Insurance for Regulatory Investigations

July 9, 2013

Insurance LawThe subprime mortgage crisis continues to trigger investigations by a broad spectrum of state and federal agencies.  Recent enforcement actions by the FDIC, as well as policy statements by government officials, suggest the government is again ramping up its investigative activities.

These investigations can last for years and require the time and attention of dozens of a target corporation’s officers and directors, causing the corporation and its personnel to incur millions of dollars in legal fees and investigatory costs. In one recent widely-publicized case, a company spent $29.5 million responding to SEC and state investigations.

A critical threshold question for companies seeking coverage for these costs is whether the government investigations qualify as a “claim” under the companies’ “claims-made” D&O and E&O policies. The answer is highly fact specific, depending on the nature of the investigation and the variety of ways policies define the term “claim.”

Nature of Government Investigations

Investigations are difficult to categorize. The government’s purpose will affect the scope and nature of the investigation, and the purpose, scope and nature of an investigation usually evolve over time. For example, SEC investigations typically start as informal inquiries. At this initial stage, the SEC lacks subpoena power and depends on the voluntary cooperation of the target company to make progress. SEC staff have the power to subpoena witnesses and compel production of documents only after the Commission issues a “formal order of investigation.” Following a formal investigation, the Commission and the target of the investigation often settle without formal charges, or the Commission decides not to pursue the matter further. Only if the staff recommends further action, and the Commission agrees, will the SEC initiate a lawsuit or administrative action against the target of the investigation.

Critical Importance of Policy Language

Where the policy language places the term “claim” on the continuum from informal investigation to formal investigation to enforcement action can have tremendous practical significance for the policyholder. Many policyholders elect to cooperate with the government investigators for strategic reasons. Consequently, large amounts of money can be spent trying to prevent informal investigations from becoming formal.

Coverage for Informal Regulatory Inquiries

Although at least one insurer is now offering specialty (and very expensive) coverage for “pre-suit inquries,” requests for voluntary cooperation in a government inquiry without the use of subpoena power will not qualify as a “claim” within most D&O or E&O policies. For example, in Office Depot v. National Union Fire Insurance Co. of Pittsburgh, PA, 453 Fed.Appx. 871, 2011 WL 4840951 (11th Cir. [Fla.] Oct. 13, 2011), Office Depot sought to recover the cost of cooperating with an SEC inquiry under a D&O policy that defined a securities claim as “an administrative or regulatory proceeding against an Organization.”  (Emphasis added.) In upholding the insurer’s denial of coverage, the Eleventh Circuit held that the SEC’s requests for voluntary cooperation constituted an informal “investigation of” Office Depot, rather than a proceeding against Office Depot.

The general rule will, however, yield when policy language justifies doing so. In MBIA, Inc. v. Federal Insurance Company, 652 F.3d 152 (2d Cir. [N.Y.] 2011), the Second Circuit construed a policy that defined the term “Securities Claim” broadly to “include 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 found that that the insured was entitled to recover not just the cost of complying with the SEC’s subpoenas, but thecost of voluntary compliance with the SEC’s oral document requests as well. In finding coverage for those portions of the SEC investigations conducted by way of oral requests rather than subpoenas, the court explained that “the insurers cannot require that as an investigation proceeds, a company must suffer extra public relations damage to avail itself of coverage a reasonable person would think was triggered by the initial investigation.”

In addition, the Second Circuit found that a subpoena issued by the New York Attorney General  during the SEC’s investigation, but not pursuant to that investigation, qualified as claims under the policy. Refusing to “put[] form over substance,” the court found that a reasonable businessperson would view a regulatory agency’s subpoena as a “formal or informal investigatory order” even if the policy definition of “Securities Claim” did not explicitly include a proceeding commenced by the service of a subpoena.