A professional services exclusion in a D&O policy barred indemnity coverage for securities lawsuits arising out of NASDAQ’s system failures on the day of Facebook’s initial public offering according to a New York federal judge in Beazley Ins. Co. v. ACE Am. Ins. Co.

NASDAQ’s professional liability insurers, including Beazley, accepted coverage for the lawsuits, while NASDAQ’s D&O liability insurers, including ACE, denied coverage pursuant to the professional services exclusion. NASDAQ settled and assigned its rights under the D&O policies to Beazley, which sued the D&O insurers. The Honorable Judge Jed Rakoff ruled that ACE owed a duty to advance defense costs after which the parties engaged in discovery. Beazley then sought summary judgment on the issue of the D&O insurers’ indemnity obligations.

The professional services exclusion precluded coverage for claims “by or on behalf of a customer or client of [NASDAQ], alleging, based upon, arising out of, or attributable to the rendering or failure to render professional services.”

Judge Rakoff first determined that plaintiffs in the underlying lawsuits, retail investors in Facebook, constituted “customers or clients” of NASDAQ. In his previous ruling on ACE’s defense obligation, Judge Rakoff concluded that the phrase “customer or client” was ambiguous and could reasonably be read to exclude retail investors in a NASDAQ-listed company. Judge Rakoff here was presented with the fruits of discovery and decided that the issue warranted a “fresh look.” Customs, practices and usage, and earlier decisions by the 2nd U.S. Circuit Court of Appeals, made clear that retail investors unambiguously qualified as “customers or clients” of NASDAQ.

The parties acknowledged that the design and operation of NASDAQ’s systems constituted professional services. Beazley asserted, however, that the misrepresentation allegations underlying the securities claims were not attributable to professional services. Judge Rakoff disagreed concluding that the alleged misstatements were not mere advertisements promoting NASDAQ’s services. Under New York law’s “but for” test, the securities claims would have failed, but for NASDAQ’s allegedly “botched rendering of professional services,” including “the wholesale breakdown in NASDAQ’s trading platforms” causing, among other things, “erroneous and failed trade executions.”

If NASDAQ’s systems had functioned properly during the Facebook IPO, the investors would have had no damages and their claims would have failed. Accordingly, the underlying investors’ claims fell within the exclusion and ACE had no indemnity obligation.

The previous ruling on the duty to defend stood as there was, until this ruling, “legal uncertainty” over whether retail investors were “customers or clients” of NASDAQ. The case was remanded for trial to ascertain the amount of unreimbursed defense costs for which ACE was obligated in excess of its $2 million retention.

Judge Rakoff’s ruling for the D&O insurers is consistent with the view that D&O and E&O policies cover different risks and are not intended to provide duplicative or overlapping coverage. A number of jurisdictions apply the “but for” test used by Judge Rakoff, which can result in a broad interpretation of exclusions that include a “based upon or arising out of” preface. Even if the claim alleges nonprofessional services, a professional services exclusion could bar indemnity obligations if the insurer can establish a causal connection.