Federal Insurance Company v. Axos Clearing LLC ( 2020 )

United States Court of Appeals
For the Eighth Circuit
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No. 18-2653
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Federal Insurance Company
lllllllllllllllllllllPlaintiff - Appellee
v.
Axos Clearing LLC
lllllllllllllllllllllDefendant - Appellant
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Appeal from United States District Court
for the District of Nebraska - Omaha
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Submitted: September 23, 2020
Filed: December 7, 2020
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Before LOKEN, SHEPHERD, and ERICKSON, Circuit Judges.
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LOKEN, Circuit Judge.
Federal Insurance Company (“Federal”) issued a Financial Institution Bond
(the “Bond”) to COR Clearing LLC (“COR”), a settlement and clearing firm that
allows independent broker-dealers to access public equities markets and place trades
for their customers.1 The Bond was issued in April 2014 and April 2015. In 2016,
COR paid $2,080,000 to settle claims by investors that a former COR registered
representative, Christopher Cervino (“Cervino”), had conspired with others to defraud
investors by carrying out a “pump-and-dump” scheme in a risky penny-stock called
VGTel. COR filed a claim with its liability insurer, a subsidiary of XL Specialty
Insurance Company, for VGTel and other settlement payments, which it later settled
for $3,625,000 above the policy’s deductible. COR also filed a claim under Federal’s
Bond to recover its losses for the VGTel settlements.
Federal denied coverage and commenced this action seeking a declaratory
judgment that COR’s claim is not covered under the Bond’s insuring clauses. COR
counterclaimed for breach of contract. The district court2 granted summary judgment,
declaring that COR’s claim for reimbursement under the Bond is not covered and
dismissing COR’s counterclaim with prejudice. Fed. Ins. Co. v. COR Clearing, LLC,
328 F. Supp. 3d 956, 963 (D. Neb. 2018). COR appeals. Reviewing de novo the
district court’s grant of summary judgment, its interpretation of state law, and its
application of state law to insurance coverage disputes, we affirm. Am. Family Mut.
Ins. Co. v. Co Fat Le, 439 F.3d 436, 439 (8th Cir. 2006) (standard of review).
I. Background
COR hired Cervino in 2013 to serve as a registered representative at COR’s
Equity Desk in Edison, New Jersey. His responsibilities were limited to executing
trades as directed by clients. COR began investigating customer complaints
1
For a general description of COR’s role in the complex, heavily regulated
securities markets, see COR Clearing, LLC v. Calissio Res. Grp., Inc., 918 F.3d 579(8th Cir. 2019). COR was acquired by Axos Clearing LLC after this appeal was filed.
2
The Honorable Robert F. Rossiter, Jr., United States District Judge for the
District of Nebraska.
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regarding accounts overseen by Cervino in the summer of 2014 and terminated
Cervino in October 2014. The VGTel investors filed arbitration complaints with the
Financial Industry Regulatory Authority (“FINRA”) in late 2014 and April 2015. The
larger group3 alleged that, when COR hired Cervino from an independent broker
dealer, he was already engaged in the fraudulent VGTel pump-and-dump scheme with
a group of conspirators that included securities fraudster Edward Durante and a
crooked financial advisor, Sheik Khan. The conspirators transferred investor
accounts to COR where Cervino executed unauthorized VGTel trades. In January
2016, COR submitted a Preliminary Proof of Loss to Federal requesting coverage
under the Bond for the VGTel settlements. Also in January 2016, the Securities and
Exchange Commission filed an amended criminal complaint against Durante,
Cervino, Khan, and others; they were convicted of securities and wire fraud after a
sixteen-day jury trial in March 2017.
In the district court, the parties disagreed whether the dispute was governed by
New Jersey law, as COR contended, or by Nebraska law, as Federal urged. Before
the end of discovery, COR moved for partial summary judgment on this issue.
Federal responded by moving for summary judgment on the ground that the Bond did
not cover COR’s VGTel settlement payments under the four Insuring Clauses at
issue. Ruling on these motions (and denying other pending motions as moot), the
district court first held that New Jersey had a “more significant relationship” to the
Bond dispute and therefore New Jersey law applied in this diversity case under
Nebraska choice-of-law principles. Turning to the merits of the Insuring Clauses at
issue on appeal, the court held that Insuring Clause 1.B does not apply because, under
the leading New Jersey case of Auto Lenders Acceptance Corp. v. Gentilini Ford,
Inc., 854 A.2d 378 (N.J. 2004), COR’s loss “did not directly result from Cervino’s
3
In the VGTel settlements at issue, COR paid $80,000 to settle claims by
investor Helen Cherry (“Cherry”) and $2,000,000 to settle claims by twenty-two other
investors who the parties refer to as the “Alexen claimants.”
