RECOVERING MORE INSURANCE FOR SEC AND INTERNAL INVESTIGATIONS By Mary Craig Calkins and Linda D. Kornfeld Recent decisions in the Office Depot, 1 MBIA, 2 and Gateway, Inc. 3 cases have refined the law governing Directors and Officers ( D&O ) liability insurers obligation to pay for the defense of investigations by the Securities and Exchange Commission ( SEC ) or other regulatory bodies. The more recent decisions confirm that an insurance policy can address an informal SEC inquiry into possible securities law violations. Policy language varies broadly, with some provisions covering civil, administrative or regulatory investigations, while other policies cover actions commenced by a filing of charges, investigative order. or similar document. Newer policies can refer expressly to subpoenas or Wells notices, which advise when the SEC is planning to bring an enforcement action. The laws of each state also may differ in their construction of policy provisions. However, an insured company can pursue good arguments for coverage long before a Formal Order of Investigation is issued. If there is one theme, these cases confirm that policyholders should never presume that there is no coverage for amounts spent responding to regulatory inquiries (whether formal or informal). Instead, policyholders should review their specific policy language and relevant case law to determine the possibility of coverage. I. CASE LAW REGARDING COVERAGE FOR INVESTIGATIONS A. Office Depot. Late last year, the U.S. Court of Appeals for the Eleventh Circuit issued its controversial ruling in Office Depot. In that unpublished decision, the court ruled that under the specific policy language at issue, costs voluntarily incurred in assisting with an SEC informal investigation were not covered. The policies at issue in that action covered Securities Claims, and defined Claim as including other than an administrative or regulatory proceeding against, or investigation of an Organization, made against any Insured[.] 4 The policies also contained a carve-back provision that modified the Securities Claims definition to include an administrative or regulatory proceeding against an Organization, but only if and only during the time such proceeding is also commenced and continuously maintained against an Insured 1 Office Depot, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA., No. 11-10814 ), 2011 U.S. Dist. LEXIS 20759 (11th Cir. 10/13/11). 2 MBIA, Inc. v. Federal Ins. Co., No. 10-0355-cv, 2011 U.S. App. LEXIS 13402 (2d Cir. 7/1/11). 3 Gateway, Inc. v. Gulf Ins. Co., No. 3:10-cv-1720-WQH-JMA, 2011 U.S. Dist. LEXIS 91063 (S.D. Cal. 08/15/11). 4 Office Depot, 734 F.Supp. 2d at 1309. Reprinted with permission from The Bureau of National Affairs, Inc. ( BNA ) Corporate Counsel Weekly Copyright 2012 CCW ISSN 0886-0475
Person. 5 Based upon this specific language, the court distinguished between proceedings and investigation in deciding whether coverage existed for the informal response expenditures. In particular, according to the court, the first definition expressly precluded coverage for administrative or regulatory proceedings, and administrative or regulatory investigations. The carve-back provision restores coverage for the former under certain circumstances. But it does not restore for the latter. 6 The court thus ruled against coverage based upon its conclusion that Office Depot s expenditures responded to an expressly uncovered investigation as opposed to a potentially covered proceeding. A number of commentators have asserted that this decision broadly supports a conclusion that informal investigation costs simply are not covered. However, a reading of Office Depot makes clear that it is limited to the facts and policy language at issue in that particular action. In fact, the December 31, 2011 decision Employers Fire Ins. Co., v. ProMedica Health System, Inc. 7 makes that point abundantly clear: Office Depot does not stand for the principle ProMedica desires chiefly that Wells Notices, or their equivalent, are the minimum required for a claim to arise. Rather the case demonstrates that these inquiries largely turn on the terms of the policy and the specific underlying facts. 8 B. MBIA Discussion. In MBIA, the U.S. Court of Appeals for the Second Circuit ruled in broad language that the costs of defending investigations are covered. That action involved investigations of MBIA by both the SEC and the New York State Attorney General regarding MBIA s accounting for certain non-traditional products. Both the SEC and the NYSAG issued multiple subpoenas to MBIA. To preserve its public image, MBIA spent substantial sums to comply voluntarily with informal document requests and respond to subpoenas and informal requests. MBIA s ultimate offer to settle with the SEC included the retention of an independent consultant regarding its accounting practices. MBIA also formed a Special Litigation or Audit Committee ( SLC ) to investigate derivative lawsuit allegations, and the SLC had its own counsel to assist in that investigation. MBIA then sought coverage from its D&O insurers for these and other expenditures. The policy s definition of Securities Claim that covered a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document. The court concluded that the amounts spent by MBIA to gather and produce documents were covered, even though some of the expenditures 5 Id. at 1316. 6 Id. 7 No. 3:11 CV 9232011, U.S. Dist. LEXIS 150225 (N.D. OH 2011). 8 Id. at *22-23. 2
