INFORMAL INVESTIGATION IS NOT A COVERED SECURITIES CLAIM

INFORMAL INVESTIGATION IS NOT A COVERED SECURITIES CLAIM

In Office Depot, Inc. v. Nat’l Union Fire Ins. Co., the Eleventh Circuit recently affirmed a decision that coverage was not available for more than $20 million in fees incurred by an insured in responding to an “informal” SEC inquiry. 2011 U.S. App. LEXIS 20759 (11th Cir. Fla. Oct. 13, 2011). Office Depot sought coverage under its primary and excess D&O policies for costs incurred after receiving a July 17, 2007 letter from the SEC advising it would begin an inquiry into Office Depot to determine if there had been a violation of securities laws. The SEC asked Office Depot to voluntarily produce documents to assist in its investigation. The SEC did not issue a formal order of investigation against Office Depot until January 2008 and did not file a formal complaint until December 2009.

The National Union D&O policies provided entity coverage to Office Depot for “Loss… arising from a Securities Claim made against such organization for any Wrongful Act….” The policies defined Securities Claim as, “a Claim, other than an administrative or regulatory proceeding against, or investigation of an Organization, made against any Insured: (1) alleging a violation of any federal, state, local or foreign regulation, rule or statute regulating securities…; or (2) brought derivatively on the behalf of an Organization by a security holder of such Organization.” Id. at *7-8 (emphasis in original). The definition for Securities Claim included a carve-back provision for regulatory proceedings, “Notwithstanding the foregoing, the term ‘Securities Claim’ shall include an administrative or regulatory proceeding against an Organization, but only if and only during the time such proceeding is also commenced and continuously maintained against an Insured Person.” Id. at *8 (emphasis in original).

Office Depot argued for coverage for all costs incurred since the July 2007 “inquiry” letter, i.e., the start of the SEC’s investigation. Office Depot argued that the policies did not define “administrative or regulatory proceeding” and did not include “clear and unmistakable language excluding coverage for SEC investigations.” The District Court disagreed, as did the Eleventh Circuit.

The Eleventh Circuit focused on the first sentence of the definition for Securities Claim. The court held that sentence “creates a clear disjunctive through the use of ‘or’” and “eliminates coverage for two types of potential Securities Claims: (1) Claims in the form of administrative or regulatory proceedings . . . and (2) Claims in the form of an administrative or regulatory investigation . . . .” Id. at *9 (emphasis added). The Court held the carve-back provision only restored coverage for administrative or regulatory proceedings, not investigations. The Eleventh Circuit found the omission of language in the carve-back relating to investigations to be dispositive. The court held that “[b]ecause the SEC’s requests for voluntary cooperation in furtherance of its pre-suit discovery constituted an ‘investigation’ rather than an ‘administrative or regulatory proceeding,’ Office Depot’s expenses incurred after the receipt of the SEC letters are excluded from coverage.” Id. at *9.

The Court applied a strict construction of the policies, and based on that, the outcome seems correct. Insureds who desire coverage for SEC investigations should look closely at the definition of Securities Claim, and any exclusions that might apply. Carriers being asked to pay for SEC investigations also should review closely the Office Depot decision and applicable definitions for Securities Claims.