As we explained in our case summary, the question in this case was whether an insurance policy covering “wrongful acts” but excluding “penalties imposed by law” covers disgorgement ordered by the Securities and Exchange Commission. In a 6–1 decision, the Court (DiFiore, C.J.) held that the policy’s exclusion for “penalties imposed by law” did not apply to SEC-ordered disgorgement.
The case arises out of Bear Stearns’s 2006 SEC settlement for “late trading” and engaging in “deceptive market timing.” As part of that settlement, Bear Stearns paid $90 million in “civil money penalties” and $160 million in “disgorgement.” All $250 million was placed into a “Fair Fund” to compensate investors for their losses. Bear Stearns then asked its insurers to indemnify it for $140 million of the disgorgement—the part that corresponded to investor losses. The insurers refused, citing the policy’s exclusion for “penalties imposed by law.” Bear Stearns (and later it successor J.P. Morgan) sued for a declaration that the policy covered its disgorgement penalty.
The Court concluded that a reasonable insured would not have believed that disgorgement was a penalty imposed by law. The Court began by interpreting “penalty”—based on case law, treatises, and dictionary definitions—to mean “a monetary sanction designed to address a public wrong that is sought for purposes of deterrence and punishment rather than to compensate injured parties for their loss.” Under that definition, the Court held, Bear Stearns’s disgorgement was not a penalty. In so ruling, the Court cited record evidence showing that the disgorgement amount was calculated based on investors’ losses stemming from Bear Stearns’s practices. The Court also observed that Bear Stearns had to treat its $90 million civil money penalty, but not the disgorgement, as a penalty for tax purposes. Finally, the Court acknowledged that the U.S. Supreme Court, in Kokesh v. SEC, 137 S. Ct. 1635 (2017), held that disgorgement was a penalty. But the Court reasoned that Kokesh could not have changed the reasonable expectations of an insured 17 years earlier, when Bear Stearns bought its insurance policy.
Judge Rivera dissented. She relied on case law, dictionary definitions, and the SEC’s own statements showing that the SEC intends disgorgement to deter wrongful conduct. She buttressed that view by citing an SEC regulation requiring disgorged funds to be paid into the U.S. Treasury if not used to compensate victims—evidence, in her view, that disgorgement is not necessarily used to compensate victims. And she chastised the majority for its temporal distinction of Kokesh. As Judge Rivera noted, Kokesh, though decided after the policy issued, relied on pre-policy case law in concluding that SEC-ordered disgorgement is a penalty.