Many corporate executives generously serve as directors and officers of nonprofit organizations. While they are undoubtedly inundated with meetings and workshops focusing on corporate risk management at their day job, they may not consider potential liability arising from their philanthropic work. Just as a corporate director may face lawsuits, even those lacking merit, for allegedly breaching fiduciary obligations to shareholders, so, too, a nonprofit director may face similar allegations of wrongdoing for a broad range of activities including, for example, allegedly permitting the mismanagement of funds or approving an employee’s termination. Even if the director ultimately prevails after a trial on the merits, the nonprofit may not possess the financial means to indemnify her or his legal fees. Before any such issue threatens financial well-being, it is prudent for any individual joining a nonprofit organization to take the time to make sure the nonprofit has appropriate insurance coverage. So what is appropriate coverage?
On Tuesday, in deciding J.P. Morgan Securities, Inc., et al. v. Vigilant Insurance Company, et al., the New York Court of Appeals handed down a victory for policyholders seeking insurance coverage for liabilities arising from Securities & Exchange Commission (SEC) claims, particularly broker-dealers and clearing firms. Frequently, the SEC resolves such claims by way of a consent order (e.g., an “Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions”), which requires a policyholder to pay certain amounts as “disgorgement.” Insurers typically refuse to cover disgorgement remedies, contending that public policy prohibits insurance recovery for the return of so-called “ill-gotten gains.”
But not all “disgorgement” is created equal. In J.P. Morgan, the Court of Appeals clarified that mere labels used in an SEC consent order will not determine a policyholder’s rights under an insurance policy. Using the court’s analysis, the insurer must examine the nature of the disgorgement payment to determine whether it represents revenue that the policyholder pocketed or improper profits acquired by third parties. If the disgorged monies are not the policyholder’s own revenue, then the company will not be unjustly enriched by recouping insurance proceeds and may obtain coverage for its loss. This is particularly good news for financial companies with potential liability to the SEC for allegedly ill-gotten profits that ultimately end up in third parties’ pockets, such as hedge fund customers. Continue reading “New York’s Highest Court Clarifies That “Disgorgement” Losses May Be Insurable”