Indemnification and D&O Insurance in SEC Matters.

Advance payments on defense expenses are the most immediate form of protection. While advancement and indemnification together address an individual’s defense expenses in SEC proceedings, this is typically limited to “covered” expenses. Because corporate indemnification eligibility is often not determined until after an investigation or enforcement proceeding concludes, advance payments are necessary to ensure that individuals have a defense funded by the corporate entity. Advance payments on defense expenses are subject to indemnification and D&O policy terms, so it is important to ensure that these provisions are favorable to individuals.

Indemnification then determines the question of ultimate responsibility. Because advance payments on defense expenses are advances, the question of indemnification remains. The question of indemnification is one of who ultimately bears the cost of covered defense expenses and any liabilities and sanctions for which the individual has become obligated to pay.

Side A coverage provides protection when corporate indemnification is unavailable. While D&O insurance policies may provide for coverage both when indemnification is available and when it is unavailable, most policies include Side A coverage specifically to protect individuals in the event that corporate indemnification is unavailable.

Corporate D&O insurance policies also usually have shared limits. This means that the insurance policy limits are shared among the corporate entity and the individuals covered. Shared limits apply in the event that either the corporate entity or an individual is covered for defense expenses or liabilities and sanctions.

Permissive indemnification is available under Delaware law for individuals who conduct themselves in good faith. Specifically, Delaware law permits indemnification for “good-faith” conduct that is qualifying. Permissive indemnification does not obligate a corporation to indemnify; rather, it allows the corporation to do so.

Mandatory indemnification is also available under Delaware law to present or former directors and officers who are successful. Mandatory indemnification covers present or former directors and officers who are successful, for expenses actually and reasonably incurred in connection with the defense.

For indemnification under subsections (a) and (b), an individual’s eligibility is determined by disinterested directors, independent counsel, or stockholders. The authority to make this determination is set by statute: it rests with a majority vote of the directors who are not parties to the proceeding, a committee of such directors, independent legal counsel in a written opinion, or the stockholders.

Can I Force My Company to Advance My SEC Defense Costs?

1. Does Delaware Law Require Companies to Advance Defense Expenses?

Unlike the indemnification obligations imposed on Delaware corporations under Delaware law, advancement is generally permissive. That is, Delaware corporations need not advance defense expenses unless the company’s governing documents (or a separate agreement between the company and the individual) mandate advancement.

Although corporate bylaws and indemnification agreements commonly contain provisions that convert a Delaware corporation’s permissive right to advance into a mandatory obligation to advance, these provisions will have no effect unless they are adopted in the company’s bylaws or in a separate agreement signed by an officer or director.

2. When is a Delaware Corporation Required to Indemnify for Defense Expenses?

Under Delaware law, corporations are required to indemnify qualifying present or former directors and officers who are successful in defending SEC proceedings. Delaware law mandates expense indemnification for individuals who are successful “on the merits or otherwise.” “Successful on the merits” includes any favorable result that ends the litigation on substantive grounds without further appeal. “Successful otherwise” includes results that end litigation for any reason other than an adjudication on the merits.

Under Delaware indemnification law, settlement also does not inherently establish an individual’s lack of “good faith.” Settlement in SEC enforcement proceedings is typically not evidence of lack of “good faith,” and as such, it can have different consequences under permissive indemnification (when indemnification is optional) than under mandatory indemnification (when indemnification is required).

3. How do I enforce my right to advancement and indemnification?

If you have a right to advancement and indemnification under your company’s bylaws and/or individual agreement, you have two avenues to enforce these rights: (i), contract action, and (ii), statutory action under Delaware law.

4. Can I sue in Delaware or Texas for indemnification and advancement?

There are potential issues with enforcing an individual’s right to indemnification and advancement when the company is incorporated in Delaware but does business in Texas. In most circumstances, an individual will need to establish the right to indemnification and advancement in either Delaware or Texas.

5. Does the Delaware Court of Chancery have exclusive jurisdiction?

The Delaware Court of Chancery does have exclusive jurisdiction in all matters that relate specifically to whether a Delaware corporation is required to advance expenses. Under 8 Del. C. § 145(k), the Delaware Court of Chancery is the only Delaware forum that has authority to hear claims in the nature of the provision of defense costs to individuals, or who is otherwise covered.