were not incurred in response to any actual subpoena. The court held that insurers cannot require that as an investigation proceeds, a company must suffer extra public relations damage to avail itself of coverage. 9 The court also ruled in favor of coverage for the other amounts spent by MBIA. With respect to the SLC expenses, the court rejected the insurers argument that the SLC was independent of MBIA and thus not an insured under the policy. Among other reasons supporting coverage, the court found that the SLC acted on behalf of MBIA and thus was covered. C. Defense Expenses for Third Party Witnesses Are Covered. Testimony of current and often former corporate employees as fact witnesses also can be critical to the defense of SEC investigations and enforcement actions. Some D&O policies contain language explicitly covering legal demands or compulsion in the form of subpoenas in the definition of Claim. 10 At least one recent court has found those fees can be covered. In Gateway, Inc. v. Gulf Insurance Co. 11, the policyholder filed suit to recover fees incurred in defending current and former employees under subpoena to testify in an SEC lawsuit as fact witnesses. The primary insurer had consented to the expense because the defense team had extensive knowledge of the issues and facts that carried over into the SEC s claims against the Individual Defendants in the SEC Lawsuit and the parties and their counsel could leverage prior work done by the firm to reduce overall costs. The excess insurers denied coverage, arguing that as mere witnesses, they were testifying employees and no Claim as recognized by the Policy had been made against them. Gateway contended that the defense costs were Losses incurred to indemnify company directors and officers (the Employees ) from any claim, and that alternatively, the subpoenas to testify constituted Claims under the policy and case law. Gateway also argued, but the court did not reach, the alternative contention that the representation of the Employees was reasonably related to the defense of the Insureds. Instead, the court analyzed the policy definition of Directors and Officers and found that employees qualified as covered Insureds under the clear and explicit reading of the policy. The court reasoned that coverage clauses are interpreted broadly so as to afford the greatest possible protection to the insured, [whereas] exclusionary clauses are interpreted narrowly 9 Id. at *7. 10 See, e.g., Polychron v. Crum & Forster Ins. Cos., 916 F.2d 461, 463 (8th Cir. 1990) ( The function of a subpoena is to command a party to produce certain documents and therefore constitutes a claim against a party. ); Minuteman Int l, Inc. v. Great Am. Ins. Co., No. 03 C 6067, 2004 U.S. Dist. LEXIS 4660 (N.D. Ill. March 18, 2004). 11 No. 10cv1720-WQH-JMA, 2011 U.S. Dist. LEXIS 91063 (S.D. Cal. Aug. 15, 2011). 3
against the insurer. 12 Alternatively, the court found that competing interpretations of the Directors and Officers definition highlighted an ambiguity in the coverage to be read favorably to Gateway to protect the objectively reasonable expectations of the insured. 13 The lesson)s from these cases are clear. The language of D&O policies is important. As a result, policyholders must take aggressive steps to protect coverage before and after a Claim. II. MORE RETURN ON YOUR INSURANCE INVESTMENT Companies pay large premiums, expecting coverage to be there for SEC and internal investigations. However, Insurers are in business too. That natural tension between expecting coverage and avoiding payment of defense costs or settlement can be difficult. The following ten steps can help a policyholder maximize available insurance dollars. 1. Rely on Rules of Policy Interpretation to Broaden Coverage. Each state has its own rules of contract interpretation, and most states require an insurer to construe ambiguous provisions in favor of coverage. Some states have good case law requiring an insurer to prove there is no possibility of coverage before it can avoid defense costs. Others require insurers to issue an express reservation and preserve a right to recoupment, or waive the right to seek return of defense fees. The choice of law can be the difference between coverage and no coverage. Coverage counsel can review these rules or recommend steps through defense counsel or brokers to protect a company during internal and external investigations. 2. Push for All Reasonable Defense Fees and Settlements. Newer D&O policies contain allocation provisions, which insurers use to justify paying only a portion of the defense costs and/or policyholder contributions to settlement. However, strong arguments may exist for full insurer payments. For example, the Larger Settlement Rule followed by many states requires insurers to advance defense expenses that are reasonably related to the defense of an action. 14 Allocation provisions can be read consistently with the Larger Settlement Rule to negotiate greater participation by the insurer. 3. Conduct Internal Investigations Under Joint Defense/Cooperation Agreements. The Sarbanes-Oxley Act of 2002 and other rules of corporate governance require management to empanel SLC or Audit Committees to investigate SEC, stockholder or whistleblower claims. The Company should instruct SLC counsel to make the evidence from internal investigations available to defense counsel if possible, and advise insurers of its use to avoid duplicative 12 Id. at *11. 13 Id. 14 See, e.g., Safeway Stores v. National Union Fire Ins. Co., 64 F.3d 1282, 1289 (9th Cir. 1995). 4
