The initiation of a criminal investigation against a company or its directors and officers can be a watershed moment in the life of any company. In addition to the question of how it will respond, the company must also determine how it will fund the associated legal expense. It is at this critical juncture that the company confronts issues surrounding the availability and limitation of D&O insurance in connection with criminal investigations.


These issues are explored in a December 2008 article by Patricia Bronte of the Jenner & Block firm entitled "D&O Coverage for Corporate Criminal Investigations" (here). As Bronte notes, the availability of coverage for a criminal investigation depends upon the particular language in the applicable policy, particularly the policy’s definition of the term "claim." The critical question will be whether or not the particular circumstances presented constitute a "claim."


The article opens with a review of case law from an earlier era, when D&O policies did not routinely define the term "claim." However, as the article discusses, the typical D&O policy now defines the term and includes within its definition a specific reference to a "criminal proceeding," which usually is further defined as having been "commenced by the return of an indictment."


One of the useful things Bronte’s article does is that by reviewing the early case law, she shows how the carriers came to insert the language limiting coverage for criminal proceedings to post-indictment matters. Prior cases where carriers were compelled to fund a wide range of expenses related to investigations and other pre-indictment matters clearly led to this change.


However, Bronte’s article also illustrates the difficulties, from the policyholder’s perspective, of this post-indictment limitation of coverage for criminal matters. That is, "a corporation’s best hope for a favorable outcome – and sometimes the best way to avoid disaster – is to persuade the prosecutor not to file any formal criminal charges at all."


As a consequence of this need to try to avert indictment, the corporation can incur considerable expense pre-indictment in respond to subpoenas, addressing a grand jury investigation, or otherwise attempting to answer the investigative threat. Costs incurred in connection with these efforts represent defense expenses, whether or the investigation ultimately results in an indictment.


Disputes over these kinds of legal costs are among the perennial battles in the D&O claims arena. Invariably, policyholders will argue that these expenses were indispensible to their post-indictment defenses, or even that they helped avert an indictment. Further complicating these discussions is the fact that these expenses associated with the pre-indictment criminal investigation often are being incurred at the same time that the company is also incurring legal expense in connection with an SEC investigation and also separate civil litigation. These various proceedings may be covered in whole or in part under the policy.


Because all of these various legal matters are going forward simultaneously and usually pertain to a single set of circumstances, sorting out which legal expenses relate to which proceeding (and therefore which expenses are covered under the policy) can become a vexing problem and source of tension between the policyholder and the carrier.


Exacerbating these problems is the fact that among all these proceedings, the criminal matter usually looms the largest and therefore may consume the larges amount of legal effort and expense. This is particularly true if, as is often the case, the individuals involved each retain separate counsel. The potentially massive expense associated with the criminal investigation underscores why these issues can be so critical.


In light of these considerations, the article offers some practical suggestions. Bronte notes:


Brokers and risk managers should press for "claim" definitions and coverage limits that adequately protect the corporate entity from the expense of criminal investigations, which almost inevitably involve multiple teams of lawyers defending the corporation and its employees.


In that regard, many D&O insurers now include within the definition of the term "claim" not only a reference to post-indictment (or post-information) criminal proceedings, but also a separate explicit reference to "investigations" (including criminal investigations), usually delimited in some way around the requirement for the naming of an insured person as a target of a possible indictment. The precise wording of the definitional provisions relating to "investigations" potentially could be critical.


In addition, at least one major carrier now has a form that removes any reference to an indictment requirement, and instead refers simply to "criminal proceedings." The removal of the indictment requirement, together with the reference to "proceedings," at least potentially opens the door to coverage for grand jury investigations, subpoenas, and other matters. While this alternative wording is not universally or even widely available, it does present an alternative for consideration.


The article also notes, in connection with efforts to secure coverage for criminal proceedings that "policyholders do not advance their position if they or their brokers characterize the criminal investigation as merely a ‘potential claim.’" An alternative possibility is to refer to the matters involved as a claim, or, in the alternative, a potential claim.


The article correctly points out that "the high cost of defending against accusations of criminal wrongdoing is one of the reasons that corporations purchase D&O insurance." Nevertheless, the extent of coverage for criminal proceedings remains one of the perennially disputed claims issues. The further development of D&O policy wordings that better address policyholder expectations is a continuing challenge for the D&O insurance industry and one on which there are fruitful areas for further discussion.


More About NERA’s Year-End Securities Litigation Study: In a prior post (here), I linked to NERA Economic Consulting’s year-end report on 2008 securities litigation activity. (The report itself can be found here). In a December 19, 2008 post (here), the Securities Docket has an interesting interview with the report’s authors, my good friends Stephanie Plancich and Svetlana Starykh. Among other things, the interview quotes the authors as saying, with respect to their projections for litigation activity in 2009:

While our paper does not forecast trends into the next year, our best guess is that filing activity will remain high into 2009. As mentioned above, there have been a number of new filings in late December — traditionally a slow time for litigation activity — indicating that the rate of filings has yet to decrease.

And while the first credit crisis cases were concentrated in the financial industry, there has been an emerging trend of credit crisis- and recession-related filings emerge outside of the financial sector.


Ghost of Christmas Preset, 2008 Version: With apologies to Charles Dickens, I excerpt below an imagined version of his holiday classic, updated for current circumstances. We can only hope that the Ghost of Christmases Yet-to-Come bears happier tidings. 


And taking Scrooge by the arm, the Spirit lifted him high above the financial landscape. Below him, Scrooge could see a parade of spectacles he scarcely could have imagined: the largest bank failure ever; the largest bankruptcy ever; the largest government bailout; the collapse of the housing market and the near-collapse of the entire financial system. 

"Spirit!" said Scrooge. "Show me no more! Conduct me home. Why do you delight to torture me?"

"One Shadow More!" exclaimed the Ghost.

And below, in the mist, Scrooge could see an avuncular man. Oddly and incongruously, the man wore a baseball cap. 

"Who is that man, Spirit?" Scrooge asked.

"Those who used to think of themselves as his friends called him ‘Bernie’" the Spirit said.

"No more!" cried Scrooge. "No more, I don’t wish to see it. Show me no more!"


Break in the Action: I think we could all use a break. I will discontinue my regular publishing schedule for the next few days. Regular publication will resume after the New Year.