In the 1941 case of American Surety Company of New York v. Bethlehem National Bank et al., the Supreme Court ruled in favor of Bethlehem National Bank. The dispute arose when a bank employee embezzled funds and falsified records to cover his actions, leading to an incorrect audit report by independent auditors who were unaware of the fraud. When the bank discovered this, it filed a claim with its insurer, American Surety Company (ASC), which refused payment on grounds that losses caused by false entries are not covered under their policy's "Employee Dishonesty" clause. The court held that ASC was liable for covering these losses because they resulted from fraudulent acts committed by an employee within his employment scope. It rejected ASC’s argument that since external auditors failed to detect discrepancies during audits, such loss should be considered as resulting from dishonest or fraudulent acts committed by someone other than employees insured under their policy. This ruling established important precedent regarding insurance coverage for financial institutions against internal fraud and clarified insurers' liability in cases where third-party professionals fail to detect such misconduct due to deceptive practices employed by rogue employees.

In the dissenting opinion for American Surety Company of New York v. Bethlehem National Bank et al., Justice Frankfurter argued that the majority's decision was inconsistent with established principles of suretyship law and failed to consider important aspects of commercial practice. He contended that a surety is only liable for losses directly caused by its principal's default, not those resulting from an independent act by the obligee (in this case, the bank). The bank’s decision to apply funds in a certain way was such an independent act. Therefore, according to Justice Frankfurter, it should bear responsibility for any loss incurred as a result rather than shifting it onto the surety company. Furthermore, he criticized the majority's reliance on "equitable subrogation," arguing that this principle applies only when there has been full performance under a contract - which had not occurred here since part of debt remained unpaid due to bank’s actions.