Disgorge This: The Restitution Defense Meets the Duty to Defend

The restitution defense to insurance coverage proceeds from a simple and logical premise. If I steal money from you and am forced to return it, there is no loss for my insurer to reimburse because I never had a right to the money in the first place. I cannot insure against the risk of having to return stolen property. Life is rarely so simple, however, and insurers have asserted the restitution defense ' with varying degrees of success ' in a broad range of situations, some having little connection to the original premise. What if my payment to you includes both the money I stole and other items? What if I acquired your money innocently? What if I spent your money already and cannot repay it, so I assign to you my rights under the insurance policy? Or what if I exaggerated the value of my company's stock, which you then purchased from a third party without conferring a direct benefit on me?

The restitution defense declares that a claim for restitution or disgorgement is uninsurable as a matter of law. Nevertheless, the precise contours of the restitution defense remain unclear, in part, because of ambiguous terminology. Many courts articulate the defense as applying to the recovery of “ill-gotten gains” ' which could apply not only to stolen property, but also to personal injury caused by a corporation's unwillingness to incur the costs of adequate safety precautions. A merchant who exaggerates the quality or value of his products may be said to reap “ill-gotten gains.” The same could be true of an entrepreneur who “borrows” another's idea and develops it into a profitable enterprise. Plaintiffs typically allege that the defendant had a profit or cost-savings motive for his wrongful conduct, but that does not necessarily mean that the relief sought is restitutionary. Moreover, as difficult as it may be to determine whether a damages award represents the return of “ill-gotten gains” and for that reason is not subject to indemnification, that difficulty grows when determining whether the insurer owes a duty to defend or to reimburse defense costs associated with a claim for restitution.

A Defense Born of Dicta

Judge Richard A. Posner of the Seventh Circuit Court of Appeals is widely credited with popularizing the restitution defense in his opinion in Level 3 Communications, Inc. v. Federal Insurance Company, 272 F.3d 908 (7th Cir. 2001). The underlying claimants in Level 3 were shareholders of another corporation who had sold their shares to Level 3, allegedly based on Level 3's fraudulent statements. The shareholders wanted to rescind the transaction but, because their corporation no longer existed, they instead sought the true value of the shares they sold to Level 3 less the amount Level 3 paid for them. Level 3 agreed to settle the underlying case by paying the shareholders $11.8 million. Then the insurance coverage saga began.

Initially, the trial court held that the insured-versus-insured exclusion of the directors' and officers' liability (“D&O”) policy barred coverage altogether because one of the plaintiff-shareholders was also a director of a Level 3 subsidiary. In its first review of the case, the Seventh Circuit reversed that holding and determined that, “in the absence of other defenses,” Level 3 was entitled to coverage for the settlement amount except for the portion paid to the director-shareholder. Id. at 909. On remand, the trial court determined that the settlement was a “loss” under the policy, that the director-shareholder had received $1.8 million from the settlement, and that the policy covered the remaining $10 million.

In its second review of the case, the Seventh Circuit held that the settlement was not a covered “loss” at all because the policy's definition of that term could not be interpreted as including “the restoration of an ill-gotten gain.” Id. at 910. Judge Posner, writing for the court, noted that this holding made it unnecessary to consider the insurer's argument that even if the policy permitted coverage for restitution payments, such coverage would violate public policy. Nevertheless, Judge Posner went on to discuss the public policy argument in some detail.

Judge Posner found that the shareholders in the underlying suit were, in effect, seeking “to deprive the defendant of the net benefit of the unlawful act.” Id. at 911. The court accepted the insurer's analogy: “It's as if ' Level 3 had stolen cash from [the] shareholders and had been forced to return it and were now asking the insurance company to pick up the tab.” Id. at 910. The settlement was restitutionary not because of the measure of damages sought or the wording of the complaint or settlement, but rather because of the essential nature of the shareholders' claim. Id. at 910-11. In the most frequently quoted passage of the opinion, Judge Posner said:

An insured incurs no loss within the meaning of the insurance contract by being compelled to return property that it had stolen, even if a more polite word than “stolen” is used to characterize the claim for the property's return. Id. at 911.

Judge Posner also took pains to point out that the restitution defense would not render D&O policies illusory. He provided two examples of securities claims that would still be covered: 1) inflating the price of a corporation's stock through fraud, but “without conferring any measurable benefit on the corporation”; and 2) theft by a corporate officer that benefited the corporation without its knowledge, causing the corporation to incur hefty defense costs. Id. In Judge Posner's view,
“[t]hose expenses would be a loss to the company not offset by any benefit to it, unlike the 'expense' that consists simply of the value of the stolen property, a wash.” Id. As discussed below, this view ' that defense costs may constitute a covered loss, even if the underlying claim is for restitution ' has not always been followed.

Nothing But Restitution

Several cases involving the restitution defense have turned on whether the underlying claim, settlement, or judgment was entirely restitutionary. For example, the Ninth Circuit Court of Appeals reversed summary judgment for the insurers in two cases, finding that whether the underlying claim sought to recoup damages in excess of the policyholder's ill-gotten gains was an issue of fact. Unified Western Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106 (9th Cir. 2006); Pan Pacific Retail Properties, Inc. v. Gulf Ins. Co., 471 F.3d 961 (9th Cir. 2006). The policyholders in Unified Western Grocers were officers and directors accused of siphoning $8.5 million from a corporate subsidiary and misleading creditors about the subsidiary's financial condition. The subsidiary was sold to another entity and then sought bankruptcy protection, whereupon the bankruptcy trustee sued for $13.5 million in damages. Citing Level 3, the court noted that the distinction between insurable damages and non-insurable restitution cannot rest on the wording of the complaint. 457 F.3d at 1115. The court also rejected a test based on “whether the insured received 'some benefit' from a wrongful act[.]” Id. Rather, the court said, the question is whether the complaint “necessarily restrict[s] all potential recovery to restitution.” Id. The answer in this case was no, because the trustee sought damages in excess of the amounts allegedly siphoned to the officers and directors. Id. As a result, the court remanded the case to the trial court for a determination of “the extent [to which] the Underlying Complaint sought restitution of money wrongfully acquired by Unified.” Id. at 1116.

Four months later, the same panel of the Ninth Circuit Court of Appeals reached a similar conclusion in Pan Pacific, a case involving a shareholder suit seeking additional consideration for shares sold to an acquiring corporation, Pan Pacific, in a merger. The court had dismissed the derivative claims for additional consideration but allowed the shareholders' direct claims to go forward, including a fiduciary duty claim alleging failure to disclose material information before the merger. The parties then settled the underlying suit for approximately $1 million.

