Allegis Inv. Servs., LLC v. Arthur J. Gallagher & Co.

• Decision Date: 01 March 2019
• Docket Number: Case No. 2:17CV515DAK
• Citation: 371 F.Supp.3d 983
• Court: U.S. District Court — District of Utah
• Parties: ALLEGIS INVESTMENT SERVICES, LLC, Allegis Investment Advisors, LLC, Plaintiffs, v. ARTHUR J. GALLAGHER & CO; Indian Harbor Insurance Company; and Paige Nabavian, Defendants.

371 F.Supp.3d 983

ALLEGIS INVESTMENT SERVICES, LLC, Allegis Investment Advisors, LLC, Plaintiffs,

v.ARTHUR J. GALLAGHER & CO; Indian Harbor Insurance Company; and Paige Nabavian, Defendants.

Case No. 2:17CV515DAK

United States District Court, D. Utah, Central Division.

Signed March 1, 2019

Mary Anne Q. Wood, Jared M. Asbury, Wood Balmforth LLC, Salt Lake City, UT, Douglas C. Smith, Lewis Brisbois Bisgaard & Smith LLP, Sandy, UT, for Plaintiffs.

Kristine M. Larsen, Mark W. Pugsley, Ray Quinney & Nebeker, Salt Lake City, UT, Charles W. Chotvacs, Pro Hac Vice, Thomas J. Judge, Pro Hac Vice, Dykema Gossett PLLC, Washington, DC, David S. Bridge, Scalley Reading Bates Hansen & Rasmussen, Salt Lake City, UT, for Defendants.

MEMORANDUM DECISION AND ORDER

DALE A. KIMBALL, United States District Judge

This matter is before the court on several motions: Plaintiffs Allegis Investment Services, LLC, and Allegis Investment Advisors, LLC's Motion for Summary Judgment [Docket No. 122]; Defendant Indian Harbor Insurance Company's Motion for Summary Judgment [Docket No. 125]; Defendants Arthur J. Gallagher & Co. and Paige Nabavian's Motion for Summary Judgment [Docket No. 126]; and Plaintiffs' Expedited Motion to Add a Claim for Reformation Under Plaintiffs' Declaratory Judgment Action or, Alternatively, to Amend Pleading to Conform to Proof [Docket No. 215].¹ On December 13, 2018, the court held a hearing on the motions. At the hearing, Plaintiffs were represented by Mary Anne Q. Wood and Jared M. Asbury, Defendant Indian Harbor was represented by Thomas J. Judge, Charles W. Chotvacs, and Defendants Arthur J. Gallagher & Co. and Paige Nabavian were represented by Kristine M. Larsen, Mark W. Pugsley, and Aaron Hinton. The court heard argument and took the motions under advisement. After carefully considering the parties' memoranda and the law and facts relevant to the pending motions, the court issues the following Memorandum Decision and Order.

BACKGROUND

Allegis Investment Services, LLC, ("AIS") is a broker-dealer investment company and Allegis Investment Advisors, LLC ("AIA"), is a registered investment advisor company (collectively, "Allegis"). In this case, Allegis seeks insurance coverage for claims against AIS and AIA relating to a "Net Credit Spread" investment strategy that Allegis employed in 2015. On August 20, 2015, Allegis, with full discretionary authority for its clients, executed a "put credit spread" based on the Russell 2000 index on a total of 39,200 put options on each side of the spread. This trade had a maximum potential profit of $ 313,600, and a maximum potential loss of $ 38,886,400. Allegis' investor accounts suffered the maximum potential losses from the August 20, 2015 trade, and many of the investors initiated arbitrations against Allegis to recover their losses.

On February 28, 2014, AIS was approved by the Financial Industry Regulatory Authority ("FINRA") as a broker-dealer. As part of the approval process, AIS was required to have broker-dealer investment advisors errors and omissions insurance coverage. Allegis tasked Brian C. Pierce, an accountant for AIS, with securing E & O coverage for AIS and AIA in 2014 and 2015. Pierce contacted Gallagher & Company and was put in contact with Paige Nabavian, a Gallagher representative. Nabavian assembled the application and forwarded it to John Churney, a wholesaler who worked for CRC Crump. Gallagher then proposed a policy to Allegis through Indian Harbor Insurance Company.

On February 28, 2014, Nabavian sent Pierce an email with two attachments: a Proposal for Insurance and an Indian Harbor "E & O" policy form and endorsements. The Proposal of Insurance contained information pertaining to the Broker-Dealers and Investment Advisors Errors & Omissions Policy Form through Indian Harbor Insurance Company for the policy period of March 3, 2014 to March 3, 2015, with limits of liability of $ 1,000,000 each claim/$ 2,000,000 aggregate for all losses. Allegis accepted the terms and conditions of the 2014 Proposal of Insurance and signed the Client Authorization to Bind coverage with Indian Harbor. The Client Authorization states that Allegis "understood this proposal provides only a summary of the details; the policies contain the actual coverages."

