Prior Acts Exclusion in E&O Policy Bars Coverage for Arbitration Award

Applying New York law, the United States Court of Appeals for the Tenth Circuit held that an insurer had no duty to indemnify an insured for an arbitration award because the prior acts exclusion in the E&O policy barred coverage for the arbitration. Templeton v. Catlin Spec. Ins. Co., 2015 WL 4072128 (10th Cir. July 6, 2015). However, the court held that the insurer, which issued a reservation of rights letter and agreed to defend, breached its duty to defend the arbitration by failing to appoint separate counsel for the insured person.

Two investors filed a Financial Industry Regulatory Authority (FINRA) arbitration against the insured securities broker and brokerage firm for failing to disclose risks associated with a series of investments made both before and after the securities broker joined the brokerage firm. The brokerage firm tendered the arbitration to its insurer under an E&O policy. The insurer agreed to defend the securities broker and the brokerage firm in the arbitration subject to a reservation of rights and appointed defense counsel, who later withdrew. The insurer then rejected the brokerage firm’s preferred counsel but agreed to preferred counsel’s limited representation of the brokerage firm to reach a settlement with the investors. Although the preferred counsel reached a settlement on behalf of the brokerage firm, the investors refused to release the securities broker. The investors obtained a judgment against the securities broker in the arbitration because counsel did not appear to defend the securities broker. The broker satisfied the judgment in the arbitration and filed suit against the insurer for breaching its duty to defend and indemnify him for the arbitration award.

First, the court held that the insurer breached its duty to defend the securities broker in the arbitration. The insurer did not contest that it had a duty to defend the securities broker because it issued a reservation of rights and agreed to provide a defense. However, it contended that it satisfied the duty to defend because it believed the brokerage firm’s preferred counsel was defending the insured and that the settlement released the securities broker. The court held that the insurer breached its duty to defend because (i) it never consented to the retention of the brokerage firm’s preferred counsel because of conflict issues, (ii) even if it consented to the retention, it agreed to the retention only for purposes of settlement discussions and not for the entire arbitration, and (iii) the securities broker was entitled to separate counsel from the brokerage firm because of a potential conflict of interest. However, the court determined that the insurer did not breach any duty to defend the securities broker after the arbitration concluded because the securities broker had no reasonable basis to appeal the arbitration award.

Second, the court held that the insurer did not breach its duty to indemnify because a prior acts exclusion in the E&O policy barred coverage for the arbitration award. The exclusion barred coverage for any claim “arising out of, based upon or in consequence of, directly or indirectly resulting from or in any way involving . . . any Wrongful Act occurring on or after the Retroactive Date which, together with a Wrongful Act occurring on or prior to such Retroactive Date, would constitute Interrelated Wrongful Acts.” The Policy defined “Interrelated Wrongful Acts” as Wrongful Acts that are “similar, repeated, or continuous” or “connected by reason of any common fact, circumstance, situation, transaction, casualty, event, decision or policy or one or more series of facts, circumstances, situations, transactions, casualties, events, decisions or policies.” The Retroactive Date was the date that the securities broker joined the brokerage firm. The insurer contended that the prior acts exclusion applied because the securities broker’s wrongful acts occurring after the retroactive date were related to the wrongful acts allegedly committed before the retroactive date. The court agreed. It held that “common facts” connected all wrongful acts—namely, failure to disclose risks in multiple investments. Specifically, the investments were sold to the same clients, were solicited by the same securities broker, and were made in subsidiaries of the same company. Further, the securities broker’s liability was based on the same conduct with respect to each investment:  failure to disclose material facts about the investments, failure to investigate the investments, and failure to investigate the suitability of the investments for the two investors.

Finally, the court held that the insurer was not equitably estopped from relying on the prior acts exclusion. Although the insurer did not specifically reference the prior acts exclusion in its reservation of rights letter, the letter broadly reserved rights to deny coverage. The court held that the insured securities broker could not prove detrimental reliance on the insurer’s failure to specifically reference the prior acts exclusion because the insurer generally reserved its rights to deny coverage for the arbitration.