While businesses have struggled most immediately with loss of revenue and threats to supply chains stemming from the COVID-19 pandemic, financial and other uncertainties create complex disclosure issues for companies across all industries. The directive by the US Securities and Exchange Commission (SEC) that companies provide investors with assessments and plans for addressing material risks to their businesses and operations created by the coronavirus "to the fullest extent possible" positions companies for heightened scrutiny by regulators and shareholders alike. Stock market volatility, share price declines, and the rise in "event-driven" securities litigation have companies and their officers and directors bracing for regulatory investigations, as well as private shareholder lawsuits.

Claims and government investigations of COVID-related issues and required public disclosures implicate directors and officers liability and possible insurance coverage under directors and officers (D&O) liability policies. Indeed, lawsuits have already been filed alleging that companies and their directors and officers violated SEC Rule 10b-5 by disseminating or approving disclosures relating to COVID-19 that they knew or should have known were false or misleading. And the SEC's Co-Directors of Enforcement have already warned about some issues they anticipate in future investigations. Below, we outline some of the issues that may prompt COVID-related government investigations and private litigation, and we highlight the D&O insurance coverage considerations that companies should be focusing on now.

COVID-Related Claims & Government Investigations

We foresee a number of possible COVID-related claims and government investigations, including:

  • Investigations by the SEC and State Attorneys-General into inadequate disclosure of a company’s financial situation, including alleged misstatements and omissions of material negative information and risks related to COVID-19 stresses and impacts, concealment or improper valuation of impaired assets, insider trading or fair disclosure (Reg FD) issues, and inadequate due diligence;
  • Whistleblower claims relating to federal and state funds received from government programs;  
  • Investigations by the SEC and the US Department of Justice (DOJ) regarding potential violations of the Foreign Corrupt Practices Act (FCPA) associated with the increased bribery risks prompted by travel restrictions, mandatory quarantine and the challenging economic landscape; and
  • Inquiries by the SEC, state securities regulators, and self-regulatory organizations that regulate financial services firms (including the Financial Industry Regulatory Authority (FINRA)) regarding alleged unsafe or unsound business practices, such as failures related to supervision, books and records retention and perhaps, most notably, Business Continuity Plans, and investigations related to customer-facing issues that challenge suitability or the discharge of other standard of care obligations imposed on these regulated entities and licensed individuals in connection with, for example, the sale of complex, structured or illiquid products, particularly to retail investors.

D&O Coverage Considerations

Much of the commentary concerning insurance coverage for COVID-19 issues has focused on business interruption coverage. However, as US companies publicly disclose the material risks to their businesses and plans for addressing those issues, the public filings may trigger enforcement investigations and shareholder lawsuits. The significant defense costs and other expenses associated with these actions could implicate D&O coverage, depending upon the specific language of the policy and circumstances under which a claim is made. With respect to government investigations, in particular, any coverage assessment requires a close textual analysis of the language of the insurance policy and application of key contractual terms to the intricacies of the complex and often opaque governmental investigative process.

A company’s D&O policies provide coverage for directors and officers named in securities lawsuits. Almost without exception, companies, themselves, also have coverage for securities lawsuits – although, in many policies, there is coverage for a company for a securities lawsuit only if the securities lawsuit is also lodged against a director or officer. Shareholder allegations that directors and officers failed to properly manage the impact of COVID-19 issues on their companies, or that the company failed to disclose potential or actual COVID-19 concerns, would in most cases be covered under standard D&O policy language, absent applicable exclusions.

Some of the most common business insurance coverages, such as commercial general liability (CGL) insurance, commercial automobile insurance and property insurance are highly standardized – primarily because an insurance industry organization develops most of the forms that comprise those coverages. However, there is no insurance industry organization or other group that develops the majority of the forms that comprise D&O insurance. Over the years, marketplace competition and other factors have led to standardization of a good deal of D&O policy wording, but, as with cyber insurance, media insurance, and some other types of insurance, there still is a fair amount of somewhat idiosyncratic or even sui generis language.

