In separate opinions, a federal appellate court affirmed rulings that insurers could dodge liability for wrongful acts by their policyholders because the actions were not covered by the policies.
In a decision filed Sunday, a panel of the 8th Circuit Court of Appeals upheld a ruling that Federal Insurance Co. is not liable for $3,620,000 in settlements paid to investors who were victims of a penny stock “pump-and-dump scheme” orchestrated by a bonded securities brokerage.
Also on Sunday, a separate 8th Circuit panel upheld a decision that Allied World National Assurance Co. is not liable for settlement money paid by a retailer who took his company public but failed to disclose that his largest supplier was owned by his brother-in-law.
Allied World won its case because of a carefully crafted policy exclusion. Federal won because the surety bond it sold to is client did not cover the type of dishonest acts that were alleged.
Tile Shop Holdings asked for coverage under its directors-and-officer’s policies with Allied after the chain of retail stores decided in 2012 to go public. Robert Rucker, who founded the company in 1984, did not disclose in Securities and Exchange Commission filings that the Chinese export companies where the stores purchased supplies were substantially owned and controlled by Rucker’s brother-in-law.
An investment research reported about 15 months after the first public stocks were sold that Tile Shop had not disclosed “related-party transactions.” The company reported that the company was secretly controlled by its largest supplier, and its gross margins “were too good to be true.”
The report spawned shareholder class-action lawsuits against Tile Shop and derivative suits against the company’s officers and directors for breaches of fiduciary duty and unjust enrichment. Tile Shop sought coverage from its primary insurer, American International Group, but its claim exceed the $10 million policy limit.
Tile Shop turned to its excess carrier, Allied, to cover the remaining losses. Allied denied coverage, saying the claims were barred by a policy exclusion that included a “follow-form clause” for prior wrongful acts. The policy excluded coverage for wrongful acts that took place before Aug. 20, 2012 and also any wrongful acts after that date if they arose out of or were related to a previous wrongful act.
U.S. District Court Judge Ann D. Montgomery concluded that Tile Shop’s claim was barred by the policy exclusion under Minnesota law. The 8th Circuit affirmed that judgment in an opinion written by Circuit Judge David R. Stras.
“The bottom line is that Tile Shop’s wrongful acts started well before Aug. 20, which made any ‘[l]oss[es]’ from them excludable under the relation-back clause,” the panel opinion states.
In the separate case involving Federal Insurance Co., COR Clearing sought payment under a financial institution bond after it settled claims by investors who got caught up in a scheme by one of its brokers to inflate the price of a stock and sell the shares before the price dropped.
An investigation by the Financial Industry Regulatory Authority led to the securities and wire fraud conviction of New Jersey stock brokers Christopher Cervino, Edward Durante, Sheik Kahn and others in 2017. After COR Clearing paid settlements to investors burned by the scheme, the brokerage sought coverage under the bond issued by Federal.
The carrier denied the claim. The U.S. District Court in Omaha, Nebraska ruled that under New Jersey law, Cervino’s actions were not covered the policy because he was not accused of a dishonest act that caused COR to lose money directly. The bond promised to pay only if Cervino caused a direct loss to COR. Cervino’s dishonest acts, in contract, caused damages to third parties.
The 8th Circuit panel rejected the policyholder’s arguments that there were material issues of fact as to whether Cervino had committed dishonest acts that were covered by the bond.
“Traditionally, financial institution bonds and similar employee dishonest coverages were indemnity contracts that covered the insured’s direct losses from employee dishonesty (and other risks such as forgery), not the insured liabilities to third parties for tortious acts of its employee intended to injure or defraud the third party,” the appellate panel said in an opinion written by James B. Loken.
About the photo: A Tile Shop showroom is shown. Phot courtesy of the Tile Shop.
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