In January 2002, the Securities and Exchange Commission ("SEC") and NASD Regulation, Inc. (NASDR") accused Credit Suisse First Boston Corporation ("CSFB") of coercing customers into paying a portion of their profits to CSFB from flipping CSFB-underwritten IPO stock. In this lawsuit, the court is asked to decide whether insurance companies should reimburse CSFB for 70 million dollars representing "disgorgement" that it agreed to pay to settle these accusations.

For the public policy reasons I discuss below, I agree with the insurers that CSFB is not covered for the settlement amount.

This issue arises in motions 001 and 002 that are decided together. This declaratory judgment action involves a dispute over insurance coverage for amounts that CSFB paid, in January 2002, to settle claims that it coerced certain clients, investors in Initial Public Offerings ("IPOs") that CSFB had underwritten, to pay a portion of the profits they made from flipping ^[FN1] their IPO stock.

In the first motion, plaintiff Vigilant Insurance Company (Vigilant), along with third-party defendants Continental Casualty Company ("Continental") and Traveler's Casualty and Surety Co. of America ("Traveler's") move, pursuant to CPLR 3212, for summary judgment: 1) declaring that the liability insurance policy they and other insurers issued to CSFB does not provide coverage for the 70 million dollars that CSFB paid to settle litigations with the Securities and Exchange Commission (SEC) and NASD Regulation, Inc. (NASDR); 2) dismissing CSFB's counterclaims for: (a) a declaration of coverage and (b) breach of contract, and 3) dismissing CSFB's claims against third-party defendants Continental and Travelers. By separate motion, third-party defendants Various Underwriters at Lloyd's of London and Certain London Companies and Swiss Reinsurance [*2]Company move, pursuant to CPLR 3212, for an order granting summary judgment.^[FN2] CSFB cross moves for summary judgment declaring that it is entitled to coverage for that portion of the 70 million dollar payment and associated defense costs over the policy's self-insured retention.

CSFB is a financial services and investment banking firm. It is a leading underwriter of initial public offerings (IPOs). CSFB purchased a Global Financial Services Professional Liability Insurance Policy, covering the period from September 1, 2000 to September 30, 2002 from Vigilant, Continental, Lloyds, Travelers and Swiss RE (collectively Insurers). The policy covered losses up to $100 million, with a self-insured retention of $25 million per loss or group of related losses.

The policy provided coverage for "[l]oss arising from any Claim or Claims first made against [CSFB]...for any actual or alleged Wrongful Act arising from the rendering of, or the failure to render, services to any client, customer or other person or entity." The policy defined the term "Claim" to include any civil, criminal, injunctive, regulatory, arbitration, governmental or administrative proceeding for monetary or non-monetary relief commenced by service of a complaint. The policy defined "Loss" as:

all damages, awards, judgments, settlements, costs and Defense Costs, and shall include, without limitation, pre-judgment interest, post-judgment interest, equitable relief, punitive or exemplary damages, treble or other multiplied damages and the legal expenses of any plaintiff or claimant if the Insured(s) is legally liable for such expenses.

In May 2000, the SEC and the NASDR commenced investigations into CSFB's business practices involving the allocation of shares in initial public offerings that CSFB had underwritten. The SEC eventually commenced a civil action against CSFB in the United States District Court for the District of Columbia on January 22, 2002 that resulted in a consent judgment against CSFB on January 29, 2002. In its complaint, the SEC alleged that "[i]n exchange for shares in 'hot' IPOs, CSFB wrongfully extracted from certain customers a large portion of the profits those customers made by flipping their IPO stock." (Complaint at 1). It further alleged that "[f]rom at least April 1999 through June 2000, CSFB employees allocated shares of IPOs to over 100 customers who were willing to funnel between 33 and 66 percent of their profits to CSFB." (Complaint at 1). "The profits were channeled to CSFB in the form of excessive brokerage commissions generated by the customers in unrelated securities trades that the customers generally effected solely to satisfy CSFB's demands for a share of the IPO profits." (Complaint at 1). The complaint alleged that the customers funneled tens of millions of dollars in profits to CSFB through improper commission payments. The SEC alleged that CSFB's actions violated Rules 2110 and 2330 of the NASD Rules of Conduct and Section 17(a) of the Exchange Act, 15 USC § 78q(a) and Rule 17a-3(a)(6), 17 CFR § 240.17a-3(a)(6).

