Canada: Jacobson Family Investments: New York Appellate Division Interprets Scope Of Financial Institution Bond's Investment Advisor Coverage And Securities Broker Exclusion

Last Updated: June 29 2015
Article by David S. Wilson and Christopher McKibbin

On June 18, 2015, the New York Supreme Court, Appellate Division released its decision in Jacobson Family Investments, Inc. v. National Union Fire Insurance Company of Pittsburgh, Pa. This decision examines the interplay between a Financial Institution Bond's Outside Investment Advisor coverage rider and the Securities Broker exclusion, in the context of a loss resulting from Bernie Madoff's Ponzi scheme.

The Facts

Jacobson Family Investments (JFI) managed the assets of several companies, including MDG 1994 Grat LLC (MDG). In 2008, JFI submitted a claim to National Union for losses, including losses to MDG, allegedly sustained as a result of the dishonest acts of Bernie Madoff. MDG alleged that:

  • Madoff provided fraudulent investment advice to MDG;
  • Madoff serviced a securities brokerage account that MDG created in 2006, via the execution of a Customer Agreement and a Trading Authorization;
  • Madoff provided MDG with false brokerage account statements purporting to show deposits and withdrawals in MDG's brokerage account; various false purchases and sales of stocks and other securities; and non-existent interest and dividends; and,
  • MDG also paid compensation to Madoff, in the form of commissions on the falsely-reported trades.

By the time of the trial, the coverage dispute had distilled down to two issues. First, were MDG's losses covered under the Outside Investment Advisor coverage provided by Rider 14 of the Bond? Second, did exclusion X (the "Securities Broker" exclusion) apply?

Relevant Bond Provisions

Rider 14 to the Bond provided indemnity for:

Loss resulting directly from the dishonest acts of any Outside Investment Advisor, named in the Schedule below, solely for their duties as an Outside Investment Advisor, on behalf of the Insured, committed alone or in collusion with others ... provided, however, the Insured shall first establish that the loss was directly caused by dishonest acts of any Outside Investment Advisor which results in improper personal financial gain to such Outside Investment Advisor and which acts were committed with the intent to cause the Insured to sustain such loss. [emphasis added]

Madoff's company, Bernard L. Madoff Investment Services, LLC, was listed on the relevant schedule.

Exclusion X provided that:

This bond does not cover: ... loss resulting directly or indirectly from any dishonest or fraudulent act or acts committed by any non-Employee who is a securities, commodities, money, mortgage, real estate, loan, insurance, property management, investment banking broker, agent or other representative of the same general character.

At trial, National Union submitted that Madoff had acted as both an investment advisor and securities broker throughout his dealings with MDG. Accordingly, MDG's loss was not caused by Madoff solely in performing his duties as an Outside Investment Advisor.

The trial court rejected National Union's submission, holding that this argument would render Rider 14's coverage meaningless. Although Madoff was expressly listed as an investment advisor in the relevant schedule, he was both a registered securities broker and investment advisor, and could never satisfy the coverage requirements. The trial court further held that exclusion X did not apply, as National Union had not established that the losses were caused by Madoff acting in his capacity as a securities broker.

The Appellate Division reversed on all points. After finding that there was no ambiguity in Rider 14, the Appellate Division held that the trial court had erred in effectively reading the "solely" qualifier out of the coverage grant:

Rider 14 limits coverage to losses where the identified Outside Investment Advisor acts "solely" in that capacity. Any other interpretation would completely negate and render superfluous the significant term "solely" contained in Rider 14. MDG's interpretation of Rider 14, that losses caused by any person or entity identified in the schedule as an Outside Investment Advisor are covered, regardless of the capacity in which such person or entity is acting when incurred, impermissibly broadens the scope of coverage. ... Nor does restricting coverage to situations where the loss results directly from the dishonest act of an outside investment advisor "solely for their duties as an Outside Investment Advisor" effect a blanket preclusion of coverage for any act by Madoff simply because he happened to be both a registered securities broker and investment advisor. In evaluating what capacity someone otherwise identified as an Outside Investment Advisor acted, a close examination of the actions actually undertaken that created the loss is necessary. [emphasis added]

The Appellate Division reviewed the evidence at trial. It was undisputed that the MDG-Madoff Customer Agreement expressly referred to the creation of a broker-customer relationship. MDG had designated Madoff, individually, to act as its agent for purchases, sales or trades of securities on its behalf. MDG supplied investment funds which were deposited into a bank account held solely in Madoff's name. In view of the evidence at trial, the Appellate Division concluded that there was "simply no way to separate Madoff's activities as an investment advisor from his activities as a securities broker insofar as they produced the losses claimed. The duality of the services Madoff provided places MDG's claims outside Rider 14".

The Appellate Division also held, as an alternate basis for a finding of no coverage, that exclusion X applied to MDG's loss, noting that exclusion X does not require that the non-employee must have actually been "acting as" a securities broker at the time of the loss; it only requires that the non-employee "is" a securities broker. As Madoff was a securities broker, the losses he caused were excluded.


Jacobson Family Investments is useful in clarifying the intended contours of the Outside Investment Advisor coverage rider under the Financial Institution Bond. The use of the term "solely" reflects an obvious intention to limit the coverage as drafted, notwithstanding that there will be losses (such as MDG's loss) which involve the defaulting advisor-broker acting in a hybrid capacity. The Appellate Division's thorough consideration of the trial evidence in its interpretation of Rider 14 also reinforces the necessity of careful investigation and analysis of the loss-causing actions in interpreting these types of coverages.

The Appellate Division's holding with respect to exclusion X is brief, but significant, insofar as it emphasizes that coverages and exclusions can be drafted on either an "action" or "status" basis (or both); Rider 14 focused on the loss-causing actions, whereas the exclusion focused on the status of the defaulter as a securities broker, notwithstanding that the loss might not be fully attributable to the broker's conduct as a broker.

Jacobson Family Investments, Inc. v. National Union Fire Insurance Company of Pittsburgh, Pa., 2015 WL 3767850 (N.Y.A.D. 1st Dept.)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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David S. Wilson
Christopher McKibbin
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