Coverage for SEC Investigations

“Are we covered for SEC investigations” is a question I hear over and over again from public company officers and directors. It’s an important question worth asking . . . and it’s concerning when I hear that questioners are receiving a variety of answers ranging from “yes absolutely” to “maybe” to “not at all.”

What’s going on?

Like so many issues with D&O insurance, the answer is susceptible to nuance based on how the question is presented. A little background on SEC investigations is useful place to start the discussion.

As a reminder, the SEC has the power to investigate individual directors and officers, the company they serve, or both.  Be it insider trading or accounting fraud, the SEC has a lot of discretion when it comes to how it wants to conduct its investigation.  However, as a practical matter, and simplifying a little for our purposes, I usually see the SEC follow this pattern:

• Informal questions asked of the company, usually including document requests;
• Informal questions asked of individuals, maybe including document requests;
• Formal investigation of the company—when you get a subpoena, you know the investigation is now “formal”; and
• Formal investigation of individuals—often involving a Wells Notice and/or a subpoena.

The nuance of what an investigation looks like, including whether it’s formal or not and whether individuals or the company that have been named and/or targeted impacts whether and how a D&O insurance responds.

So what should you expect? Of course you have to check your specific policy terms to see what will happen in your particular situation.  I expect that most public companies will have the following coverage situation when faced with an SEC investigation:

• Informal investigation of the company: no coverage
• Informal investigations of individuals: coverage
• Formal investigations of the company: no coverage

So the good news is that in most cases individual Ds and Os will be protected by their policies.  The bad news is—at least absent special endorsements that require additional premiums—is that D&O insurance policies usually do not cover the corporate entity when it is investigated by the SEC.

“But individual Ds and Os benefit when the corporation cooperates with the SEC, so the insurance carriers should pay for this cooperation since it benefits them as the insurer and is really done in defense of the individuals” you say? Yes, we’re all law-and-economics scholars when we are seeking insurance coverage—me too! But when the language is clearly drafted to the contrary, you can see that insurance carriers may be frustratingly unsympathetic to this argument.

By the way, a Wells Notice is a letter from the SEC to an individual that basically asks the question “why shouldn’t we bring a civil complaint against you?” Very serious—not to mention scary—and the SEC takes the responses very seriously.  There’s some good news here: the Wall Street Journal recently reported that the SEC declines to pursue individuals after receiving responses a Wells Notice 20% of the time.  So responding to a Wells Notice is one of the times it definitely pays to hire excellent lawyers.  And hiring excellent lawyers is certainly made easier by the promise that your D&O insurance carrier will advance your costs to pay yours lawyers should you receive a Wells Notice.

Bottom line: when you ask “Are we covered for SEC investigations?” what you are hoping to hear from your insurance brokers is not a cavalier, short answer.  You will know that they have done their work for you in a knowledgeable and sophisticated way, however, if they say something along the lines of, “To answer this question, let me break apart for you the various forms an SEC investigation can take . . ."

The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: phuskins@woodruffsawyer.com.