In the coverage action that followed, Pan Pacific submitted declarations by the attorneys on both sides of the settlement negotiations. The declarations stated that the dismissed claims for additional consideration ' in effect, seeking the return of improperly withheld funds ' were no longer viable, notwithstanding the possibility of a reversal on appeal. Id. at 968. Pan Pacific argued that the settlement was based not on the claims for additional consideration but rather on the direct claims for withholding information, under which the shareholders could have recovered the value of the information allegedly withheld from them before they agreed to sell their shares to Pan Pacific. Id. at 969. Nevertheless, the trial court relied on Level 3 and found that the settlement amount was “entirely restitutionary relief” and therefore uninsurable. Id. at 964.

The Court of Appeals reversed and remanded the case for a determination of whether any portion of the settlement was non-restitutionary in nature. The court explained, in somewhat confusing terms, that:

The insurance companies here were required to cover claims that sought compensation for a loss, even if the loss to the victim could also be construed as an ill-gotten benefit to the insured. ' In deciding whether a certain remedy is insurable, we must look beyond the labels of the asserted claims or remedies. ' An insurer is not required to provide coverage for claims seeking the return of something wrongfully received, but must still indemnify for claims that seek compensation for injury suffered as a result of the insured's conduct. Id. at 966-67 (citations omitted).

The Court of Appeals found that Pan Pacific had established “a genuine issue of fact as to whether the settlement contained nonrestitutionary amounts” reflecting Pan Pacific's “value of information” theory of damages. Id. at 969.

The Second Circuit Court of Appeals reached a similar result in McCostis v. Home Insurance Co. of Indiana, 31 F.3d 110 (2d Cir. 1994). McCostis was a lawyer and outside general counsel to Barr Laboratories, which engaged the firm of Winston & Strawn to perform legal services. McCostis and a Winston partner named Fox fraudulently overbilled Barr Labs and shared the proceeds of more than $750,000. Winston & Strawn repaid Barr Labs for the overbillings, and Barr assigned to Winston & Strawn the right to sue the two errant lawyers. Winston & Strawn did so, alleging that McCostis was jointly and severally liable for all of the overbillings. Home, McCostis' professional liability insurer, refused to defend him because the insurance policy excluded coverage for “the return of or restitution of legal fees.” Id. at 112. The court held that this exclusion was ambiguous as applied to McCostis, since he was being sued not just for the fees he received, but also for the fees that went to Fox. Arguably, the court noted, Winston & Strawn was seeking more than just restitution. Id. at 112-13.

The Effect of Assignment on the Restitution Defense

A policyholder who improperly acquires or retains someone else's money cannot keep the money at his insurer's expense. But some courts have upheld coverage if the policyholder assigns his insurance rights to the innocent victim, because depriving the victim of restitution does not promote the purpose of the restitution defense. For example, in Liss v. Federal Insurance Co., 2006 WL 2844468 (N.J. Super. A.D. Oct. 6, 2006), a fraud victim, Liss, sued the perpetrator of the fraud, Ilutzi. In June 2001, Liss also sued Ilutzi's D&O insurer, Federal, under a third-party beneficiary theory. In 2003, Federal argued for the first time that the Liss claim was for restitution and, therefore, under Level 3, it was uninsurable and outside the coverage of the policy. Ilutzi then settled the fraud claim by assigning his rights under the D&O policy to Liss. Id. at *4. The court held that, under New Jersey law, a public policy argument like the restitution defense does not defeat coverage that would benefit an innocent victim but not the wrongdoer. Id. at *7.

Innocent victims do not always succeed in obtaining the proceeds of the wrongdoer's insurance policy, however. In Grey v. Allstate Insurance Company, 769 A.2d 891 (Md. 2001), Smith, the policyholder, was drunk and drove his Jeep Cherokee into the Grey family car, killing one family member and seriously injuring two others. Smith pleaded guilty to manslaughter and agreed to pay $80,000 in restitution to the Greys. The criminal restitution order was recorded as a money judgment against Smith. The Greys tried to collect part of the restitution amount by attaching the proceeds of Smith's insurance policy. Discussing authorities dating back to the Code of Hammurabi, the Book of Exodus, and Roman law, the Maryland Court of Appeals examined the historical roots and development of the law of restitution and victim compensation. Id. at 895-99. Ultimately, the court held that the automobile liability policy did not cover the criminal restitution order. Any other result, according to the court, would “raise[ ] serious due process concerns” and upset “the reasonable expectations of the insurer and insured.” Id. at 903.

The New York Cases

New York is the country's largest financial center, so it is not surprising that New York courts have been asked to decide whether insurance covers regulatory settlements that arguably entailed restitution. New York Supreme Court Judge Karla Moskowitz has issued two decisions ' both involving investment banks and Vigilant Insurance Company ' that have sparked considerable litigation and debate over the “restitution” or “disgorgement” defense to coverage.

In Vigilant Insurance Company v. Credit Suisse First Boston Corp., 800 N.Y.S.2d 358, 2003 WL 24009803 (N.Y. Sup. 2003), Judge Moskowitz held that, for reasons of public policy, Vigilant's professional liability insurance policy did not cover a $70 million consent judgment with federal regulators. The regulators had alleged that Credit Suisse obtained excessive brokerage commissions by coercing favored customers ' those given access to “hot” initial public offerings ' to “flip” the IPO shares in the secondary market. The consent judgment recited that Credit Suisse did not admit any wrongdoing, but it also earmarked the settlement amount as “disgorgement of monies obtained improperly by CSFB as a result of the conduct alleged in the Complaint[.]” Id. at *4. Allowing Credit Suisse to recoup the disgorgement payment from its insurer, the judge found, would defeat the purpose of the disgorgement remedy ' i.e., the return of ill-gotten gains. This was so even though the Credit Suisse payment was made to regulators and not to the customers who paid the commissions. Id. Finally, noting that the insurers did not object to covering Credit Suisse's defense costs, Judge Moskowitz held that Credit Suisse was entitled to recover them under the policy. Id. at *5.

In a three-paragraph opinion, the Appellate Division affirmed Judge Moskowitz's ruling that the disgorgement payment was not a covered “loss” under the policy. 10 A.D.3d 528 (N.Y. App. Div. 2004). The final paragraph of the opinion, however, reversed Judge Moskowitz's ruling on defense costs. Without alluding to the insurers' apparent waiver of the issue in the trial court, the Appellate Division reasoned that:

(a) Defense costs are a component of “loss” under the policy; and

(b) The policy provides that “loss” cannot include “matters which are uninsurable” under applicable law ' such as the return of ill-gotten gains; and

(c) The policyholder must reimburse defense costs advanced by the insurer upon a finding that the policy did not cover such costs; therefore

(d) “[D]efense costs are only recoverable for covered claims.” Id. at 529.

