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Allegis Investment Services, LLC v. Arthur J Gallagher & Co.

United States District Court, D. Utah, Central Division

March 1, 2019




         This matter is before the court on several motions: Plaintiffs Allegis Investment Services, LLC, and Allegis Investment Advisors, LLC's Motion for Summary Judgment [Docket No. 122]; Defendant Indian Harbor Insurance Company's Motion for Summary Judgment [Docket No. 125]; Defendants Arthur J. Gallagher & Co. and Paige Nabavian's Motion for Summary Judgment [Docket No. 126]; and Plaintiffs' Expedited Motion to Add a Claim for Reformation Under Plaintiffs' Declaratory Judgment Action or, Alternatively, to Amend Pleading to Conform to Proof [Docket No. 215].[1] On December 13, 2018, the court held a hearing on the motions. At the hearing, Plaintiffs were represented by Mary Anne Q. Wood and Jared M. Asbury, Defendant Indian Harbor was represented by Thomas J. Judge, Charles W. Chotvacs, and Defendants Arthur J. Gallagher & Co. and Paige Nabavian were represented by Kristine M. Larsen, Mark W. Pugsley, and Aaron Hinton. The court heard argument and took the motions under advisement. After carefully considering the parties' memoranda and the law and facts relevant to the pending motions, the court issues the following Memorandum Decision and Order.


         Allegis Investment Services, LLC, (“AIS”) is a broker-dealer investment company and Allegis Investment Advisors, LLC (“AIA”), is a registered investment advisor company (collectively, “Allegis”). In this case, Allegis seeks insurance coverage for claims against AIS and AIA relating to a “Net Credit Spread” investment strategy that Allegis employed in 2015. On August 20, 2015, Allegis, with full discretionary authority for its clients, executed a “put credit spread” based on the Russell 2000 index on a total of 39, 200 put options on each side of the spread. This trade had a maximum potential profit of $313, 600, and a maximum potential loss of $38, 886, 400. Allegis' investor accounts suffered the maximum potential losses from the August 20, 2015 trade, and many of the investors initiated arbitrations against Allegis to recover their losses.

         On February 28, 2014, AIS was approved by the Financial Industry Regulatory Authority (“FINRA”) as a broker-dealer. As part of the approval process, AIS was required to have broker-dealer investment advisors errors and omissions insurance coverage. Allegis tasked Brian C. Pierce, an accountant for AIS, with securing E&O coverage for AIS and AIA in 2014 and 2015. Pierce contacted Gallagher & Company and was put in contact with Paige Nabavian, a Gallagher representative. Nabavian assembled the application and forwarded it to John Churney, a wholesaler who worked for CRC Crump. Gallagher then proposed a policy to Allegis through Indian Harbor Insurance Company.

         On February 28, 2014, Nabavian sent Pierce an email with two attachments: a Proposal for Insurance and an Indian Harbor “E&O” policy form and endorsements. The Proposal of Insurance contained information pertaining to the Broker-Dealers and Investment Advisors Errors & Omissions Policy Form through Indian Harbor Insurance Company for the policy period of March 3, 2014 to March 3, 2015, with limits of liability of $1, 000, 000 each claim/$2, 000, 000 aggregate for all losses. Allegis accepted the terms and conditions of the 2014 Proposal of Insurance and signed the Client Authorization to Bind coverage with Indian Harbor. The Client Authorization states that Allegis “understood this proposal provides only a summary of the details; the policies contain the actual coverages.”

         The Proposal of Insurance Disclosures section also informed Allegis that “the insurance policies themselves must be read” for details regarding all the terms, coverage, exclusions, limitations, and/or conditions of the actual policy contract language. The disclosures further stated that Gallagher & Co “will not be operating in a fiduciary capacity, but only as your broker/agent, obtaining a variety of coverage terms and conditions to protect the risks of your enterprise. We will seek to bind those coverages based upon your authorization; however, we can make no warranties in respect to policy limits or coverage considerations of the carrier. Actual coverage is determined by policy language so read all policies carefully.”

         The Proposal of Insurance also stated that “Gallagher strives to find appropriate coverage at a competitive price for our customers. In order to achieve these goals, we gather and analyze data about our customers and their insurance coverage. This data and the resulting analytical tools help us better understand the current marketplace, more accurately predict future trends and offer tailored solutions to our customers.”

         Allegis admits that it received a copy of the 2014 E&O Policy. The Policy contains the following exclusion: “This insurance does not apply to any Claim or Defense Expenses: . . . Arising out of the actual or alleged purchase, sale, attempted sale, solicitation or servicing of any of the following: . . . . Commodities, any type of futures contracts, any type of option contract or derivative. However, this exclusion shall not apply to fully covered put or call options.”

