We buy insurance hoping to never need it. Nonetheless, we pay the premiums so that we can sleep better in the event that we have a problem someday. But, in the early stages of a government investigation, your insurance policy may not provide the coverage that you hoped for.
A Colorado federal court recently ruled that a D&O insurance policy did not provide coverage for an SEC investigation because the SEC had not yet issued a Wells Notice or otherwise alleged a violation of securities laws. In MusclePharm Corporation v. Liberty Insurance Underwriters, Inc., the SEC’s Division of Enforcement sent a letter to the company advising that it was conducting an investigation into its operations. The letter also requested voluntary production of certain documents. Less than two months later, the SEC issued an “Order Directing Private Investigation and Designating Officers to Take Testimony.” The order said that the SEC had “information that tends to show” “possible violations” of federal securities laws by MusclePharm and/or its officers and directors.
The Insurance Policy
The company had previously purchased a D&O insurance policy that provided coverage for “Securities Action Liabilities.” The insurance company refused to cover MusclePharm’s claim for legal fees and expenses incurred during the investigation. It denied coverage because the SEC had not yet issued a Wells Notice or target letter. Absent such notice or letter, the insurance company asserted that the SEC had not alleged wrongdoing to trigger coverage. (A Wells Notice is a notification that the SEC is close to recommending that the Commission commence action against the recipient. A target letter is a notification from a prosecutor that the recipient is the target of a federal criminal investigation.).
The policy’s coverage section provided that it covered losses resulting from a “Securities Action” for a “Wrongful Act” that occurred during the policy period. “Wrongful Act” was defined to mean:
any actual or alleged error, misstatement, misleading statement, act, omission, neglect, or breach of duty, actually or alleged committed or attempted by the Insured Persons in their capacities as such or in an Outside Position, or, with respect to Insuring Agreement 1.3, by the Insured Organization[.]
The Court’s Ruling
The court held that the insurance policy did not cover the investigation. In reaching this decision, the court found that the SEC had not alleged conduct in any of its communications that met the definition of “Wrongful Act” in the policy. To meet that definition, the “alleged error or omission must involve a positive assertion that the implicated error or omission is believed to have actually occurred, even if still subject to proof,” according to the court.
None of the SEC’s communications had ever asserted that an error or omission had actually occurred. To the contrary, the SEC’s Order repeatedly said that the SEC had not determined if any of the acts described in the Order had actually occurred. The court held that the policy did not cover the investigation until the SEC alleged a past “Wrongful Act.” The court did not consider the SEC’s comment that “[I]nformation that tends to show” “possible violations” existed sufficient to trigger coverage.
How to Protect Your Company Before a Government Investigation
Although this case does not establish any startling, new legal principal, it illustrates how vulnerable companies and their officers and directors may be during the early stages of a government investigation if the company has not purchased “pre-claim inquiry” coverage for the officers and directors and coverage for investigative costs for the company. Kevin M. LaCroix, an insurance executive with RT ProExec, notes in his blog that such coverage is now available, either as a stand-alone policy or as an accessory to the primary D&O policy.
Government investigations are exorbitantly expensive. They often require separate counsel for the company and each officer and director, all paid for by the company. Additional coverage for investigative costs may be considered expensive by some. However, the additional premium likely pales in comparison to the $3 million in legal fees and expenses paid by MusclePharm during the SEC investigation. This case demonstrates that absent adequate coverage, a government investigation may be a devastating hit to your bottom line.
MusclePharm has appealed the decision, so stay tuned. This may not be the last word on this case.
Photo courtesy of Photos of Money on Flickr.