The truncated nature of the Appellate Division's opinion could lend itself to an erroneously broad interpretation. Credit Suisse certainly stands for the proposition that, if a policy explicitly limits coverage to defense costs incurred in connection with a covered loss, and if none of the losses are covered, then the insurer need not pay or reimburse defense costs. But it would be a mistake to construe Credit Suisse as establishing a global rule against coverage for defense costs relating to a claim for restitution, regardless of the policy language. As Judge Posner noted in Level 3, defense costs are not themselves “ill-gotten gains” that are uninsurable as a matter of public policy.

Two and one-half years after issuing her opinion in Credit Suisse, Judge Moskowitz again presided over a coverage case in which Vigilant denied coverage to an investment bank for payments under a consent judgment with regulatory authorities. In Vigilant Insurance Company v. Bear Stearns Companies Inc., 814 N.Y.S.2d 566, 2006 WL 118368 (N.Y. Sup. 2006), Bear Stearns agreed to pay $80 million to settle a joint investigation by federal and state regulators into the activities of Bear Stearns research analysts and the potential conflicts of interest between the research analysis and investment banking units. The settlement funds were allocated to “disgorgement of commissions and other monies” ($25 million), penalties ($25 million), and funding for independent research ($25 million) and investor education ($5 million). Id. at *2. The consent judgment specified that the independent research and investor education funds would not be “considered disgorgement or restitution, and/or used for compensatory purposes.” Id.

Vigilant and the other insurers first argued that Bear Stearns had entered the consent judgment without the insurers' consent and that the investment banking exclusion barred coverage under the policies. Judge Moskowitz held that questions of fact precluded summary judgment on these issues, because Bear Stearns presented evidence that the settlement agreement was subject to further negotiation and court approval when Bear Stearns notified the insurers of it. Id. at *3. Second, the insurers argued that the disgorgement payment was uninsurable as a matter of public policy. The judge agreed, noting that “it is clear that Bear Stearns was disgorging money that it had obtained as the result of wrongful acts that the Complaint describes.” Id. at *5. Finally, the judge denied the insurers' request for summary judgment on the independent research and investor education components of the settlement, because the policy did not limit coverage to compensation for past injuries. Id. at *6.

The Appellate Division essentially agreed with Judge Moskowitz on every issue except disgorgement. In one short paragraph, the Appellate Division reversed Judge Moskowitz's ruling and held that Bear Stearns had raised “an issue of fact as to whether the portion of the settlement attributed to disgorgement actually represented ill-gotten gains or improperly acquired funds.” 824 N.Y.S.2d 91, 94 (N.Y. App. Div. 2006). The court noted that Bear Stearns had tendered evidence that the settlement amount allocated to “disgorgement of commissions” was, in fact, based on market share and not on the amount of commissions that Bear Stearns had improperly obtained. Id. The Appellate Division affirmed Judge Moskowitz's rulings on insurer consent, independent research, and investor education. The court also went further than Judge Moskowitz had and granted Bear Stearns a ruling it had not requested: summary judgment on the investment banking exclusion. Id. at 93-94. In the parlance of New York state courts, the Appellate Division “affirmed” Judge Moskowitz's ruling “as modified” with respect to the disgorgement and investment banking exclusion issues. Id. at 92-93.

Without reaching the disgorgement issue, the New York Court of Appeals reversed the lower court decisions on the issue of the insurers' lack of consent to the Bear Stearns settlement. 884 N.E.2d 1044, 1047 (N.Y. 2008). The Court of Appeals rejected the argument that the settlement with the regulators was not final ' and therefore did not require the insurers' approval ' because it remained subject to court approval when the insurers were notified. Id. at 1048. The court did not address Bear Stearns' evidence that the court could have, and did in fact, require the parties to renegotiate certain terms of the earlier settlement. Id.; see 2006 WL 118368 at *3. Because the court held that the lack of insurer consent vitiated any insurance coverage, it saw no need to address the disgorgement defense. 884 N.E.2d at 1047.

Fallout from the New York Cases

After the Appellate Division but before the Court of Appeals decided Bear Stearns, a federal district court in Florida relied extensively on Judge Moskowitz's original ruling in Bear Stearns and held that a shareholder class action settlement was neither insurable under New York law nor a “loss” under the D&O policies. CNL Hotels & Resorts, Inc. v. Houston Cas. Co., 505 F. Supp. 2d 1317, 1326 (M.D. Fla. 2007). The shareholders in the underlying case had alleged that CNL's misrepresentations and improper accounting practices violated the securities laws and inflated the price they paid for their stock. Id. at 1318. Some of the shareholders had purchased their stock directly from CNL, while others had purchased their stock from other shareholders in the secondary market. Id. at 1326. Without admitting liability, CNL agreed to establish a settlement fund of $35 million, $7 million of which the court awarded to the shareholders' lawyers. Id. at 1318, 1326 n.12. The settlement specifically stated that the $35 million did not represent “restitution or disgorgement.” 291 Fed. Appx. 220, 224 (11th Cir. 2008). Another portion of the settlement gave $5.5 million to a different class of shareholders to compensate them for the effects of a merger on allegedly unfair terms. Id. at 222.

Interestingly, the same trial judge that approved the settlement of the underlying shareholder class action in CNL also denied the policyholder insurance coverage for the settlement. 505 F. Supp. 2d at 1318. Relying primarily on Judge Moskowitz's decision in Bear Stearns and on the Level 3 decision, the CNL court recited the facts and conclusions of Bear Stearns in some detail ' including Judge Moskowitz's reliance
on the fact that the consent judgment identified $25 million of the settlement as “disgorgement” ' without mentioning that the Appellate Division had reversed Judge Moskowitz on this point. Id. at 1322-23. The CNL court also noted that the substance and not the form of the policyholder's payment is what determines whether it is restitutionary. Id. at 1325. Even though some of the shareholders had overpaid third parties in the secondary market rather than buying their stock directly from CNL, the trial court held that no portion of the $35 million settlement fund qualified as a “loss” under the policies, and the settlement was uninsurable as a matter of law. Id. at 1326.

When CNL moved to reconsider the trial court's decision and pointed out that Judge Moskowitz's disgorgement ruling had been reversed on appeal, the trial judge's response was scathing:

As should be obvious to any second-year law student, this Court relied on [Bear Stearns] for its specific legal point about insurability and disgorgement, not its specific factual point about the particular sums that Bear Stearns was purportedly disgorging. 2007 WL 1128965, *2 (Apr. 16, 2007) (emphasis in original).