         On February 21, 2015, Gallagher provided Allegis a Proposal of Insurance for the renewal of Allegis' E&O Policy through Indian Harbor for the policy period of March 3, 2015 to March 3, 2016, with limits of $1, 000, 0000 each claim/$2, 000, 000 aggregate for all loses. Allegis accepted the terms of the 2015 Proposal and signed the Client Authorization to Bind. The authorization and proposal contained the same provisions as the 2014 versions. Allegis received a copy of the 2015 E&O Policy. The 2015 E&O Policy contains the same terms and exclusions.

         Pierce cannot recall whether anyone at Allegis read the 2014 or 2015 E&O policies. However, after the August 2015 losses occurred, Pierce and Heath Bowen, Allegis' Chief Executive Officer, read the language of the 2015 E&O Policy and concluded that any claims arising from the August 2015 losses would be covered because Allegis' strategy allegedly involved fully covered puts. Bowen testified that the Net Credit Spread strategy involves the trading of fully covered put options.

         While Allegis claims that it disclosed its options trading in documents attached to its application for insurance, it cannot identify any document that explains the nature of Allegis' Net Credit Spread strategy. Pierce completed a 2014 Chubb Application and Supplemental Questionnaire for the E&O Policy, but he did not include information regarding Allegis' trading strategy. On the XL Application, Allegis stated that 25% of its recommended investments involved options but did not state the type of options contracts it traded or the nature of its strategy. Pierce, who was in charge of obtaining the insurance, had no personal knowledge regarding the type of options trading that Allegis transacted or any understanding of the nature of the Net Credit Spread strategy. Gallagher did not have any independent understanding of the nature of Allegis' Net Credit Spread strategy.

         Allegis never requested that Gallagher analyze the adequacy of the coverage or advise Allegis as to whether $1 million per claim/$2 million aggregate for all losses was an adequate amount of coverage for Allegis' business risks and potential exposure. Pierce cannot recall any specific discussion with Nabavian concerning the adequacy of Allegis' requested liability limits. However, he recalls discussing the fact that carriers were only willing to write certain limits due to the fact that Allegis was a relatively small start-up company. In addition, Pierce did not ask Gallagher to advise it as to whether claims specifically arising out of Allegis' Net Credit Spread strategy would be covered under the 2015 E&O Policy.

         Bowen considered the August 2015 losses to be an unexpected event. Prior to the August 2015 losses, Allegis had never incurred losses arising out of the Net Credit Spread strategy even though Bowen had been using the strategy since 2009.

         AIA conducted options trading for its clients via TD Ameritrade's platform for the Cboe. AIA advisors executed a TD Ameritrade Account Agreement for Options Trading. Pursuant to that agreement, the AIA advisor agreed that the advisor had implemented policies and procedures to obtain and retain client option information as well as to follow the position and exercise limits “set forth by FINRA Rule 2360.” FINRA Rule 2360 addresses “options” and defines the term “covered” in connection with put options. “The term ‘covered' in respect of a short position in a put option contract means that the writer holds in the same account as the short position, on a unit-for-unit basis, a long position in an option contract of the same class of options having an exercise price equal to or greater than the exercise price of the option contract in such short position.” Rule 2360's definition of a “covered” put is consistent with, and essentially identical to, the definition provided by Rule 1.1(y) of the Cboe which is the exchange where AIA traded options.

         AIA provided its investors with a disclosure for “uncovered puts” which stated that AIA would “honor all exercise assignments . . . on any uncovered put positions by purchasing the underlying security or settling the contract in cash.” AIA also provided the required FINRA Rule 2360 “Special Statement for Uncovered Option Writers.” The special statement disclosed that the “risk of writing uncovered put options is substantial. The writer of an uncovered put option bears the risk of loss if the value of the underlying instrument declines below the exercise price.” This was exactly the risk AIA's investors faced in the bull put/net credit spread strategy.

         On August 20, 2015, AIA placed a block trade for all of its options investors employing a bull put/net credit spread, with the cost and losses distributed pro rata among the investors. AIA directed the sale of 39, 200 RUT put option contracts with an August 21, 2015 expiration and a strike price of $1, 155.00. AIA received a premium from each contract of $0.5272. Allegis also directed the purchase of 39, 200 RUT put option contracts with an August 21, 2015 expiration and a strike price of $1, 145.00. The cost of each contract was $0.4472. Because each option contract involved a multiplier of 100, Allegis investors collectively received $2, 066, 624 for the puts sold, and paid $1, 753, 024 for the puts purchased, thereby creating a net credit in premium of $313, 600 (minus transactional costs).

