customer Agreement and a Trading Authorization;
  • Madoff provided MDG with false brokerage account statements purporting to show deposits and withdrawals in MDG’s brokerage account; various false purchases and sales of stocks and other securities; and non-existent interest and dividends; and,
  • MDG also paid compensation to Madoff, in the form of commissions on the falsely-reported trades.

By the time of the trial, the coverage dispute had distilled down to two issues. First, were MDG’s losses covered under the Outside Investment Advisor coverage provided by Rider 14 of the Bond? Second, did exclusion X (the “Securities Broker” exclusion) apply?

Relevant Bond Provisions

Rider 14 to the Bond provided indemnity for:

Loss resulting directly from the dishonest acts of any Outside Investment Advisor, named in the Schedule below, solely for their duties as an Outside Investment Advisor, on behalf of the Insured, committed alone or in collusion with others … provided, however, the Insured shall first establish that the loss was directly caused by dishonest acts of any Outside Investment Advisor which results in improper personal financial gain to such Outside Investment Advisor and which acts were committed with the intent to cause the Insured to sustain such loss. [emphasis added]

Madoff’s company, Bernard L. Madoff Investment Services, LLC, was listed on the relevant schedule.

Exclusion X provided that:

This bond does not cover: … loss resulting directly or indirectly from any dishonest or fraudulent act or acts committed by any non-Employee who is a securities, commodities, money, mortgage, real estate, loan, insurance, property management, investment banking broker, agent or other representative of the same general character.

At trial, National Union submitted that Madoff had acted as both an investment advisor and securities broker throughout his dealings with MDG. Accordingly, MDG’s loss was not caused by Madoff solely in performing his duties as an Outside Investment Advisor.

The trial court rejected National Union’s submission, holding that this argument would render Rider 14’s coverage meaningless. Although Madoff was expressly listed as an investment advisor in the relevant schedule, he was both a registered securities broker and investment advisor, and could never satisfy the coverage requirements. The trial court further held that exclusion X did not apply, as National Union had not established that the losses were caused by Madoff acting in his capacity as a securities broker.

The Appellate Division reversed on all points. After finding that there was no ambiguity in Rider 14, the Appellate Division held that the trial court had erred in effectively reading the “solely” qualifier out of the coverage grant:

Rider 14 limits coverage to losses where the identified Outside Investment Advisor acts “solely” in that capacity. Any other interpretation would completely negate and render superfluous the significant term “solely” contained in Rider 14. MDG’s interpretation of Rider 14, that losses caused by any person or entity identified in the schedule as an Outside Investment Advisor are covered, regardless of the capacity in which such person or entity is acting when incurred, impermissibly broadens the scope of coverage. … Nor does restricting coverage to situations where the loss results directly from the dishonest act of an outside investment advisor “solely for their duties as an Outside Investment Advisor” effect a blanket preclusion of coverage for any act by Madoff simply because he happened to be both a registered securities broker and investment advisor. In evaluating what capacity someone otherwise identified as an Outside Investment Advisor acted, a close examination of the actions actually undertaken that created the loss is necessary. [emphasis added]

The Appellate Division reviewed the evidence at trial. It was undisputed that the MDG-Madoff Customer Agreement expressly referred to the creation of a broker-customer relationship. MDG had designated Madoff, individually, to act as its agent for purchases, sales or trades of securities on its behalf. MDG supplied investment funds which were deposited into a bank account held solely in Madoff’s name. In view of the evidence at trial, the Appellate Division concluded that there was “simply no way to separate Madoff’s activities as an investment advisor from his activities as a securities broker insofar as they produced the losses claimed. The duality of the services Madoff provided places MDG’s claims outside Rider 14”.

The Appellate Division also held, as an alternate basis for a finding of no coverage, that exclusion X applied to MDG’s loss, noting that exclusion X does not require that the non-employee must have actually been “acting as” a securities broker at the time of the loss; it only requires that the non-employee “is” a securities broker. As Madoff was a securities broker, the losses he caused were excluded.

Conclusion

Jacobson Family Investments is useful in clarifying the intended contours of the Outside Investment Advisor coverage rider under the Financial Institution Bond. The use of the term “solely” reflects an obvious intention to limit the coverage as drafted, notwithstanding that there will be losses (such as MDG’s loss) which involve the defaulting advisor-broker acting in a hybrid capacity. The Appellate Division’s thorough consideration of the trial evidence in its interpretation of Rider 14 also reinforces the necessity of careful investigation and analysis of the loss-causing actions in interpreting these types of coverages.

The Appellate Division’s holding with respect to exclusion X is brief, but significant, insofar as it emphasizes that coverages and exclusions can be drafted on either an “action” or “status” basis (or both); Rider 14 focused on the loss-causing actions, whereas the exclusion focused on the status of the defaulter as a securities broker, notwithstanding that the loss might not be fully attributable to the broker’s conduct as a broker.

Jacobson Family Investments, Inc. v. National Union Fire Insurance Company of Pittsburgh, Pa., 2015 WL 3767850 (N.Y.A.D. 1st Dept.)

Leave a comment

Filed under Outside Investment Advisor Rider, Securities Broker Exclusion