To protect themselves against white-collar criminal charges and to minimize their negative consequences, corporations have been designing, implementing, and enforcing internal compliance programs—not only for anticorruption purposes, but also to protect themselves against a variety of civil and criminal risks. They are also making sure that their insurance policies are adequate in terms of scope and limits. However, corporate indemnifications and indemnification insurance do not always provide adequate coverage for the costs incurred in connection with government investigations. In fact, in some jurisdictions (outside the United States), it is illegal to indemnify, and, a fortiori, to obtain indemnification insurance coverage—even for successful defense. Such insurance is viewed in these countries as a waste of corporate assets. In most jurisdictions where this coverage is available, it is of recent vintage; it was not previously considered commercially feasible by corporations, and it is now, on a limited basis, available for purchase directly by officers and directors.
The U.S. Foreign Corrupt Practices Act (FCPA),15 U.S.C. §§ 78dd-1 et seq., makes it a crime for a U.S. person to make any corrupt payment to a foreign official for the purpose of obtaining or retaining business for or with any person or directing business to any person. A non-U.S. person is also subject to the FCPA if he, she, or it causes, directly or through agents, any act taking place in U.S. territory in furtherance of such a corrupt payment.
The accelerating number of investigations, prosecutions, settlements, and convictions in the United States has created a sense of urgency in corporate boardrooms and officers’ suites, not only in the United States, but also in countries where business relationships with U.S. entities exist or are being contemplated. Separate from the company’s liability, officers and directors are at risk and they face possible imprisonment and fines. Even if innocent, they may not be able to pay the high costs of representation through a lengthy government investigation and possible tangential actions such as shareholder-class derivative actions or whistleblower proceedings.
In order to protect themselves, corporate executives and their lawyers are carefully studying the court decisions and agreements entered into by the SEC and the DOJ relative to FCPA compliance standards. Further, in order to avoid prosecution and minimize the risk of long, drawn-out, and costly investigations, corporations have been engaging special outside counsel, hiring trained investigators, conducting increased due diligence, expanding internal staff by adding experts tasked with internal and external reviews and investigations, and carefully analyzing and continuously reviewing and updating their own compliance programs and activities.
U.S. companies (and companies dealing, or hoping to deal, with U.S. companies) must be able to prove that their officers, employees, subsidiaries, affiliates, agents, and partners around the world do not and will not run afoul of the these laws in their own operations. For that reason, comprehensive and fully enforced anticorruption compliance programs are essential. Compliance programs, however, do not provide a shield against the high costs incurred by a corporation defending itself during investigations, nor from the expenses that officers and directors may have to pay their own lawyers.
U.S. corporations generally provide indemnification for their officers and directors pursuant to provisions in their bylaws, and when authorized and statutorily available, purchase directors’ and officers’ insurance (D&O) to cover those individuals’ costs in the event of attacks upon them resulting from their duties on behalf of the corporation—subject to the limitation that they must not have acted in bad faith or violated any laws. Such coverage has historically been available to protect against personal liability and legal expenses that may result from shareholder derivative suits naming them as parties. In recent years, D&O coverage has been crafted increasingly to cover defined costs of other civil and criminal challenges. By extension, those could include the cost of FCPA investigations. However, the availability of such coverage by insurers is limited, and to date, except for an extremely small number of companies, the corporate community has not been responsive.
Companies often believe that their existing D&O coverage is adequate and/or that purchasing targeted coverage against FCPA investigation costs would be prohibitively expensive. In reality, companies should more seriously consider D&O coverage.
Coverage under a D&O policy typically provides that both defense costs and any liability payments reduce the liability limits by the aggregate amount of payments. Therefore, to the extent that defense costs that are paid fully exhaust the liability limits, there will be no amount left under the policy to pay for any liability incurred. This feature distinguishes these types of policies from others, such as comprehensive general liability policies, where amounts paid in defense costs do not reduce the available liability limit. Given the extremely high costs of investigations, the liability limits can quickly be reached, long before the investigation is completed.
D&O claims must be asserted against an officer or director during the defined policy period (unless there is extended coverage by endorsement). Generally, a “claim” is a lawsuit or an administrative or regulatory proceeding served on a director or officer. In most D&O policies, insured parties are given the opportunity to provide the insurer with notice of circumstances that will likely give rise to a claim. If such notice is provided during the policy period or an extended “discovery period,” and a claim is subsequently made, according to the terms prescribed in the notice provision, the claim is deemed to be made during the policy period. The discovery period is a feature found in many D&O policies that allows insured parties to provide notice of claims and circumstances for a limited time, beyond the termination of the policy.
Most D&O policies require the insured party to retain its own counsel, subject to the insurer’s consent. Thereafter, as the insured’s counsel bills for services rendered, unless otherwise stipulated, the insured party is typically obligated to pay the defense costs directly. The insurer reimburses the insured for covered payments, either at the conclusion of the proceeding or on a contemporaneous basis, as agreed upon among the insured, the insurer, and defense counsel. An agreement to proceed on a contemporaneous basis constitutes an advancement of defense costs, which is typically made at the option of the insurer.
There are four kinds of coverage in D&O policies.