Section 145(k) provides for expedited proceedings, allowing for determinations on a summary basis, as it may. This statutory provision applies to all advancement and indemnification actions, whether they are brought under Section 145 itself or under a corporation’s bylaws, an individual indemnification agreement, a vote of stockholders or disinterested directors, or otherwise.

6. Are SEC investigations considered “proceedings”?

Under Delaware indemnification law, Section 145 reaches “any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative.” This language indicates that Delaware corporations have an obligation to advance and indemnify individuals who face enforcement actions, which includes SEC investigations.

When Does an SEC Investigation Trigger D&O Coverage?

1. Does an Informal SEC Inquiry Trigger D&O Coverage?

An informal SEC inquiry will not satisfy every policy’s definition of a “Claim.” Therefore, simply receiving an informal SEC inquiry is not enough to trigger coverage in all circumstances.

However, while an informal SEC inquiry will not automatically trigger coverage under all D&O policies, in some cases, an informal SEC inquiry (or interview) will constitute a report of circumstances that may preserve coverage under a claim-made policy’s reporting periods. This means that an individual and/or their company must ensure that they promptly report an informal SEC inquiry (or any other SEC matter) to their D&O insurance carrier so that coverage is preserved in case of a future formal enforcement proceeding.

2. Does a Formal SEC Subpoena Trigger D&O Coverage?

A formal SEC subpoena does not automatically trigger coverage under all D&O policies either. While a formal SEC subpoena will be a “Claim” in some instances, if a company’s or individual’s D&O insurance policy has a restrictive claim definition, a formal SEC subpoena may not satisfy the definition.

While companies’ and individuals’ D&O insurance policies may provide coverage for voluntary interviews and other informal SEC requests that are not formally subpoenas, it depends on how these policies provide for this coverage. Companies’ and individuals’ D&O policies may provide coverage for voluntary interviews and other informal SEC requests through endorsements that include “informal interview” coverage and/or “voluntary response” coverage. When individuals voluntarily interview with the SEC without regard to a subpoena, these endorsements provide coverage in cases where the insurance policy’s definition of a “Claim” does not cover these events.

However, when the SEC opens an investigative proceeding that targets both a Delaware corporation and its individual officers or directors, the corporation’s and individual’s D&O insurance policies may provide for corporate investigation coverage and entity investigation coverage. The D&O policy must provide for coverage that covers the specific circumstances under which the company or an individual is being investigated by the SEC.

For example, under entity investigation coverage, an individual’s D&O policy may only provide coverage if the corporate entity is also under investigation. This means that even if the individual was involved in civil proceedings in which a violation of securities law is alleged, the insurance policy may not extend coverage unless there is also an investigation of the corporate entity.

3. When is a Report of a Claim or a Report of Circumstances Required?

In relation to claim-made D&O policies, the time and reporting requirements are determined by the terms of each policy. A report of a “Claim” is required within the contractual reporting period of a claim-made policy. A report of circumstances will allow an individual to preserve coverage for all claims that relate to a reported circumstance.

If an individual is covered under runoff coverage, a report of a Claim is required during the company’s runoff period. Runoff coverage generally covers Wrongful Acts occurring before a transaction was completed (such as a merger or IPO), and a report of a Claim under a runoff policy must usually be filed within the runoff period.

4. What is the Effect of an Internal Investigation?

While an internal investigation can provide necessary information for a company’s or individual’s defense efforts, the opening of an internal investigation does not, in and of itself, constitute a reportable “Claim” under a D&O insurance policy. Individuals who believe that an internal investigation may eventually trigger coverage should still report these circumstances to their D&O insurance carrier.

Who Controls Counsel and Settlement in an SEC Matter?

1. Does the Insurer Control the Defense?

In most cases, a company’s or individual’s D&O insurance policy only provides reimbursement for a covered Loss. This includes a Company’s or individual’s Right to Counsel. With a reimbursement-based policy, the insured party has the right to select counsel and the Right to Control the Defense. Even with an indemnity-based policy, a company’s or individual’s D&O insurance company will not usually be required to provide for the defense. Instead, under an indemnity-based D&O policy, the company’s or individual’s D&O insurance company will usually be responsible for the reimbursement of the covered defense and settlement expenses.

Under an indemnity-based D&O policy, the right to select and control the defense and settlement usually resides with the insured party; however, the D&O insurance carrier can usually reserve various conditions to the Right to Reimbursement. These include the insurer’s Right to Consent, Right to Cooperation, and Right to Reasonable and Customary Expenses. While coverage exists under a D&O policy, D&O insurance carriers may limit their financial exposure to an individual’s and/or company’s defense expenses incurred during a proceeding. This includes an insured party’s Right to Counsel and a party’s obligation to select defense counsel who is reasonable, customized, and customary.