         Indian Harbor alleges that the trade was not “covered” as that term is defined by FINRA Rule 2360 and Cboe Rule 1.1(y) because instead of buying puts at the same or higher strike price than the puts AIA sold, AIA bought puts at a lower strike price, which was solely a play for premium. AIA bet that the RUT price near the end of August 2015 would largely stay the same or increase. If the RUT had expired above the strike price of $1, 155, AIA's option contracts would have expired “out of the money, ” and its investors would have retained the premium difference between the sold and bought puts-$313, 600.

         However, the trade settled down “in the money” at $1, 145.06, which was well below the strike price for the puts sold by AIA and just a little higher than the strike price for the puts AIA purchased. AIA was required to buy 3, 920, 000 shares (39, 200 options contracts with a multiplier of 100) of the RUT Index at $1, 155 for a total of $4, 527, 600, 000. AIA had to simultaneously sell the 3, 920, 000 shares of the RUT Index at the market price of $1, 145.06 for a total of $4, 488, 635, 200, paying the more than $38 million difference from the assets in client accounts. Factoring in the $313, 600 in premium realized on the spread, AIA investors permanently lost a combined total of $38, 651, 200 on the August 20, 2015 trade. That loss amounted to roughly half of what AIA investors had in their accounts. In sum, AIA risked a total of $39.2 million for a maximum potential gain of $313, 600. Following those losses, Allegis permanently discontinued its bull put/net credit spread strategy.

         With all of Allegis' options investors losing half of their accounts on one trade, between September and mid-November 2015, AIA investors began to complain and threaten lawsuits and arbitrations. For example, one investor lost $50, 000 for a potential gain of only $381. Allegis reported those matters to Indian Harbor. In addition to Allegis' investors asserting claims, state and federal regulators opened investigations. Allegis retained coverage counsel in August 2015 before it provided notice of investor claims to Indian Harbor.

         Allegis reported eight matters to Indian Harbor arising out of the August 2015 options trade from disgruntled investors. On September 2, 2015, Indian Harbor sent letters acknowledging receipt of notice. Indian Harbor's letters also advised Allegis that it would provide Allegis with an initial analysis of the Policy as it applies to the complaints received and, until it completed its initial review, it reserved all rights and defenses under the Policy and applicable law.

         In mid-September 2015, Indian Harbor suggested three qualified law firms for Allegis to review and evaluate as potential defense counsel. Allegis wanted to use Quinn Emmanuel but Indian Harbor would not consider an international law firm with hourly rates exceeding $400 per hour for a $2 million policy. On September 22, 2015, Allegis chose Gordon & Rees to serve as defense counsel. On September 23, 2015, Indian Harbor sent confirmation to Allegis of Gordon & Rees' retention and stated that XL would issue a coverage position in the near term and, in the meantime, reserved all rights under the Policy and applicable law.

         Following assessment of the submitted claim materials, Indian Harbor determined that the Policy did not provide coverage for the options investors' claims. On December 7, 2015, Indian Harbor issued a letter declining coverage for the eight noticed claims. Indian Harbor determined that the claims arose out of the trading of options which were not fully covered put or call options and, therefore, the Options Trading Exclusion barred coverage for the claims. Indian Harbor also determined that the matters arose out of the same options trade and strategy and were thus a single claim.

         Indian Harbor's email to Allegis forwarding the letter, as well as the letter itself, asked Allegis to contact Indian Harbor with any questions or if it wished to discuss the matter. Indian Harbor's letter also advised that it “will gladly review any additional information or evidence you believe will aid us in reaching a different conclusion.” Indian Harbor's claim counsel called Heath Bowen in conjunction with sending the December 7 letter and invited a telephone conference in the event that Allegis had any questions or disagreed with Indian Harbor's analysis. Until this action was filed on June 5, 2017, no one associated with Allegis ever disputed Indian Harbor's coverage determination or provided Indian Harbor with any additional information for it to consider.

         Based on Indian Harbor's denial of coverage, it did not pay any of the defense expenses incurred by Allegis. Through December 7, 2015, Gordon & Rees had incurred $31, 332.00 in fees and expenses, which fall under the Policy's $35, 000.00 deductible.

         At the time Indian Harbor denied coverage, only one arbitration statement of claim had been served, which Allegis reported to Indian Harbor in November 2015. In addition to the eight matters reported to Indian Harbor between September and mid-November 2015, Allegis also seeks coverage for twelve additional matters arising out of the August 2015 trade that Allegis noticed to Indian Harbor during the policy period.

         Following expiration of the 2015 E&O Policy, Allegis sought coverage through Pioneer Underwriters. In connection with its 2017 policy application, Allegis disclosed that 21 professional liability complaints had been made against it, and it listed 18 of the matters for which it seeks coverage for in this action.


