One of the highest profile D&O insurance coverage decisions last year was the district court’s October 2010 opinion  holding that Office Depot’s D&O insurance policy does not cover defense expenses the company incurred in responding to an informal SEC investigation. The company’s appeal of the district court’s decision has been closely watched. On October 13, 2011, the Eleventh Circuit issued an unpublished per curium opinion affirming the district court, concluding that Office Depot did not have coverage under the language of the policy at issue for the defense expenses incurred in connection with the informal SEC investigation. A copy of the Eleventh Circuit opinion can be found here.



In June 2007, Office Depot was the subject of news report suggesting the company had improperly disclosed material information to securities analysts in violation of SEC Regulation FD. In a July 17, 2007 letter, the SEC advised Office Depot it was "conducting an inquiry" to determine whether the securities laws had been violated, and requested certain information from Office Depot "on a voluntary basis." Office Depot provided documents and made its employees and officers available for sworn testimony. On July 31, 2007, the SEC requested that Office Depot preserve the records of numerous employees and offices. Office Depot forwarded the letter to its insurers. Office Depot’s primary insurer accepted the letter as a "Notice of Circumstances" that may give rise to a claim.


In addition, in July 2007, before it received the SEC’s informal inquiry, Office Depot received an internal whistleblower letter raising concerns relating to the timing of recognition of Office Depot’s vendor rebate funds. Office Depot self-reported the whistleblower allegations to the SEC, which expanded its inquiry to include the whistleblower allegations. The company’s audit committee conducted its own investigation of the allegations, retaining lawyers, accountants and consultants for those purposes. The internal investigation resulted in Office Depot’s restatement of its 2006 financial statements.


In November 2007, two shareholder derivative lawsuits and two securities class action lawsuits were filed against the company. The shareholder suits alleged misrepresentations in connection with the company’s financial reporting of vendor rebates. In January 2010, the defendants’ motions to dismiss the securities class action lawsuit were granted.The plaintiffs in the derivative lawsuits voluntarily dismissed those cases.


In January 2008, the SEC issued a formal "order directing private investigation" and during the course of 2008 subpoened the company and at least eight current and former Office Depot officers and directors, including several who previously voluntarily testified. The notice did not name any individuals as wrongdoers. In November and December 2009, the SEC issued Wells notices to three Office Depot officers. In December 2009, the company reached an undisclosed settlement with the SEC staff.


Office Depot requested reimbursement from its D&O insurers of the over $23 million the company had incurred in responding to the SEC, indemnifying individuals against defense expenses, and conducting an internal investigation of the whistleblower allegations.


The primary carrier acknowledged its obligation to reimburse Office Depot for defense costs incurred by officers and directors after having been served with SEC subpoenas and Wells notices, and for the costs incurred in the various securities lawsuits. However, the approximately $1.1 million of acknowledged expenses did not exceed the policy’s $2.5 million retention. The primary insurer denied coverage for the other expenses, and Office Depot filed an action alleging breach of contract and seeking a judicial declaration of coverage. Office Depot’s excess D&O insurer intervened in the action.


The parties filed cross motions for summary judgment. As discussed here, on October 15, 2011, Southern District of Florida Judge Kenneth Marra granted the insurers’ motions for summary judgment and denied Office Depot’s motion. Office Depot filed an appeal.


The Eleventh Circuit’s Opinion

In an October 13, 2011 unpublished per curiam, a three judge panel of the Eleventh Circuit affirmed the district court’s decision. Office Depot had sought to have the district court’s decision overturned on four separate grounds. The Eleventh Circuit rejected each of Office Depot’s four arguments.


First, Office Depot had argued that the insurers’ policies did not expressly exclude coverage for costs associated with SEC investigations, and that the “carve back” language in the definition of “Securities Claim” provided coverage for the costs. The “carve back” argument refers to language in the policy definition that, on the one hand said that a “Securities Claim” is a claim “other than an administrative or regulatory proceeding against, or investigation of an Organization,” but on the other hand also provided that 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.”


