Does D&O Insurance Cover SEC Investigation

Does D&O Insurance Cover SEC Investigation

The short answer is: probably some of it, but not what you think, and not as much as you’re assuming. Your D&O insurance will likely cover defense costs for individual officers and directors facing SEC investigation. It will probably NOT cover your company’s investigation costs. And the gap between those two things is where companies lose millions of dollars they thought were insured.

Hertz Global Holdings learned this the hard way. They incurred $27 million in costs responding to an SEC investigation. They filed a claim with their D&O insurers. The insurers denied coverage for the company’s investigative costs. Hertz sued. The court sided with the insurers. Twenty-seven million dollars the company assumed would be covered – not covered.

This happens constantly. Companies buy D&O insurance specifically because they’re worried about regulatory risk. They assume the policy covers SEC investigations. They respond to an SEC inquiry, hire lawyers, produce documents, prepare executives for testimony. Then they file an insurance claim and discover that most of what they spent isn’t covered. The policy they thought protected them has gaps large enough to drive a truck through.

The Individual vs Entity Coverage Gap

Heres the fundamental thing you need to understand about D&O insurance and SEC investigations: coverage for individuals is good, coverage for the company is terrible.

A modern D&O policy typically covers defense costs for individual officers and directors in SEC investigations. If your CEO gets subpoenaed for testimony, the preparation costs – which can be substantial – are usually covered. If an individual executive needs lawyers to respond to SEC document requests in there personal capacity, thats usually covered too.

But investigations of the company itself? Generally not covered. D&O insurers routinly deny coverage for entity investigation costs. And when companies challenge those denials in court, judges almost always side with the insurers.

The Office Depot case made this clear. A federal court determined that no coverage was available under the companys D&O policy for costs incurred responding to an SEC investigation of the company or for an internal audit committee investigation. The court looked at the policy language, looked at the precedent, and ruled in the insurers favor.

This isnt some obscure legal technicality. This is the fundamental structure of how D&O insurance works. The policies are designed primarily to protect individuals – directors and officers – not the corporate entity. Entity coverage exists, but its limited and often excluded for government investigations specificaly.

WARNING: D&O insurance routinely covers individual officers and directors for SEC investigation defense costs but routinely DENIES coverage for corporate entity investigation costs. Do not assume your company’s investigation costs are covered.

The Definition of “Claim” Problem

Whether your D&O insurance covers SEC investigation costs often comes down to a single question: does the policy define an SEC investigation as a “claim”?

Some D&O policies define “claim” broadly to include “formal and informal government investigations.” Under these policies, when the SEC issues an investigative subpoena, coverage may trigger right away. Defense costs incurred responding to the subpoena are covered becuase the subpoena itself constitutes a claim.

Other policies define “claim” narrowly. Coverage only triggers when formal proceedings begin – when the SEC actualy files an enforcement action or when a Wells notice issues. Under these policies, everything you spend responding to the investigation before formal charges is on you. The company can incur millions in legal fees during the investigation phase with no insurance coverage at all.

Most policyholders have no idea which version they have. They bought D&O insurance through a broker, signed the paperwork, and assumed it covered SEC investigations. They never read the policy carefully. They never understood that “claim” has a specific definition that determines when coverage actually starts.

Then the SEC shows up. The company responds for two years, spends $15 million on lawyers and document production, and files an insurance claim. The insurer denies coverage becuase no formal proceeding has been filed. The investigation isnt a “claim” under the policy. All that money was out-of-pocket.

The Related Claims Trap That Destroys Coverage

OK so heres were it gets really complicated and were companies lose the most money. This is the thing that insurance professionals understand but that most executives have never thought about, and it can turn what looks like comprehensive coverage into almost nothing.

D&O policies are “claims made” policies. This means coverage applies to claims first made during the policy period – not when the underlying conduct happened, but when the claim arrives. If a claim is “related” to an earlier claim, the related claim is treated as made when the first claim was made. This sounds like technical insurance jargon but the practical impact is enormous. Everything flows from this concept. And most policyholders dont understand it until there coverage has already been collapsed.

This matters enormously for SEC investigations becuase of how they unfold over time:

• An SEC investigation might start in 2021 with an informal inquiry
• It might progress to formal investigation in 2022
• The company might recieve a Wells notice in 2023
• The SEC might file enforcement action in 2024
• And a shareholder class action might be filed in 2024 as well

Thats four years of events across potentially four different policy periods.

Under the related claims doctrine, all of those events might collapse into a single claim dated back to 2021, when the informal inquiry first arrived. If the company had Policy A in 2021, Policy B in 2022, Policy C in 2023, and Policy D in 2024, only Policy A covers everything – even though the formal charges and the class action came years later. The company paid premiums for policies B, C, and D, but those policies dont apply to any of this becuase all the claims “relate back” to the first event.

