MBIA, Inc. v. Federal Insurance Company : D&O Coverage For Regulatory Subpoenas & Derivative Investigations

Judging by the numbers, the SEC’s Enforcement Division had a banner year in 2009. Investigations opened by the SEC during the fiscal year ended September 30, 2009 jumped 6% over the same period in 2008 and by 22% over FY 2007.[1] The frenetic pace of SEC enforcement activity appears to have continued into FY 2010.[2] Directors, officers and the corporations they lead may be troubled by the new administration’s emphasis on enforcement—particularly since D&O coverage for SEC investigations and related subpoenas can be clouded by complicated terms and conditions. Yet, into this murky regulatory environment and the sometimes ambiguous world of D&O liability insurance, U.S. District Judge Richard Berman has cast a timely and well-reasoned ray of sunshine in his recent opinion in MBIA, Inc. v. Federal Insurance Company.

Regulatory Investigations of MBIA, Inc.

Between 2001 and 2007, MBIA, Inc. was a company facing significant legal challenges. In March 2001, the SEC began a formal investigation into “loss mitigation insurance products,”[3] which ultimately spawned a series of subpoenas to MBIA, Inc. from the SEC and the Office of the New York State Attorney General (“NYAG”). These subpoenas, issued in late 2004 and early 2005, sought information relating to (1) so-called “non-traditional products”;[4] and (2) “advisory fees, “loss reserves,” and “credit default protection.”[5] By mid-2005, MBIA entered into an agreement with regulators to comply voluntarily with further requests for information in order to “minimize the ‘disproportional’ negative market impact from the March 30, 2005 subpoenas.”[6] Pursuant to this agreement and a later-concluded “offer of settlement,” MBIA provided additional documentation to both the SEC and NYAG regarding MBIA’s investment in Capital Asset Holding GP, Inc. (the “Capital Asset Transaction”) and MBIA’s exposure on notes issued by U.S. Airways 1998-1 Repackaging Trust (the “US Airways Transaction”).[7] Ultimately, in the spring and fall of 2005, shareholders made derivative demands for an investigation of alleged wrongful acts by MBIA’s officers and directors in connection with the AHERF Transaction.[8] Shareholders subsequently filed derivate lawsuits in which the law firm of Dickstein Shapiro, L.L.P. represented both the “special litigation committee” and MBIA, Inc. as the nominal defendant.[9]

The Coverage Dispute

In 2008, MBIA filed suit against its insurers—Federal Insurance Company and ACE American Insurance Company (the “Insurers”)—to obtain reimbursement for the approximately $29.5 million incurred in “defending and responding to the regulatory investigations and follow-on litigation” under primary and excess insurance policies issued between February 2004 and August 2005 (the “Policies”).[10] The Insurers denied liability, in part, on the bases that (1) the NYAG’s subpoenas and the “informal requests” made for documents relating to the Capital Asset and U.S. Airways Transactions do not fit within the Policies’ coverage for “securities claims”; and (2) the fees incurred by Dickstein Shapiro were incurred on behalf of a “special litigation committee” as opposed to an entity insured under the Policies.

On cross-motions for summary judgment, Judge Berman ruled that the NYAG’s subpoenas are “orders” or “similar documents” triggering the Policies’ coverage for “securities claims,” including “a formal or information administrative or regulatory proceeding or inquiry commenced by the filing of a . . . formal or informal investigative order or similar document.”[11] The district court also rejected the Insurers’ attempts to distance and detach requests for information relating to the Capital Asset and U.S. Airways Transactions from the original March 2001 SEC order.[12] Instead, the court recognized the error of arbitrarily pre-judging the focus or outcome of an investigation undertaken by the SEC (or the NYAG), which “performs a function similar to that of a grand jury, ‘the scope of whose inquiries is not to be limited narrowly by questions of propriety or forecasts of the probable result of the investigation.’”[13] Finally, the court also refused to distinguish between MBIA, Inc. and the “special litigation committee” formed to respond to the derivative lawsuits—whose members were selected from the company’s board of directors.[14]

A “Subpoena” Is A “Claim”

Judge Berman’s decision is noteworthy for at least two reasons. First, the court’s order joins a growing number of opinions concluding that a regulatory “subpoena” is a “claim” or “securities claim” triggering coverage under a D&O policy.

The rate at which the SEC opened investigations in FY 2009—nearly one every nine hours—makes it numerically more likely that a director or officer will be the target of a subpoena than a defendant in a suit filed by the SEC.[15] Yet, coverage under many directors and officers liability insurance policies is not expressly triggered by the issuance of a subpoena or even an investigation of an insured “entity.” Instead, many policy forms define the “claim,” which along with a “wrongful act” is a basic precondition of coverage, to include demands for monetary and non-monetary relief, civil proceedings, and even investigations of “insured persons”—without specifically including subpoenas issued to “insured persons.”[16]

Over the years, courts have struggled—sometimes inconsistently—with the absence of express terms insuring the cost of responding to regulatory “subpoenas.”[17] While coverage will ultimately depend on the particular terms and definitions of a given policy, the common-sense, textual approach made by the court in MBIA takes an important step toward fulfilling the reasonable expectations of insured directors and officers, particularly in the current regulatory environment.

