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D&O Insurance and SEC Investigations

Most executives believe their D&O insurance will protect them if the SEC comes calling. They’re often wrong. Directors and officers liability insurance is one of the most misunderstood coverages in corporate America. Executives assume they have protection that doesn’t exist. They discover the gaps only when they need coverage most – when they’re facing an SEC investigation with legal bills climbing into seven or eight figures. By then, it’s too late to fix the policy. The coverage you have is the coverage you have. And the coverage you have may be far less than you thought.

Here’s the uncomfortable truth: D&O policies typically cover defense costs for individual directors and officers facing SEC investigations. They typically do NOT cover costs incurred by the company responding to the same investigation. The company’s investigation expenses – which can dwarf individual expenses – routinely get denied. Insurers argue that an “investigation of the organization” isn’t a “Securities Claim” under the policy. Courts often agree. You thought you were covered. Your policy says otherwise.

Understanding D&O coverage before you need it is essential. The distinctions between what’s covered and what isn’t, between individual and entity coverage, between formal and informal investigations – these technical differences determine whether your insurance pays or denies. Most executives don’t understand these distinctions until they’re fighting with their insurer while simultaneously fighting the SEC.

The Three Sides of D&O Coverage

D&O insurance isn’t one coverage – it’s three, and they work very differently.

Side A protects individual directors and officers when the company cannot or will not indemnify them. This is your personal protection when everything else fails. If the company goes bankrupt and cant pay your defense costs, Side A kicks in. If the company is prohibited from indemnifying you – as it often is for certain securities violations – Side A kicks in. No self-insured retention applies to Side A. It’s direct coverage for individuals.

Side B reimburses the company when it indemnifies directors and officers. You get sued. The company pays your defense costs under its indemnification obligations. Side B reimburses the company for those payments. This coverage has a self-insured retention – the company pays a deductible before insurance kicks in.

Side C provides entity coverage for securities claims against the company itself. When shareholders sue the company directly, Side C responds. But here’s the catch: Side C only covers securities claims – and SEC investigations often don’t qualify as “securities claims” under policy definitions. The investigation that costs millions may not trigger Side C coverage.

All three sides share a single policy limit. If Side C exhausts the limit paying entity claims, there may be nothing left for individual directors and officers. This is why sophisticated boards purchase additional Side A DIC (Difference in Conditions) policies – dedicated limits that protect individuals regardless of what happens to the main policy.

The Investigation Gap

SEC investigations cost money. Lots of money. Legal fees for responding to SEC inquiries regularly reach seven or eight figures. Document production alone can cost hundreds of thousands of dollars. Witness preparation, OTR testimony, responding to subpoenas – the expenses accumulate rapidly.

And most D&O policies dont cover these costs when the investigation targets the company.

Look at the Hertz case. The SEC sent the company a demand for documents pertaining to financial statements. The SEC later issued a formal investigation order stating it had “information that tends to show” securities law violations. The company incurred massive costs responding. When it submitted a claim to its D&O insurer, the insurer denied coverage.

The court agreed with the insurer. The policy covered “Securities Claims” against the organization. But it specifically excluded “investigations” of the organization from the definition of Securities Claims. The formal SEC investigation – despite the huge costs it generated – wasnt covered.

This pattern repeats constantly:

• Companies assume there D&O policy covers investigation costs
• Policy language says otherwise
• Insurers deny
• Courts uphold the denials

By the time executives understand what there policy actually covers, they’ve already incurred massive uninsured expenses.

The Fraud Exclusion Trap

Every D&O policy excludes coverage for fraud, dishonest acts, and willful misconduct. If you’re charged with securities fraud, does your insurance cover you?

The answer depends on precise policy language – and timing.

Most modern policies require “final adjudication” before fraud exclusions apply. This means the insurer must pay defense costs until a court actually finds you committed fraud. The exclusion doesn’t kick in just because fraud is alleged – it kicks in when fraud is proven. So defense costs get covered while you fight the allegations.

But here’s the trap. If you ultimately lose – if a court finds you committed fraud – the insurer may seek recoupment of all the defense costs they paid. Your “covered” defense costs become a debt you owe back to your insurer. You thought insurance was paying. It was actually a loan that comes due when you’re found liable.

And policies that exclude coverage upon “allegations” rather then “final adjudication” are even worse. Under those policies, merely being accused of fraud could trigger exclusion from the start. Defense costs denied from day one. No coverage at all while you fight allegations that may ultimately be dismissed.

The wording matters enormously. “Final adjudication” language protects you during the fight. “Allegations” language abandons you immediately. Know which you have.