2. When Does the Insurer have Right to Consent and Right to Control in an SEC Matter?

D&O policies provide for various Allocation, Voluntary Payment, Replacement, and Prior Consent clauses, but the scope of these policies will depend on the specific terms of the D&O policy. The following is an example of these provisions’ effects in an SEC matter.

As an example, if an insurance carrier must allocate its coverage between a company’s and individual’s covered and uncovered claims, the D&O policy will usually include an Allocation clause. Under an Allocation clause, the insurer’s coverage can be pro rated to apply to uncovered claims or claims that the insurer does not recognize as a “Claim.”

Under a Voluntary Payment clause, any voluntary payments made during settlement negotiations will typically need to be approved by the insurer before it will provide coverage for the covered portion of the payments made. Prior Written Consent provisions may also apply to coverage for voluntary payments.

Replacement provisions apply when a company’s or individual’s D&O insurer provides for the assumption of defense. For example, if the insurer assumes the defense for the SEC proceedings, the insurer will then need to provide its prior written consent before counsel is replaced.

Generally, the insurer’s consent will be required regardless of whether the individual, company, and/or others are cooperating with the SEC, as the individual, company, and/or others’ cooperation with the SEC may also affect coverage under their D&O policies.

3. Are There Conflicts of Interest Between the Company and Individual?

Concurrent representation by a single law firm for a company’s and individual’s defense is possible. Under ABA Model Rule 1.7, lawyers may concurrently represent a company and an individual when the requirements for consentable representation are met and each affected client gives informed consent confirmed in writing. For instance, this is not permitted if the conflict is non-waivable or if either the company or an individual is not willing to sign a written informed consent form.

If you are facing this situation, Spodek Law Group handles federal criminal defense matters nationwide, from offices in New York and Los Angeles.

What Happens When Defense Costs Exhaust the D&O Tower?

Side A Difference in Conditions (DIC) policies provide separate limits that protect individuals. In an SEC matter, individuals covered under a company’s primary D&O insurance policy may also have separate DIC policies that they need to understand to ensure that their D&O tower provides for adequate coverage. Companies’ and individuals’ DIC policies may include “drop down” coverage that applies when primary underlying insurers do not respond or fail to pay what is owed to their insured parties. However, this is not always the case, so it is important to check both sides of the tower to ensure coverage.

Usually, defense costs will reduce the limits available for the reimbursement of covered settlements or judgments. While some companies’ and individuals’ D&O insurance policies have terms that prevent defense costs from eating into these limits, it is more common for defense costs to reduce the available limits.

In the case of tower exhaustion, Priority-of-Payments clauses may be important. Priority-of-Payments clauses determine which individuals’ or entities’ Side A claims take priority over others. These provisions can affect all parties’ ability to obtain coverage.

In cases of bankruptcy, disputes over the ownership of the policy proceeds and the ability to access policy proceeds may arise. While D&O insurance coverage is generally for individuals covered under the policy and for the corporate entity as a whole, in bankruptcy, certain provisions will allow the corporate entity’s estate to assert claims against the individual insured’s coverage proceeds. Some companies’ and individuals’ D&O policies will favor claims against individuals who were not indemnified by the company over claims against the company’s estate in the event of bankruptcy.

4. When is Excess Insurance Triggered?

In most cases, an insurance company will not trigger excess insurance until it pays out all of its underlying policy limits. However, in the case of DIC and other specific excess policies, these policies may trigger immediately or at another triggering event. When seeking coverage under the company’s or individual’s D&O tower, it is important to make sure all applicable coverage is triggered.

5. Do Follow-Form Excess Policies Always Apply?

Follow-form excess policies are similar to underlying policies, and they generally cover the same events that trigger underlying policies. However, these policies are still separate from the underlying policies, so it is important to look for independent terms and conditions that can affect coverage.

Can Exclusions or Reservations Stop Payment of Defense Costs?

