Archive for June, 2017

SEC Disgorgement Constitutes a Penalty – How Far Will the Argument Go?

Wednesday, June 28th, 2017

By: Carol Gerner

On June 5, 2017, Justice Sotomayor delivered the unanimous opinion in Kokesh v. SEC, 2017 U.S. LEXIS 3557 (June 5, 2017), holding that disgorgement collected by the Securities and Exchange Commission (SEC) constitutes a “penalty” under 28 U.S.C. §2462,[1] and thus subject to a five-year statute of limitations. In a relatively short, but thorough opinion, the Court overturned a Tenth Circuit decision finding that disgorgement was not properly characterized as a penalty within the federal statute and therefore not subject to the limitation period.

In the underlying case, the SEC sought civil monetary penalties, disgorgement, and an injunction barring Charles Kokesh, the owner of two investment-adviser firms, from violating securities laws in the future. After a 5-day trial, a jury found that Kokesh’s actions violated various securities laws. As to civil penalties, the district court determined that the 5-year limitations period precluded any penalties for misappropriation of funds prior to October 27, 2004 (i.e., prior to the date the Commission filed the complaint), but ordered a civil penalty of $2.3 million for the amounts Kokesh received during the limitations period. Regarding the Commission’s request for a $34.9 million disgorgement judgement ($29.9 million of which resulted from violations outside the limitations period) the court agreed with the Commission that because disgorgement was not a “penalty ” within the meaning of §2462, no limitation period applied. The court thereafter entered a disgorgement judgment in the amount of $34.9 million. On appeal, the Tenth Circuit affirmed, agreeing with the district court that disgorgement was not a penalty or a forfeiture, and therefore, the statute of limitations did not apply to the SEC’s disgorgement claims.

Thereafter, the Supreme Court granted certiorari to resolve disagreement among the Circuits regarding whether disgorgement claims in SEC proceedings were subject to the 5-year limitations period.  Applying legal principles governing the interpretation and meaning of a “penalty,” the court articulated three reasons why it concluded that SEC disgorgement constituted a penalty within the meaning of §2462. First, SEC disgorgement is imposed by the courts as a consequence for violating “public laws.” Second, SEC disgorgement is imposed for punitive purposes. Third, in many cases SEC disgorgement is not compensatory. Thus, the Court reasoned that SEC disgorgement “bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.”

Since the Kokesh decision arose out of an SEC enforcement action, its impact will likely be seen in how the SEC chooses its targets for future enforcement actions. It remains to be seen, however, whether similar arguments that disgorgement is a penalty will be raised in other contexts. For example, the issue is often raised in insurance coverage disputes between insurers and insureds, as claims seeking disgorgement are generally not covered. Whether courts will be receptive to similar arguments in other contexts is an area insurers and their counsel should continue to monitor.

[1] 28 U.S.C. §2462, applies to “any action, suit or proceeding for the enforcement of any civil fine, penalty or forfeiture, pecuniary of otherwise.”

New York Court of Appeals Clarifies Scope of Additional Insured Coverage, Resolves Appellate Division Split?

Thursday, June 8th, 2017

By: Cara Vecchione

In New York, differing views have been offered by the Appellate Divisions in the First and Second Departments regarding the scope of additional insured coverage when the named insured did not cause the accident. This split appears to be resolved by the New York Court of Appeals in its new decision in Burlington Ins. Co. v. NYC Transit Auth., No. 57, 2017 N.Y. LEXIS 1404 (N.Y. 2017), where the court held that additional insured coverage is only available if the named insured’s conduct is the proximate cause of the underlying injuries. In its decision, the Court of Appeals made clear that “there is no coverage because, by its terms, the policy endorsement is limited to those injuries proximately caused by [the named insured].” Given the Court of Appeals’ focus on policy language, this decision has the potential to impact a wide range of additional insured coverage disputes.

In brief, Breaking Solutions, Inc. purchased commercial general liability insurance from Burlington, which included an endorsement listing the NYC Transit Authority, MTA and the City as additional insureds. The additional insured endorsement at issue provides, in relevant part, that the NYC Transit Authority, MTA and the City are additional insureds:

only with respect to liability for ‘bodily injury’, ‘property damage’ or ‘personal and advertising injury’ caused, in whole or in part, by:

  1. Your acts or omissions; or
  2. The acts or omissions of those acting on your behalf.

The plaintiff in the underlying litigation, a NYC Transit Authority employee, allegedly sustained injuries in a fall at a construction site while he was trying to avoid an explosion that occurred after a Breaking Solutions machine touched a live, underground electrical cable. Discovery in the underlying litigation revealed that the NYC Transit Authority was at fault. As a result, Burlington denied coverage to the NYC Transit Authority and MTA on the ground that neither entity qualified as an additional insured within the meaning of the policy, because the NYC Transit Authority was solely responsible for the accident that caused the underlying injuries.

In the subsequent coverage litigation, Burlington argued that the policy did not afford coverage in such circumstances (i.e., where the additional insured was the sole proximate cause of the underlying injuries). Reversing the Appellate Division, the Court of Appeals determined that “where an insurance policy is restricted to liability for any bodily injury ‘caused, in whole or in part’ by the ‘acts or omissions’ of the named insured, the coverage applies to injury proximately caused by the named insured.”

This decision should provide some relief and clarification for insurers that include additional insured endorsements on their liability policies, as the Court of Appeals now has established the extent of a named insured’s role in the accident for additional insured coverage to be triggered. However, insurers should be mindful of the analysis offered by the dissent, which explained that a stricter application of the policy wording should have been used to resolve the coverage question.

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