A CNA Financial Corp. unit was not obligated to defend or indemnify a tax preparation firm that recommended illegal tax shelters under an exclusion in its professional liability policy, a federal appeals court ruled in upholding a lower court ruling.

Memphis, Tennessee-based Financial Strategy Group P.L.C. bought professional liability insurance from Continental Casualty Co., a unit of Chicago-based CNA, in 2008, according to Tuesday’s ruling by the 6th U.S. Circuit Court of Appeals in Cincinnati in Financial Strategy Group P.L.C. v. Continental Casualty Co.

The insurance policy said Continental would defend FSG against claims arising from its tax preparation services and, if necessary, pay the claims, but excluded claims “based on, arising out of or in connection with the design, recommendation, referral, sale or promotion” of illegal tax shelters, according to the ruling.

Soon thereafter, two groups of former clients sued FSG for malpractice, fraud and other claims, charging the firm had conspired with other advisers to “develop, promote, sell, and implement ‘investment strategies’ that the IRS later determined were illegal tax shelters,” according to the ruling.

FSG filed insurance claims with Continental, which denied the claims, stating the policy’s exclusion for tax shelters relieved it of any duty to defend or indemnify the firm. FSG then sued Continental for breach of the policy.

The U.S. District Court in Memphis dismissed the case, and a unanimous three-judge appeals court panel of the 6th Circuit upheld the ruling.

“FSG argues that it did not design, recommend or sell illegal tax shelters because FSG prepared tax returns for the (tax preparation clients) after the shelters had been designed, marketed, and sold.

“But a ‘recommendation’ is a piece of advice or suggestion of how to do something,” based on the Oxford English Dictionary? definition, said the ruling. The clients “alleged that FSG ‘advised’ them that they ‘could properly’ claim losses from the illegal tax shelters.”

“Moreover, FSG’s act of including a proposed loss on a tax return was itself a suggestion to claim the loss. Thus, regardless of when the shelters here were sold, FSG’s actions in preparing (the clients’) returns amounted to a recommendation to proceed with them,” said the panel in ruling the policy exclusion applied and affirming the case’s dismissal.