A “dishonest acts” exclusion clause in its liability policies does not exempt insurers from covering a $250 million settlement reached between the Securities and Exchange Commission and a J.P. Morgan subsidiary, a Manhattan state judge ruled.

In J.P. Morgan Securities v. Vigilant Insurance, 600979/2009, Justice Charles Ramos (See Profile) held that a clause preventing coverage for “any deliberate, dishonest, fraudulent or criminal act or omission” established by a “judgment or other final adjudication” would not apply because the SEC settlement order did not constitute a judgment.

“Exclusionary provisions are generally accorded a strict and narrow construction, and an insurer bears the burden of establishing that the exclusion applies in a particular case,” Ramos held in his Feb. 28 decision dismissing the insurers’ affirmative defenses.

The case arises from a 2006 settlement between Bear Stearns, which J.P. Morgan acquired in 2008, and the SEC in which the company agreed to pay $160 million in disgorgement and $90 million in civil penalties to settle accusations that it helped clients engage in late trading and deceptive market timing between 1999 and 2003.

Without admitting or denying the findings, Bear Stearns agreed, pursuant to the SEC order, to waive all defenses and never dispute the factual findings, including post-hearing procedures and judicial review by any court.

The financial services firm consented to similar findings by the New York Stock Exchange and also agreed to pay $14 million to settle 13 civil class action lawsuits arising from related allegations.

When Bear Stearns sought coverage under a $200 million professional liability policy, the insurers refused to pay, arguing that disgorgement payments from ill-gotten gains are not insurable as a matter of law. Bear Stearns’ primary policy was with Vigilant Insurance and its excess liability insurers were Travelers Indemnity Co., Federal Insurance, National Union Fire Insurance Co., Liberty Mutual, Certain Underwriters at Lloyd’s London and American Alternative Insurance.

In 2009, J.P. Morgan filed suit, seeking indemnification for the loss.

Ramos’ most recent ruling marks the second time in the five-year-old case in which the judge has rejected the insurers’ attempts to dismiss J.P. Morgan’s claims. In 2010, the judge declined to dismiss the suit, stating that the SEC consent order “does not contain an explicit finding that Bears Stearns directly obtained ill-gotten gains or profited by facilitating these trading practices.”

A year later, a unanimous panel of the Appellate Division, First Department, reversed Ramos, stating that for public policy reasons and to preserve the “deterrent effect of a disgorgement action,” Bear Stearns could not receive coverage for these payments.

In June 2013, the Court of Appeals reversed the First Department, stating that there was sufficient question as to whether the payment actually represented disgorgement of Bear Stearns’ own profits to preclude dismissal of the claims.

In his most recent ruling on partial summary judgment motions from both sides, Ramos held that the policy’s “Dishonest Acts Exclusion” did not warrant dismissal because the SEC consent order was “the product of a settlement between Bear Stearns, the SEC and the NYSE” rather than any adjudication.

“The factual findings were neither admitted or denied except as to the SEC’s jurisdiction and the subject matter of the proceedings, and were not the subject of hearings or rulings on the merits by a trier of fact,” Ramos stated.

“To infer, as the Insurers urge, that the term ‘final adjudication’ encompasses settlement of an administrative order, is to expand its reasonable interpretation beyond what is permitted under New York law,” he continued.

Ramos’ decision cited National Union Fire Insurance Co. of Pittsburgh v. Xerox Corp., 6 Misc. 3d 763, in which the First Department affirmed a ruling rejecting a similar argument based on a fraud coverage exclusion arising from Xerox’s settlement with the SEC over alleged financial misstatements.

In that case, the First Department held that a consent judgment between a federal agency and company is “not the result of an actual adjudication of any of the issues” and “cannot be used as evidence in subsequent litigation between that corporation and another party.”

J.P. Morgan is represented by partner John Gross of Proskauer Rose. Vigilant Insurance is represented by Joseph Finnerty III of DLA Piper. Gross did not return a message seeking comment. Finnerty declined to comment on the ruling.