Companies engaged in the capital markets are at risk of claims and lawsuits alleging investment mismanagement and other misconduct. For this reason, they typically purchase directors and officers liability (“D&O”) insurance policies to provide a defense against, and indemnification for, allegations of wrongful acts in the course of their delivery of financial services. To ensure that they will be adequately protected, D&O policyholders must be wary of “professional services” exclusions often lurking in their policies. When broadly worded, these exclusions purport to bar coverage for claims “arising out of, based upon, or attributable to” the insured’s “professional services” (which may or may not be a defined term). While the intent of such exclusions is presumably to bar coverage for claims arising out of “traditional” professional services, such as the provision of legal or accounting advice (often insured under other types of policies), some insurers have recently sought to expand the exclusion to apply generally to finance and investment activities. Such a broad interpretation of the exclusion would essentially swallow and render illusory the D&O coverage purchased by participants in the financial services industry, because insurers could attempt to characterize nearly every aspect of their insureds’ businesses as “professional services.”
Courts in some jurisdictions have agreed with insurers’ unduly broad application of the professional services exclusion. For instance, last May, the United States District Court for the Southern District of Florida held in Goldberg v. National Union that a lawsuit arising out of a bank’s failure to detect a Ponzi scheme was not covered under its D&O policy because the suit’s allegations concerned the bank’s internal management and regulatory compliance functions, which were specialized “professional services” triggering the exclusion.
Earlier this month, however, the District of Columbia Court of Appeals sided with the policyholder in construing the professional services exclusion narrowly. In Carlyle Investment Management, LLC v. ACE American Insurance Company, the insured, a subsidiary of the Carlyle Group, was sued over the failure of a mortgage-backed securities fund that it managed. The complaint alleged that the investment management company had enticed investors into unsafe investments with false promises of high returns, failed to warn investors about increasing risk, and mismanaged the investments even after the market deteriorated. While the trial court held that these “management liability claims” involved professional services and were therefore excluded from D&O coverage, the appellate court disagreed and reversed, holding that the policy’s professional services exclusion was ambiguous and must be construed against the insurer. Specifically, the court focused on the fact that key terms in the particular exclusion at issue, such as “investment management services,” were undefined. Therefore, the court found that the policy was unclear as to whether the exclusion should apply only to allegations involving the operational management of the fund, or whether its scope extended to allegations involving the company’s corporate governance and risk management procedures as well. These doubts were resolved against the insurer and in favor of coverage.
Companies in the financial services community should be mindful of the wording of professional services exclusions in their professional liability insurance policies. When possible, policyholders should request that the professional services exclusion – often added by endorsement – be deleted entirely. At a minimum, companies should request that the language of the exclusion be narrowed so that it is clearly limited to areas of their business that are covered under professional errors and omissions policies, but does not encompass core functions of the policyholders’ business or management. Lowenstein’s Insurance Recovery Group has deep experience in the D&O coverage space and is available to review professional services exclusions with insureds and their brokers.