- Side A coverage provides direct coverage to directors and officers.
- Side B coverage is for amounts the company has indemnified to directors and officers.
- Side C coverage provides entity coverage for securities claims, such as securities class actions.
- Side D coverage is at times offered to cover the full or partial costs of an investigation arising from a shareholder demand in the context of a derivative lawsuit. It is intended to pay for the cost of convening a special litigation committee only and is not intended to cover the directors’ and officers’ defense costs or any liability resulting from a derivative action. Typically, Side D coverage has a reduced sub-limit, which is substantially less than the limit of liability set forth in the policy. Once exhausted, the policy, and specifically, Side D, will no longer respond to cover costs incurred in connection with a special litigation committee.
Side B coverage is the form of coverage most commonly triggered in a D&O policy. Side A coverage is typically triggered when a corporation is insolvent or when a director or officer is not entitled to indemnification, which potentially arises in such situations as derivative actions or insolvencies. When corporate indemnification is available or presumed, Side B coverage is typically triggered, which only extends to amounts paid to the corporate directors and officers in the form of corporate indemnification. No direct, derivative, or vicarious coverage is available under Side B for claims asserted against the corporation itself. It should be possible, and may well be advisable, for directors and officers to contract and pay for their own Side A protection, notwithstanding the cost. The premiums for such policies can be structured in a staged way, so that the protection kicks in (and is paid for) on an as-needed basis.
The introduction of Side C and Side D coverage has changed the character of D&O insurance and has created corporate coverage that can create competing interests between the corporation and its directors and officers. “By providing corporate protection, D&O policies are more apt to become depleted in a corporate crisis such as a securities class action or governmental proceeding. The exhaustion of the policy limits as a result of corporate liability and defense costs coverage could potentially leave the directors and officers unprotected, while being left to defend a concurrent or subsequent action.” (Perry Granof, chair of the Professionals’, Officers’, and Directors’ Liability Committee of the ABA Torts and Insurance Practice Section.) This situation could be worsened in the event of a corporate insolvency, leaving directors and officers without the benefit of company indemnification.
The dishonesty/personal profit exclusions preclude coverage for directors and officers who caused financial losses to the entities they served as a result of their own dishonesty, criminal conduct, or personal profit, or of the improper advantage they may have realized. These exclusions are typically triggered upon the establishment of such conduct through a judicial decree or factual findings. Before dishonest conduct or personal profit is established, defense costs may be advanced.
Many D&O policies have bifurcated listings of exclusions, which apply depending upon whether Side A or Side B coverage is triggered. Where bifurcated, the dishonesty/personal profit exclusions typically apply to Side A coverage only and not to coverage provided when Side B, company reimbursement, is triggered. Public policy is typically addressed in the definition of “loss,” which would also likely preclude coverage for fines and penalties assessed by law enforcement and regulatory authorities, as well as matters deemed uninsurable as a violation of law.
Reimbursement for legal costs incurred in connection with U.S. and state government investigations, as well as regulatory and law enforcement proceedings, is of increasing importance. These investigations and proceedings can arise in connection with such matters as possible accounting misstatements, wrongful disclosures of inside information to third parties, and of course, violations of the FCPA. Since the financial crisis of 2008 and the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. No.111-203, H.R. 4173 (2010)), the growing need to respond to SEC informal requests for information, documentation, and testimonies, as well as subpoenas, means that corporations increasingly seek reimbursement under their respective D&O policies. Coverage is typically sought under Side C, which provides direct corporate coverage in connection with securities claims. SEC investigations often start out in the form of general inquiries, but as they proceed and as the SEC acquires more information, they typically evolve into proceedings for specific violations of federal law against corporations. The proceedings can also identify wrong conduct and violations of law against specific directors and senior officers. While coverage would normally apply to FCPA coverage in the event of an SEC investigation, coverage would not necessarily apply if brought by the Department of Justice without SEC involvement.
In August 2010, in MBIA Inc. v. Federal Insurance Company, the Second Circuit ruled in favor of MBIA entitling the company to “securities defense costs” incurred in connection with SEC and New York Attorney General investigations and for costs associated with a special litigation committee investigation and an independent consultant. In contrast, in October 2011, the Eleventh Circuit in Office Depot, Inc., v. National Union Fire Insurance Company of Pittsburgh ruled in favor of the insurers in concluding that the policy at issue did not cover defense costs associated with an SEC investigation, until the investigation resulted in the issuance of subpoenas and Wells notices. In these two cases, both courts relied on the wording of the relevant policies, which were clearly distinguishable. In MBIA the policy expressly provided coverage for “Securities Claims,” which was defined to include “a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document” (emphasis added). The policy in Office Depot had no such language.
Since the MBIA and Office Depot opinions, some D&O carriers have begun to provide coverage for costs incurred in connection with informal investigations. More can be expected inasmuch as the issues surrounding D&O liability and coverage are in a state of flux, and the industry lacks a standardized D&O policy.
The ultimate coverage will be governed by the precise language of the insuring clauses and the policy as a whole. Therefore, lawyers need to be well-versed in insurance contracts, evolving liabilities, and new insurance solutions, and they must be prepared to negotiate language that works for their clients.