The trial judge also asserted that the Appellate Division had “actually affirmed with modifications, rather than reversed” Judge Moskowitz's ruling in Bear Stearns. Id. at *2 n.4. Finally, the trial judge dismissed as “baseless” and “too lacking in merit to warrant discussion” CNL's argument that the underlying settlement agreement specified that the settlement amount was not disgorgement. The CNL court noted that the “agreement is not binding on non-parties, including the [insurers] and this Court” ' i.e., the court that approved the settlement. Id. at *3.

In an unpublished opinion, the Eleventh Circuit Court of Appeals affirmed the trial court's holding that the settlement amount was restitutionary, despite the contrary language of the settlement agreement. 291 Fed. Appx. at *2-3. The Court of Appeals did not mention the fact that some of the shareholders in the underlying action had purchased their stock in the secondary market and, thus, that CNL had received no direct benefit from the inflated stock price in those transactions.

The Duty to Defend Against Claims for Restitution

Many insurance policies promise to defend policyholders against all “claims,” even though indemnification against judgments or settlements may be limited to non-restitutionary amounts. In these circumstances, the insurer must provide a defense against claims seeking relief that is entirely excluded from coverage under the policy. The court in Doeren Mayhew & Co., P.C. v. CPA Mutual Insurance Co. of America Risk Retention Group, 2007 WL 2050826 (E.D. Mich. July 18, 2007), confronted this issue directly. Doeren Mayhew was an accounting firm that settled regulatory proceedings by agreeing to improve its auditing procedures and to disgorge certain auditing fees. Under the firm's professional liability policy, the insurer assumed the duty to defend “any Claim,” where “Claim” was defined as “a demand for money or services made in writing against the Insured[.]” Id. at *8. Doeren Mayhew acknowledged that the disgorged fees were excluded from coverage under the policy, but argued that “disgorgement is nonetheless 'money'” within the policy's definition of a “Claim.” As a result, the firm contended, the regulator's claim for disgorgement triggered the insurer's duty to defend. Id. at *7. The court agreed. Noting that the duty to defend is defined by the terms of the insurance policy, the court held that the insurer was required to defend against the disgorgement claim even though the disgorged fees themselves were not covered under the policy. Id. at *9-10.

Another recent decision reached the opposite conclusion. Judge Marcy S. Friedman of the New York Supreme Court recently held that a hedge fund could not recoup from its D&O insurer $10 million (the policy limit) of the $19 million the hedge fund spent in defending against investigations by federal and state regulators into fraudulent “market timing” activity. Millennium Partners, L.P. v. Select Ins. Co., 2009 WL 586127 (N.Y. Sup. Mar. 9, 2009). Market timing, a practice of frequent or late trading in mutual fund shares “in order to exploit inefficiencies in mutual fund pricing,” is not illegal per se, but regulators had accused Millennium of engaging in a fraudulent scheme to conceal its market timing trades. Id. at *2 n.1. Under consent orders with the regulators, Millennium agreed to undertake remedial measures and to pay “$148 million in disgorgement” as well as civil penalties. The orders noted that Millennium neither admitted nor denied the regulators' findings. Millennium also agreed not to seek insurance reimbursement of the “disgorgement” or penalty amounts. Id. at *2. Instead, Millennium sought insurance recovery for the amounts spent defending against the regulatory investigations.

The D&O policy defined “loss” to include defense costs that Millennium “shall become legally obligated to pay ' as a result of a Claim,” but the definition excludes “penalties ' or matters uninsurable under the law[.]” Id. at *1. A “Claim” is “any judicial or administrative proceeding ' against ' any Insured(s) for a Wrongful Act” that may subject Millennium to “a binding adjudication of liability for damages or other relief[.]” Id. Unlike the policy in Credit Suisse, Millennium's policy apparently did not require the policyholder to repay defense costs advanced by the insurer upon a finding that the underlying claim was not one for a covered “loss.” Given these policy provisions, Millennium's defense costs would appear to fall squarely within the meaning of “loss” under the policy.

Nevertheless, the Millennium court read Credit Suisse broadly for the proposition that defense costs relating to a disgorgement claim are just as uninsurable as the disgorged amount itself, regardless of the language of the policy:

The reasoning of [Credit Suisse] that disgorgement of improperly acquired funds is not a covered loss, and that defense costs in connection with a claim for disgorgement are therefore also not a covered loss is equally applicable here. Id. at *3.

The court also distinguished Bear Stearns on the ground that, in that case, the policyholder had tendered evidence that the settlement payment, despite its “disgorgement” label, had been based on market share rather than improperly obtained commissions. Millennium, in contrast, had proffered no evidence to substantiate its claim that the “disgorgement” label was a misnomer. Id. at *4.

Reconciling the Millennium holding with the terms of the insurance policy required two critical assumptions. First, the court ignored the broad definition of a “Claim,” which encompassed demands for relief other than damages. The consent orders required Millennium to undertake remedial measures that would seem to qualify as “other relief.” Second, the court concluded that defense costs are per se uninsurable if they are associated with any claim that ultimately results in the payment of restitution. This is a rather extraordinary outgrowth of the restitution defense, particularly considering its roots in Level 3 ' where the Seventh Circuit specifically identified defense costs as an insurable “loss to the company not offset by any benefit to it.” 272 F.3d at 911. Defense costs should not automatically become uninsurable just because a later settlement or judgment includes restitutionary relief.

Millennium also illustrates the importance of timing. By the time the court considered Millennium's claim for coverage of the defense costs, the settlements with regulators were final and included “disgorgement” language. Indeed, by the time of the coverage decision, Millennium had been required to disclose the consent orders in a SEC filing that described the orders as including disgorgement, “civil penalties and other relief.” 2009 WL 586127 at *4. The Millennium court relied on the “disgorgement” language in concluding that the related defense costs were not covered under the policy. But if the regulatory investigations into market timing had been ongoing at the time of the coverage decision, disgorgement would have been just one possible remedy among many. Under those circumstances, the coverage analysis for defense costs could very well have been different.

Conclusion

The restitution defense is still evolving, and the case law is far from uniform, particularly on the question of coverage for defense costs. The current climate of increased investigation and enforcement activity by government regulators will probably cause more and more companies to be investigated and sued over “ill-gotten gains.” That, in turn, will trigger requests for insurance coverage, inevitably prompting more insurers to invoke the restitution defense and more courts to construe it. The coming months and years will surely bring more case law and perhaps more clarity to the issue.

Patricia A. Bronte, a member of this newsletter's Board of Editors, practices civil rights and employment discrimination law at Stowell & Friedman, Ltd. in Chicago. She thanks her former colleagues at Jenner & Block LLP for their support in the preparation of this article.