expense and assist the defense. Protect claims of privilege, but recognize that internal investigation findings can be reasonably related to the defense. 4. Insist on Reasonable and Prompt Advancement. Object in writing when insurers impose a mathematical or mechanical allocation, saying that they will cover only one fourth of the fees because one out of four claims is covered, or uncovered parties are named. 15 Do not allow the insurer to wait until after resolution of the case to advance fees. The insurer is obligated to pay defense costs contemporaneously, as they are incurred, and the policy itself may require payment within a set period of time. 16 Moreover, Litigation Guidelines cannot interfere with the ethical defense, and case law requires coverage for many items that insurer audits try to eliminate. 5. Provide Information in Advance of Mediation or Trial. An insurance company requires factual support and administrative approvals before it will write a large check. Equally important, an insurer has reinsurers who will demand facts supporting payments. Companies must provide sufficient information to trigger settlement authority up to full policy limits. Oral reports or predictions that a case might be defensible will not support settlement decisions. Coverage counsel can work with defense counsel to craft written reports addressing issues such as potential adverse rulings (motion practice or in limine rulings), jury sympathies, or damages analyses triggering full coverage. 6. Demand Full Coverage. Pursue coverage aggressively to recover all available defense fees and indemnity payments. Address potential impediments to payment, which often are listed in a Reservation of Rights letter or later insurer position letters. Similarly, the policyholder must make a strategic policy limits demand as supported by the facts, to leverage the insurers full participation. If defense counsel is focusing on trial or his or her hands are tied because of insurer appointments, bring in coverage counsel to confirm compliance with policy conditions and making timely demands. 7. Be Aware of Policy Notice and Cooperation Conditions. Provide notice of claims, or facts and circumstances that could give rise to claims, as soon as possible. Pre-tender defense fees may not be reimbursed in some states unless there are exigent circumstances. Also consider other milestones for notice. An amended complaint can raise additional theories triggering expanded coverage, or might expand existing bases for coverage. New claims for punitive damages or intentional conduct can affect available coverage and 15 See, e.g., Fire Ins. Exchange v. American States Ins. Co., 39 Cal. App. 4th 653, 661 (Cal. App. 1995) ( counting insureds is an unsatisfactory way to allocate payment ). 16 See, e.g., Gon v. First State Ins. Co., 871 F.2d 863, 868 (9th Cir. 1989) (insurer must pay legal expenses as they are incurred, because an insured becomes legally obligated to pay legal expenses as soon as the services are rendered. ). 5
increase exposure, making settlement more expedient. Report significant changes to the insurer in writing, to ensure that information will be in the insurers file when needed. 8. Obtain Insurer Consent Before Settling. Most policies include provisions requiring written consent by the insurer before settlement. Before embarking on a settlement discussion, check the policy and provide advance warning to the insurer as soon as possible. Settlement without consent can cost the company millions in insurance. 17 Treat this provision with care. 9. Pre-Purchase and Renewal Policy Audits. Pre-purchase or pre-renewal audits of insurance policies can expand the coverage or eliminate certain issues from dispute. Paying a slightly higher premium can pay off if one policy covers only formal SEC investigations while another covers investigations ranging from initial informal inquiries or defense costs responding to a subpoena. Some popular D&O policies contain mandatory offshore arbitration provisions that could subject a company to procedures favoring the insurer. Even panel counsel and so-called rights to control the defense can interfere with a company s right to use long-time counsel. Address those issues in advance. 10. Create an Insurance Team for Any Formal or Informal Investigation. Finally, coverage attorneys have different perspectives and experiences from brokers, often through litigation. National trends and case law can drastically affect insurance recovery. Counsel also can funnel information to brokers from the sidelines, or engage in separate claims discussions simultaneously with broker-underwriters. Coverage counsel and brokers working together before and during an investigation can assure that insurance is there when you need it. About the Authors Mary Craig Calkins and Linda D. Kornfeld are partners in Jenner & Block LLP s Los Angeles office. They are members of Jenner s insurance coverage practice. Both have extensive litigation and consulting experience in seeking coverage for D&O liability, errors and omissions, media and entertainment, intellectual property, property, and other high ticket complex business disputes. 17 See, e.g., Federal Ins. Co. v. Safenet, Inc., 758 F. Supp. 2d 251 (S.D.N.Y. 2010) (insured lost $25 million in class action settlement because it did not follow consent to settle provisions); but see Risely v. Interinsurance Exch. of the Auto. Club, 183 Cal. App. 4th 196 (Cal. App. 2010), review denied No. S182429, 2010 Cal. LEXIS 5105 (Cal. June 9, 2010) (where an insurer has repudiated its duty to defend, the insured may, without forfeiture of any right to indemnity, settle upon the best terms possible without insurer consent). 6