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actions.” Insuring Clause 1.D does not apply because there is no evidence Cervino
committed covered dishonest acts. COR appeals those rulings.4
On appeal, COR argues the district court properly applied New Jersey law but
misapplied Gentilini Ford in concluding that COR is not seeking indemnity for direct
losses, as Clause 1.B requires. In appealing the grant of summary judgment
dismissing its Clause 1.D counterclaim, COR argues the district court incorrectly held
that there was no evidence Cervino’s dishonest acts triggered coverage under Clause
1.D. Federal raises three additional issues: (i) the court should have held that
Nebraska rather than New Jersey law governs COR’s Bond claims; (ii) COR
presented insufficient evidence Cervino intended to cause COR to incur losses, as
Clauses 1.B and 1.D require; and (iii) COR cannot prove it suffered a loss in excess
of the Bond’s deductible. The district court concluded the latter two issues presented
material fact disputes not appropriate for summary judgment. As we agree with the
district court’s decision on the issues COR appealed, we decline to consider these
additional issues. Regarding the choice of law issue, “[w]here the laws of the two
jurisdictions would produce the same result . . . the Court should avoid the choice-of-
law question.” Ronnoco Coffee, LLC v. Westfeldt Bros., Inc., 939 F.3d 914, 920 (8th
Cir. 2019) (quotation omitted).
II. Analysis
A. Insuring Clause 1.B. Section 1 of the Bond’s Insuring Clauses includes four
“Dishonesty” coverages. Clause 1.B provides coverage for:
4
The district court also held that Insuring Clause 1.A does not apply because
COR’s alleged loss arose from trades and therefore must be covered by Clause 1.B,
which is an exception to 1.A. The court held that Clause 4, the Forgery or Alteration
coverage, does not apply because there is no evidence of forgery or material alteration
of covered documents. COR does not appeal those rulings.
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Loss resulting directly from dishonest acts of any Employee, committed
alone or in collusion with others except with a director or trustee of the
ASSURED who is not an Employee, which arises totally or partially
from:
(1) any Trade, or
(2) any Loan,
provided, however, the ASSURED shall first establish that the loss was
directly caused by dishonest acts of any Employee which result in
improper personal financial gain to such Employee and which acts were
committed with the intent to cause the ASSURED to sustain such loss.
(Bold terms are defined in the Bond.) The district court concluded that Clause 1.B
does not cover the VGTel settlement payments because:
The only loss COR suffered was payments made to settle claims brought
by third parties for their losses. COR did not suffer any risk that its own
assets would be directly lost as a result of Cervino’s actions.
Fed. Ins. Co., 328 F. Supp. 3d at 961. COR appeals that ruling.
Traditionally, financial institution bonds and similar employee dishonesty
coverages were indemnity contracts that covered the insured’s direct losses from
employee dishonesty (and other risks such as forgery), not the insured’s liability to
third parties for tortious acts of its employee intended to injure or defraud the third
party. As the Seventh Circuit has explained, “[i]nsurance covers the liability of the
insureds to a third-party, while fidelity bonding covers the loss of property owned by
the insureds or held by the insureds, as a consequence of employee dishonesty.”
Universal Mortg. Corp. v. Württembergische Versicherung AG, 651 F.3d 759, 762
n.1 (7th Cir. 2011) (quotation omitted); accord RBC Mortg. Co. v. Nat’l Union Fire
Ins. Co. of Pittsburgh, 812 N.E.2d 728, 733 (Ill. App. 2004); Vons Cos. v. Fed. Ins.
Co., 212 F.3d 489, 491-93 (9th Cir. 2000). Thus, the direct loss provisions in fidelity
bonds “do not describe indirect and consequential injuries to the employer resulting
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from legal settlements with third parties who were the actual targets of the
employee’s acts.” Aetna Cas. & Sur. Co. v. Kidder, Peabody & Co., 676 N.Y.S.2d
559, 564 (App. Div. 1998).
In most jurisdictions, this type of employee dishonesty provision covers the
insured’s loss if its employee embezzled customer funds in the insured’s possession
or control. See Vons, 212 F.3d at 491; First Defiance Fin. Corp. v. Progressive Cas.
