Tenth Circuit Holds Underlying Securities Claims Interrelated

In its recent decision in Brecek & Young Advisors, Inc. v. Lloyds of London Syndicate 2003, 2013 U.S. App. LEXIS 9599 (10^th Cir. May 13, 2013), the United States Court of Appeals for the Tenth Circuit, applying New York law, had occasion to consider whether an underlying securities arbitration related back to claims first made prior to the policy’s inception date, and if so, whether the insurer was estopped from denying coverage on this basis.

Lloyds insured Brecek & Young Advisors, Inc. (“BYA”) under a claims-made and reported broker/dealer professional liability policy in effect for the period December 1, 2006 to December 1, 2007.  The policy contained an “Interrelated Wrongful Acts” provision stating that all claims based on the same wrongful act or interrelated wrongful acts would be deemed a single claim.  The policy also contained an exclusion applicable to claims arising out of wrongful acts for which notice had been given under any prior policy or “any other Wrongful Act whenever occurring, which together with a Wrongful Act which has been the subject to such claim or notice, would constitute Interrelated Wrongful Acts.”  The policy defined “Interrelated Wrongful Acts” as wrongful acts that are:

1.   similar, repeated or continuous; or

2.   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 Brecek decision addressed the interrelatedness of three underlying proceedings.  The first, referred to as the “Wahl Arbitration” was a claim first made against BYA while the Lloyds policy was in effect.  The claim alleged that BYA sold unsuitable investment products and that BYA and a co-defendant engaged in practices of churning investments during the period 1999 through 2005.   The claim alleged causes of action against BYA for various theories of agency liability and failure to supervise.   The complaint filed in the Wahl Arbitration was subsequently amended to add twenty-five additional claimants who claimed similar injuries as a result of similar misconduct.

Relevant to coverage for the Wahl Arbitration was a claim first made against BYA in September 2005, referred to as the Knotts Arbitration.  The Knotts Arbitration contained similar allegations and causes of action as alleged in the Wahl Arbitration, and identified the same individual defendants as those identified in the Wahl Arbitration.  Also relevant was a claim first made against BYA in June 2006, referred to as the Colaner Arbitration, which also contained allegations of unsuitability and churning over the same time period by the same group of individual defendants. 

Lloyds initially took the position that the Wahl Arbitration was interrelated to the Colaner Arbitration and therefore should be covered under BYA’s prior policy which had been issued by Fireman’s Fund.  Lloyds subsequently advised, however, that it had determined the Wahl and Colaner matters were not interrelated.  Lloyds thereafter agreed to provide BYA with a defense in the Wahl Arbitration, but took the position that each claimant in the proceeding represented an entirely unrelated claim subject to a separate $50,000 self-insured retention.  While BYA eventually settled with each of the claimants in the Wahl Arbitration, Lloyds prorated the defense costs among all claims and paid indemnity on those claims which exceeded the $50,000 retention.  As a result, Lloyds indemnified BYA for only $385,000 of some $932,000 incurred by BYA in legal fees and settlement payments.

The issue of multiple-retentions eventually was briefed to the United States District Court for the District of Kansas, where the declaratory judgment action was filed.  On motion for summary judgment, Lloyds argued that there was not a sufficient factual nexus between the claimants in the Wahl Arbitration such that they could be considered interrelated, notwithstanding the fact that the claimants were part of the same lawsuit.  In a footnote, Lloyds argued that in the alternative, if the claims asserted in the Wahl Arbitration were found to have arisen from interrelated wrongful acts, then they would necessarily relate back to claims made in the Knotts Arbitration or the Colaner Arbitrations, and therefore excluded by the Lloyds policy.  The district court ruled against Lloyds on the number of retentions, but ordered briefing on Lloyds “relation back” theory.  BYA argued that the Wahl Arbitraiton did not relate back to the earlier claims, but that even if they did, Lloyds was precluded from taking this position based on the doctrines of waiver or estoppel.  The district court ruled against BYA on the issues of waiver and estoppel, but ultimately concluded that the three arbitrations were not interrelated for the purpose of the policy’s exclusion.

On appeal, the Tenth Circuit reasoned that the matters would be deemed interrelated if they shared a “sufficient factual nexus,” which is the standard articulated by New York courts in considering similar “interrelated wrongful act” provisions.  Applying this standard, the court found sufficient common facts to establish interrelatedness.  As the court explained:

Several common facts connect the Wahl, Knotts, and Colaner Arbitrations. All named as respondents BYA, B&G Financial Network, Gergel, and Snyder. Further, both the Wahl and Colaner arbitrations included claims against broker/agents Brandt and Farrar. All of the misconduct was alleged to have taken place during roughly the same time period-from the late 1990s to the mid 2000s. All claims allege the respondents sold unsuitable investment products including various types of annuities. Further, all claims involved allegations of churning or flipping of investment accounts in order to enrich the broker/agents at the expense of account holders. Finally, BYA's liability was predicated on theories of vicarious liability and failure to supervise its broker/agents in each of the claims.

The court concluded that the three arbitrations were connected by common facts, circumstances, decisions and policies such that they were “interrelated” for the purpose of the exclusion in the Lloyds policy.

The court, however, also concluded that Lloyds was potentially estopped from relying on the exclusion as a defense to coverage since it undertook BYA’s defense in the Wahl Arbitration with knowledge of the coverage defense, but only asserted the defense for the first time late in the coverage litigation.  The court agreed BYA was potentially prejudiced in the form of detrimental reliance as a result of Lloyd’s control of BYA’s defense without having properly reserved rights on the “relation back” coverage defense.  The Tenth Circuit, therefore, remanded the proceedings for further consideration of whether BYA detrimentally relied on Lloyds’ conduct, and if so, whether it was entitled to further recovery under the policy notwithstanding the otherwise applicable coverage defense.