CSFB entered into settlements with the SEC and the NASDR on January 29, 2002. The NASDR action consists of a document titled NASD Regulation, Inc. Letter of Acceptance, Waiver [*3]and Consent.^[FN3] In the SEC action, CSFB consented to the District Court's entry of an injunctive decree. The District Court entered a Final Judgment (Final Judgment) in the SEC action on January 29, 2002. The Final Judgment stated, in pertinent part, that

IT IS FURTHER ORDERED, ADJUDGED, AND DECREED that, CSFB shall pay $70 million, representing disgorgement of monies obtained improperly by CSFB as a result of the conduct alleged in the Complaint...

CSFB notified Vigilant on January 31, 2002, seeking coverage for that portion of the settlement representing the 70 million dollar disgorgement.^[FN4] Vigilant commenced this action on February 26, 2002, for a declaration that its policy did not cover CSFB's claim.

Vigilant now moves for summary judgment declaring that its policy does not cover any part of the $70 million disgorgement payment. CSFB cross-moves, based on its counterclaims against Vigilant and its third-party claims against the additional insurers, for summary judgment declaring that CSFB is entitled to coverage for the disgorgement payment and for its defense costs in the underlying actions.^[FN5]

The moving party on a motion for summary judgment must make a prima facie showing of entitlement to judgment as a matter of law by putting forth sufficient evidence to eliminate any material issues of fact from the case. Winegrad v NYU Medical Center, 64 NY2d 851. The opposing party must then demonstrate the existence of a factual issue requiring a trial of the action. Zuckerman v City of New York, 49 NY2d 557, 560.

Vigilant argues that New York law and public policy prohibit CSFB from receiving insurance coverage for the funds CFSB had to disgorge pursuant to the Final Judgment. Specifically, Vigilant argues that, should CSFB prevail, it will reap the benefits of its improper activities and recoup the money that it agreed to disgorge by passing the financial burden to its insurers. This would defeat the purpose of requiring CSFB to disgorge the money in the first place. Vigilant relies basically on the holding in Reliance Group Holdings, Inc. v National Union Fire Ins. Co. of Pittsburgh, Pa., 188 AD2d 47 in support of its argument. The First [*4]Department stated in Reliance that "[i]t is well established that one may not insure against the risk of being ordered to return money or property that has been wrongfully acquired." Id. at 55, quoting Bank of the West v Superior Court, 2 Cal 4th 1254, 1266.

CSFB argues that denial of coverage here would render the insurance policy illusory and deprive CSFB of insurance coverage for which it paid millions of dollars in premiums. CSFB also contends that there was no final adjudication of wrongdoing on its part, and, therefore, permitting coverage would not result in CSFB retaining a benefit that it may have obtained wrongfully. Finally, it contends that a denial of its claim would deprive CSFB of the benefits of having settled with the SEC and NASDR, even though the law encourages parties to settle their disputes. CSFB argues that the decision in Reliance is inapplicable here because CSFB did not return any property or money to its customers.

CSFB cannot recoup the $70 million disgorgement payment through its insurance policy. Such a result would defeat the purpose of the disgorgement provision in the Final Judgment.

The Reliance decision is clear that, in general, a party may not insure against the risk of being ordered to return money that it has obtained improperly. The court in Reliance relied on the decision in Bank of the West, supra, in which the California Supreme Court stated that "[w]hen the law requires a wrongdoer to disgorge money or property acquired through a violation of the law, to permit the wrongdoer to transfer the cost of disgorgement to an insurer would eliminate the incentive for obeying the law." Bank of the West, supra at 1269. "Otherwise, the wrongdoer would retain the proceeds of his illegal acts, merely shifting his loss to an insurer." Id.

