Index Fund, Inc. v. Insurance Co. of North America

• Decision Date: 14 September 1978
• Docket Number: D,No. 771,771
• Citation: 580 F.2d 1158
• Parties: Fed. Sec. L. Rep. P 97,164 INDEX FUND, INC., Plaintiff-Appellant, v. INSURANCE COMPANY OF NORTH AMERICA, Defendant-Appellee. ocket 77-7600.
• Court: U.S. Court of Appeals — Second Circuit

Page 1158

580 F.2d 1158

Fed. Sec. L. Rep. P 97,164

INDEX FUND, INC., Plaintiff-Appellant, v. INSURANCE COMPANY OF NORTH AMERICA, Defendant-Appellee.

No. 771, Docket 77-7600.

United States Court of Appeals, Second Circuit.

Argued March 23, 1978.

Decided Aug. 1, 1978.

Rehearing Denied Sept. 14, 1978.

Charles E. McGuinness, New York City, for plaintiff-appellant.

William P. Sullivan, Jr., New York City (Bigham, Englar, Jones & Houston, New York City), for defendant-appellee.

Jacob H. Stillman, Principal Asst. Gen. Counsel, S.E.C., Washington, D. C. (Harvey L. Pitt, Gen. Counsel, Sue E. Auerbach and John M. Metzger, Attys., S.E.C., Washington, D. C., of counsel), for Securities and Exchange Commission, amicus curiae.

Sullivan & Cromwell, New York City, Marvin Schwartz, Stephen K. West and Ann T. Bailen, New York City, on the brief, for Investment Company Institute, amicus curiae.

Before KAUFMAN, Chief Judge, and SMITH and MESKILL, Circuit Judges.

J. JOSEPH SMITH, Circuit Judge:

This is an appeal in an action on a fidelity bond from a judgment of the United States District Court for the Southern District of New York, Charles H. Tenney, Judge, entered for the defendant bonding company notwithstanding the verdict and ordering a remittitur or a new trial in the event this judgment is vacated or reversed. We reverse the judgment N. o. v. and affirm the order granting a new trial Nisi.

Index Fund, Inc. ("Index Fund") is a Massachusetts corporation organized pursuant to the Investment Company Act of 1940 (the "Act"), 15 U.S.C. § 80a-1 Et seq. Rule 17g-1 of the Securities and Exchange Commission (the "Rule"), 17 C.F.R. § 270.17g-1, promulgated under § 17(g) of the Act, 15 U.S.C. § 80a-17(g), required Index Fund to obtain a fidelity bond against larceny and embezzlement covering those of its officers who had access to its funds or securities or the authority to draw such funds or dispose of such securities. The Rule also required that the bond "shall provide that it shall not be cancelled, terminated or modified except Over a period of years Index Fund purchased three bonds from Insurance Company of North America ("I.N.A."), a Pennsylvania corporation. The third of these bonds, effective from July 30, 1971 to June 31, 1973, was procured through Bleichroeder Bing & Co., Inc., 127 John Street, New York, New York. ¹ Attached to the first two bonds were riders containing the so-called "cancellation clause." The rider accompanying the second of these bonds bore the legend: "For use with brokers' blanket bonds, Forms 14 Basic and 14 Broad, when issued to registered investment companies. To comply with the rules of the Securities and Exchange Commission."

after written notice shall have been given by the acting party to the affected party and to the Commission not less than 30 days prior to the effective date of cancellation, termination, or modification." 17 C.F.R. § 270.17g-1(a).

Each of the bonds issued by I.N.A. to Index Fund contained the provisions set out in the margin. ² Losses up to a monetary limit of $100,000 were covered by each of the bonds.

On November 4, 1969 Robert R. Hagopian was elected president of Index Fund. Hagopian's duties as president included the purchase, sale, delivery and receipt of stocks, bonds and other securities, cash and other forms of investment in the name and on behalf of Index Fund. While he was president, Hagopian bought and sold securities on behalf of Index Fund on many occasions.

Plaintiff's case is based on a claim that on about June 1, 1970, Hagopian was bribed by and entered into a conspiracy with certain persons who were not employees of Index Fund to purchase certain securities at prices which Hagopian knew to be manipulated. From June 16, 1970 to August 6, 1970 Hagopian purchased for Index Fund at inflated prices the securities of various companies, including those of a corporation named Computerized Knitwear, for a total expenditure of funds in the amount of $1,034,840. From September 17, 1970 to December 13, 1972 these securities were sold, after their prices had fallen, for $301,594.

On August 7, 1972 an indictment was returned in the United States District Court for the Southern District of New York against Hagopian and four co-defendants. Named as a co-conspirator but not as a co-defendant was Akiyoshi Yamada, an investment advisor whose activities in the securities markets are not unknown to this court. ³ Count 19 of the indictment charged that Hagopian and one Peter Galanis "unlawfully, wilfully and knowingly, did abstract, convert to their own use, and embezzle monies, funds, securities, credits, property, and assets of . . . Index Fund . . . (on) 8/6/70 . . . (in the amount of) $98,870." On January 22, 1973 On the basis of information in the indictment and in a bill of particulars which followed it, Index Fund later reconstructed the securities transactions mentioned above and filed proof of claim for loss on the bonds. I.N.A. denied liability and this action followed. There was evidence from records of the custodian bank of the purchase of Computerized Knitwear shares for $98,870 and the sale of the same shares for $36,698.