The restitution defense to insurance coverage proceeds from a simple and logical premise. If I steal money from you and am forced to return it, there is no loss for my insurer to reimburse because I never had a right to the money in the first place. I cannot insure against the risk of having to return stolen property. Life is rarely so simple, however, and insurers have asserted the restitution defense ' with varying degrees of success ' in a broad range of situations, some having little connection to the original premise. What if my payment to you includes both the money I stole and other items? What if I acquired your money innocently? What if I spent your money already and cannot repay it, so I assign to you my rights under the insurance policy? Or what if I exaggerated the value of my company's stock, which you then purchased from a third party without conferring a direct benefit on me?

The restitution defense declares that a claim for restitution or disgorgement is uninsurable as a matter of law. Nevertheless, the precise contours of the restitution defense remain unclear, in part, because of ambiguous terminology. Many courts articulate the defense as applying to the recovery of “ill-gotten gains” ' which could apply not only to stolen property, but also to personal injury caused by a corporation's unwillingness to incur the costs of adequate safety precautions. A merchant who exaggerates the quality or value of his products may be said to reap “ill-gotten gains.” The same could be true of an entrepreneur who “borrows” another's idea and develops it into a profitable enterprise. Plaintiffs typically allege that the defendant had a profit or cost-savings motive for his wrongful conduct, but that does not necessarily mean that the relief sought is restitutionary. Moreover, as difficult as it may be to determine whether a damages award represents the return of “ill-gotten gains” and for that reason is not subject to indemnification, that difficulty grows when determining whether the insurer owes a duty to defend or to reimburse defense costs associated with a claim for restitution.

A Defense Born of Dicta

Judge Richard A. Posner of the Seventh Circuit Court of Appeals is widely credited with popularizing the restitution defense in his opinion in Level 3 Communications, Inc. v. Federal Insurance Company , 272 F.3d 908 (7th Cir. 2001). The underlying claimants in Level 3 were shareholders of another corporation who had sold their shares to Level 3, allegedly based on Level 3's fraudulent statements. The shareholders wanted to rescind the transaction but, because their corporation no longer existed, they instead sought the true value of the shares they sold to Level 3 less the amount Level 3 paid for them. Level 3 agreed to settle the underlying case by paying the shareholders $11.8 million. Then the insurance coverage saga began.

Initially, the trial court held that the insured-versus-insured exclusion of the directors' and officers' liability (“D&O”) policy barred coverage altogether because one of the plaintiff-shareholders was also a director of a Level 3 subsidiary. In its first review of the case, the Seventh Circuit reversed that holding and determined that, “in the absence of other defenses,” Level 3 was entitled to coverage for the settlement amount except for the portion paid to the director-shareholder. Id. at 909. On remand, the trial court determined that the settlement was a “loss” under the policy, that the director-shareholder had received $1.8 million from the settlement, and that the policy covered the remaining $10 million.

In its second review of the case, the Seventh Circuit held that the settlement was not a covered “loss” at all because the policy's definition of that term could not be interpreted as including “the restoration of an ill-gotten gain.” Id. at 910. Judge Posner, writing for the court, noted that this holding made it unnecessary to consider the insurer's argument that even if the policy permitted coverage for restitution payments, such coverage would violate public policy. Nevertheless, Judge Posner went on to discuss the public policy argument in some detail.

Judge Posner found that the shareholders in the underlying suit were, in effect, seeking “to deprive the defendant of the net benefit of the unlawful act.” Id. at 911. The court accepted the insurer's analogy: “It's as if ' Level 3 had stolen cash from [the] shareholders and had been forced to return it and were now asking the insurance company to pick up the tab.” Id. at 910. The settlement was restitutionary not because of the measure of damages sought or the wording of the complaint or settlement, but rather because of the essential nature of the shareholders' claim. Id. at 910-11. In the most frequently quoted passage of the opinion, Judge Posner said:

An insured incurs no loss within the meaning of the insurance contract by being compelled to return property that it had stolen, even if a more polite word than “stolen” is used to characterize the claim for the property's return. Id. at 911.

Judge Posner also took pains to point out that the restitution defense would not render D&O policies illusory. He provided two examples of securities claims that would still be covered: 1) inflating the price of a corporation's stock through fraud, but “without conferring any measurable benefit on the corporation”; and 2) theft by a corporate officer that benefited the corporation without its knowledge, causing the corporation to incur hefty defense costs. Id. In Judge Posner's view,
“[t]hose expenses would be a loss to the company not offset by any benefit to it, unlike the 'expense' that consists simply of the value of the stolen property, a wash.” Id. As discussed below, this view ' that defense costs may constitute a covered loss, even if the underlying claim is for restitution ' has not always been followed.

Nothing But Restitution

Several cases involving the restitution defense have turned on whether the underlying claim, settlement, or judgment was entirely restitutionary. For example, the Ninth Circuit Court of Appeals reversed summary judgment for the insurers in two cases, finding that whether the underlying claim sought to recoup damages in excess of the policyholder's ill-gotten gains was an issue of fact. Unified Western Grocers, Inc. v. Twin City Fire Ins. Co. , 457 F.3d 1106 (9th Cir. 2006); Pan Pacific Retail Properties, Inc. v. Gulf Ins. Co. , 471 F.3d 961 (9th Cir. 2006). The policyholders in Unified Western Grocers were officers and directors accused of siphoning $8.5 million from a corporate subsidiary and misleading creditors about the subsidiary's financial condition. The subsidiary was sold to another entity and then sought bankruptcy protection, whereupon the bankruptcy trustee sued for $13.5 million in damages. Citing Level 3, the court noted that the distinction between insurable damages and non-insurable restitution cannot rest on the wording of the complaint. 457 F.3d at 1115. The court also rejected a test based on “whether the insured received 'some benefit' from a wrongful act[.]” Id. Rather, the court said, the question is whether the complaint “necessarily restrict[s] all potential recovery to restitution.” Id. The answer in this case was no, because the trustee sought damages in excess of the amounts allegedly siphoned to the officers and directors. Id. As a result, the court remanded the case to the trial court for a determination of “the extent [to which] the Underlying Complaint sought restitution of money wrongfully acquired by Unified.” Id. at 1116.

Four months later, the same panel of the Ninth Circuit Court of Appeals reached a similar conclusion in Pan Pacific, a case involving a shareholder suit seeking additional consideration for shares sold to an acquiring corporation, Pan Pacific, in a merger. The court had dismissed the derivative claims for additional consideration but allowed the shareholders' direct claims to go forward, including a fiduciary duty claim alleging failure to disclose material information before the merger. The parties then settled the underlying suit for approximately $1 million.

