Aetna Cas. & Sur. Co. v. Kidder, Peabody & Co. Inc.

• Decision Date: 06 August 1998
• Court: New York Supreme Court — Appellate Division
• Parties: , 1998 N.Y. Slip Op. 7302, 1998 N.Y. Slip Op. 7303 The AETNA CASUALTY & SURETY CO., Plaintiffs-Counterclaim-Defendants-Respondents, v. KIDDER, PEABODY & CO. INCORPORATED, et al., Defendants-Counterclaim-Plaintiffs-Appellants, and Richard B. Wigton, et al., Defendants.

Page 559

676 N.Y.S.2d 559

246 A.D.2d 202, 1998 N.Y. Slip Op. 7302,

1998 N.Y. Slip Op. 7303

The AETNA CASUALTY & SURETY CO. Plaintiffs-Counterclaim-Defendants-Respondents, v. KIDDER, PEABODY & CO. INCORPORATED, et al Defendants-Counterclaim-Plaintiffs-Appellants and Richard B. Wigton, et al., Defendants.

Supreme Court, Appellate Division First Department.

Aug. 6, 1998.

Arthur N. Lambert, of counsel (Daniel W. White, on the brief, Lambert Weiss & Pisano, attorneys), for plaintiffs-counterclaim-defendants-respondents The Aetna Casualty & Surety Co. and Insurance Company of North America.

Robert B. Budelman, Jr., of counsel (Jeffrey M. Winn, William J. Lutz and Jay L. Taylor, on the brief, Sedgwick, Detert, Moran & Arnold, attorneys), for all other plaintiffs-counterclaim defendants-respondents.

David N. Wynn, of counsel (C. Stephen Heard, Jr., Jeffrey W. Berkman, Mark P. Monack and Michael S. Cryan, on the brief, Arent Fox Kintner Plotkin & Kahn, attorneys), for plaintiffs-counterclaim-defendants-respondents Vigilant Insurance Company.

Peter J. Kalis, of counsel (Thomas M. Reiter, Thomas J. Smith, Ellen R. Nadler, Mark J. Headley, Eric A. Tirschwell and Jennifer L. Meyerhardt, on the brief, Kirkpatrick & Lockhart LLP and Kramer, Levin, Naftalis & Frankel, attorneys), for defendants-appellants.

John F.X. Peloso, John E. Failla, Nora von Stange, Stuart J. Kaswell and Fredda L. Plesser, of counsel (Morgan, Lewis & Bockius LLP and The Securities Industry Association), for The Securities Industry Association as Amicus Curiae, on behalf of defendants-counterclaim-plaintiffs-appellants.

Before MILONAS, J.P., and RUBIN, TOM and MAZZARELLI, JJ.

TOM, Justice.

This is an action by plaintiff insurers seeking a declaration that they are not obligated to indemnify defendant insureds under the terms of numerous fidelity bonds issued by the insurers for the insureds. The issue before us is whether the securities brokerage firm of Kidder, Peabody & Co. is covered under the fidelity bonds for third-party claims arising out of the misconduct of its employee in divulging confidential information relating to corporate takeovers and mergers of Kidder's clients, which resulted in massive insider trading and losses to third parties.

The transactions giving rise to the claimed losses arose from the multiple insider-trading schemes perpetrated by Ivan Boesky, Martin Siegel and others during the 1980's. During that time period, defendant Kidder was a broker-dealer registered with the Securities and Exchange Commission which provided a broad range of investment banking and financial services to its clientele. Martin Siegel was employed by Kidder from 1971 through 1986 as a mergers and acquisitions specialist. Ivan Boesky was a Kidder customer and an arbitrageur who traded in securities of companies involved in corporate takeovers.

From 1982 through 1986, Siegel was involved in two insider-trading schemes that resulted in losses to Kidder giving rise to the instant action. In 1983, Diamond Shamrock, a Dallas-based oil and gas company, retained Kidder to provide financial advice regarding a proposed hostile acquisition of Natomas Company, a San Francisco--based oil and gas company. Siegel informed Boesky of the contemplated tender offer for Natomas before the information became public. Siegel received from Boesky payments of approximately $700,000 for disclosure of tender offers involving Kidder clients including the proposed acquisition of Natomas. Based on this inside information, Boesky purchased a substantial position of common stock of Natomas. The hostile tender offer by Diamond Shamrock eventually resulted in a friendly merger with Natomas, and Boesky realized a huge profit when he sold the Natomas securities.

During this period of time, Siegel also exchanged inside information with Robert Freeman, a general partner of Goldman Sachs & Company, concerning certain mergers, acquisitions, and leveraged buyouts. Siegel used this information to assist Kidder's Risk Arbitrage Department to make illegal trades, which realized millions of dollars in profit for Kidder.

