“Claim to Securities” Exclusion Applied Where the Notes Constituted “Security” as Defined by Securities Laws | Wiley Rein LLP


The United States District Court for the Eastern District of Michigan, applying Michigan law, has ruled that an exclusion in the policy of professional liability of an investment advisor applicable to claims arising from the sale of a ” unregistered security ”excluded coverage of lawsuits arising from an investment product because it was a“ security ”within the meaning of the Federal Securities Act and the Federal Securities Exchange Act. Saoud v. Everest Indem. Ins. Co., 2021 WL 4458680 (ED Mich. 29 September 2021).

Policyholders offered their clients an investment product in which policyholders would lend money to businesses that were unwilling or unable to borrow from traditional banks and in return received a percentage of the businesses’ daily income. Policyholders reportedly used $ 50 million in investor funds to buy bad credit card debts and an additional $ 28 million for personal use. The Securities Exchange Commission and several clients have filed a number of lawsuits against policyholders for which they have sought coverage from their professional liability insurer. The insurer denied coverage on the basis of an exclusion prohibiting coverage for any “Loss resulting from a Claim against an Insured … based on, attributable to, or resulting from the use or investment in all Security which is not registered with the Securities and Exchange Commission.

The policyholders sought a declaratory judgment that the insurer was required to reimburse them for legal fees they spent and settlements they paid in state lawsuits. After the discovery, both parties filed summary judgment motions. The court ruled that the insurer might be entitled to summary judgment on the basis of the “exclusion of securities claims”, but asked for further information on whether the investment product was a “security” as defined by the Securities Exchange Commission because the term was not defined. in politics. Specifically, the court asked for information on whether the investment product fell within one of the exceptions to the definition of a “security”: (1) whether the note had a maturity at the time of the issue not exceeding nine months; and (2) if so, whether the product qualified as “commercial paper”.

First, the court ruled that since the notes were automatically renewed at nine months in the absence of a request for a nine-month termination, the notes had a maturity. at the time of issue exceeding nine months. Second, the court ruled that even though the notes had a maturity of no more than nine months, the exclusion still applied because the notes were not commercial paper. “Commercial paper” is defined as notes “made to mature in a few months and which are not generally advertised for sale to the general public” and which are “eligible for discount by Federal Reserve banks” . The court noted that the investment product had raised $ 287 million from 3,400 investors in at least 25 states to support the conclusion that the product had been sold to the public and not just to “very sophisticated investors.” Thus, concluding that none of the exceptions to the definition of “security” under securities laws applied to the investment product at issue here, the court concluded that the exclusion of “securities” is applied and granted summary judgment in favor of the insurer.


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