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UBS Financial Services, Inc. v. XL Specialty Insurance Co.

United States Court of Appeals, First Circuit

July 3, 2019

UBS FINANCIAL SERVICES, INC. OF PUERTO RICO AND UBS TRUST COMPANY OF PUERTO RICO, Plaintiffs, Appellants,
v.
XL SPECIALTY INSURANCE CO., AXIS REINSURANCE CO., AND HARTFORD FIRE INSURANCE CO., Defendants, Appellees.

          APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF PUERTO RICO [Hon. Francisco A. Besosa, U.S. District Judge]

          Robert T. Smith, with whom Rajesh R. Srinivasan, Michael I. Verde, David L. Goldberg, Philip A. Nemecek, Tenley Mochizuki, Katten Muchin Rosenman LLP, Jaime E. Toro-Monserrate, Nayda I. Pérez-Román, and Toro, Colón, Mullet Rivera & Sifre PSC were on brief, for appellants.

          Cara Tseng Duffield, with whom Karen L. Toto, Kimberly M. Melvin, John E. Howell, and Wiley Rein LLP were on brief, for appellee XL Specialty Insurance Company.

          Francisco E. Colón-Ramírez and Colón Ramírez LLC on brief, for appellees XL Specialty Insurance Company, AXIS Reinsurance Company and Hartford Fire Insurance Company.

          Joshua D. Weinberg and Shipman & Goodwin LLP on brief, for appellee Hartford Fire Insurance Company.

          Michael R. Goodstein, James M. Young, and Bailey Cavalieri LLC on brief, for appellee AXIS Reinsurance Company.

          Before Howard, Chief Judge, Torruella and Kayatta, Circuit Judges.

          TORRUELLA, CIRCUIT JUDGE.

         In this case, titans of their respective industries clash as to the interpretation of an exclusion clause in an insurance policy representing millions of dollars in potential coverage. In the process of deciding this appeal, we are granted a glimpse into the ethics that apparently prevail in some sectors of the financial industry.

         Appellants UBS Trust Company ("UBS-Trust") and UBS Financial Services Inc. of Puerto Rico ("UBS-PR") filed suit against their primary insurance provider, XL Specialty Co. ("XL"), as well as their secondary insurance providers, claiming that the insurers' refusal to cover certain legal disputes constituted a breach of their insurance contract. XL argues that those disputes fall under a "specific litigation exclusion" clause in the insurance policy that excepts from coverage claims related to prior matters specified therein. UBS-Trust and UBS-PR (collectively, "UBS"), on the other hand, assert that the specified prior matters and the disputed matters at issue in this case are not sufficiently related and XL is misinterpreting the scope of the exclusion.

         After the parties filed cross-motions for summary judgment, the district court held that the prior and disputed matters were sufficiently related such that the exclusion clause applied, and granted summary judgment in favor of the insurers. UBS appealed. After careful review, we affirm, finding that the clear and unambiguous language of the specific litigation exclusion bars coverage of the disputed litigation matters here.

         I. Background

         A. Factual Background

         UBS-PR was an underwriter for various tax-exempt Puerto Rican municipal bonds.[1] UBS-PR, also a licensed broker-dealer, sold shares of closed-end funds ("CEFs") to brokerage customers in Puerto Rico.[2] UBS-Trust, on the other hand, was responsible for managing or co-managing twenty-three CEFs. From 2009 to 2012, UBS was the subject of various proceedings concerning the CEFs, two of which are relevant here: (1) a 2009 Securities and Exchange Commission ("SEC") investigation, and (2) a 2010 lawsuit filed by CEF investors (collectively, the "Prior Matters").

         1. 2009 SEC Investigation

         In August 2009, the SEC began investigating UBS-PR for violations of securities laws (the "2009 SEC Investigation"). The SEC ultimately concluded that UBS-PR misrepresented the risks associated with its CEF shares. Although UBS-PR told customers that the share price was determined by supply and demand, the investigation concluded that UBS-PR was effectively setting the price of shares by controlling sales in the secondary market. In addition, the SEC found that by not informing investors it purchased millions of dollars of CEF shares into its inventory, UBS-PR made CEF shares appear more liquid and in higher demand than they actually were. The SEC further concluded that UBS-PR offloaded shares it owned by selling them at lower prices while "numerous UBS PR customers were also attempting to sell their holdings[, ] . . . effectively prevent[ing] certain customers from selling their CEF shares." Ultimately, UBS-PR settled with the SEC through the entry of an "Order Instituting Administrative and Cease-and-Desist Proceedings," in which UBS-PR agreed to pay over $26 million in disgorgement, prejudgment interest, and civil money penalties.