In the coverage action that followed, Pan Pacific submitted declarations by the attorneys on both sides of the settlement negotiations. The declarations stated that the dismissed claims for additional consideration ' in effect, seeking the return of improperly withheld funds ' were no longer viable, notwithstanding the possibility of a reversal on appeal. Id. at 968. Pan Pacific argued that the settlement was based not on the claims for additional consideration but rather on the direct claims for withholding information, under which the shareholders could have recovered the value of the information allegedly withheld from them before they agreed to sell their shares to Pan Pacific. Id. at 969. Nevertheless, the trial court relied on Level 3 and found that the settlement amount was “entirely restitutionary relief” and therefore uninsurable. Id. at 964.

The Court of Appeals reversed and remanded the case for a determination of whether any portion of the settlement was non-restitutionary in nature. The court explained, in somewhat confusing terms, that:

The insurance companies here were required to cover claims that sought compensation for a loss, even if the loss to the victim could also be construed as an ill-gotten benefit to the insured. ' In deciding whether a certain remedy is insurable, we must look beyond the labels of the asserted claims or remedies. ' An insurer is not required to provide coverage for claims seeking the return of something wrongfully received, but must still indemnify for claims that seek compensation for injury suffered as a result of the insured's conduct. Id. at 966-67 (citations omitted).

The Court of Appeals found that Pan Pacific had established “a genuine issue of fact as to whether the settlement contained nonrestitutionary amounts” reflecting Pan Pacific's “value of information” theory of damages. Id. at 969.

The Second Circuit Court of Appeals reached a similar result in McCostis v. Home Insurance Co. of Indiana , 31 F.3d 110 (2d Cir. 1994). McCostis was a lawyer and outside general counsel to Barr Laboratories, which engaged the firm of Winston & Strawn to perform legal services. McCostis and a Winston partner named Fox fraudulently overbilled Barr Labs and shared the proceeds of more than $750,000. Winston & Strawn repaid Barr Labs for the overbillings, and Barr assigned to Winston & Strawn the right to sue the two errant lawyers. Winston & Strawn did so, alleging that McCostis was jointly and severally liable for all of the overbillings. Home, McCostis' professional liability insurer, refused to defend him because the insurance policy excluded coverage for “the return of or restitution of legal fees.” Id. at 112. The court held that this exclusion was ambiguous as applied to McCostis, since he was being sued not just for the fees he received, but also for the fees that went to Fox. Arguably, the court noted, Winston & Strawn was seeking more than just restitution. Id. at 112-13.

The Effect of Assignment on the Restitution Defense

A policyholder who improperly acquires or retains someone else's money cannot keep the money at his insurer's expense. But some courts have upheld coverage if the policyholder assigns his insurance rights to the innocent victim, because depriving the victim of restitution does not promote the purpose of the restitution defense. For example, in Liss v. Federal Insurance Co., 2006 WL 2844468 (N.J. Super. A.D. Oct. 6, 2006), a fraud victim, Liss, sued the perpetrator of the fraud, Ilutzi. In June 2001, Liss also sued Ilutzi's D&O insurer, Federal, under a third-party beneficiary theory. In 2003, Federal argued for the first time that the Liss claim was for restitution and, therefore, under Level 3, it was uninsurable and outside the coverage of the policy. Ilutzi then settled the fraud claim by assigning his rights under the D&O policy to Liss. Id. at *4. The court held that, under New Jersey law, a public policy argument like the restitution defense does not defeat coverage that would benefit an innocent victim but not the wrongdoer. Id. at *7.

Innocent victims do not always succeed in obtaining the proceeds of the wrongdoer's insurance policy, however. In Grey v. Allstate Insurance Company , 769 A.2d 891 (Md. 2001), Smith, the policyholder, was drunk and drove his Jeep Cherokee into the Grey family car, killing one family member and seriously injuring two others. Smith pleaded guilty to manslaughter and agreed to pay $80,000 in restitution to the Greys. The criminal restitution order was recorded as a money judgment against Smith. The Greys tried to collect part of the restitution amount by attaching the proceeds of Smith's insurance policy. Discussing authorities dating back to the Code of Hammurabi, the Book of Exodus, and Roman law, the Maryland Court of Appeals examined the historical roots and development of the law of restitution and victim compensation. Id. at 895-99. Ultimately, the court held that the automobile liability policy did not cover the criminal restitution order. Any other result, according to the court, would “raise[ ] serious due process concerns” and upset “the reasonable expectations of the insurer and insured.” Id. at 903.

The New York Cases

New York is the country's largest financial center, so it is not surprising that New York courts have been asked to decide whether insurance covers regulatory settlements that arguably entailed restitution. New York Supreme Court Judge Karla Moskowitz has issued two decisions ' both involving investment banks and Vigilant Insurance Company ' that have sparked considerable litigation and debate over the “restitution” or “disgorgement” defense to coverage.

In Vigilant Insurance Company v. Credit Suisse First Boston Corp. , 800 N.Y.S.2d 358, 2003 WL 24009803 (N.Y. Sup. 2003), Judge Moskowitz held that, for reasons of public policy, Vigilant's professional liability insurance policy did not cover a $70 million consent judgment with federal regulators. The regulators had alleged that Credit Suisse obtained excessive brokerage commissions by coercing favored customers ' those given access to “hot” initial public offerings ' to “flip” the IPO shares in the secondary market. The consent judgment recited that Credit Suisse did not admit any wrongdoing, but it also earmarked the settlement amount as “disgorgement of monies obtained improperly by CSFB as a result of the conduct alleged in the Complaint[.]” Id. at *4. Allowing Credit Suisse to recoup the disgorgement payment from its insurer, the judge found, would defeat the purpose of the disgorgement remedy ' i.e., the return of ill-gotten gains. This was so even though the Credit Suisse payment was made to regulators and not to the customers who paid the commissions. Id. Finally, noting that the insurers did not object to covering Credit Suisse's defense costs, Judge Moskowitz held that Credit Suisse was entitled to recover them under the policy. Id. at *5.

In a three-paragraph opinion, the Appellate Division affirmed Judge Moskowitz's ruling that the disgorgement payment was not a covered “loss” under the policy. 10 A.D.3d 528 (N.Y. App. Div. 2004). The final paragraph of the opinion, however, reversed Judge Moskowitz's ruling on defense costs. Without alluding to the insurers' apparent waiver of the issue in the trial court, the Appellate Division reasoned that:

(a) Defense costs are a component of “loss” under the policy; and

(b) The policy provides that “loss” cannot include “matters which are uninsurable” under applicable law ' such as the return of ill-gotten gains; and

(c) The policyholder must reimburse defense costs advanced by the insurer upon a finding that the policy did not cover such costs; therefore

(d) “[D]efense costs are only recoverable for covered claims.” Id. at 529.

