By Karen Freifeld
NEW YORK, June 11 (Reuters) - A subsidiary of Chubb Corp. and other insurers must defend themselves against a lawsuit for refusing to cover more than $200 million paid out by Bear Stearns over illegal mutual fund trading practices, New York's highest court ruled on Tuesday.
Reversing an intermediate court, the Court of Appeals revived claims seeking coverage for a 2006 settlement between Bear Stearns and the U.S. Securities and Exchange Commission over market timing and late trading. The settlement included $160 million in ill-gotten gains and a $90 million penalty, according to court papers.
JPMorgan Chase & Co., which acquired Bear Stearns in 2008, brought the claims accusing the insurance companies of breach of contract. It sought insurance payments to cover the $160 million, plus $14 million it paid to settle related private cases, and $40 million in legal fees. It did not seek coverage for the $90 million penalty.
The insurers argued, among other things, that Bear Stearns could not recoup the $160 million payment as a matter of public policy since the SEC found Bear Stearns willfully violated securities laws by facilitating late trading and market timing by hedge funds. As is typical in SEC actions, Bear Stearns neither admitted nor denied the findings.
In its ruling on Tuesday, the state Court of Appeals said that while it did not condone late trading or market timing, the insurers had failed to meet the "heavy burden" to prove that "Bear Stearns is barred from pursuing insurance coverage under its policies."
The ruling, written by Judge Victoria Graffeo, reinstated the lawsuit.
Mark Greenberg, a Chubb spokesman, declined to comment. Vigilant Insurance Company, a Chubb subsidiary, was one of seven insurance companies sued.
Jennifer Zuccarelli, a JPMorgan spokeswoman, did not return a call seeking comment.
The court said Bear Stearns could be precluded from coverage if it acted with the intent to harm or injure others. It also said the SEC had not established whether the $160 million in ill-gotten gains was based on money Bear Stearns improperly earned.
JPMorgan claims at least $140 million of the SEC payment was illegal profits by hedge fund customers, not its own gains.
The American Insurance Association, which represents some 300 insurers, filed a brief in the case, arguing that allowing policyholders to insure against the return of ill-gotten gains created a moral hazard and would increase "undesirable underlying conduct."
A spokesman for the association declined to comment on the ruling.
The case is J.P. Morgan Securities Inc v Vigilant Insurance Company, New York State Supreme Court New York County No. 600979/2009.