Recent Changes In SEC Enforcement Policy Require Renewed Attention To Directors’ And Officers’ Insurance Terms

by Perkins Coie
Contact

In recent months, the Securities and Exchange Commission (SEC) has announced and implemented policy shifts that could compromise the availability of directors’ and officers’ (D&O) insurance coverage for entities and individuals. 

  • First, after years of not requiring admissions of wrongdoing unless there was an underlying criminal conviction, the SEC will no longer agree to “no admit, no deny” settlements in cases involving “widespread harm to investors” or “egregious intentional misconduct.” 
  • Second, the SEC is pursuing more enforcement actions against individuals in an effort to increase deterrence.  While the SEC has long prevented insureds from accessing insurance proceeds for penalties and disagreements in settlements, these two policy shifts may seriously impact companies’ and individuals’ ability to tap into their D&O insurance policies for the defense of enforcement actions and in connection with coverage for civil litigation based on related facts.  In light of this shift, policyholders should examine key D&O insurance provisions during policy renewal and before settling an enforcement action where an admission of wrongdoing is sought.

Recent Settlements of SEC Enforcement Actions

In two high-profile cases, the SEC has required admissions of wrongdoing as a condition of settling enforcement actions.  In both cases, the defendants included provisions that appear to mitigate the impact of the admissions on insurance coverage.

“London Whale” Enforcement Actions.  In its $900 million settlement of several “London Whale” enforcement actions, JPMorgan admitted wrongdoing in connection with its SEC settlement.  But the admissions were not made on behalf of any single individual, and court approval was not needed because the settlement negotiations took place in an administrative proceeding.  Therefore, JPMorgan was allowed to avoid the specific and direct admissions of wrongdoing that are more likely to trigger D&O coverage exclusions regarding conduct.  

Philip Falcone and Harbinger Capital Partners Enforcement Actions.  The other noteworthy settlement with the SEC involved two enforcement actions against billionaire Philip Falcone and his hedge fund, Harbinger Capital Partners.  The SEC alleged that Falcone improperly used $113.2 million of investors’ funds to pay his own taxes, favored some investors’ redemption requests over those of others and improperly traded in bonds.  The SEC required Falcone to admit wrongdoing in addition to paying an $18 million penalty after the SEC commissioners rejected an earlier settlement that did not contain an admission of wrongdoing.  But the settlement does not prohibit Falcone and Harbinger from taking legal and factual positions in subsequent cases not involving the SEC, which will allow them room to maneuver in related civil suits.  

Enforcement Actions Not Involving “Widespread Investor Harm.”  While the SEC has demonstrated its policy shift in these two recent cases, enforcement actions that do not appear on their face to involve “widespread investor harm” continue to be resolved without an admission of wrongdoing.  As SEC enforcement co-directors Andrew Ceresney and George Canellos have recently clarified, admissions will be considered in the public interest:

  • when misconduct has harmed large numbers of investors or placed investors or the market at risk of potentially serious harm; 
  • when admissions might safeguard against risks posed by the defendant to the investing public, particularly when the defendant engaged in egregious intentional misconduct; or 
  • when the defendant engaged in unlawful obstruction of the SEC’s investigative processes. 

D&O Insurance Provisions Implicated by the SEC’s Shift

The full effect of the SEC’s policy shift remains to be seen, but thus far it implicates several different provisions in D&O insurance policies:  

  • so-called “conduct exclusions;” 
  • the severability provisions in the policy, including with respect to the application for insurance; and 
  • possible repayment of previously advanced defense costs.   

Conduct Exclusions

All D&O insurance policies contain what are referred to as “conduct exclusions.”  These exclusions are meant to carve out from coverage those claims that involve deliberate fraudulent or criminal conduct or the gaining of profit or advantage that is illegal.  Under some policies, insurers might argue that admissions in an SEC settlement are sufficient to trigger the conduct exclusion and thus bar coverage in a civil lawsuit arising out of the same set of facts. 

  • Avoiding Conduct Exclusions.  The first line of defense against this argument is to negotiate a settlement with the SEC that, like the JP Morgan settlement, keeps vague who did what wrong and avoids any mention of intent.  And like in the Harbinger/Falcone case, the settlement must allow the defendant leeway to deny allegations in lawsuits arising out of the same conduct.  

    A conduct exclusion may also be avoided if insureds insist that the exclusion can be triggered only when the deliberately fraudulent conduct is established by a “final adjudication.”  If the settlement is in the context of an administrative proceeding, like the JPMorgan settlement, an insured may be able to argue that, absent court approval, the conduct exclusions have not been implicated.  Insureds will also be in a better position if the conduct exclusion is triggered only when the finding of fact or admission occurs in the “underlying action,” as opposed to the broader “underlying claim” language found in some policies. 

Severability Provisions

D&O insurance policies also often contain what are referred to as “severability provisions,” which prevent one individual insured’s knowledge or wrongful acts to be imputed to another, or a director’s or officer’s knowledge or acts to be imputed to the entity itself, which would eviscerate coverage for that individual or entity.  Generally, these provisions come into play only when specific individuals are established to have facts or knowledge that would trigger one of the conduct exclusions discussed above.  

  • Rescission Based on Representations in the Application.  Another type of severability provision relates to the application for D&O insurance and can be implicated even when the admissions do not rise to the level of triggering a conduct exclusion.  As part of that application process, an insurer may insist on certain representations and warranties regarding facts or circumstances that may later give rise to a claim, including documents filed with the SEC.  These application severability provisions can differ from policy to policy, but well-drafted ones limit relevant knowledge to certain defined individuals, sometimes including only the signer of the application.  If it turns out that one of the defined individuals knew material facts before the signing of the application, and admits this in an SEC settlement, there is an increased risk that a D&O insurer might make a rescission argument with respect to coverage for that individual, the entity or others, depending on the insurance policy’s language. 

Repayment of Previously Advanced Defense Costs

Finally, insurers may argue that they are entitled to repayment of previously advanced defense costs if a settlement with the SEC contains specific allegations sufficient to trigger one or more conduct exclusions.  Insurers have met with mixed success on this issue, but they were often denied an opportunity to establish a lack of coverage where insureds settle civil cases and regulatory actions without admissions of wrongdoing.  While the likelihood that insurers will pursue previously advanced defense costs remains low, the risk increases in larger cases where millions of dollars have been spent.  Insureds should pay careful attention to 

  • whether the D&O insurance policy explicitly grants the right to recoupment of previously paid defense costs, and 
  • whether an insurer explicitly reserves this right when it starts making defense cost payments.

Conclusion

Although the SEC’s policy shift has just begun, and has so far been limited to headline-grabbing cases, policyholders should keep in mind its potential impact on the above provisions when negotiating D&O insurance policies and before beginning serious settlement discussions in regulatory enforcement actions.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Perkins Coie | Attorney Advertising

Written by:

Perkins Coie
Contact
more
less

Perkins Coie on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.