Insurance Coverage for SEC Disgorgement Awards After the Supreme Court's Kokesh Decision

In Short

The Situation: In 2017, the United States Supreme Court held in Kokesh that disgorgement awards by federal courts in U.S. Securities and Exchange Commission ("SEC") enforcement proceedings are "penalties" for purposes of a federal statute of limitations, 28 U.S.C. § 2462. Some professional liability insurers have since cited that decision in attempting to argue that such awards are therefore also "penalties" excluded from coverage under their policies.

The Result: Without adequate analysis of whether the Supreme Court's statute of limitations analysis is relevant to construing insurer-drafted policy language, a New York intermediate appellate court and a federal district court in Maine have surprisingly agreed with the insurers by barring coverage for SEC disgorgement awards.

Looking Ahead: Given the numerous reasons why SEC disgorgement awards are not uncovered "penalties" overlooked by these early decisions, future courts properly considering them should conclude that the Supreme Court's Kokesh decision is inapplicable 

The Kokesh Statute of Limitations Decision

In actions brought by the SEC alleging violation of federal securities laws, the Commission is authorized by statute to seek civil monetary penalties and injunctive relief. In addition, federal district courts, citing their inherent equitable powers, have also ordered violators to "disgorge" any profits that they have made as a result of their illegal conduct and even profits that others have made as a result of that conduct.

In Kokesh v. SEC, 137 S. Ct. 1635 (2017), the Supreme Court held that for purposes of 28 U.S.C. § 2462, a federal statute of limitations governing any "action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise," disgorgement is a "penalty." Despite acknowledging that disgorgement "serves compensatory goals," the Court determined that it also serves "retributive or deterrent purposes," which made disgorgement a punishment and therefore a "penalty" for purposes of 28 U.S.C. § 2462.

Early Decisions Misapplying Kokesh to Insurance Coverage Disputes

In J.P. Morgan Sec. v. Vigilant Ins. Co., 84 N.Y.S.3d 436 (N.Y. App. Div. 2018), the insured had settled a threatened SEC enforcement action by paying a $90 million civil penalty and $160 million in disgorgement, of which $20 million represented the insured's own profits and $140 million represented profits made by the insured's customers as a result of the insured's alleged violations. The insured then sought coverage for the $140 million under its professional liability policy. The insured won in the trial court, but that decision was reversed on appeal. Noting that the policy language barred coverage for "fines or penalties imposed by law," the Appellate Division relied upon Kokesh in holding that disgorgement in SEC enforcement actions is a "penalty." The Appellate Division acknowledged that, in J.P. Morgan Sec. v. Vigilant Ins. Co., 992 N.E.2d 1076 (N.Y. 2013), New York's highest court had refused to dismiss the insured's claim for the $140 million, but held that the 2013 decision was not binding because Kokesh subsequently had changed the law on an issue that had not been directly considered by the high court's earlier decision.

In Marcus v. Allied World Ins Co., 384 F. Supp.3d 115 (D. Me. 2019), the court relied in part upon Kokesh to reach a similar conclusion, holding that the insurer was not required to defend its insured in an SEC enforcement action because the language of a professional liability policy barred coverage for "penalties."

Placing Kokesh in Its Proper Context 

Notwithstanding their holdings, these early decisions have surprisingly overlooked numerous reasons why SEC disgorgement awards are not uncovered "penalties" for purposes of insurance coverage and Kokesh is inapplicable to issues of insurance policy interpretation. 

First, Kokesh addressed the difference between punitive and remedial sanctions under federal law. It does not govern questions of how insurance policies are to be interpreted under state insurance law. In particular, interpreting the federal statute in question, the Supreme Court had no reason to and did not apply key insurance contract principles of interpretation when seeking to determine the meaning of the term "penalty." For example, while Kokesh held that disgorgement awards, because they serve both compensatory and punitive purposes, are a "punishment" and therefore "penalties," New York's highest court has held that if an award serves both compensatory and punitive purposes, it is not "punitive" for purposes of insurance coverage and is insurable under New York law. Zurich Ins. Co. v. Shearson Lehman Hutton, Inc., 642 N.E.2d 1065 (N.Y. 1994).

 Second, because the SEC can seek both civil penalties and disgorgement, it is at the very least ambiguous whether disgorgement is a "penalty" within the meaning of an insurance policy. Ambiguities are construed against the insurer and in favor of the policyholder, particularly when the ambiguity could result in a limitation or restriction on coverage.

Third, although in 2018 the Appellate Division held in J.P. Morgan that it was not bound by the Court of Appeals' 2013 decision in the same case, the Court of Appeals eventually may well disagree with the intermediate appellate court's analysis.

Finally, and equally importantly, even in the unlikely scenario where there may be no duty to indemnify, there may still be a duty to defend. In Animal Found. of Great Falls, Montana v. Philadelphia Indem. Ins. Co., No. CV 13-30, 2013 WL 12141485 (D. Mont. Nov. 22, 2013), the court held that although monetary sanctions awarded for contempt of court were "fines or penalties" and thus not covered, the language of the policy nevertheless required the insurer to afford coverage for the insured's costs of defending against the sanctions.

Two Key Takeaways

  1. Some professional liability insurers have cited the Supreme Court's statute of limitations decision in Kokesh v. SEC, 137 S. Ct. 1635 (2017) in attempting to argue that SEC disgorgement awards are "penalties" excluded from coverage under their policies.
  2. While two early decisions have surprisingly overlooked the weaknesses of this insurer position, policyholders should nevertheless be able to recover the costs of defending against SEC claims for disgorgement and any judgments or settlements resulting from such claims.
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