         Allegis' Motion for Summary Judgment deals only with its insurance coverage claims against Indian Harbor, not any of its claims against Gallagher & Co. and Paige Nabavian. Therefore, it is actually a motion for partial summary judgment. Indian Harbor's motion for summary judgment seeks dismissal of all the claims Allegis has asserted against it. Gallagher and Nabavian's motion for summary judgment also seeks dismissal of all of Allegis' claims against them. Because Allegis' and Indian Harbor's motions are essentially cross motions on the same claims, the court will address them together. The court will then address Gallagher and Nabavian's motion.

         Allegis' & Indian Harbor's Cross Motions for Summary Judgment

         Allegis seeks insurance coverage from Indian Harbor under the E&O Policy in relation to its investors' arbitrations against it, claiming that Indian Harbor had a duty to defend and indemnify it for the investors' actions under the terms of the Policy. Indian Harbor contends that the Options Exclusion in the E&O Policy barred coverage for the investors' actions against Allegis because Allegis' August 2015 trade did not involve fully covered put options. Allegis, however, argues that the Options Exclusion's carve-back for fully covered put options applies and it allows for coverage of the investors' claims against Allegis.

         In interpreting the Policy, this court looks to Utah law. Berry & Murphy, P.C. v. Carolina Cas. Ins. Co., 586 F.3d 803, 808 (10th Cir. 2009). Under Utah law, “[a]n insurance policy is merely a contract between the insured and the insurer and is construed pursuant to the same rules applied to ordinary contracts.” Alf v. State Farm Fire & Cas. Co., 850 P.2d 1272, 1274 (Utah 1993). “Like other contracts, an insurance policy is interpreted to give effect to the intent of the parties as expressed by the plain language of the instrument itself.” Headwaters Res., Inc. v. Ill. Union Ins. Co., 770 F.3d 885, 891 (10th Cir. 2014).

         If the policy language is clear and unambiguous, the court must construe it according to its plain and ordinary meaning.” Alf, 850 P.2d at 1274. An insurance policy is ambiguous “if it is unclear, omits terms, or is capable of two or more plausible meanings.” S.W. Energy Corp. v. Cont'l Ins. Co., 974 P.2d 1239, 1242 (Utah 1999). “However, policy terms are not necessarily ambiguous simply because one party seeks to endow them with a different interpretation according to his or her own interests.” Id. Rather, “the proposed interpretation must be plausible and reasonable in light of the language used.” Id. Courts construe ambiguous policy terms liberally in favor of coverage in order to promote the purpose of insurance. S.W. Energy, 974 P.2d at 1242. “To protect against overreaching insurers and because courts construe contracts against their drafters, ambiguities in the policy are resolved in favor of coverage.” Quaker State Minit-Lube, Inc. v. Fireman's Fund Ins. Co., 868 F.Supp. 1278, 1292 (D. Utah 1994).

         The insured bears the initial burden of showing that there is coverage for a particular claim under the policy. See Utah Farm Bureau Ins. v. Dairyland Ins., 634 F.2d 1326, 1328 (10th Cir. 1980). The insurer then bears the burden of proving by a preponderance of the evidence that an exclusion to coverage applies. LDS Hosp. v. Capitol Life Ins., 765 P.2d 857, 859-60 (Utah 1988). Courts construe provisions that limit or exclude coverage strictly against the insurer. U.S. Fid. & Guar. Co. v. Sandt, 854 P.2d 519, 522-23 (Utah 1993). “After an insurer meets its burden of proof that an exclusion applies, the burden then shifts to the insured to prove an exception to the exclusion applies.” Ironshore Specialty Ins. v. Callister, Nebeker & McCullough, P.C., No. 2:15CV677RJS, 2017 WL 6550678, at *5 (D. Utah Dec. 21, 2017) (unpublished); Quaker State Minit-Lube, Inc. v. Fireman's Fund Ins., 868 F.Supp. 1278, 1312-13 (D. Utah 1994), aff'd, 52 F.3d 1522 (10th Cir. 1995). Therefore, in this case, Indian Harbor has the burden to demonstrate that the Options Exclusion applies, and Allegis has the burden to prove that the carve-back exception for fully covered put options applies.

         1. Duty to Defend

         Allegis first argues that it was a breach of contract for Indian Harbor to undertake the defense and then abandon it when Indian Harbor concluded that there was no coverage under the Policy. “An insurer's duty to defend a lawsuit against its insured is both separate and distinct from the insurer's duty to indemnify its insured for liability that is imposed against the insured after trial.” Aspen Specialty, 954 F.Supp.2d at 1315. “[A]n insurer may have a duty to defend an insured even if . . . the insurer is ultimately not liable to indemnify the insured.” Id. Under Utah law, an insurer must defend “when the ...

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