inancial raud law report · 2017. 1. 27. · Bethany N. Schols Member of the Firm Dykema Gossett PLLC Bruce E. Yannett Partner Debevoise & Plimpton LLP. 820 ... In the summer of 2005,

Financial Fraud law report

VOLUME 3 NUMBER 9 OCTOBER 2011

HEADNOTE: THINKING ABOUT FINANCIAL FRAUDSteven A. Meyerowitz 781

PLEADING RICO CLAIMS AGAINST “FLY-BY-NIGHT” NO-FAULT FRAUD RINGSMax Gershenoff 783

FALSE CLAIMS ACT INVESTIGATIONS: TIME FOR A NEW APPROACH?John T. Bentivoglio, Jennifer L. Bragg, Michael K. Loucks, and Gregory M. Luce 801

DO FCPA REMEDIES FOLLOW FCPA WRONGS? “DISGORGEMENT” IN INTERNAL CONTROLS AND BOOKS AND RECORDS CASESPaul R. Berger, Steven S. Michaels, and Amanda M. Ulrich 812

COSTS RELATING TO REGULATORY INVESTIGATIONS, DERIVATIVE LAWSUITS, AND INDEPENDENT CONSULTANT’S INVESTIGATIONS ARE COVERED UNDER CONTRACTS FOR DIRECTORS’ AND OFFICERS’ LIABILITY INSURANCEMichael S. Levine and Erika L. Smith 820

FIRST TRIAL IN “CATCH 22” FOREIGN CORRUPT PRACTICES ACT PROSECUTION ENDS IN HUNG JURY ON ALL COUNTSIris E. Bennett, Jessie K. Liu, Sean J. Hartigan, and Julia K. Martinez 826

SEC’S FIRST USE OF A NON-PROSECUTION AGREEMENT SHOWS POTENTIAL BENEFITS FOR RESPONDENTS BUT ALSO DEMONSTRATES POTENTIAL PITFALLSBruce A. Hiler and Thomas A. Kuczajda 831

THE DODD-FRANK ACT’S NEW WHISTLEBLOWER AND BOUNTY PROVISIONSJoseph P. Sirbak, II 840

THE U.K. BRIBERY ACT TODAYJames Maton and Antonio Suarez-Martinez 846

THE U.K. PROCEEDS OF CRIME ACT AND THE SFO’S LATEST BRIBERY-RELATED SETTLEMENTKarolos Seeger and Matthew Getz 863

DC AND SEVENTH CIRCUITS SPLIT FROM SECOND CIRCUIT: ALLOW FOR CORPORATE LIABILITY UNDER ALIEN TORT STATUTESander Bak 871

The FINANCIAL FRAUD LAW REPORT is published 10 times per year by A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207, Copyright © 2011 THOMPSON MEDIA GROUP LLC. All rights reserved. No part of this journal may be reproduced in any form — by microfilm, xerography, or otherwise — or incorporated into any information retrieval system without the written permission of the copy-right owner. For permission to photocopy or use material electronically from the Financial Fraud Law Report, please access www.copyright.com or contact the Copyright Clearance Center, Inc. (CCC), 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400. CCC is a not-for-profit organization that provides licenses and registra-tion for a variety of users. For subscription information and customer service, call 1-800-572-2797. Direct any editorial inquires and send any material for publication to Steven A. Meyerowitz, Editor-in-Chief, Meyerowitz Communications Inc., PO Box 7080, Miller Place, NY 11764, [email protected], 631.331.3908 (phone) / 631.331.3664 (fax). Material for publication is welcomed — articles, decisions, or other items of interest. This publication is designed to be accurate and authoritative, but neither the publisher nor the authors are rendering legal, accounting, or other professional services in this publication. If legal or other expert advice is desired, retain the services of an appropriate professional. The articles and columns reflect only the present considerations and views of the authors and do not necessarily reflect those of the firms or organizations with which they are affili-ated, any of the former or present clients of the authors or their firms or organizations, or the editors or publisher.POSTMASTER: Send address changes to the Financial Fraud Law Report, A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207. ISSN 1936-5586

EDITOR-IN-CHIEFSteven A. Meyerowitz

President, Meyerowitz Communications Inc.

BOARD OF EDITORS

Frank W. AbagnaleAuthor, Lecturer, and ConsultantAbagnale and Associates

Stephen L. Ascher Partner Jenner & Block LLP

Thomas C. BoglePartnerDechert LLP

David J. CookPartnerCook Collection Attorneys

Robert E. EggmannPartnerLathrop & Gage LLP

Jeffrey T. HarfenistManaging Director,Disputes & InvestigationsNavigant Consulting (PI) LLC

James M. KeneallyPartnerKelley Drye & Warren LLP

Frank C. RazzanoPartnerPepper Hamilton LLP

Bethany N. ScholsMember of the FirmDykema Gossett PLLC

Bruce E. YannettPartnerDebevoise & Plimpton LLP

820

Costs Relating to Regulatory Investigations, Derivative Lawsuits, and Independent Consultant’s Investigations

Are Covered Under Contracts for Directors’ and Officers’ Liability

Insurance

MICHAEL S. LEVINE AND ERIKA L. SMITH

The authors discuss a United States Court of Appeals for the Second Cir-cuit decision holding that a policyholder was entitled to coverage under a directors’ and officers’ liability insurance contract for costs associated

with financial regulators’ investigations.