Hagopian entered a plea of guilty to Count 19 of the indictment. ⁴

The trial judge charged the jury that to return a verdict for Index Fund, it must find by a preponderance of the evidence that Index Fund suffered a loss, that the loss was caused by Hagopian's acts, and that such acts were dishonest and fraudulent. He further instructed the jury that if it found the fund suffered such a loss that it must then consider "whether the losses fell within a specific exclusion from liability contained in the bond." Section 1(e)(1) was then read to the jury. Finally, the jury was told that if it found that the losses were caused by fraudulent or dishonest acts by Hagopian which did not result from trading, that the jury must determine the amount of Index Fund's loss. During its deliberations the jury requested and received a copy of the indictment to which Hagopian had pled guilty. The jury returned a verdict in favor of Index Fund in the amount of $98,870.

After trial, I.N.A. moved for a judgment notwithstanding the verdict. The court granted this motion on the ground that Index Fund's claim was excluded from coverage because the transactions at issue came within the meaning of "trading" in § 1(e)(1). I.N.A. also moved for a new trial and the court, pursuant to Fed.R.Civ.P. 50(c)(1), decreed that if its judgment was vacated or reversed on appeal that this motion would be granted unless Index Fund agreed to accept a remittitur in the amount of $36,698. ⁵

Index Fund appealed and we assumed jurisdiction under 28 U.S.C. § 1291. Briefs were submitted by the Investment Company Institute and by the Securities and Exchange Commission as Amici curiae.

Index Fund argues on appeal that its losses are not excluded from coverage by virtue of § 1(e)(1) because the transactions were not "trading" within the meaning of that provision. Second, Index Fund argues that even if the transactions were "trading," the provision should be given no legal effect since recovery was sought under a statutory bond for losses as to which the statute requires coverage. Third, it argues that the amount of the award is not excessive, not against the evidence, and not speculative and should therefore be reinstated on remand. ⁶

Since this action under the complaint as amended is based on diversity, we apply the Under New York conflict of law rules, courts when construing the meaning of words in or the validity of a provision in a contract, apply the local law of that state which has the greatest interest in or most significant relationship to the transaction and the parties. See Intercontinental Planning, Ltd. v. Daystrom, Inc., 24 N.Y.2d 372, 382-85, 300 N.Y.S.2d 817, 825-28, 248 N.E.2d 576, 580-82 (1969); Auten v. Auten, 308 N.Y. 155, 124 N.E.2d 99 (1954). In the case before us the state with the most significant contacts and greatest interest is the State of New York.

substantive law, which includes the conflict of law rules, of the State of New York. See Klaxon Co. v. Stentor Electric Mfg. Co., 313 U.S. 487, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941); Erie R.R. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938); Sutro Bros. & Co. v. Indemnity Insurance Co. of North America, 386 F.2d 798, 801 (2d Cir. 1967); 1A, Part 2, Moore's Federal Practice P 0.311.

Where the words in a provision of a fidelity bond are subject to more than one reasonable construction, the courts applying New York law construe such words most favorably to the insured and most strictly against the insurer; see Cohon v. U.S. Fidelity & Guaranty Co., 172 Misc. 51, 13 N.Y.S.2d 976, Aff'd, 259 App.Div. 707, 19 N.Y.S.2d 144 (1940); McClare v. Massachusetts Bonding & Ins. Co., 366 N.Y. 371, 377, 195 N.E. 15, 17 (1935); Whitestown v. Title Guaranty & Surety Co., 72 Misc. 498, 131 N.Y.S. 390, 393, Aff'd,148 App.Div. 900, 132 N.Y.S. 1149, Aff'd, 209 N.Y. 512, 102 N.E. 1115 (1913), especially where the doubt is found in an exclusionary provision, see Thomas J. Lipton, Inc. v. Liberty Mutual Ins. Co., 34 N.Y.2d 356, 361, 357 N.Y.S.2d 705, 708, 314 N.E.2d 37, 39 (1974); Sincoff v. Liberty Mutual Fire Ins. Co., 11 N.Y.2d 386, 391, 230 N.Y.S.2d 13, 16, 183 N.E.2d 899, 902 (1962). Accordingly, if fairly possible, § 1(e)(1) must be construed against I.N.A. and in favor of Index Fund so as not to exclude Index Fund's losses from coverage. Where, as here, the obligee is a regulated investment company, rather than a broker, fraudulent purchase of securities for the company by the covered employee at a manipulated price may well be considered outside the contemplated meaning of "trading."

Moreover, even if "trading" were ordinarily read to include activities such as Hagopian's, there is another factor present here. The bond at issue is a so-called "statutory bond." Under New York law it must be read in...