The truncated nature of the Appellate Division's opinion could lend itself to an erroneously broad interpretation. Credit Suisse certainly stands for the proposition that, if a policy explicitly limits coverage to defense costs incurred in connection with a covered loss, and if none of the losses are covered, then the insurer need not pay or reimburse defense costs. But it would be a mistake to construe Credit Suisse as establishing a global rule against coverage for defense costs relating to a claim for restitution, regardless of the policy language. As Judge Posner noted in Level 3, defense costs are not themselves “ill-gotten gains” that are uninsurable as a matter of public policy.

Two and one-half years after issuing her opinion in Credit Suisse, Judge Moskowitz again presided over a coverage case in which Vigilant denied coverage to an investment bank for payments under a consent judgment with regulatory authorities. In Vigilant Insurance Company v. Bear Stearns Companies Inc. , 814 N.Y.S.2d 566, 2006 WL 118368 (N.Y. Sup. 2006), Bear Stearns agreed to pay $80 million to settle a joint investigation by federal and state regulators into the activities of Bear Stearns research analysts and the potential conflicts of interest between the research analysis and investment banking units. The settlement funds were allocated to “disgorgement of commissions and other monies” ($25 million), penalties ($25 million), and funding for independent research ($25 million) and investor education ($5 million). Id. at *2. The consent judgment specified that the independent research and investor education funds would not be “considered disgorgement or restitution, and/or used for compensatory purposes.” Id.

Vigilant and the other insurers first argued that Bear Stearns had entered the consent judgment without the insurers' consent and that the investment banking exclusion barred coverage under the policies. Judge Moskowitz held that questions of fact precluded summary judgment on these issues, because Bear Stearns presented evidence that the settlement agreement was subject to further negotiation and court approval when Bear Stearns notified the insurers of it. Id. at *3. Second, the insurers argued that the disgorgement payment was uninsurable as a matter of public policy. The judge agreed, noting that “it is clear that Bear Stearns was disgorging money that it had obtained as the result of wrongful acts that the Complaint describes.” Id. at *5. Finally, the judge denied the insurers' request for summary judgment on the independent research and investor education components of the settlement, because the policy did not limit coverage to compensation for past injuries. Id. at *6.

The Appellate Division essentially agreed with Judge Moskowitz on every issue except disgorgement. In one short paragraph, the Appellate Division reversed Judge Moskowitz's ruling and held that Bear Stearns had raised “an issue of fact as to whether the portion of the settlement attributed to disgorgement actually represented ill-gotten gains or improperly acquired funds.” 824 N.Y.S.2d 91, 94 (N.Y. App. Div. 2006). The court noted that Bear Stearns had tendered evidence that the settlement amount allocated to “disgorgement of commissions” was, in fact, based on market share and not on the amount of commissions that Bear Stearns had improperly obtained. Id. The Appellate Division affirmed Judge Moskowitz's rulings on insurer consent, independent research, and investor education. The court also went further than Judge Moskowitz had and granted Bear Stearns a ruling it had not requested: summary judgment on the investment banking exclusion. Id. at 93-94. In the parlance of New York state courts, the Appellate Division “affirmed” Judge Moskowitz's ruling “as modified” with respect to the disgorgement and investment banking exclusion issues. Id. at 92-93.

Without reaching the disgorgement issue, the New York Court of Appeals reversed the lower court decisions on the issue of the insurers' lack of consent to the Bear Stearns settlement. 884 N.E.2d 1044, 1047 (N.Y. 2008). The Court of Appeals rejected the argument that the settlement with the regulators was not final ' and therefore did not require the insurers' approval ' because it remained subject to court approval when the insurers were notified. Id. at 1048. The court did not address Bear Stearns' evidence that the court could have, and did in fact, require the parties to renegotiate certain terms of the earlier settlement. Id.; see 2006 WL 118368 at *3. Because the court held that the lack of insurer consent vitiated any insurance coverage, it saw no need to address the disgorgement defense. 884 N.E.2d at 1047.

Fallout from the New York Cases

After the Appellate Division but before the Court of Appeals decided Bear Stearns, a federal district court in Florida relied extensively on Judge Moskowitz's original ruling in Bear Stearns and held that a shareholder class action settlement was neither insurable under New York law nor a “loss” under the D&O policies. CNL Hotels & Resorts, Inc. v. Houston Cas. Co. , 505 F. Supp. 2d 1317, 1326 (M.D. Fla. 2007). The shareholders in the underlying case had alleged that CNL's misrepresentations and improper accounting practices violated the securities laws and inflated the price they paid for their stock. Id. at 1318. Some of the shareholders had purchased their stock directly from CNL, while others had purchased their stock from other shareholders in the secondary market. Id. at 1326. Without admitting liability, CNL agreed to establish a settlement fund of $35 million, $7 million of which the court awarded to the shareholders' lawyers. Id. at 1318, 1326 n.12. The settlement specifically stated that the $35 million did not represent “restitution or disgorgement.” 291 Fed. Appx. 220, 224 (11th Cir. 2008). Another portion of the settlement gave $5.5 million to a different class of shareholders to compensate them for the effects of a merger on allegedly unfair terms. Id. at 222.

Interestingly, the same trial judge that approved the settlement of the underlying shareholder class action in CNL also denied the policyholder insurance coverage for the settlement. 505 F. Supp. 2d at 1318. Relying primarily on Judge Moskowitz's decision in Bear Stearns and on the Level 3 decision, the CNL court recited the facts and conclusions of Bear Stearns in some detail ' including Judge Moskowitz's reliance
on the fact that the consent judgment identified $25 million of the settlement as “disgorgement” ' without mentioning that the Appellate Division had reversed Judge Moskowitz on this point. Id. at 1322-23. The CNL court also noted that the substance and not the form of the policyholder's payment is what determines whether it is restitutionary. Id. at 1325. Even though some of the shareholders had overpaid third parties in the secondary market rather than buying their stock directly from CNL, the trial court held that no portion of the $35 million settlement fund qualified as a “loss” under the policies, and the settlement was uninsurable as a matter of law. Id. at 1326.

When CNL moved to reconsider the trial court's decision and pointed out that Judge Moskowitz's disgorgement ruling had been reversed on appeal, the trial judge's response was scathing:

As should be obvious to any second-year law student, this Court relied on [Bear Stearns] for its specific legal point about insurability and disgorgement, not its specific factual point about the particular sums that Bear Stearns was purportedly disgorging. 2007 WL 1128965, *2 (Apr. 16, 2007) (emphasis in original).

