Despite Disclosure In Application Of One Claim For Recommending Investment In Ponzi Scheme, Securities Firm’s Non-Disclosure of Facts Supporting Future Claims By Other Investors In Scheme Barred Coverage For Later Claims

Despite Disclosure In Application Of One Claim For Recommending Investment In Ponzi Scheme, Securities Firm’s Non-Disclosure of Facts Supporting Future Claims By Other Investors In Scheme Barred Coverage For Later Claims

05.19.2015

 On April 10, 2015, in Crown Capital Securities, L.P. v. Endurance American Specialty Insurance Co., 235 Cal.App.4th 1122 (2015), the Court of Appeal upheld summary judgment for an insurer which issued a professional liability policy to a securities firm.  When it applied for coverage, the securities firm disclosed one claim, but did not disclose the facts supporting other potential customer claims arising out of investments through the same entity as that involved in the disclosed claim.

The insured securities firm, through several of its employed broker-dealers, recommended investments to multiple clients in various real estate investments promoted by a real estate developer, DBSI.  One of the insured’s clients, Bou-Sliman, wrote to the insured complaining about the losses he sustained from his DBSI investments.   DBSI had declared bankruptcy.  Bou-Sliman forwarded to the insured the final report of a court-appointed examiner, which concluded that DBSI had defrauded investors through an eight-year Ponzi scheme, paying existing debts with new investors’ money.  DBSI tendered the Bou-Sliman claim to its then professional liability insurer.

About six months later, the insured sought professional liability insurance from Endurance.   The application disclosed the Bou-Sliman claim in response to a question asking whether “any claims, suits or proceedings . . . [had] been made during the past five years.”  However, in response to Question 10, “Is the Applicant . . . aware of any fact, circumstance, incident, situation, or accident . . . that may result in a claim,” the insured answered, “No.”  The application stated that “any claim or lawsuit against the Applicant . . . arising from any fact, circumstance, act, error or omission disclosed or required to be disclosed in response to Questions 9, 10 and/or 11, is hereby expressly excluded from coverage under the proposed insurance policy.”

After inception of the Endurance policy, three separate clients brought claims against the insured for losses in DBSI investments recommended to them by the insured.  The new claimants’ losses arose from different DBSI investments than were at issue in the Bou-Sliman matter, and the insured’s broker-dealers who advised the new claimants did not include the broker-dealer who advised Bou-Sliman.  The insured argued that the new claims did not “arise from” or relate to the Bou-Sliman claim, such that its responses in the application were accurate and the application exclusion did not apply.

The Court rejected the insured’s argument, reiterating that California courts give a broad interpretation to the “arising out of” language.  Noting that, prior to applying for the Endurance policy, the insured had received the court-appointed examiner’s final report from DBSI’s bankruptcy proceedings concluding that DBSI was engaged in a Ponzi scheme, and that the insured knew other of its clients had been steered to DBSI investments, the Court reasoned that the insured was aware of facts that might result in a claim being made against it for any DBSI investment.  Summary judgment for Endurance was affirmed.

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