In MBIA Inc. v. Fed. Ins. Co.1 the U.S. Court of Appeals for the Sec-ond Circuit held that a policyholder was entitled to coverage under directors’ and officers’ liability insurance contracts for costs associ-

ated with financial regulators’ investigations, including costs associated with the investigation of a derivative shareholder litigation and the cost of an independent consultant’s investigation pursuant to a settlement with government regulators.

Michael S. Levine, counsel with Hunton & Williams LLP, represents and advises policyholders and other commercial clients in complex insurance coverage and business disputes. Erika L. Smith is an associate at the firm.

Published by A.S. Pratt in the October 2011 issue of the Financial Fraud Law Report

Copyright © 2011 THOMPSON MEDIA GROUP LLC. 1-800-572-2797.

CONTRACTS FOR DIRECTORS’ AND OFFICERS’ LIABILITY INSURANCE

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BACKGROUND

MBIA, Inc. (“MBIA” or the “Policyholder”), a Connecticut bond in-surer, purchased directors’ and officers’ insurance policies from Federal Insurance Co. (“Federal”) and ACE American Insurance Co. (“Ace”) (col-lectively the “Insurers”). The policies provided coverage for, among other things, “Securities Claims” and “Securities Defense Costs.” Securities Claims were defined to be “a formal or informal administrative or regula-tory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document.” Securities Defense Costs were defined as “costs incurred in defending or investigat-ing Securities Claims.” On March 9, 2001, the Securities and Exchange Commission (“SEC”) issued a formal order of investigation of MBIA. In 2004, as part of the investigation, the SEC issued several subpoenas to MBIA, seeking docu-ments concerning its compliance with securities laws, financial record-keeping and financial reporting. The New York attorney general (“NYAG”) followed suit and issued a subpoena to MBIA in connection with a sepa-rate, but similar, investigation. Following the initial phases of the SEC and NYAG investigations, MBIA was targeted for three specific transactions: the AHERF transaction, the Capital Asset transaction, and the US Airways transaction. In May 2005, MBIA informed its Insurers that it was the subject of a regulatory investigation by providing the SEC and NYAG subpoenas to the Insurers. The Insurers did not view the subpoenas as sufficient to trig-ger coverage; however, they accepted the subpoenas as notice of a poten-tial claim under the policies. In the summer of 2005, when the SEC and the NYAG considered issuing additional subpoenas, MBIA negotiated volun-tary compliance in lieu of the subpoenas to avoid further adverse publicity. The SEC and the NYAG accepted voluntary compliance concerning the Capital Asset and US Airways transactions. In August 2005, federal and state regulators advised MBIA that they intended to take action against MBIA for securities law violations. MBIA sought consent from its Insurers to settle with the regulators. The Insurers contended the settlement was not covered by the policy, but, nevertheless,

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agreed to waive lack of written consent to settlement as a defense to cov-erage. Accordingly, MBIA signed a preliminary offer of settlement with the SEC and the NYAG, which included, among other terms, that MBIA agreed to hire an independent consultant to review the Capital Asset and US Airways transactions, both of which were at issue in the investigation and alleged violations. As a result of the investigations, MBIA’s shareholders brought two de-rivative suits alleging financial wrongdoing by MBIA. In accordance with Connecticut law, MBIA was required to set up a committee of independent directors (the “Demand Investigation Committee” or “DIC”) and a special litigation committee (the “SLC”) to determine whether maintaining the suits was in the best interests of MBIA. The SLC ultimately determined that the lawsuits should be dismissed, but not before MBIA had incurred substantial costs. MBIA agreed to pay $50 million in civil penalties for the AHERF transaction, and MBIA was exonerated of any wrongdoing for the Capi-tal Asset and US Airways transactions. The Insurers, however, agreed to cover only $6.4 million in costs, refusing to cover costs associated with the NYAG investigation, the Capital Asset investigation or the US Airways investigations. As a result, MBIA filed a lawsuit in the Southern District of New York to compel the Insurers to cover the costs of all three investigations. After review, the district court granted summary judgment in favor of MBIA regarding coverage for costs associated with all three investigations, as well as the costs incurred by the SLC. The district court awarded summary judgment to the Insurers with respect to coverage for costs associated with the independent consultant’s investigation. Both parties appealed. The Insurers argued that the district court erred in two ways. First, the Insurers argued that the NYAG investigation, the Capital Asset investiga-tion and the US Airways investigations were not “Securities Claims,” as defined by the policies. In support, the Insurers contended that the NYAG subpoena did not constitute a formal order, and the caption on the SEC or-der served to limit the scope of the investigation to a certain class of trans-actions, not to include the Capital Asset or US Airways investigations. The Insurers also argued that the Capital Asset and US Airways investigations