In 1986, the Federal government investigated insider trading on Wall Street and uncovered the illegal activities of Kidder, Siegel, Boesky and Freeman. On February 13, 1987, Siegel pleaded guilty to violating the securities laws by obtaining inside information from Goldman Sachs, and using the illegal information for trades made by Kidder's Risk Arbitrage Department. Boesky pled guilty to criminal violation of securities laws and disgorged illegal profits to the Federal government totaling $100,000,000.

In the aftermath of the Federal government's investigations, Kidder was sued in various class actions. The plaintiffs in these actions were public shareholders of companies that were the subject of Kidder's insider trading; they alleged that they would not have sold at the prices at which the securities were sold if they had the same insider information. In the settlement of these actions, Kidder agreed to pay $7,633,000 and $13,000,000 in damages and $7,045,000 in attorneys' fees and costs. In a separate settlement involving Diamond Shamrock's tender offer for Natomas (the Maxus settlement), Kidder agreed to pay the sum of $165 million in two components: a straight cash payment from Kidder of $125 million and $40 million payment for warrants to purchase up to 8 million shares in Maxus common stock. In the Maxus litigation it was claimed that Boesky, using inside information from Siegel, purchased over $12 million worth of Natomas stock, driving up the price of the shares, and resulting in an unfair stock exchange ratio when a friendly merger subsequently was reached. These are the losses for which Kidder sought coverage from plaintiffs' insurers under the fidelity bonds.

In March of 1993, Kidder submitted a proof of loss statement to the fidelity insurers. Kidder sought recoupment of the bonds' limits for the amounts it paid in the securities-action settlements and the attorneys' fees it had incurred in defense of the class actions.

The insurers then commenced this action to obtain a declaration of rights as to whether Kidder is covered for the losses under the bonds. Among the arguments raised in the amended complaint against coverage were: that the bonds are not liability policies and therefore do not cover losses sustained by non-insureds third parties (fifth cause of action); that the bonds provide coverage for "direct losses" or "direct compensatory damages" only, and not for consequential or incidental losses (sixth cause of action); that the bonds provide coverage only where the employee had the "manifest intent to cause the insureds to sustain the loss" (seventh cause of action); and that the bonds provide coverage only where the losses have been "solely and directly" caused by the employee's misconduct (eighth cause of action).

Kidder counterclaimed for breach of the insurance contracts based upon the insurer's refusal to honor its claim and for restitution of the premium payments. Kidder asserted that the losses were a direct result of its employee's fraudulent acts, which were undertaken with the intent to convert Kidder's and its clients' proprietary information.

The insurers moved to dismiss Kidder's breach of contract counterclaim and for partial summary judgment on their claim for declaratory relief with respect to the 5th, 6th and 8th causes of action, i.e. no coverage for third-party claims, no coverage for indirect or consequential losses, and no coverage for losses not caused "solely and directly" by the faithless employee. Kidder cross-moved for partial summary judgment dismissing the foregoing causes of action.

The motion court found that the terms of the fidelity bonds were not ambiguous and that the fidelity coverage did not insure Kidder for losses resulting from liability for the third-party claims against it, reasoning that the bonds' "direct loss" language required this result. The court further found that coverage was barred by the exclusion limiting coverage to "direct compensatory damages," insofar as the damages that resulted from Kidder's settlement of the Maxus class action asserting excessive stock purchase claims, and from attorneys' fees, were consequential rather than direct. The court granted plaintiffs partial summary judgment, declaring that the bonds did not cover the losses claimed, and dismissed defendants' counterclaim. Defendants insureds appeal from the motion court's order and we now affirm.

Kidder's 1993 proof of loss statement seeking indemnification characterized its losses as resulting from the dishonest and fraudulent acts of its faithless employee, Siegel. Whether Siegel was a "faithless" employee within the meaning of the fidelity bonds, though is the point squarely in dispute. This litigation also requires a clear definition of what fidelity bonds historically have been understood to be, and what they are not.

The various bonds, consisting of primary coverage bonds and two excess layers of coverage, were issued in 1986 with coverage of $50 million and a $5 million deductible. They are blanket bonds, which basically means that all employees, rather than named employees, are covered (see, Couch on Insurance 3d, § 100:1, p. 100-4). All of the bonds start with a general statement of purpose, that the purpose of the agreements incorporated therein is "to indemnify and hold harmless the insureds," against risks specified elsewhere in the bonds. The bonds then specify six areas of coverage: fidelity, losses caused by dishonest or fraudulent acts of an employee of the assured; on-premises losses or damage to the insureds' property caused by robbery, burglary, or theft; similar types of losses occurring in transit; forgery or losses by the insureds resulting from alterations; the insureds' securities losses; and the insureds' losses resulting from counterfeit currency. Basically, these are distinct...