Coverage for Government Investigations

In our experience, most D&O policies now provide coverage for expenses incurred in response to government investigations, including subpoenas and requests for documents. In most D&O policies providing this coverage, the coverage is triggered only if an individual insured receives a formal request from the government or is the target of the investigation, regardless of whether the company, itself, is also named. This coverage sometimes is subject to a "sublimit" that is well below general per-claim limit of the D&O policy.

Insurance policies are contracts and, generally speaking, are interpreted pursuant to the rules that govern the interpretation of contracts. Not surprisingly, with rare exceptions, unambiguous insurance policy language will be enforced as written. Coverage for expenses incurred in response to government investigations typically turns, then, on what the policy says in that regard, and if what it says is unambiguous in the context of the matters at issue. This subject was recently addressed in Jalbert v. Zurich Services Corporation, 953 F.3d 14 (1st Cir. 2020). In Jalbert, the First Circuit ruled that a Formal Order of Investigation issued by the SEC during a prior D&O policy period constituted a "Claim" first made during that earlier policy period, allowing two excess insurers under the later policy period to deny coverage for subsequent related actions. There was no dispute that the investigation initiated by the Formal Order was a "formal investigation," and therefore a "Claim," defined in both policies as "a formal regulatory proceeding (civil, criminal or administrative) against, or formal investigation of an Insured, including when such Insured is identified in a written Wells or other notice from the SEC or a similar state of foreign government authority that describes or alleged violations of securities or other laws by such Insured … for a Wrongful Act… ."

With respect to notice to the insurer, the policies contained a provision that "[a] Claim shall be deemed first made" with respect to a formal investigation on the date when "an Insured [has been] identified by name in an order of investigation, subpoena, Wells Notice or target letter … as someone against whom a civil, criminal, administrative or regulatory proceeding may be brought…." Jalbert turned on whether the "Claim" against the company was "deemed made" by the SEC's Formal Order where the Order arguably was not conclusive proof that enforcement proceedings against the company were a "reasonable possibility."

Noting the ordinary meaning of the policies’ language, the First Circuit drew a distinction between an investigative subpoena or other investigative request that merely seeks information from an individual or entity and a Formal Order of Investigation issued by the SEC ordering the investigation into conduct that, if verified, would constitute violations of federal laws. Agreeing with the District Court, the First Circuit concluded that the issuance of a Formal Order supported the inference that commencement of proceedings against the company was entirely possible and, therefore, satisfied the “Deemed-Made” clause.

The nature of the regulatory inquiry – and whether it constitutes a "Claim" under a particular policy, and against whom – is not always as clear. Particularly for regulated entities, this can be complicated, since investigations may commence with one or more regulatory requests, which may include a vague, broadly-titled investigation name that does not include your firm or identify any individual. Until such time as a subpoena is issued, for example, to obtain materials from a third party or testimony, the SEC Staff may choose not seek a Formal Order of investigation. Thus, if all that a company receives is a regulatory request, the issue of whether an insured should notify the insurance company is one that should be carefully analyzed, particularly since some insurance policies will cover regulatory investigations even absent the issuance of a Formal Order.

Key Takeaways

Businesses confronted with COVID-19-related lawsuits and government inquiries should carefully evaluate their D&O insurance policies when assessing available coverage. The timing of notice to insurers is critical (an issue that we will address in greater detail in a subsequent alert), and can impact coverage for related claims that arise from the same underlying facts. In most cases, companies should immediately give notice of the lawsuit or regulatory inquiry under any insurance policies that could potentially provide coverage.

Further, if COVID-19 related events put the company at risk of particular claims, including claims by shareholders in connection with a stock drop, companies should consider providing notice of circumstances under relevant policies – particularly where policies are scheduled for renewal. This is not only because subsequent policies may include less favorable terms, including COVID-19 and/or infectious disease-related exclusions, but also because the insured’s awareness of circumstances that could later give rise to an actual "Claim" could result in a finding, for a number of reasons, that there is no coverage for that "Claim" under subsequent policies.

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