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were not Securities Claims because MBIA voluntarily complied with the SEC’s document requests rather than producing them through the sub-poena process and because the SEC official making the requests was not named on the initial SEC order. Second, the Insurers argued that the district court erred because costs incurred by the SLC either were not covered, since the SLC was not an “Insured Person,” or they were subject to a $200,000 policy sublimit. MBIA argued that the district court erred in denying coverage for the costs of the independent consultant.

HOLDING

Upon review, the Second Circuit affirmed the district court’s ruling for MBIA concerning the costs associated with the three investigations and the costs incurred by the SLC. But, the Second Circuit reversed the district court concerning the independent consultant’s costs and held that MBIA is also entitled to coverage for those costs. According to the Second Circuit, the NYAG’s subpoena came within the definition of a “Securities Claim” because the subpoena was “at least a similar document” to a “formal or informal investigative order” that com-menced a regulatory proceeding. Thus, because the subpoena amounted to a Securities Claim, the investigatory costs associated with that subpoena were “Securities Losses” as defined in the policy. The court also held that the SEC’s investigations of the Capital Asset and US Airways transactions were covered “Securities Losses.” The court looked to the nature and scope of the SEC’s formal order, and not to the caption or persons named on the subpoena, as the Insurers had argued, to define the scope of the investigation. The court stated that the investigation need not be pursued by only individuals named on the formal order. The court also refused to attach significance to MBIA’s voluntarily compliance with the regulators’ document requests, explaining that a company may take steps to mitigate public relations damage and exposure without jeop-ardizing coverage that otherwise would be reasonably expected to apply. Next, the Second Circuit held that MBIA could recover the costs as-sociated with the SLC, thereby rejecting the Insurers’ argument that the

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SLC was not an “Insured Person” under the policy. The court reasoned that the SLC’s independence was an “independence of judgment,” rather than a new source of authority. The court also held that the Insurers failed to prove that the SLC costs fell within the $200,000 policy sublimit for shareholder demand investigations. The court reasoned that the $200,000 sublimit would apply only to pre-litigation demand costs and not to litiga-tion-related costs of the SLC. Finally, the Second Circuit determined whether the costs associated with the independent consultant were covered under the policies. The district court had found that MBIA could not recover the independent consultant costs because MBIA breached the policies’ “right to associate” provision. But, the Second Circuit disagreed, finding that MBIA fulfilled its obligations under the right to associate clause when it provided notice to the Insurers of the claims involved in the settlement discussions. The court explained that “where the insured gives the insurers an invitation to associate with adequate information about the claim under consideration for settlement, the insured has done what is required under this clause.” This is the case even if, as in MBIA, the policyholder simply informs the insurers of the proposed settle-ment, but fails to inform the insurers of any additional components, such as an independent consultant. Any other result, according to the court, would require the policyholder to revisit the claim with the nonparticipating insurer each time negotiations about the same claim “take a new twist.” The court noted that independent consultants are not a “rare component of regulatory settlements” and should not be an unforeseeable component of the settle-ment discussions. Thus, where the Insurers were notified of the proposed settlement but failed to take part in settlement negotiations, the Policyholder was entitled to recover the costs of the independent consultant’s investiga-tion, particularly where the Insurers failed to object after they learned of the independent consultant component.

IMPLICATIONS

The MBIA decision is of particular significance to policyholders in today’s economy, where lawmakers, governmental auditors and regulators are becoming increasingly suspicious of corporate dealings and transac-

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tions, thereby requiring policyholders to incur substantial investigation and compliance costs. As illustrated in MBIA, the costs of such regulatory suspicion and investigation should be covered under contracts for Direc-tors & Officers liability insurance. The decision is also significant because it broadly interprets the defini-tion of “Securities Claims” and “Securities Defense Costs,” thereby sug-gesting that other fees and costs associated with a covered Directors & Officers liability claim likewise should be covered under contracts for Di-rectors & Officers liability insurance. Finally, the MBIA decision underscores the importance of keeping an insurer informed, even when the insurer denies coverage, defends under a reservation of rights or chooses to opt out of settlement negotiations. Al-though the policyholder ultimately prevailed on the independent consul-tant issue, the court stressed the importance of providing adequate notice to the insurer regarding the claim under consideration for settlement.

NOTE1 No. 10-0355-cv, 2011 U.S. App. Lexis 13402 (2d Cir. July 1, 2011).