Coverage For Regulatory Investigations and Derivative Investigation Costs

Second, Judge Berman’s decision provides important recognition of the uncabined quality of regulatory investigations and the practical implications for D&O insurance coverage. As noted by the court, the SEC functions, in some respects, like a “grand jury.”[18] “The identity of the offender, and the precise nature of the offense, if there by one, normally are developed at the conclusion of the grand jury’s labors, not at the beginning.” Order at 13 (quoting Consol. Mines of Cal. v. S.E.C., 97 F.2d 704, 708 (9th Cir. 1938)).

Yet, in many D&O policies, coverage for investigations facially depends, in part, on identifying the “target”—whether it be an insured officer/director or the insured organization. Policies may provide coverage for an investigation of the “insured organization” only if also continuously maintained against an “insured person.”[19] Other forms may explicitly address investigations against “insured persons” but make no mention of coverage for an investigation of the “insured organization.”[20]

The court’s opinion demonstrates the fallacy of attempting such distinctions at the outset of a regulatory investigation. Indeed, the original March 2001 SEC order in the MBIA matter references “[c]ertain persons or entities [involved] in the offer or sale, or in connection with the purchase or sale, of the securities of certain companies that purchased loss mitigation insurance products from AIG and others.”[21] Nowhere is MBIA (or any of its officers or directors) referenced. Yet, pursuant to this order, the SEC issued multiple subpoenas several years later in 2004 and 2005.[22]

The SEC’s investigations are not only increasing in number but also in length.[23] As investigations lengthen, their scope will inevitably also increase. For the same reasons the district court refused to draw bright-line distinctions between the SEC’s subpoenas and later requests for information—whether on the basis of subject matter or otherwise—insured officers and directors should not be required to provide proof of an inchoate plan by the SEC or other regulator to target an “insured person” in order to obtain coverage for the high cost of responding to subpoenas or other demands in a regulatory investigation. To insist on explicit identification of an “insured person” as a “target” or other formalization of an investigation as a prerequisite to coverage not only works a detriment to the insured but also its D&O liability insurer, whose fortunes are linked by the D&O policy.[24]

Instead, it should be the insurer’s burden to demonstrate that a subpoena directed to an insured officer or director or other enforcement activity requiring an insured person to retain counsel is limited to the “insured organization” or otherwise excluded from coverage. See, e.g., Order at 13 (“Defendants have offered no persuasive evidence to support their argument that the SEC ran a series of separate concurrent investigations.”).

The near parity of “insured persons” and the “insured organization” in an investigation is also underscored by the court’s decision to allow coverage for the cost incurred by MBIA’s “special litigation committee” (“SLC”). While the court’s order is somewhat limited in that it depends, in part, on the fact the one firm represented both the nominal defendant, MBIA, Inc., and the SLC, Judge Berman’s rationale equating MBIA with the SLC authorized to act on its behalf is itself significant to insureds whose policies do not already contain sublimited coverage for derivative investigations.

Moreover, what is perhaps more noteworthy is the fact that, based on the district court’s opinion, Federal Insurance Company’s denial of coverage for the SLC’s attorneys’ fees was based on the assertion that the SLC was not an insured—as opposed to the more traditional argument that investigatory costs incurred in connection with a derivative demand do not involve the “defense” of a claim “against” an insured. See, e.g., ACE Bermuda, Investigation Costs: What Is Covered Under A D&O Policy?, D&O Newsletter (Sept. 2007), available at http://www.acebermuda.com/AceBermudaRoot/AceBermuda/Media+Centre/D+and+O+Newsletter/Investigation+Costs+What+Is+Covered+Under+A+DampO+Policy.htm (Jan. 26, 2010). Of course, the insuring agreements of many D&O policies are not qualified in terms of the “defense” of an insured. Instead, coverage is generally extended for “loss” “arising out of,” or “resulting from,” or “by reason of” claims against an insured for wrongful acts.[25] Likewise, many policies—including forms which include separate, specific coverage for the cost of derivative investigations—define “loss” to include fees incurred in “investigating” as well as “defending” claims for wrongful acts.[26] These terms suggest and support much broader coverage than simply the cost of “defending” otherwise covered claims, including coverage for derivative “demands,” which are by nature “claims” against insureds. While it is not clear from the district court’s opinion whether the Insurers denied coverage for the SLC’s fees on some basis other than the SLC’s insured status, it is clear that the MBIA decision will prompt future claims for SLC/derivative investigation costs by other D&O policyholders.



Conclusion

The tide of regulatory enforcement against directors and officers is rising in the form of more subpoenas and more and longer investigations. The coverage provided by D&O liability insurance—whose purpose it is to protect insured individuals from the extreme costs of litigation—needs to keep pace with this new regulatory regime and reflect the changeable nature of regulatory investigations. Fortunately, Judge Berman’s recent opinion in MBIA, Inc. v. Federal Insurance Company provides the conceptual themes needed for insured directors and officers to obtain the requisite coverage within the framework of traditional D&O insurance.

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