SEC Investigations and D&O Insurance Coverage

In my last post, I explained why a full-blown Securities and Exchange Commission (SEC) investigation often results in legal fees and expenses that run well into seven or eight figures. (Again, this is just for legal costs at the investigative stage; if the SEC decides to sue you, that’s another story entirely.) Depending on the scope of the investigation relative to the size of your company, these costs can be material.

Now let’s talk about insurance. Directors and officers (D&O) insurance policies generally do a great job responding to private litigation such as securities class action litigation and fiduciary duty suits. But to what extent will most public company D&O policies respond to an SEC or other government investigation?

In this post, I’ll discuss the difference between coverage for individuals and coverage for the corporate entity. I’ll also discuss whether additional investigation-focused coverage is worth purchasing.

Individual Defense Costs: Generally Covered

First, let’s talk about government investigation costs that are covered. A modern public company D&O policy will typically cover defense costs and expenses incurred by individual officers and directors in an SEC investigation. This is good news. Coverage for testimony costs for officers and directors might come in particularly handy because testimony preparation often requires a lot of expensive billable lawyer hours.

Before taking testimony, the SEC often sends document subpoenas to individuals. Coverage for individual document production costs is also nice, but not usually particularly valuable to the company. Document subpoenas to officers and directors are not drivers of significant document-related costs because individuals are not usually the custodians of most documents the SEC is seeking. Because the company has possession and handles the production of the vast majority of relevant documents, high costs associated with document production come from subpoenas sent to the company itself.

A few important notes. First, recall that the SEC sometimes sends voluntary requests instead of subpoenas. Whether there is coverage for complying with these voluntary requests will depend on the specific language in your policy. Coverage for oral voluntary interview requests by regulators may also be available in the market if you ask. (Yes, sometimes the government just casually calls up your lawyer and says, “Bring your client in for an interview, please.”)

Second, your D&O policy includes a retention—akin to a deductible—that the company needs to meet before your insurers will begin making payments. If the SEC hauls your entire C-suite and board in for testimony and you don’t have an especially high retention, the company should get some of the costs paid by insurance. If you have a high retention and the SEC only wants to talk to two senior executives, the company is going to absorb those indemnified defense costs if the total falls below your self-insured retention. However, these costs should erode your retention so if there are more related eligible costs in the future, at least you’ll be closer to getting those covered.

Third, keep in mind that coverage is only available for “insured persons.” In a wide-reaching investigation, the government may talk to many (10+) of your employees and there may be strategic reasons why you will want to indemnify lower-level employees. Keep an eye on how your policy defines “insured persons” for the purpose of individual investigation coverage. Does it cover only investigations of directors and senior executives or does it also cover indemnified defense costs for lower-level employees?

Company Defense Costs: Generally Not Covered

Your D&O policy provides coverage of defense costs when the company is facing securities litigation. Unfortunately, you can’t trust your policy to provide coverage of defense costs when your company is facing a securities investigation.

As discussed above, investigations of individuals are usually explicitly included in the definition of a claim. Unfortunately, investigations of the company are generally not included. D&O insurance carriers routinely deny coverage for company investigation costs. In a dispute, a judge is very likely to agree with the insurer. If you want to be confident that company investigation costs are covered, you need to work with your broker to purchase that specific coverage.

Company Investigation Coverage: Available (For a Price)

Over the years, some D&O insurance carriers have offered coverage for an additional cost that specifically covers company investigations. In today’s soft market, we are seeing this coverage offered again as insurers compete for D&O business.

This coverage can take different forms. One available option: Coverage for company investigations that are related to securities or derivative litigation. Here’s a relatively common sequence of events: (1) a corporate scandal happens; (2) plaintiff’s lawyers rush to file a lawsuit; and (3) the SEC separately opens an investigation into the same conduct. If you have related investigations coverage, you can get your company investigation costs covered along with the litigation costs.

If you don’t like this limitation, broader coverage is available for formal company investigations without any related securities litigation. You can also purchase coverage for Foreign Corrupt Practices Act (FCPA) investigations. (FCPA investigations are a special kind of hell, and they can be incredibly expensive during the documents stage.)

Is Company Investigation Coverage Worth Purchasing?

Should you consider adding coverage for company investigations? Depending on your company, maybe. Here are some things to think about.

• What is your company’s unique government investigation risk profile? If you are a stable, mature, enterprise-facing company and you attract little attention in the Wall Street Journal, your risk profile may be lower. If you are a high-growth, disruptive media darling, and/or consumer-facing technology company, your risk profile may be higher. If you are a life sciences company, you may have a unique basket of risks.
• How much will you have to pay in premiums and what coverage will you get for your money? In the past, company investigation coverage has not been a big seller, probably because the value of the specific coverage offered has not been worth the relatively high price tag.
• What is your cash position and how would it be impacted by, say, $10 million in investigation defense costs? The appeal of company coverage may be different for a company with $50 million in cash and a company with $1 billion in cash.

Before making any decision, it might be worth asking your broker whether related investigations coverage is available at an attractive price point. Let’s say you are facing a securities class action and an SEC investigation at the same time. Your defense lawyer gets the litigation thrown out at the motion to dismiss stage: great job! But, because this was a quick win, you haven’t yet exceeded your retention and your policy hasn’t paid anything. And, unlike plaintiffs, SEC Enforcement decides to stick around and investigate your company for two years and many millions. With the related investigations coverage, you can get these costs covered. Without it, you’ll probably be out of luck for the company portion of the costs.

There’s no elegant, one-size-fits-all solution here. You can take some comfort in the fact that if your directors and officers get subpoenaed by the government, those costs are likely to be covered by your D&O policy if you exceed your retention. If you are also worried about company costs, it can’t hurt to see what’s available in the market.