Insurance Agent Should not Sell Unregistered Securities

William Saoud sells insurance-related products. Beginning in 2017, he offered some of his clients a new financial instrument: a Memorandum of Indebtedness issued by 1 Global Capital, LLC. The investment opportunity was too good to be true.

William Saoud, Patricia Boland- Saoud, and Bill Saoud Financial, LLC v. Everest Indemnity Insurance Company, No. 21-1621, United States Court of Appeals, Sixth Circuit (July 14, 2022)

FACTS

Global Capital declared bankruptcy, and the SEC sued the company for alleged violations of the Securities and Exchange Act. Saoud’s clients also sued him. Saoud sought indemnification from his insurer, Everest Indemnity Insurance Company, and ultimately sued seeking a declaratory judgment and breach of contract. The district court granted summary judgment in favor of Everest, concluding that the claims related to 1 Global Capital did not fall within the scope of the insurance policy.

Several clients sued Saoud and his wife, Patricia, who was also an employee of the firm. Their complaints generally alleged that the Saouds had falsely represented that the 1 Global Memorandum of Indebtedness was a secure investment and had sold an unregistered security in violation of Michigan’s securities laws.

On February 19, 2019, Saoud Financial notified Lancer of two additional lawsuits filed by clients and of investigations by Michigan’s Department of Licensing and Regulatory Affairs and the SEC. Saoud Financial claimed expenses of over $100,000. Lancer and Everest never responded to this notice.

Being in “limbo” as to Everest’s position on coverage, Saoud Financial reached out again to Lancer and notified it of an upcoming mediation, so that Everest could participate. But the Saouds never heard from Lancer or Everest. The Saouds eventually settled the lawsuits.

On July 10, 2019, the Saouds and Saoud Financial sued Everest in Michigan state court, claiming breach of contract and seeking a declaratory judgment. Everest removed the suit to federal court and finally notified the Saouds that it would not defend or indemnify them for the lawsuits because, in its view, the claims did not fall within the scope of the policy. The district court ultimately granted summary judgment to Everest, concluding that a coverage exclusion applied. The Saouds appeal.

DISCUSSION

The Everest policy included an “Unregistered Security Exclusion.” That provision excludes coverage for any claim “[b]ased upon, attributable to, or arising out of the use of or investment in any security that is not registered with the Securities and Exchange Commission.”

The parties disputed whether the 1 Global Memorandum of Indebtedness was a “security” within the meaning of the exclusion. The district court explained that a “note” is presumed a “security” under the Securities Acts and concluded that the 1 Global Memorandum of Indebtedness was a “note.”

The court also confirmed, after ordering supplemental briefing, that the 1 Global Memorandum of Indebtedness was a “security” because it was not a note that matured in nine months or less and, even if it was, the 1 Global Memorandum of Indebtedness was not “commercial paper.”

The Saouds argued that the “Unregistered Security Exclusion” applies only if the complaints alleged that the Saouds sold “securities” that were required to be registered with the SEC and concluded that the Security Exclusion does not apply.

The Saouds argued that waiver or estoppel should preclude Everest’s reliance on the “Unregistered Securities Exclusion” because Everest failed to timely disclaim coverage. In limited circumstances, Michigan courts prohibit insurers from raising defenses to coverage that they could have raised earlier. But this doctrine cannot broaden the coverage of a policy to protect the insured against risks that were not included in the policy or that were expressly excluded from the policy.

Everest never represented the Saouds in the underlying litigation and therefore never controlled the Saouds’ litigation strategy to their detriment. Nor have the Saouds provided any evidence of actual prejudice from Everest’s delay in informing the Saouds that it would neither defend nor indemnify them. Instead, they argue that prejudice should be presumed. No presumptive prejudice applies, and Everest did not waive the right to raise the exclusion.

Finally, the Saouds appear to argue that, even if Everest had no duty to indemnify, it nonetheless had a duty to defend. Of course, the duty to defend is not “limited by the precise language of the pleadings” nor “limited to meritorious suits and may even extend to actions which are groundless, false, or fraudulent, so long as the allegations against the insured even arguably come within the policy coverage.

Contrary to the Saouds’ argument, the duty to defend is not unlimited. The insurer is not required to defend against claims for damage expressly excluded from policy coverage. In other words, there is no duty to defend if there is no duty to indemnify as a matter of law. Here, all the claims against the Saouds were premised on the same unregistered security.

Both the duty to defend and the duty to indemnify turn on whether the “Unregistered Security Exclusion” applies. Because the Sixth Circuit concluded that the exclusion applies Everest had no duty to defend.

Everest had an effective exclusion. It refused to defend or indemnify. Although the duty to defend is broad it is not unlimited. Since there was no duty to indemnify there was no duty to defend especially when it was determined they were defrauding their clients selling the unregistered securities and that fraud should never be an action where insurance protects the fraudsters.