Ins. Co., 688 F. Supp. 2d 703, 708 (N.D. Ohio 2010). But if the employee embezzled
a customer’s personal funds not in the employer’s possession or control, that is not
a covered direct loss even if the employer later reimbursed the customer in a legal
judgment or settlement. See Lynch Props. v. Potomac Ins. Co., 140 F.3d 622, 629
(5th Cir. 1998); Kidder, Peabody, 676 N.Y.S.2d at 564. In RBC Dain Rauscher, Inc.
v. Fed. Ins. Co., a case involving the same fidelity bond language -- “loss resulting
directly from dishonest acts” -- the court explained that, under Minnesota law, “loss
of third-party property in [the insured’s] possession” is covered, whereas “theft
committed against third-parties by its employees” is not. 370 F. Supp. 2d 886, 890
n.3 (D. Minn. 2005), followed in Avon State Bank v. BancInsure, Inc., 787 F.3d 952,
956-57 (8th Cir. 2015).
In construing “direct loss” provisions in various types of insurance policies,
including fidelity bonds, state court decisions have frequently divided into “[t]wo
interpretive camps . . . the ‘proximate cause’ camp and the ‘direct means direct’
camp.” Universal Mortg., 651 F.3d at 761. Because state law governs the
interpretation of Federal’s Bond in this diversity action, the district court looked to
Gentilini Ford, the controlling decision of the Supreme Court of New Jersey on this
issue. COR argues on appeal, as it did to the district court, that the Court in Gentilini
Ford “adopt[ed] the conventional proximate cause test as the correct standard to apply
when determining whether a loss resulted from the dishonest acts of an employee,”
854 A.2d at 386-87; that the loss suffered by the insured in Gentilini Ford “is not
distinguishable from the loss COR suffered”; that “employee dishonesty was a peril
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specifically insured against”; and therefore that the district court erred in denying
coverage under Clause 1.B.
In Gentilini Ford, an automobile dealership allowed its higher risk customers
to purchase vehicles on installment contracts, paying a cash deposit and executing a
note. Gentilini Ford then assigned its rights in the financed vehicles to a financing
company, Auto Lenders, in exchange for a cash payment equivalent to the purchasers’
notes. 854 A.2d at 381-82. After a number of customers defaulted on their loans,
Auto Lenders discovered that a Gentilini Ford employee had submitted fraudulent
credit applications based on falsified pay stubs to overstate the borrowers’
creditworthiness. Gentilini Ford settled Auto Lenders’ fraud and breach of contract
claims for $215,000 and filed a complaint to recover the settlement payment from its
insurer under the commercial insurance policy provision covering a direct loss caused
by an employee’s dishonest acts. Id. at 383. Reversing an appellate decision in favor
of the insurer, the Supreme Court of New Jersey adopted “the conventional proximate
cause test” for direct losses and ruled that “Gentilini suffered a direct loss of or
damage to twenty-seven automobiles when it exchanged those vehicles for
installment contracts of an otherwise unacceptable risk.” But the Court held that the
$215,000 settlement payment was not “an accurate measure of direct loss under the
terms” of the policy and remanded, directing that “Gentilini will have the burden of
proving its loss on each contract through further proceedings.” Id. at 398-99.
While Gentilini Ford adopted the proximate cause test to determine whether
an employee’s dishonest acts caused the insured’s direct loss, we agree with the
district court that the direct loss the Court found in Gentilini Ford was the transfer of
automobiles for riskier-than-anticipated notes, not the $215,000 settlement payment
the insured sued to recover. Therefore, the Court held, “[t]he losses it incurred . . .
depend on whether Gentilini still has an interest in those contracts, the amount
outstanding on those contracts that have entered default, and Gentilini’s ability to
mitigate its losses through repossession.” Id. at 399. This reasoning demonstrates
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that the Supreme Court of New Jersey applied the principle that direct losses covered
by employee dishonesty provisions in financial institution bonds do not include
“indirect and consequential injuries to the employer resulting from legal settlements
with third parties who were the actual targets of the employee’s acts.” Kidder,
Peabody, 676 N.Y.S.2d at 564. Indeed, in remanding, the Court noted that “Gentilini
is not entitled to an award of attorneys’ fees incurred in prosecuting its action against
[the insurer]” because New Jersey law “does not authorize an award of attorneys’ fees
to enforce first-party coverage,” and “the policy under which Gentilini seeks coverage
. . . does not concern liability to third parties.” Id. at 399-400 (emphasis added).
For these reasons, we agree with the district court that Gentilini Ford stands for
the proposition that, under New Jersey law, COR’s payments to settle third-party
liability claims based on an employee’s dishonest acts directed at the third parties
were not a direct loss under Insuring Clause 1.B of the Bond.
