The second is Alstrin v. St. Paul Mercury Ins. Co., in which the United States District Court for the District of Delaware rejected defenses to coverage raised by the D&O insurer based on an intentional fraud exclusion.

Although the cases were strikingly similar, their results were anything but.

California Amplifier had one primary and two excess D&O policies that insured its directors and officers against liability for, among other things, violations of state securities laws. RLI was one of the excess insurers.

In 1997, California Amplifier and two of its officers were named as defendants in a class action alleging violations of Cal. Corporations Code Sections 25400(d) and 25500. The plaintiffs alleged that the company and two officers had made false statements to the market about California Amplifiers stock as part of a scheme to artificially inflate its price.

The case settled at the beginning of the trial, with California Amplifier, the primary D&O insurer, and one of the excess insurers contributing to the settlement. RLI, however, denied coverage and refused to pay any part of the settlement.

California Amplifier and the two officer defendants then sued RLI in the Superior Court of Ventura County, alleging claims for breach of the excess policy, bad faith refusal to respond to their demand for payment, and unfair business practices. RLI responded by moving for judgment on the pleadings, asserting that the class action claims were uninsurable under Cal. Insurance Code Section 533.

Section 533 provides that an “insurer is not liable for a loss caused by the willful act of the insured; but he is not exonerated by the negligence of the insured, or of the insureds agents or others.”

(Other states have similar statutes. For example, North Dakotas is virtually identical to Californias Section 533. In addition, some states have similar provisions as a matter of common law. For example, a 1985 Supreme Court of New York decision in Austro v. Niagara Mohawk Power Corp., held that “indemnification agreements are unenforceable as violative of public policy to the extent that they purport to indemnify a party for damages flowing from the intentional causation of injury.”)

The trial court granted RLIs motion. On appeal, the California Court of Appeal, Second District, affirmed in December 2001.

The Court of Appeal first engaged in an extensive analysis of what mental state was required for the claims asserted in the class action. The court determined that the class action claims depended on conduct that was “knowing and deliberate,” and concluded that such conduct would constitute a “willful act” under Section 533. For that reason, the court held that the claims were not insurable.

In reaching this decision, however, the court suggested that it agreed with a federal decision holding that, because securities fraud claims under Section 10(b) of the Securities Exchange Act of 1934 can be based on reckless conduct, Section 533 did not preclude coverage of such claims. Coverage for claims brought under the 1934 Act might be precluded only if it was proven that the defendants conduct was more than reckless, the California Court of Appeal suggested in Amplifier.

It should be noted that in performing its analysis, the California Amplifier Court focused only on the elements of the claims that were alleged. It did not acknowledge that there was no proof of any of the elements nor any finding of liability. That the case was settled, and thus no “willful conduct” was established, seems to have been of no moment.

This gives the Alstrin decision, which was handed down just over one month after California Amplifier, even greater importance. Despite the fact that the factual settings of California Amplifier and Alstrin are remarkably similar, its legal setting–and its result–are remarkably different.

In Alstrin, the corporation had a primary and two excess D&O policies, and an overlapping D&O policy issued by National Union Fire Insurance Company of Pittsburgh, which provided separate coverage. The plaintiffs reached a partial settlement in the underlying federal securities litigation and sought coverage under the National Union policys “Run-Off” endorsement. National Union contended that the intentional fraud exclusion in its policy barred the plaintiffs claims.

The most immediate difference can be seen by comparing Section 553 with Exclusion 4(c) of the Alstrin policy. The California Amplifier court seems to have held that Section 553s exclusion is triggered by the mere assertion (or settlement) of a claim that depends upon willful conduct. In contrast, the Alstrin policy excluded claims “arising out of, based upon or attributable to the committing in fact of anydeliberate fraud,” and National Union contended that the exclusion was only triggered by a judicial determination of deliberate conduct.

The district court made short work of this exclusion.

Noting that the policy appeared on its face to provide unrestricted coverage for securities claims, including securities fraud claims, the court held that the insurer could not give coverage with one hand and then appear to take away most of that coverage with the other, noting that insureds would not read the broad securities coverage to include only claims based on reckless or negligent behavior. The court therefore concluded that National Union could not rely on the exclusion to deny coverage.

Probably the most significant question raised by the remarkably different outcomes of California Amplifier and Alstrin is which decision is likely to have the more significant impact on the D&O field. Because of a recent change in federal law, it is likely that California Amplifier will be the anomalous decision.

Congress passed the Securities Litigation Uniform Standards Act in 1998. The SLUSA was intended to preempt certain state-law securities class actions, allow the removal of such actions to federal court, and allow federal courts to stay discovery in certain state-court actions. In particular, the SLUSA requires removal and dismissal of a (i) “covered class action” that is (ii) based on state law and (iii) alleges a misrepresentation or omission of a material fact or deceptive act (iv) in connection with the purchase or sale of a “covered security.”

A “covered security” is, among other things, a security that is listed (or authorized for listing) on the New York Stock Exchange, the American Stock Exchange, or the National Market System of the Nasdaq Stock Market. The term “covered class action” includes both traditional class actions under state law analogs of Federal Rule of Civil Procedure 23 and sufficiently large groups of parallel individual actions. When state law claims are covered by SLUSA, they must be dismissed.

Because SLUSA is now in effect, claims like those at issue in California Amplifier are unlikely to arise again in the class action context, and so the result in California Amplifier is unlikely to recur in the securities arena. If the complaint at issue in California Amplifier were filed today, it would be subject to immediate removal and dismissal under SLUSA.

Because it was filed in June 1997, just under eighteen months before SLUSA became effective, the defendants could not take advantage of SLUSAs preemption of state law securities class actions.

Although Congress intended SLUSA to close loopholes left after the Private Securities Litigation Reform Act of 1995 was enacted, it appears to have done much more. By preempting state law class actions based on statutes that require “willful” acts for liability to attach, SLUSA may also take a great deal of the potential sting out of the California Amplifier decision for insureds.

Douglas Henkin is a partner in the litigation department of Milbank, Tweed, Hadley & McCloy LLP. He is resident in Milbanks New York office and his practice includes securities and structured financial product litigation.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, May 6, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.