The trial judge also asserted that the Appellate Division had “actually affirmed with modifications, rather than reversed” Judge Moskowitz's ruling in Bear Stearns. Id. at *2 n.4. Finally, the trial judge dismissed as “baseless” and “too lacking in merit to warrant discussion” CNL's argument that the underlying settlement agreement specified that the settlement amount was not disgorgement. The CNL court noted that the “agreement is not binding on non-parties, including the [insurers] and this Court” ' i.e., the court that approved the settlement. Id. at *3.

In an unpublished opinion, the Eleventh Circuit Court of Appeals affirmed the trial court's holding that the settlement amount was restitutionary, despite the contrary language of the settlement agreement. 291 Fed. Appx. at *2-3. The Court of Appeals did not mention the fact that some of the shareholders in the underlying action had purchased their stock in the secondary market and, thus, that CNL had received no direct benefit from the inflated stock price in those transactions.

The Duty to Defend Against Claims for Restitution

Many insurance policies promise to defend policyholders against all “claims,” even though indemnification against judgments or settlements may be limited to non-restitutionary amounts. In these circumstances, the insurer must provide a defense against claims seeking relief that is entirely excluded from coverage under the policy. The court in Doeren Mayhew & Co., P.C. v. CPA Mutual Insurance Co. of America Risk Retention Group, 2007 WL 2050826 (E.D. Mich. July 18, 2007), confronted this issue directly. Doeren Mayhew was an accounting firm that settled regulatory proceedings by agreeing to improve its auditing procedures and to disgorge certain auditing fees. Under the firm's professional liability policy, the insurer assumed the duty to defend “any Claim,” where “Claim” was defined as “a demand for money or services made in writing against the Insured[.]” Id. at *8. Doeren Mayhew acknowledged that the disgorged fees were excluded from coverage under the policy, but argued that “disgorgement is nonetheless 'money'” within the policy's definition of a “Claim.” As a result, the firm contended, the regulator's claim for disgorgement triggered the insurer's duty to defend. Id. at *7. The court agreed. Noting that the duty to defend is defined by the terms of the insurance policy, the court held that the insurer was required to defend against the disgorgement claim even though the disgorged fees themselves were not covered under the policy. Id. at *9-10.

Another recent decision reached the opposite conclusion. Judge Marcy S. Friedman of the New York Supreme Court recently held that a hedge fund could not recoup from its D&O insurer $10 million (the policy limit) of the $19 million the hedge fund spent in defending against investigations by federal and state regulators into fraudulent “market timing” activity. Millennium Partners, L.P. v. Select Ins. Co., 2009 WL 586127 (N.Y. Sup. Mar. 9, 2009). Market timing, a practice of frequent or late trading in mutual fund shares “in order to exploit inefficiencies in mutual fund pricing,” is not illegal per se, but regulators had accused Millennium of engaging in a fraudulent scheme to conceal its market timing trades. Id. at *2 n.1. Under consent orders with the regulators, Millennium agreed to undertake remedial measures and to pay “$148 million in disgorgement” as well as civil penalties. The orders noted that Millennium neither admitted nor denied the regulators' findings. Millennium also agreed not to seek insurance reimbursement of the “disgorgement” or penalty amounts. Id. at *2. Instead, Millennium sought insurance recovery for the amounts spent defending against the regulatory investigations.

The D&O policy defined “loss” to include defense costs that Millennium “shall become legally obligated to pay ' as a result of a Claim,” but the definition excludes “penalties ' or matters uninsurable under the law[.]” Id. at *1. A “Claim” is “any judicial or administrative proceeding ' against ' any Insured(s) for a Wrongful Act” that may subject Millennium to “a binding adjudication of liability for damages or other relief[.]” Id. Unlike the policy in Credit Suisse, Millennium's policy apparently did not require the policyholder to repay defense costs advanced by the insurer upon a finding that the underlying claim was not one for a covered “loss.” Given these policy provisions, Millennium's defense costs would appear to fall squarely within the meaning of “loss” under the policy.

Nevertheless, the Millennium court read Credit Suisse broadly for the proposition that defense costs relating to a disgorgement claim are just as uninsurable as the disgorged amount itself, regardless of the language of the policy:

The reasoning of [Credit Suisse] that disgorgement of improperly acquired funds is not a covered loss, and that defense costs in connection with a claim for disgorgement are therefore also not a covered loss is equally applicable here. Id. at *3.

The court also distinguished Bear Stearns on the ground that, in that case, the policyholder had tendered evidence that the settlement payment, despite its “disgorgement” label, had been based on market share rather than improperly obtained commissions. Millennium, in contrast, had proffered no evidence to substantiate its claim that the “disgorgement” label was a misnomer. Id. at *4.

Reconciling the Millennium holding with the terms of the insurance policy required two critical assumptions. First, the court ignored the broad definition of a “Claim,” which encompassed demands for relief other than damages. The consent orders required Millennium to undertake remedial measures that would seem to qualify as “other relief.” Second, the court concluded that defense costs are per se uninsurable if they are associated with any claim that ultimately results in the payment of restitution. This is a rather extraordinary outgrowth of the restitution defense, particularly considering its roots in Level 3 ' where the Seventh Circuit specifically identified defense costs as an insurable “loss to the company not offset by any benefit to it.” 272 F.3d at 911. Defense costs should not automatically become uninsurable just because a later settlement or judgment includes restitutionary relief.

Millennium also illustrates the importance of timing. By the time the court considered Millennium's claim for coverage of the defense costs, the settlements with regulators were final and included “disgorgement” language. Indeed, by the time of the coverage decision, Millennium had been required to disclose the consent orders in a SEC filing that described the orders as including disgorgement, “civil penalties and other relief.” 2009 WL 586127 at *4. The Millennium court relied on the “disgorgement” language in concluding that the related defense costs were not covered under the policy. But if the regulatory investigations into market timing had been ongoing at the time of the coverage decision, disgorgement would have been just one possible remedy among many. Under those circumstances, the coverage analysis for defense costs could very well have been different.

Conclusion

The restitution defense is still evolving, and the case law is far from uniform, particularly on the question of coverage for defense costs. The current climate of increased investigation and enforcement activity by government regulators will probably cause more and more companies to be investigated and sued over “ill-gotten gains.” That, in turn, will trigger requests for insurance coverage, inevitably prompting more insurers to invoke the restitution defense and more courts to construe it. The coming months and years will surely bring more case law and perhaps more clarity to the issue.

Patricia A. Bronte, a member of this newsletter's Board of Editors, practices civil rights and employment discrimination law at Stowell & Friedman, Ltd. in Chicago. She thanks her former colleagues at Jenner & Block LLP for their support in the preparation of this article.