         2. 2010 Unión Lawsuit

         In 2010, CEF investors filed a lawsuit concerning UBS's management of four CEFs, derivatively on behalf of the four funds and directly as a putative class of fund investors (the "2010 Unión Lawsuit"). See Verified Shareholder Derivative Action and Class Action Complaint, Unión de Empleados de Muelles de P.R. PRSSA Welfare Plan v. UBS Fin. Servs. of P.R., No. 10-1141-ADC (D.P.R. Mar. 31, 2011) (ECF No. 1). The CEFs incorporated pension bonds issued by Puerto Rico's Employee Retirement System ("ERS"), which were underwritten by UBS-PR and purchased by UBS-Trust. The investors alleged that: (1) in 2007, UBS-PR became financial advisor to the ERS; (2) afterwards, it served as underwriter when ERS sold $2.9 billion in pension bonds, which resulted in approximately $27 million in fees for UBS-PR and its co-underwriters; (3) ERS pension bonds were rated just one step above junk by Moody's Investors Service and other rating agencies; (4) UBS-Trust purchased more than half of the total bond offering; and (5) "near-junk" ERS bonds were concentrated in the four CEFs at issue, creating an over-concentration of low-quality ERS bonds.

         Hence, plaintiffs claimed that UBS, "[o]perating on all sides of mutual fund and bond transactions . . . manipulated the [CEF] Funds and the bond market to the detriment of the Funds and its unsuspecting investors." They alleged that by serving as "investment advisor, bond underwriter, and mutual fund manager," UBS's actions "created a disabling conflict of interest which caused [it] . . . to breach [its] fiduciary and other duties to the Funds." They further alleged that UBS caused "millions of dollars in . . . losses which [were] exacerbated . . . [by] the illiquidity of the market for the Funds, which [was] in large part controlled by [UBS]." To that end, investors claimed UBS engaged in "material misstatements and fraudulent omissions," including the withholding of information that demand was created through large-scale purchases of ERS bonds, thereby "artificially inflat[ing]" the price and masking the bonds' substantial risk. As a result, investors claimed UBS used the CEFs as a "dumping ground for the toxic pension bonds . . . in order to maximize the [bonds'] offering price."

         3. The Insurance Policies

         In 2011, UBS began searching for a new insurance provider to cover legal disputes. UBS's broker, Marsh, approached XL for primary coverage and Axis Reinsurance ("Axis") and Hartford Fire Insurance ("Hartford") (collectively, "Insurers") for secondary coverage. UBS negotiated the terms of the policies with the advice of Marsh and coverage counsel, Covington & Burling LLP. In the process, UBS requested numerous changes to the policy language proposed by XL. While XL agreed to many of UBS's requested changes, it did not agree to alter the terms of a specific litigation exclusion. Ultimately, XL issued a primary $10 million policy, Axis issued a $5 million first excess policy, and Hartford issued a $5 million second excess policy in UBS's favor. The primary and secondary policies (together, the "Policy") shared most terms and conditions, including a specific litigation exclusion. The exclusion precluded coverage of:

any Claim in connection with any proceeding set forth below, or in connection with any Claim based on, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any such proceeding or any fact, circumstance or situation underlying or alleged therein:
Unión de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan, et al. v. UBS Financial Services Incorporated of Puerto Rico, et al., Case No. 10-1141, U.S. District Court, District of Puerto Rico.
The [2009] investigation by the Securities and Exchange Commission captioned "in the Matter of UBS (Certain Puerto Rico Bonds and Funds)" SEC File No. FL-3491.

(the "Specific Litigation Exclusion") (emphasis added). Hence, if a new claim was related to either the 2009 SEC Investigation or the 2010 Unión Lawsuit as described in the clause above, it was not covered by the Policy. Crucially, during negotiations, UBS attempted to narrow the scope of the Specific Litigation Exclusion, but XL rejected the proposed changes. Specifically, UBS sought to replace "any fact, circumstance or situation underlying or alleged therein" with "the same Wrongful Acts alleged in any such proceeding," and to remove the phrase "in any way."

         Generally, the Policy protected UBS against claims alleging wrongful acts made during the policy period.[3] A "claim" included any "written notice received by an Insured that any person or entity intends to hold any Insured responsible for a Wrongful Act," any "proceeding in a court of law or equity," or "any formal, civil, criminal, administrative, or regulatory investigation of an Insured." Moreover, a "wrongful act" was "any actual or alleged act, error, omission, misstatement, misleading statement or breach of fiduciary duty . . . committed by [UBS] in the performance of, or failure to perform, Professional Services." "Professional services" meant "financial, economic or investment advice given or investment management services performed for others for a fee or commission by [UBS]."

         In addition, the Policy included a "notice of claim endorsement" that required written notice of any claim "as soon as practicable after it is first made . . . but in no event later than ninety (90) days after the expiration of the Policy Period." Lastly, the Policy contained an "interrelated claims" provision mandating that all claims resulting from interrelated wrongful acts constitute a single claim.

         4. Legal Disputes Since 2012

         Since the beginning of the policy period, UBS has litigated, as pertinent here, two civil actions (the "Casasnovas" and "Fernández" Litigations), two regulatory investigations (by the SEC and the Financial Institutions Regulatory Association ("FINRA")), and hundreds of FINRA arbitrations (collectively, the "Disputed Matters"). UBS contends that the financial crisis in the Puerto Rico bond market catalyzed litigation against it.

         a. 2013 ...


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