The Proposal of Insurance Disclosures section also informed Allegis that "the insurance policies themselves must be read" for details regarding all the terms, coverage, exclusions, limitations, and/or conditions of the actual policy contract language. The disclosures further stated that Gallagher & Co "will not be operating in a fiduciary capacity, but only as your broker/agent, obtaining a variety of coverage terms and conditions to protect the risks of your enterprise. We will seek to bind those coverages based upon your authorization; however, we can make no warranties in respect to policy limits or coverage considerations of the carrier. Actual coverage is determined by policy language so read all policies carefully."

The Proposal of Insurance also stated that "Gallagher strives to find appropriate coverage at a competitive price for our customers. In order to achieve these goals, we gather and analyze data about our customers and their insurance coverage. This data and the resulting analytical tools help us better understand the current marketplace, more accurately predict future trends and offer tailored solutions to our customers."

Allegis admits that it received a copy of the 2014 E & O Policy. The Policy contains the following exclusion: "This insurance does not apply to any Claim or Defense Expenses: ... Arising out of the actual or alleged purchase, sale, attempted sale, solicitation or servicing of any of the following: .... Commodities, any type of futures contracts, any type of option contract or derivative. However, this exclusion shall not apply to fully covered put or call options."

On February 21, 2015, Gallagher provided Allegis a Proposal of Insurance for the renewal of Allegis' E & O Policy through Indian Harbor for the policy period of March 3, 2015 to March 3, 2016, with limits of $ 1,000,0000 each claim/$ 2,000,000 aggregate for all loses. Allegis accepted the terms of the 2015 Proposal and signed the Client Authorization to Bind. The authorization and proposal contained the same provisions as the 2014 versions. Allegis received a copy of the 2015 E & O Policy. The 2015 E & O Policy contains the same terms and exclusions.

Pierce cannot recall whether anyone at Allegis read the 2014 or 2015 E & O policies. However, after the August 2015 losses occurred, Pierce and Heath Bowen, Allegis' Chief Executive Officer, read the language of the 2015 E & O Policy and concluded that any claims arising from the August 2015 losses would be covered because Allegis' strategy allegedly involved fully covered puts. Bowen testified that the Net Credit Spread strategy involves the trading of fully covered put options.

While Allegis claims that it disclosed its options trading in documents attached to its application for insurance, it cannot identify any document that explains the nature of Allegis' Net Credit Spread strategy. Pierce completed a 2014 Chubb Application and Supplemental Questionnaire for the E & O Policy, but he did not include information regarding Allegis' trading strategy. On the XL Application, Allegis stated that 25% of its recommended investments involved options but did not state the type of options contracts it traded or the nature of its strategy. Pierce, who was in charge of obtaining the insurance, had no personal knowledge regarding the type of options trading that Allegis transacted or any understanding of the nature of the Net Credit Spread strategy. Gallagher did not have any independent understanding of the nature of Allegis' Net Credit Spread strategy.

Allegis never requested that Gallagher analyze the adequacy of the coverage or advise Allegis as to whether $ 1 million per claim/$ 2 million aggregate for all losses was an adequate amount of coverage for Allegis' business risks and potential exposure. Pierce cannot recall any specific discussion with Nabavian concerning the adequacy of Allegis' requested liability limits. However, he recalls discussing the fact that carriers were only willing to write certain limits due to the fact that Allegis was a relatively small start-up company. In addition, Pierce did not ask Gallagher to advise it as to whether claims specifically arising out of Allegis' Net Credit Spread strategy would be covered under the 2015 E & O Policy.

Bowen considered the August 2015 losses to be an unexpected event. Prior to the August 2015 losses, Allegis had never incurred losses arising out of the Net Credit Spread strategy even though Bowen had been using the strategy since 2009.

AIA conducted options trading for its clients via TD Ameritrade's platform for the Cboe. AIA advisors executed a TD Ameritrade Account Agreement for Options Trading. Pursuant to that agreement, the AIA advisor agreed that the advisor had implemented policies and procedures to obtain and retain client option information as well as to follow the position and exercise limits "set forth by FINRA Rule 2360." FINRA Rule 2360 addresses "options" and defines the term "covered" in connection with put options. "The term ‘covered’ in respect of a short position in a put option contract means that the writer holds in the same account as the short position, on a unit-for-unit basis, a long position in an option contract of the same class of options having an exercise price equal to or greater than the exercise price of the option contract in such short position." Rule 2360's definition of a "covered" put is consistent with, and essentially identical to, the definition provided by Rule 1.1(y) of the Cboe which is the exchange where AIA traded options.

AIA provided its investors with a disclosure for "uncovered puts" which stated that AIA would "honor all exercise assignments ... on any uncovered put positions by...