BioChemics found this out in 2015. The SEC issued a document subpoena in May 2011. BioChemics policy with the current insurer didnt start until June 2011 – one month later. When the SEC eventually brought enforcement action years later, BioChemics filed for coverage under there D&O policy.

The insurer denied coverage. Why? Because the “claim” was first made when the SEC issued that initial subpoena in May 2011 – before the policy period began. Everything that followed – the investigation, the enforcement action, the settlement – all “related” back to that first subpoena. Since the first claim predated the policy, nothing was covered.

One month difference in timing. Millions of dollars in uninsured costs.

This related claims issue affects how SEC investigations interact with securities class actions too. Often, an SEC investigation triggers a shareholder class action lawsuit. The company thinks it has two separate claims – the SEC matter and the class action – and expects coverage under two policy periods.

But courts have held that if the SEC investigation and the class action are “related,” they collapse into one claim. The class action relates back to when the SEC investigation started. Now both matters are covered under the same policy period, subject to the same policy limits. If thats an older policy with lower limits, the company has way less coverage then they thought.

Pre-Claim Investigation Costs – The Gap Nobody Warns You About

This is probly the biggest surprise for companies facing SEC investigations: the costs you incur before formal proceedings often arent covered at all.

The SEC investigation timeline typically looks like this:

1. Informal inquiry begins (phone calls, voluntary document requests)
2. Formal investigation opens (subpoena power activated)
3. Document production and testimony (years of expensive legal work)
4. Wells notice issues (SEC indicates intent to recommend charges)
5. Enforcement action filed (formal charges)

Under many D&O policies, coverage doesnt trigger until step 4 or step 5. Everything before that – the informal inquiry, the document production, the executive testimony prep – might not be covered.

Courts have been clear about this. Pre-claim investigation costs are not covered if they arise before the “claim” as defined in the policy. A court explained that loss “arising from” a claim follows the claim in time. Pre-claim costs, no matter how related they turn out to be, dont qualify.

MusclePharm experienced this directly. They submitted matters to there D&O carrier and sought coverage for defense expenses. The insurer denied coverage for everything except the expenses two individual executives incurred AFTER they were served with Wells Notices. Everything the company spent responding to the investigation before Wells Notices arrived? Not covered. MusclePharm had incurred over $3 million and filed suit to try to recover it.

The Regulatory Exclusion That Changed Everything

Heres some historical context that explains why D&O coverage for government investigations is so limited.

In the 1980s, during the savings and loan crisis, D&O insurers were overwhelmed by the costs of defending insureds in regulatory enforcement actions. FDIC was bringing claims against bank directors and officers. The costs were astronomical. Insurers were losing money.

So insurers added what’s called the “regulatory exclusion” to D&O policies. This exclusion limits or eliminates coverage for claims brought by government agencies. It became standard in the industry. And it persists today.

This means that even if your D&O policy would otherwise cover SEC investigation costs, a regulatory exclusion might eliminate that coverage entirely. The exclusion varies by policy – some are broader, some are narrower – but the effect is often to deny coverage for exactly the government enforcement situations where companies most need protection.

The irony is stark. Companies buy D&O insurance precisely becuase theyre worried about regulatory risk. They pay premiums year after year. Then a regulatory investigation actually happens and they discover the regulatory exclusion means they have no coverage.

What Actually Gets Covered

Let me be specific about what D&O insurance typically DOES cover for SEC matters:

Usually Covered:

• Defense costs for individual officers/directors (not the company)
• Testimony preparation costs for subpoenaed individuals
• Individual legal representation separate from company counsel
• Defense costs after formal enforcement action is filed
• Side A coverage (pure director/officer coverage, no company involvement)

Usually NOT Covered:

• Company investigation costs
• Pre-claim investigation expenses
• Document production costs incurred by the entity
• Fines and penalties (these are generally not insurable under any policy)
• Disgorgement of profits
• Internal investigation costs
• Costs incurred before “claim” triggers under policy definition

Depends on Policy Language:

• Whether SEC subpoena constitutes a “claim”
• Whether informal investigation qualifies for coverage
• Whether entity investigation coverage was purchased as add-on
• Related claims allocation between policy periods

CRITICAL: Fines and penalties assessed by the SEC are NOT covered by D&O insurance. Only defense costs are potentially covered. If the SEC orders you to pay $50 million in disgorgement and penalties, that’s your money, not insurance money.

The Entity Investigation Coverage Add-On

Theres good news and bad news here.

Good news: some insurers now offer specific coverage for entity investigation costs as an add-on to standard D&O policies. In today’s competitive D&O market, insurers are offering this coverage to win business.