The Eleventh Circuit noted that the first of these two definitional clauses eliminates coverage for two types of potential Securities Claims – that is, claims in the form of administrative or regulatory proceedings, and claims in the form of an administrative or regulatory investigation. The Court said that “the carve-back provision restores coverage for the former under certain circumstances. But it does not restore for the latter.” Accordingly, and “because 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’s Depot’s expenses incurred after the receipt of the SEC’s letters are excluded from coverage.”


Second, Office Depot argued that the SEC’s letters were sufficient to trigger a Claim under the policy because they were sufficient to constitute notice that insured persons could have proceedings commenced against them. In rejecting this argument, the Eleventh Circuit said that the SEC’s letters “do not allege that violations have occurred or identify specific individuals that could be charged in future proceedings,” and therefore do not trigger a “Claim” under the relevant policy definition.


Third, Office Depot argued that the district court had erred in concluding that the policy covered only defense expenses incurred after a “Claim” had been made. In essence, the company argued that the policy has no temporal limitation precluding policy coverage for pre-Claim expenses. The Eleventh Circuit concluded that the policies’ “text unambiguously limits Defense Costs to those costs incurred after a Claim has been made.”


Finally, Office Depot argued that the “relation back” language in the policy’s notice of circumstances provision provides coverage for costs incurred after it provided notice to the carrier of circumstances that could give rise to a claim and before the Claim actually was made. These notice provisions specify that if the policyholder gives the insurer notice of circumstances that could give rise to a claim, and if a claim subsequently arises, then determination of the date on which the claim was first made will relate back to the date on which notice of circumstance was provided.


The Eleventh Circuit rejected Office Depot’s “relation back” argument, finding that the notice of circumstances provision simply “create a notification process” that allows a determination of when claim are “considered made … rather than expand[ing] coverage to the costs incurred before Claim is actually made.”


The Eleventh Circuit concluded that “the policy does not cover the Defense Costs associated with the SEC investigation – which did not constitute a Claim against Office Depot until events such as the issuance of subpoenas and Wells Notices occurred.”



The background circumstances of this coverage dispute dramatically highlight why the questions of coverage of expenses incurred in connection with informal SEC investigations is such a fraught issue. Office Max incurred tens of millions of dollars in defense expenses before the SEC commenced its formal investigative processes. Many other companies confronted with an informal SEC investigation similarly incur substantial costs voluntarily providing information. The sheer magnitude of these expenses ensures that policyholders will continue to try to argue that their D&O insurance covers these types of expenses, even after the Eleventh Circuit’s decision in the Office Depot case.


Insurers confronted with these coverage demands undoubtedly will seek to rely on the Eleventh Circuit’s opinion in taking the position that their policies do not cover costs incurred in connection with informal SEC investigations. In addition to arguable limitations arising from the fact that the opinion is designated “not for publication,” the insurers will also have to deal with the fact that the opinion is in many respects simply a reflection of the specific policy language at issue in the Office Depot case. In particular, the opinion rests heavily on the distinction in the relevant policy provisions between “proceedings” and “investigations.” Other policies do not contain these same distinctions or are otherwise worded differently, in reliance upon which other policyholders may attempt to distinguish their situation from the circumstances involved in the Office Depot case.


But while there may be grounds on which policyholders may attempt to argue that the Office Depot opinion is not absolutely determinative of questions whether or not there might be coverage under another D&O insurance policy for costs incurred in connection with an informal SEC investigation, the opinion nevertheless provides strong support for insurers taking the position that their policies do not cover these types of expenses.


One aspect of the opinion on which insurers are particularly likely to rely is the Eleventh Circuit’s holding that the D&O policy at issue only provides coverage for defense expenses incurred after a claim has been made. Policyholders seeking to establish coverage for costs incurred in connection with an informal investigation often try to argue that the insurer should cover the costs because the policyholder would have incurred all of the same costs after the investigation became formal if it had not voluntarily cooperated. The policyholders’ argument is the coverage for the expenses should not depend on a mere matter of timing and the policyholders should not be penalized for cooperating with the SEC. The insurers doubtlessly will argue that in reliance on the Eleventh Circuit’s opinion that its insurance obligations do not extend to pre-claim expenses.


