Alison Frankel at Reuters highlights a new New York appellate court decision where JP Morgan is being hoist on the Rakoff petard. Bear Stearns, which is now owned by JP Morgan, entered into a $250 million settlement in 2006 over allegations that it cheated customers by engaging in impermissible market timing. The agreement contained standard SEC “without admitting wrongdoing or denying” language. The payment broke down into $160 million of disgorgement and $90 million of penalties.
What may surprise many readers is that the $160 million disgorgment was covered by insurance, or at least JP Morgan thought it was. Per Frankel:
The insurance agreements said the bank was covered for damages awards and charges incurred by regulatory investigations, with one catch: The policies excluded claims “based upon or arising out of any deliberate, dishonest, fraudulent, or criminal act or omission,” if there were a final adjudication reflecting that wrongdoing.
The insurers said no dice, and JP Morgan took them to court to try to force them to pay. The lower court decided in favor of JP Morgan, but the appeals court reversed. And the logic is revealing:
But a ruling Tuesday by the New York state Appellate Division, First Department, suggests the boilerplate language that Ramos cited — and Rakoff has derided — may no longer offer defendants much benefit even without judges specifically rejecting it….
But the decision’s implications may be broader than that. In an opinion written by Justice Richard Andrias, the state judges simply didn’t pay much heed to the SEC “neither admit nor deny” boilerplate. “Read as a whole,” the decision said, “the offer of settlement, the SEC Order … and related documents are not reasonably susceptible to any interpretation other than that Bear Stearns knowingly and intentionally facilitated illegal late trading for preferred customers, and that the relief provisions of the SEC Order required disgorgement of funds gained through that illegal activity.” Moreover, in a footnote, the opinion referred explicitly to Rakoff’s criticism of SEC boilerplate in SEC v. Vitesse Semiconductor.
Putting on a public policy, rather than a legal hat, insurance that has the effect of letting companies and boards buy their way out of the economic consequences of bad conduct is a terrible idea.While it doesn't exactly surprise me, I officially had no idea that banks held (or even had the capability to hold) insurance policies to protect them against penalties arising from SEC enforcement actions. This fact only lends credence to the concept that banks are internalizing fraud-based fines as a general cost of business, and it only makes Rakoff's ruling that much more critical. More importantly, it adds another judge--Judge Richard Andrias--to the ever-growing roster of justices who are fed up with the way that the financial watchdogs treat bank fraud.
The SEC has been played as puppets here, as the banks have simply purchased insurance against anything the SEC might do. This plan only works as long as the SEC continues to allow “without admitting wrongdoing or denying” language to be a standard part of its settlements, and this is exactly what must stop.
Judge Andrias and Judge Rakoff are onto something here, and the SEC therefore has a choice--assemble a legal team that will actually prosecute instances of bank fraud, or else assemble a similar team that will appeal every like-minded judicial ruling in the Andrias-Rakoff vein. Only one of these options is consistent with the SEC's mandate, and only one of them is an acceptable use of taxpayer dollars. I think you know which one.