Bad news: its optional. You have to specificaly request and purchase it. Most companies dont know it exists. And even when purchased, it often has sublimits – meaning coverage is capped at some amount lower than the main policy limits.

If you want to be confident that your companys SEC investigation costs are covered, you need to work with your broker to purchase this specific coverage. Dont assume its included. Dont assume your standard D&O policy covers entity investigations. Ask specifically, review the policy language, and purchase the appropriate endorsements.

Notice Requirements That Kill Coverage

One more thing that destroys D&O coverage for SEC investigations: late notice.

D&O policies require prompt notice to the insurer when a potential claim arises. Failing to give prompt notice – which usually happens because nobody realized government investigations might be covered – can be fatal to obtaining coverage.

In some states, late notice is a complete defense to coverage even if the insurer suffered no prejudice from the delay. And heres the really bad part: if late notice blows coverage for the investigation, it might also blow coverage for any lawsuits or proceedings that follow.

So the SEC sends a subpoena. The company responds, thinking this is just a regulatory matter, not an insurance claim. Months or years go by. Eventually a securities class action gets filed. Now the company notifies its D&O insurer. The insurer denies coverage for everything – the investigation AND the class action – becuase the company failed to provide prompt notice when the subpoena first arrived.

The moment you receive an SEC subpoena, notify your D&O insurer. Dont wait to see if it becomes “serious.” Dont wait until formal charges are filed. Notify immediately and let the insurer determine whether coverage applies.

The Retention Problem

Even when D&O coverage does apply to SEC investigation costs, theres another issue that catches companies off guard: the retention.

Your D&O policy has a retention – basicaly a deductible – that the company must pay before insurance kicks in. Retentions vary widely. Some are relatively modest – $100,000 or $250,000. Others are substantial – $1 million, $5 million, even higher for large companies.

Heres how this plays out. The SEC subpoenas two senior executives for testimony. Each executive needs there own attorney for preparation. The legal costs come to maybe $200,000 total. If your retention is $500,000, insurance never kicks in. The company absorbs the entire cost.

On the other hand, if the SEC subpoenas your entire C-suite and board for testimony – ten or fifteen people, all needing individual legal representation, all needing substantial preparation time – the costs might run into the millions. Now you exceed the retention and insurance helps.

The irony is that smaller, more managable SEC investigations often fall below the retention threshold. The costs are entirely on the company. Its only when investigations become massive and expensive that insurance coverage actualy provides meaningful help.

And heres another thing: the retention for individual coverage may be different from the retention for entity coverage. Individual officer/director costs might have a lower retention while entity costs might have a much higher threshold. You need to understand both.

What You Should Actually Do

Stop assuming your D&O insurance covers SEC investigations. It probly covers some things and definately doesnt cover others. You need to know the specifics before an investigation starts, not after youve already incurred millions in costs.

Pull your D&O policy. Actualy read it. Look for the definition of “claim.” Does it include investigations? Does it include subpoenas? Does it require formal proceedings? This single definition will determine whether you have coverage for pre-formal-charge costs or not.

Look for exclusions. Is there a regulatory exclusion? An exclusion for government enforcement actions? An insured vs. insured exclusion that might apply to internal investigation costs? These exclusions can eliminate coverage even when the basic policy language would otherwise provide it.

Check for entity coverage. Does your policy cover company investigation costs, or just individual officer/director costs? Is entity investigation coverage an optional add-on you need to purchase seperately? If you dont have entity coverage, your companys investigation costs – potentialy millions of dollars – arent covered at all.

Understand your retention. What’s the deductible before insurance kicks in? Is it the same for individual costs and entity costs? If the SEC only interviews two executives, will the costs even exceed the retention? You might have theoretical coverage that never kicks in becuase your costs stay below the threshold.

Talk to your broker. Specifically ask about SEC investigation coverage. Dont accept vague assurances. Ask what’s covered and what isn’t. Ask about available endorsements that could fill gaps. Ask about entity investigation coverage. Ask about the definition of “claim.” Make them show you the actual policy language, not marketing summaries.

And when an SEC investigation actually starts, notify your insurer immediately. Dont wait. Dont see how it develops. Dont assume its “just an inquiry” that dosent require insurance notification. Late notice can void coverage entirely – not just for the investigation, but for all related claims that follow.

The D&O policy you have right now might not cover what you think it covers. Find out now, while you still can.

Review your policy. Talk to your broker. Understand the gaps. Before the SEC shows up and you discover that the millions youve spent on legal fees arent covered becuase your policy defines “claim” narrowly, or becuase entity investigation coverage isnt included, or becuase the regulatory exclusion applies, or becuase related claims collapsed everything onto an old policy with insufficient limits.

This matters. A lot. Figure it out now.