The Notification Nightmare

D&O insurance requires prompt notification of claims and circumstances that could give rise to claims. Failure to notify properly can void coverage entirely.

This creates particular problems at policy renewal. Your existing policy is expiring. A new policy is starting. An SEC inquiry began last month but hasnt become a formal investigation yet. What do you do?

If you dont notify your existing insurer before the policy expires, they may argue you failed to give timely notice. No coverage under the old policy. But the new insurer will argue the “circumstances” existed before there policy started. No coverage under the new policy either. You fall into a gap between policies – uncovered despite paying premiums continuously.

The solution is giving “notice of circumstances” to your existing insurer before renewal. This locks in coverage under the current policy for any claims that later arise from those circumstances. But this requires understanding your notification obligations, tracking SEC inquiries carefully, and taking action before deadlines pass.

Many executives dont understand this until the coverage dispute is already happening. By then, the gap has already formed.

What Isnt Covered – The List Nobody Reads

Beyond investigations and fraud, D&O policies contain numerous exclusions that surprise executives facing SEC matters.

Fines and penalties are generally not covered. If the SEC imposes a civil monetary penalty, your D&O policy wont pay it. The disgorgement of illegal profits? Not covered. The policy pays defense costs, not the losses you’re found liable for.

Prior acts may not be covered. If the conduct giving rise to SEC scrutiny occurred before your policy’s inception date, coverage may not apply. Policies have “prior acts” dates, and claims arising from conduct before that date are excluded.

Intentional misconduct is excluded – but determining what constitutes “intentional” varies. Did you intentionally violate securities laws? Or did you make decisions that unintentionally violated them? The characterization affects coverage.

Insured vs. insured claims may be excluded. If the company sues its own directors, or if one director sues another, the policy may not cover it. These exclusions exist to prevent collusion but can create gaps in legitimate situations.

Personal profit exclusions apply when executives are alleged to have received illegal remuneration or personal advantage. Insider trading profits. Unauthorized compensation. These claims are excluded regardless of whether guilt is established.

The SEC’s Position on Indemnification

The SEC has codified its view that indemnification for securities law violations is “against public policy.” Item 512 of Regulation S-K requires registration statements to include disclosure that the SEC considers indemnification unenforceable.

This creates a fundamental tension. Companies want to indemnify directors and officers to attract talent. The SEC says indemnification for securities violations is against public policy. D&O insurance exists partly to fill the gap that SEC policy creates.

But the SEC’s position affects what can be covered. If indemnification itself is against public policy, can insurance cover what indemnification cant? Different policies and different courts answer this differently. The coverage you expect may not be the coverage you get.

And derivative suit settlements present special problems. Companies can indemnify directors and officers for defense costs in derivative suits. But settlement costs are typically not indemnifiable. The actual liability – the money paid to resolve the suit – comes out of personal pockets or Side A coverage. This is why robust Side A protection matters so much.

What Good Coverage Actually Looks Like

If standard D&O coverage has all these gaps, what should executives demand?

First, ensure “Securities Claim” definitions include regulatory investigations, not just lawsuits. Coverage that only kicks in after the SEC files a complaint misses the most expensive phase – the investigation that precedes any complaint.

Second, confirm fraud exclusions require “final adjudication.” Coverage should continue through defense, not terminate upon allegation. And watch for recoupment provisions that convert defense cost coverage into loans.

Third, purchase adequate Side A DIC coverage. This provides dedicated limits for directors and officers that cant be exhausted by entity claims. DIC policies often have fewer exclusions and drop-down features if the underlying policy denies coverage.

Fourth, negotiate entity investigation coverage. This isnt standard, but it can be added. If you want company investigation costs covered, you need to purchase that coverage specifically.

Fifth, understand notification requirements before problems arise. Know what constitutes a “claim” versus “circumstances.” Know your notification deadlines. Have processes to ensure timely notice.

Sixth, consider personal indemnification agreements that survive policy changes. Unlike D&O policies that renew annually, indemnification agreements cant be unilaterally amended. They provide stable protection even when insurance markets harden.

The Cost Reality

SEC investigations are expensive. Average securities class action settlements exceed $30 million. Investigation costs before any lawsuit run into the seven- or eight-figure range. Defense through trial can cost more than the settlement would have.

D&O insurance exists to manage these costs. But insurance that doesn’t actually cover the costs you face is worthless regardless of the premiums you paid. The executives who survive SEC matters financially are those who understood there coverage before they needed it – and took steps to close gaps while they still could.

Your D&O policy is not a guarantee of protection. Its a contract with specific terms, exclusions, and conditions. The time to understand those terms is now, not when the SEC subpoena arrives.