On March 20, 2020, the U.S. Court of Appeals for the First Circuit affirmed a summary judgment ruling by the U.S. District Court for the District of Massachusetts in favor of two excess D&O insurers, Zurich Services Corporation (Zurich) and X.L. Global Services, Inc. (XL), both of which had denied coverage for the Claim at issue. In Jalbert v. Zurich Services Corporation et al., Case No. 18-2244 (1st Cir. March 20, 2020), the First Circuit ruled that a Formal Order of Investigation issued by the Securities and Exchange Commission (SEC) during a prior policy period constituted a Claim made during the prior D&O policy period, thereby permitting the excess insurers under the subsequent policy period to deny coverage for those subsequent actions as follow-form excess insurers.

Relevant Facts and Underlying Proceedings

Columbia Casualty Company (Columbia) issued to F-Squared a primary D&O policy for the October 3, 2012 – October 3, 2013 policy period (2012-2013 Policy) and also for the renewal period October 3, 2013 – October 3, 2014 (2013-2014 Renewal Policy). Federal Insurance Company (Federal) was an excess insurer on both policies. Zurich and XL provided excess insurance only on the 2013-2014 Renewal Policy.

Both of the Columbia primary policies defined “Claim” to include, among other things, “a formal regulatory proceeding (civil, criminal or administrative) against, or formal investigation of an Insured, including when such Insured is identified in a written Wells or other notice from the SEC or a similar state of foreign government authority that describes or alleged violations of securities or other laws by such Insured … for a Wrongful Act…” The Columbia policies also contained the following provision: “[a] Claim shall be deemed first made…” with respect to a formal investigation upon the date when “an Insured being identified by name in an order of investigation, subpoena, Wells Notice or target letter … as someone against whom a civil, criminal, administrative or regulatory proceeding may be brought…”

On September 23, 2013, the SEC commenced a private investigation of F-Squared by issuing an Order Directing Private Investigation and Designating Officers to Take Testimony (Formal Order). The Formal Order stated that the SEC possessed information that F-Squared had distributed false and misleading advertisements to clients or prospective clients in possible violation of securities laws. On September 30, 2013, the SEC issued a Supplemental Order Designating Additional Officers to the investigation and on October 2, 2013, the SEC Division of Enforcement served a subpoena on F-Squared requesting the production of documents. On October 7, 2013, the SEC served deposition subpoenas on F-Squared’s CEO and a Managing Director.

On November 7, 2013, shortly after the inception of the 2013-2014 policy period, F‑Squared sent a notice of Claim letter to Columbia and to the excess insurers on both towers (i.e., Federal, Zurich and XL) regarding the October 2 and 7, 2013 subpoenas. Columbia agreed to provide coverage under the 2012-2013 Policy – as did Federal. However, Zurich and XL denied coverage under the 2013-2014 Renewal Policy on the basis that the SEC investigation constituted a Claim first made during the 2012-2013 policy period, and prior to the inception of the 2013-2014 policy period.

The trustee for F-Squared, appointed during F-Squared’s bankruptcy proceedings, disagreed with the excess insurers’ coverage position and commenced a declaratory judgment action for breach of contract in the District Court of Massachusetts. Zurich and XL filed a summary judgment motion which the trustee opposed. Ruling in favor of Zurich and XL, the District Court held that the September 23, 2013 Formal Order constituted an investigation of F‑Squared that had commenced prior to the inception of the 2013-2014 policy period. The District Court also found that the Formal Order fit within the Columbia policy’s “Deemed-Made” clause because it sufficiently identified F‑Squared as “someone against whom a civil, criminal, administrative, or regulatory proceeding may be brought.”

The First Circuit's Decision

On appeal, there was no dispute that the SEC investigation commenced by the Formal Order was a “formal investigation” and therefore a “Claim,” as defined in both of the Columbia primary policies. The trustee, however, raised two challenges to Zurich and XL’s denials of coverage: (1) the so-called “Deemed-Made” clause was not satisfied by the Formal Order because the SEC investigation was not conclusive proof that enforcement proceedings against F-Squared were a “reasonable possibility,” and (2) the “Deemed-Made” clause should be deemed ambiguous and therefore construed in favor of F-Squared.

The First Circuit turned to the ordinary meaning of the Columbia policies’ language and agreed with the District Court that the “Deemed-Made” clause was expansive and fulfilled by the possibility of proceedings presented by the Formal Order. In deciding the first issue, the First Circuit drew a distinction between an investigative subpoena that merely requests information from a party and a formal order issued by the SEC ordering investigation into actions which, if verified, would constitute violations of multiple federal laws. According to the First Circuit, because the Formal Order: (1) indicated that F-Squared may have violated multiple securities laws; (2) directed a private investigation of F-Squared’s acts or practices; (3) was issued by the SEC’s Division of Enforcement; and (4) designated officers to issue subpoenas, take evidence and request documents, it supported the inference that the institution of proceedings against F-Squared was possible and therefore satisfied the “Deemed-Made” clause.

The First Circuit also rejected the trustee’s claim that the “Deemed-Made” clause was ambiguous simply because the word “may” connotes different levels of possibility.

Takeaways

The First Circuit’s ruling is a useful reminder that efforts to broaden the D&O policy’s definition of “Claim” can result in both unintended coverage consequences and a heightened need for policyholders to pay careful attention to active investigations and disputes pending at policy renewal to ensure that there is a shared understanding where D&O coverage will and will not apply. In this case, the plaintiff was the bankruptcy trustee for F-Squared who likely had no involvement in the D&O policy placement process, and whose subsequent involvement likely was solely focused on recovering the broadest group of assets available to satisfy claims against the bankruptcy estate.

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