(Article from Insurance Law Alert, July/August 2016)
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A Texas federal district court ruled that a commercial crime policy does not cover losses arising out of a Ponzi scheme because the policyholder did not “own” the funds for which it sought indemnification. Cooper Indus., Ltd. v. National Union Fire Ins. Co. of Pittsburgh, PA, 2016 WL 3405295 (S.D. Tex. June 21, 2016).
Cooper invested approximately $175 million in Westridge Capital Management, a registered investment advisor. Unbeknownst to Cooper, Westridge was part of a Ponzi scheme orchestrated by individuals who owned a controlling share of Westridge, as well as two other related entities (WGTC, a registered broker-dealer, and WGTI, an unregulated entity utilized to facilitate investments into WGTC). Before the scheme was discovered, Cooper recouped its investment plus earnings in Westridge’s equity fund. However, Cooper did not redeem its investment in Westridge’s bond fund. After the fraudulent activity was discovered, a receiver appointed to protect investors’ interests initiated a claw back action against Cooper to recover its earnings from the equity fund investment. Cooper ultimately settled with the receiver, and then sought coverage from National Union for lost investments, earnings and interest. National Union denied coverage, and Cooper brought suit, claiming losses of nearly $20 million.
The court ruled that the policy did not provide coverage because Cooper did not “own” the funds it lost and the policy limited coverage to property “[t]hat you own or lease.” National Union argued that Cooper did not own the funds because it did not invest directly in Westridge. Rather, Cooper loaned money to WGTI via promissory note, and WGTI then invested that money in WGTC. National Union argued that once Cooper loaned the money to WGTI, it no longer had an ownership interest in the property. The court agreed. The court explained that because both entities were limited liability partnerships, Cooper held, at most, a limited partnership interest in those entities, which under Delaware law, does not confer ownership in the underlying property. A Minnesota court reached the same conclusion in a coverage dispute arising out of the same Ponzi scheme. See 3M Co. v. National Union Fire Ins. Co. of Pittsburgh, PA, 2015 WL 5687879 (D. Minn. Sept. 28, 2015) (discussed in our October 2015 Alert).
Although the ownership issue was outcome-determinative, the court also addressed the availability of coverage for the lost earnings. The court held that “[t]o the extent that some of that money was Cooper’s legitimate earnings, Cooper would be entitled to compensation under the Policy.” The court rejected National Union’s argument that Cooper was not entitled to compensation because it was a “net winner” overall in its investments. The court reasoned that the policy insured Cooper against theft regardless of whether it was theft of principal or earnings. The court distinguished
Horowitz v. Am. Int’l Grp., Inc., 2010 WL 3825737 (S.D.N.Y. Sept. 30, 2010),
aff’d, 498 Fed. Appx. 51 (2d Cir. 2012) (discussed in our
November 2010 Alert), which held that lost profits in the Madoff Ponzi scheme were fictitious and non-compensable, reasoning that Horowitz involved a “pure Ponzi scheme . . . in which there were no actual investments or earnings of any kind.” Here, Westridge generated over $580 million in profits via legitimate trading strategies, notwithstanding the theft of funds.