In an opinion issued yesterday, Judge Engelmayer granted the motion of Level Global and the hedge funds’ management team to preliminarily enjoin their insurer, XL Specialty Insurance, from cutting off the advancement of legal fees. After Level Global and its managers became the subject of a criminal insider trading investigation by the U.S. Attorneys’ Office in 2010, XL began advancing defense costs in connection with the investigation. On January 18 of this year, a day after indicting Level Global founder Anthony Chiasson, the U.S. Attorneys’ Office unsealed a guilty plea of a mid-level Level Global employee on insider trading charges. In the guilty plea, the employee allocuted to the following facts:

From 2007 to 2010 I agreed, with others, to commit securities fraud. Namely, I agreed to obtain, directly and indirectly, material non-public information from employees of public companies. I knew that the inside information I received was disclosed by the company employees in violation of duties of trust and confidence. I agreed to share that information with the other individuals at other companies as well as with others at the hedge fund where I worked. When I gave the inside information to the others at the hedge fund where I worked, I knew the information would be used to execute trades. Moreover, I did in fact obtain such information and provide it to others. For example, on August 27, 2008, I spoke with others at the hedge fund where I worked and discussed with them inside information that I obtained indirectly from an employee at [Dell].

On March 5, XL informed Level Global and its management that it would no longer advance legal fees as a result of the facts admitted in the guilty plea. The XL insurance policy that covered Level Global’s defense costs had been executed in April 2010, at which time Level Global’s general counsel had certified that no one at the firm had knowledge of any facts or circumstances that would give rise to a claim against Level Global. Based on the plea allocution, XL stated that an individual at the fund necessarily had knowledge of the facts that gave rise to the very claims against which Level Global and its management were defending, and thus XL was not required to pay costs associated with those claims. XL told Level Global that it would not advance further funds and asked Level Global to return all funds advanced — nearly three-quarters of the $10 million policy. On the same day it sent Level Global its letter, XL filed a lawsuit seeking a declaratory judgment that it was not obligated to advance funds and was entitled to restitution of funds advanced.

On March 28, Level Global and the other insured parties moved for a preliminary injunction to prevent XL from cutting off the advancement of fees.  They argued that their ability to defend against the government investigation would be irreperably harmed without XL’s advancement of fees.  Further, the insured parties argued that they had a likelihood of success on the merits, because the insurance policy did not require Level Global’s general counsel to “attest omnisciently that no proposed Insured was aware of a basis for a claim. Rather, he was attesting—and was required to attest—only that he, on behalf of Level Global, was unaware, after a reasonable inquiry, that any proposed insured was aware of a basis for a claim.”  As the insurer, XL would have the burden of establishing that an exclusion to coverage existed. Judge Engelmayer sided with Level Global and its management.  In the wake of criminal charges, the court held, the potential harm to the insured was indisputably serious and irreperable.  Further, given the ambiguity in the insurance contract — whether Level Global’s general counsel was required to certify “ominisciently” that no one in the organization had any knowledge of facts that would give rise to a claim or only that he had take reasonable steps to ascertain that no one had such knowledge — the court held that XL had not carried its burden of establishing an exclusion to an otherwise covered cost.  As a result, Judge Engelmayer ordered XL to resume the advancement of defense costs, though he stayed his order for 14 days to allow XL time to consider its appellate options.