The Bank of the West decision is consistent with the purposes of disgorgement. Disgorgement seeks to deprive a party of ill-gotten gains and to deter improper conduct. See, SEC v Wang, 944 F2d 80, 85 [2d Cir 1991]; SEC v Tome, 833 F2d 1086, 1096 [2d Cir 1987], cert denied, 486 US 1014 [1988]; SEC v Commonwealth Chem Sec, Inc, 574 F2d 90, 102 [2d Cir 1978]. "'The effective enforcement of the federal securities laws requires that the [SEC] be able to make violations unprofitable.'" SEC v Rind, 991 F2d 1486, 1491 [9th Cir], cert denied 510 US 963 [1993], quoting Securities and Exchange Commission v. Manor Nursing Centers, Inc., 458 F2d 1082, 1104 [2d Cir 1972]. "'The deterrent effect of [a Commission] enforcement action would be greatly undermined if securities law violators were not required to disgorge illicit profits.'" Id., quoting Manor Nursing, supra at 1104. It is undisputed that the Final Judgment required CSFB to disgorge itself of money that the SEC alleged CFSB obtained improperly. CSFB argues that the Final Judgment is insufficient to demonstrate that CSFB acted improperly or that it should be denied insurance coverage because the Final Judgment is merely a reflection of its consensual settlement with the SEC and the NASDR. CSFB stresses that the Final Judgment states that CSFB is not admitting to any wrongdoing.

CSFB's argument is unpersuasive. The complaint sets forth in detail the improper acts CSFB allegedly committed in connection with its underwriting activities, and the Final Judgment specifically states that the 70 million dollar payment represented "disgorgement of monies obtained improperly by CSFB as a result of the conduct alleged in the Complaint..." . Thus, the Final Judgment specifically links the disgorgement payment to the improper activity that the SEC complaint alleged. Therefore, this is not merely a case in which a party settled an action without admitting liability.

CSFB correctly states that the Final Judgment is not the same as a final adjudication of the [*5]facts after a trial. However, the effect of the Final Judgment, under the particular facts of this case, is essentially the same because the Final Judgment states that CSFB is disgorging money that it obtained improperly. To rule in CSFB's favor would allow CSFB to pass the burden of this kind of settlement to its insurers. This result would defeat the purpose of the Final Judgment and the policy behind disgorgement.

CSFB argues that this case is different from other disgorgement cases in that CSFB is not returning any money or property to its customers. However, the purpose of disgorgement here is not to compensate CSFB's customers. The purpose is to deprive CSFB of money that it obtained unjustly and to deter similar conduct in the future. To permit CSFB to recoup the disgorged money through its insurance carrier would undermine that goal. Because of the language of the Final Judgment and policy language, this decision applies to the particular facts of this case. A different outcome might result when parties settle under different circumstances.

The court finds, however, that CSFB is entitled to summary judgment on its claims for defense costs. First, the policy states in Article II, § T that the term "Loss" includes defense costs. Thus, the term "loss" would encompass the costs incurred defending the SEC action. Moreover, none of the insurers have opposed this portion of the cross-motion. Therefore, this portion of the cross-motion is granted.

Accordingly, it is

ADJUDGED AND DECLARED that the insurance policy does not cover CSFB's 70 million dollar disgorgement payment; and it is further

ORDERED THAT defendant's counterclaims against plaintiff Vigilant and its third-party claims against Continental Casualty Company and Travelers Casualty and Surety Company of America and the other third-party defendants Swiss Reinsurance Company and Various Underwriters at Lloyds of London and Certain London Companies are dismissed except to the extent that those claims seek to recover defense costs; and it is further

ADJUDGED AND DECLARED THAT the insurance policy covers CSFB's defense costs; and it is further

ORDERED that the cross-motion by defendant Credit Suisse First Boston is granted as to its claims for defense costs and the issue of the amount of defense costs that CSFB is entitled to recover under the insurance policy is referred to a Special Referee to hear and report with recommendations, except that, in the event of and upon the filing of a stipulation of the parties, as permitted by CPLR 4317, the Special Referee, or another person designated by the parties to serve as referee, shall determine the aforesaid issue; and it is further

ORDERED that a copy of this order with notice of entry shall be served on the Clerk of the Judicial Support Office (Room 311) to arrange a date for the reference to a Special Referee.

DATED: July 8, 2003ENTER:

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J.S.C.