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

by Perkins Coie

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.


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.

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