D&O policies include a wide range of exclusions. These include, but are not limited to: (i), “prior Acts” exclusions; (ii), fraud, dishonesty, criminal acts, and deliberate misconduct exclusions; (iii), securities violations exclusions; (iv), claims made by policyholders; (v), claims involving “competitors”; (vi), claims involving the company’s control company; (vii), claims involving affiliates; (viii), claims filed by corporate executives or directors against the company; (ix), claims related to “unreasonable” fees and expenses; (x), claims related to employment-related allegations; (xi), claims related to environmental-related allegations; (xii), claims related to specific types of transactions; (xiii), claims related to the SEC, and (xiv), other general or specific exclusions. When reviewing an individual’s and/or a company’s D&O policies, it is imperative to look at these exclusions and other terms that may otherwise apply.

For instance, most D&O insurance policies include conduct exclusions for allegations involving fraud, dishonesty, criminal acts, or deliberate misconduct. These exclusions commonly apply in cases in which “final adjudication” determines that fraud, dishonesty, or a similar allegation has occurred. This type of language is critical for coverage for defense costs, because while the individual insured’s misconduct may not be “established” until after a trial, the individual will still have a Right to Counsel in SEC investigations and SEC proceedings.

While most companies’ and individuals’ D&O policies do not exclude settlements involving admissions of liability, individual’s D&O policies that include final-adjudication provisions will not generally consider settlements as meeting the “final adjudication” requirement. When reviewing settlements, it is important to ensure the settlement terms are such that an insurer cannot assert the final adjudication occurred.

Additionally, when reviewing for coverage for defense costs, it is important to consider whether the policy contains a “recoupment” clause that allows for reimbursement of covered defense expenses in the event that an exclusion is later found to apply. This type of a provision will depend on the policy language, the state law applicable, and the specific circumstances at hand.

Finally, when reviewing for coverage, individuals and entities must assess provisions related to “insureds’ knowledge,” “severability,” and “non-imputation.” These provisions impact whether a claim can be excluded based on the knowledge of a company’s officers and directors, or a misstatement made by a company’s officer or director during the policy application process. While these provisions vary, their generally-covered implications in corporate contexts can have significant and unexpected effects.

Are SEC Penalties, Disgorgement, Clawbacks, and Bars Insurable?

1. Are SEC Penalties and Other Payments Insurable?

In many instances, companies’ and individuals’ D&O insurance policies will provide coverage for covered SEC settlements, including fines, penalties, and other regulatory payments. These provisions generally contain the phrase “when such payment is made pursuant to the terms of the policy and as permitted by law.” In all instances, it is important to determine both whether the individual’s or entity’s D&O insurance policy provides for coverage and whether the policy’s payment is permissible under applicable law.

As a general rule, the insurability of various payments is based on the applicable state law. For example, the New York Court of Appeals determined that insurers’ coverage was available to Bear Stearns when the corporation disgorged the profits its clients earned in the case of Bear Stearns’ use of the foreign currency market. 417 A.2d 116, 118, 119 (1981). This is a fact-specific inquiry that requires an assessment of the specific terms of the company’s or individual’s D&O policy, and it requires careful review of the applicable state law.

2. Can the SEC Require Nonreimbursement of Civil Penalties in Settlements?

Yes, companies’ and individuals’ D&O insurance companies can be bound by the terms of settlement agreements with the SEC in which the SEC requires that civil penalties not be reimbursed or paid through insurance.

3. What If the D&O Insurance Company is Located Out-of-State?

D&O insurance policies will often include choice-of-law and forum selection clauses. These clauses will establish the governing state law, and will determine the forum in which to bring any litigation involving coverage and any other disputes.

With a valid choice-of-law clause, these policies may select a state whose laws favor the insurability of a particular type of payment. However, the choice-of-law provision is subject to various limitations. When negotiating a D&O insurance policy, individuals and companies should work closely with their D&O insurance coverage counsel.

4. Are Officer-and-Director Bars Insurable?

Officer-and-director bars are an available remedy to the SEC in enforcement proceedings. Unlike civil penalties, restitution, clawbacks, disgorgements, and fines, officer-and-director bars are nonmonetary remedies that are generally not insurable.

5. Are Clawback Repayments and SEC Remedies Insurable?

Similar to civil penalties, the insurability of clawback repayments and other SEC remedies will be dependent on the company’s or individual’s D&O insurance policy’s terminology and the applicable state law. In the example of Bear Stearns, this included a $160 million disgorgement and $90 million penalty.

Get Advice on Your Situation

If you want someone to look at the specifics of your case, Spodek Law Group handles federal criminal defense nationwide from New York and Los Angeles. The firm has been practicing since 1976 and its motto is simple: we owe loyalty to only you. Call 212-300-5196.