For those with directors and officers (“D&O”) insurance, a recent decision from a federal appellate court will be of keen interest as it strengthens coverage when faced with governmental subpoenas and Special Litigation Committee (“SLC”) board reviews. This decision is an important victory for policyholders and should serve as a helpful check on scope of coverage during a company’s next D&O renewal.

This past summer in MBIA, Inc. v. Federal Insurance Co., No. 10-0355-cv, 2011 U.S. App. LEXIS 13402 (2d Cir. July 1, 2011), the United States Court of Appeals for the Second Circuit ruled in favor of policyholder MBIA, Inc. (“MBIA”), regarding insurance coverage under D&O insurance policies for three separate categories of expenses often incurred by companies involved in government investigations and shareholder derivative actions.  

1. Coverage for governmental subpoena and investigation costs, including voluntary compliance costs

The Second Circuit first affirmed coverage for MBIA’s costs of defending itself against governmental investigations. The investigations began with a formal order of investigation issued by the SEC authorizing a private investigation into certain financial practices of a number of companies. Pursuant to that investigation, the SEC subsequently issued several document subpoenas to MBIA. The New York Attorney General (“NYAG”) also issued subpoenas to MBIA mirroring the SEC’s subpoenas. During the course of these investigations, these regulators eventually accepted MBIA’s voluntary compliance with document requests in lieu of issuing additional subpoenas.

The insurers denied coverage for much of MBIA’s costs of complying with these subpoenas and MBIA’s voluntary compliance with document demands. In affirming coverage for such costs, the Second Circuit reasoned that a subpoena issued by the regulators was at a minimum a “similar document” to “a formal or informal investigative order” that commenced a formal or informal regulatory proceeding, thus falling within the policies’ definition of “Securities Claim.” According to the Second Circuit, a reasonable businessperson also would view a regulator’s subpoena as a formal or informal investigative order, even if the policy definition did not explicitly include the word “subpoena.” The Second Circuit rejected the insurers’ view that a subpoena was a “mere discovery device” dissimilar from an investigative order; rather, the Second Circuit held such subpoena was “the primary investigative implement in the NYAG’s toolshed.”  

The Second Circuit also took a broad view of the scope of the SEC’s investigation into MBIA, rejecting the insurers’ attempts to avoid coverage for portions of the SEC’s investigation which were conducted orally rather than through subpoenas. The Second Circuit reasoned that, whether through subpoenas or through oral requests, the SEC’s investigation was conducted pursuant to a formal order. It made no sense to punish MBIA’s voluntary compliance, the court concluded, stating, “The insurers cannot require that as an investigation proceeds, a company must suffer extra public relations damages to avail itself of coverage a reasonable person would think was triggered by the initial investigation.”  

2. Coverage for SLC derivative litigation costs

The Second Circuit also affirmed coverage for costs incurred by an SLC of the board created by MBIA to respond to two shareholder derivative lawsuits concerning alleged wrongdoing that was the subject of the SEC and NYAG investigations.  

The Second Circuit rejected the assertion that the SLC was not an insured person under the policies; rather, the SLC was created by MBIA, and under relevant state law, MBIA retained control over it even though the SLC exercised independent judgment, through independent directors, over the response to the shareholder suits. In addition, the Second Circuit rejected application of a policy sublimit for investigative costs for shareholder derivative demands. The insurers failed to meet their burden to show that such sublimit applied once a shareholder derivative lawsuit (rather than the initial derivative demand) was filed.  

3. Coverage for settlements

Finally, the Second Circuit found coverage for the costs of an independent consultant that MBIA retained as part of its subsequent settlements with the regulators.

The insurers denied coverage for these independent consultant costs as a breach of the insurers’ rights under the policies to associate in investigation, defense, and settlement. According to the Second Circuit, the purpose of such rights was to provide the insurers with an option to intervene in defense and settlement of a claim. In finding coverage, the Second Circuit reasoned that MBIA provided sufficient notice to its insurers early enough to allow them to exercise their option to associate, and the insurers thereafter declined to participate, noting “ is not the insured’s duty to return to the nonparticipating insurer each time negotiations about the same claim take a new twist and ask if that insurer still wants to opt out.” Nor did MBIA violate the insurers’ rights to consent to settlement under the policies. Rather, the insurers initially agreed to waive any requirement of consent, and MBIA reasonably perceived the insurers’ silence in the face of receiving additional settlement information as a continued waiver of such rights.  

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Such commonsense and reasonable interpretation of the D&O policies at issue in this case are most helpful to policyholders seeking coverage when faced with governmental subpoenas, SLC reviews, and settlements. Policyholders would be well served to keep these issues in mind during their next D&O renewal to ensure that their policies provide adequate breadth of coverage, particularly for governmental subpoenas and SLC costs.