B. Insuring Clause 1.D. A separate insuring clause in the Bond’s Section 1
Dishonesty provisions, Insuring Clause 1.D, provides coverage for:
Loss of Customer’s Property resulting directly from the dishonest acts
of a Registered Representative, committed alone or in collusion with
others and which arises totally or partially from the Registered
Representative;
(1) soliciting such Property from the Customer when the Property has
not been in an account with the ASSURED;
(2) instructing or advising the Customer to withdraw such Property
from the Customer’s account with the ASSURED; or
(3) instructing or advising the Customer to liquidate an investment, or
terminate an insurance, annuity, futures or other contract,
provided, however, the ASSURED shall first establish that the loss was
directly caused by dishonest acts of the Registered Representative
which result in improper personal financial gain to such Registered
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Representative or other natural person acting in collusion with such
Registered Representative and which acts were committed with the
intent to cause the Customer to sustain such loss.
(Bold terms defined in the Bond). The district court granted summary judgment
dismissing COR’s counterclaim for coverage of the VGTel settlement payments under
Clause 1.D because there was “no evidence that Cervino (1) solicited property, (2)
instructed customers to withdraw property from their accounts with COR, or (3)
instructed or advised customers to liquidate or terminate anything.” Fed. Ins. Co., 328
F. Supp. 3d at 962. In reviewing that ruling, like the district court we view the
evidence in the light most favorable to COR, the nonmoving party. See United Fire
& Cas. Ins. Co. v. Garvey, 328 F.3d 411, 413 (8th Cir. 2003).
On appeal, COR argues the court erred in granting summary judgment because
a material factual dispute exists regarding these issues. In support, COR cites one
document in the limited summary judgment record. In their lengthy Amended
Statement of Claim in the FINRA arbitration proceeding, the Alexen claimants alleged
that the VGTel conspirators fraudulently opened brokerage accounts for the claimants
and executed unauthorized VGTel trades while Cervino was employed by broker
Wilson-Davis (also a named respondent). The conspirators later “transferred” Khan’s
clients to COR Clearing where “without any verbal or written authorization or
notification to his clients Mr. Cervino began executing trades to purchase VGTel
stock,” and “assisted [Durante] in the signing of fraudulent and forged documents on
behalf of Claimants that [Cervino] then submitted to COR Clearing.”
We doubt that a lawyer’s unverified factual allegations in a pleading in a
different legal proceeding satisfied the burden on COR in opposing Federal’s motion
for summary judgment to “show that admissible evidence will be available at trial to
establish a genuine issue of material fact.” Churchill Bus. Credit, Inc. v. Pac. Mut.
Door Co., 49 F.3d 1334, 1337 (8th Cir. 1995) (quotation omitted); see Fed. R. Civ. P.
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56(c). Moreover, while the allegations on which COR relies may well accuse Cervino
of “dishonest acts,” they do not provide evidence that Cervino while employed by
COR committed the dishonest acts that trigger coverage under Clause 1.D -- soliciting
property from a customer that was not in a COR account, instructing or advising a
customer to withdraw property from the customer’s COR account, or instructing or
advising a customer to liquidate an investment. In its Reply Brief, COR argues that
it need not prove Cervino committed the dishonest acts because Clause 1.D covers acts
committed “in collusion with others.” We reject this untimely contention because, by
its plain language, Clause 1.D covers only loss of customer property “resulting directly
from the dishonest acts” of Cervino, whether he was acting alone or in collusion with
others. Thus, the district court did not err in dismissing COR’s Clause 1.D
counterclaim because COR failed to show that admissible evidence would be available
at trial to prove that Cervino personally committed a covered dishonest act.5
III. Conclusion
For the foregoing reasons, the judgment of the district court is affirmed.
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5
COR argues at length on appeal that it did not have an adequate opportunity
to present additional evidence supporting its Clause 1.D counterclaim because, while
Federal’s motion for summary judgment encompassed COR’s entire counterclaim,
Federal did not argue there was no evidence supporting COR’s Clause 1.D claim until
its reply brief to the district court. But COR’s Brief in Opposition recognized that
Federal’s motion included the Clause 1.D counterclaim, and COR could have
requested more time to respond, particularly since the summary judgment cross-
motions were filed before the discovery deadline. See Fed. R. Civ. P. 56(d). As
COR’s initial Brief did not include this procedural issue in the Statement of the Issues
presented for review, we need not consider it further. See Fed. R. App. P. 28(a)(5).
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