(Article from Insurance Law Alert, October 2025)
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Holding
Settlements with third-party claimants for losses stemming from a Ponzi scheme perpetrated by an employee of the insured company are not covered by a financial institution bond. Cadaret, Grant & Co., Inc. v. Great Am. Ins. Co., 2025 U.S. Dist. LEXIS 188039 (E.D.N.Y. Sept. 23, 2025).
Background
The coverage dispute arose out of allegedly fraudulent acts perpetrated by Steven Pagartanis, a registered representative licensed to sell securities on behalf of Cadaret, a securities broker-dealer. The Securities and Exchange Commission filed a civil complaint against Pagartanis, alleging that he defrauded investors through a Ponzi scheme, and he was later indicted for securities fraud and money laundering, among other things. Additionally, several Cadaret clients filed claims against the company, seeking to hold Cadaret responsible for the losses incurred in Pagartanis’ fraudulent scheme. Cadaret settled all claims in mediation.
Cadaret sought coverage for the settlement pursuant to a financial institution bond issued by Great American which covered “[l]oss resulting directly from dishonest or fraudulent acts committed by an employee . . . with the manifest intent: (1) to cause the Insured to sustain such loss; and (2) to obtain an improper financial benefit for the Employee or another person entity.”
Great American denied coverage, and Cadaret sued, alleging breach of contract and seeking a declaration that all existing and future losses resulting from Pagartanis’ scheme are covered under the bond. The court granted Great American’s summary judgment motion.
Decision
The court ruled that Cadaret’s third-party losses are not a “direct loss” under the bond. Under New York law, “direct loss” in fidelity bonds means loss to an insured stemming “directly” from an employee’s improper conduct and does not extend to losses stemming from liability for third-party settlements. The court rejected Cadaret’s assertion that the “direct loss” requirement can be established in third-party loss contexts by a showing of proximate causation.
The court also rejected Cadaret’s argument that the funds stolen by Pagartanis from clients’ personal bank accounts constituted “covered property,” defined by the bond as “loss of Property (a) owned by the Insured, (b) held by the Insured in any capacity, or (c) owned or held by someone else under circumstances which make the Insured responsible for the Property prior to the occurrence of the loss.” The court explained that the funds at issue were held in clients’ personal accounts at the time of theft, not in any account associated with or accessible by Cadaret.
Finally, the court held that coverage was barred by an exclusion that applied to “damages of any type for which the Insured is legally liable, unless the Insured establishes that the act or acts which gave rise to the damages involved conduct which would have caused a covered loss to the Insured in a similar amount in the absence of such damages.” Cadaret argued that the exception to the exclusion restored coverage because it would have sustained the same loss had it simply reimbursed clients without the settlements. Rejecting this contention, the court stated: “The exception to the exclusion concerns conduct that would have caused a covered loss absent legal liability, not whether Cadaret would have paid the same cost if it had reimbursed the clients involved in the scheme absent the threat of legal liability.”
Comments
The decision highlights an important distinction between liability policies and institutional bonds, particularly in the context of losses stemming from an employee’s dishonest acts. Whereas a liability policy typically indemnifies against third-party liability faced by the insured entity as a result of actions by the insured or its agents, a bond generally protects against the loss of the insured’s property, caused directly by employee dishonesty.
As the court noted, the Fifth, Seventh and Ninth Circuits have followed the principle that “direct loss” language in a fidelity bond precludes coverage for losses stemming from third-party settlements.