By Eryk Gettell, Sedgwick San Francisco

In David Lerner Associates, Inc. v. Philadelphia Indemnity Insurance Company, 2013 WL 1277882 (E.D.N.Y. Mar. 29, 2013), the United States District Court for the Eastern District of New York affirmed the plain meaning of the words “professional services”. 

Philadelphia Indemnity Insurance Company (“Philadelphia”) – represented by Sedgwick LLP in the coverage action – issued a D&O liability policy to the brokerage firm David Lerner Associates, Inc. (“DLA”).  The policy contained a “professional services” exclusion, however it did not define the words “professional services”.

The Financial Industry Regulatory Authority (“FINRA”) brought a disciplinary proceeding against DLA, alleging that it misrepresented the value of certain real estate investment trust (“REIT”) shares sold to investors, and failed to perform adequate due diligence in marketing those shares.  Shortly thereafter, three related class action lawsuits were brought against DLA.  DLA tendered the FINRA proceeding and the related class actions to Philadelphia for coverage.

Philadelphia denied coverage based on the “professional services” exclusion.  DLA sued for declaratory relief and breach of contract.

The court was asked to consider whether the due diligence carried out by DLA in the course of providing investment advice constituted a “professional service” for purposes of the exclusion, and concluded it did.  In rejecting DLA’s argument that the exclusion was ambiguous merely because the words “professional services” were not defined, the court reasoned that undefined terms “should be read in light of common speech and the reasonable expectations of a business person”.  

The court was not persuaded by DLA’s argument that financial advisors do not perform “professional services” because they are not considered professionals in the malpractice sense, explaining that in the context of liability insurance “professional services” encompassed a broader range of activities. 

The court also rejected the theoretical argument that DLA’s actions were only “ministerial” in nature because “performing a due diligence analysis and marketing financial products requires specialized knowledge and training, and is not a rote activity performed by a professional”. 

Discovery was unnecessary to determine whether the exclusion applied because DLA’s alleged failings fell within the scope of the exclusion on their face. 

We are pleased to announce that three of the editors of the Insurance Law Blog have been elected to the firm’s partnership, effective January 1, 2013.  Alex Potente, David Dolendi and Maria Cousineau are longstanding members of Sedgwick’s editorial team and helped transition our insurance and property coverage newsletters to a blog format.  A few other of our insurance attorneys were promoted, including Valerie Rojas (LA – Fidelity/Bond and D&O) and John Seybert (NY – Healthcare).  Congratulations to all!

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By Ryan Chapoteau

In early June, Representative Barney Frank of Massachusetts introduced H.R. 5860.  This new bill, entitled the “Executive Compensation Clawback Full Enforcement Act,” seeks to prohibit insurance coverage for regulatory clawbacks of an employee’s compensation from a failed financial institution as well as civil penalties imposed by governmental authorities on corporate executives of financial institutions.  The legislation complements the Dodd Frank Act, the principal financial reform law currently being implemented, which allows the FDIC to act as the receiver of failed “systemically important” financial institutions and recover clawback damages from individuals responsible for such failure.

If H.R. 5860 passes, insurance companies may not provide such coverage to directors and officers, as well as employees.  Rep. Frank is trying to bolster the sanctions within the Dodd Frank Act receivership provisions and make individuals accountable for their risky financial transactions rather than permitting risk-shifting to their insurance providers.  Besides bankruptcy clawbacks, this bill also forbids coverage for monetary penalties issued by the FDIC.

So can D&O policies even cover banks anymore?  Of course.  While these new Dodd-Frank regulations seem to hinder coverage, standard D&O policies should not be affected.  For example, a clawback may arise in connection with a significant accounting restatement under Dodd Frank Act §954; 15 U.S.C. § 78j-4.  If this type of clawback is considered a penalty or fine imposed by a regulatory agency, then such a loss is usually not covered already, either due to an exclusion within the policy or as a matter of public policy under disgorgement principles.  While it would be prudent for financial institutions to seek coverage for these matters, if H.R. 5860 passes, it will only reinforce that these specific losses are not covered losses.  It will be interesting to watch how this encompassing financial reform bill will define and regulate other coverage matters for the financial industry.