There is the potentially troublesome issue of the fact that the Eleventh Circuit’s opinion is designated “Do Not Publish.” In the current era of Internet communication, this designation seems meaningless. Indeed, the Eleventh Circuit itself posted the opinion on its website. Clearly the opinion has been published despite the designation, even if the opinion will not appear in printed case reporters at some point in the future.


But beyond the question of whether or not this “unpublished” opinion in fact has been published, there is the question of whether or not the “Do Not Publish” designation could otherwise preclude carriers from relying on the opinion. While there was a time when attorneys were barred from citing unpublished opinions, revised Federal Rule of Appellate Procedure 32.1(a) specifically provides that a court may not prohibit or restrict citation to unpublished opinions dated after January 1, 2007. So there does not seem to be any problems for insurers attempting to rely on the Eleventh Circuit’s opinion, notwithstanding the fact that it is designated “Not for Publication.”


Given that the opinion is freely available on the Court’s website and given the fact that the opinion has every bit as much precedential value as if it were not designated “Do Not Publish,” you do kind of wonder what the point is of using the designation. I worry about what it implies about what the court itself thinks about the opinion. It is almost as if the court is saying “we don’t think enough of this opinion for it to be published,” as if they really didn’t give it enough of their focus to produce a publication worthy opinion.


In any event, it is worth noting that since the time that Office Depot purchased the policies at issue in this coverage dispute, the insurance marketplace has evolved. Recently, some carriers have been willing to provide coverage for costs individuals incur in connection with informal SEC investigations. In addition, at least one carrier now offers a separate insurance product that provides coverage for costs that the entity itself incurs in connection with an informal SEC investigation. Although this entity protection for informal SEC investigative costs is subject to a large self-insured retention and to coinsurance, the fact remains that if such a policy had been available to Office Depot and if Office Depot had had such a policy in place, at least a significant part of Office Depot’s costs of responding to the informal SEC investigation might have been covered.


The Wiley Rein law firm’s October 14, 2011 summary of the Eleventh Circuit’s opinion can be found here. Special thanks to a loyal reader for providing me with a copy of the Eleventh Circuit’s opinion.


SEC  Issues Disclosure Guidance on Cybersecurity: Based on the number of emails I received on the topic, I suspect that by now most readers are aware that on October 13, 2011, the SEC released Cybersecurity Disclosure Guidance, a copy of which can be found here. If you have not yet read the Cybersecurity Guidance, you may want to set aside a few minutes and read the document through. It makes for some very interesting reading.


First, the disclosure guidance is not just directed to those companies that have experienced a cyber attack. Rather, the guidance requires reporting companies to consider “on an ongoing basis, the adequacy of their disclosure relating to cybersecurity risks and cyber incidents.” The SEC also proposes that reporting companies include a discussion of these matters in the Management Discussion & Analysis (MD&A) if known incidents or the risk of potential incidents represent a material risk, trend or uncertainty.


Second, readers of this blog will find it particularly interesting that among the items the SEC suggests reporting companies include in their “ongoing disclosure” is “a description of relevant insurance coverage.”


Third, if a reporting company or any of its subsidiaries are party to material pending legal proceeding involving a cyber incident, the registrant may need to disclose information regarding this proceeding.


Fourth, reporting companies are also required to disclose conclusions on the effectiveness of cybersecurity controls and procedures.


Although the primary objective of these disclosure guidelines is to try to ensure that investors are better informed on reporting companies’ cyber vulnerabilities, one obvious consequence is cybersecurity matters are about to become a much higher profile item for all reporting companies. In addition, the requirements about disclosures regarding the effectiveness of cybersecurity controls and procedures potentially sets the stage for shareholder claimants to later contend that the companies’ disclosures about its controls and procedures were misleading.


Finally, the specific reference in the SEC disclosure guidelines to cybersecurity insurance undoubtedly will lead many companies who may not have purchased this insurance in the past to consider the need for this insurance, if only to allow the company to supplement its cybersecurity disclosures to show that its precautionary measures include the purchase of insurance designed to protect the company from the harm caused by cybersecurity risks.


Insurance professionals whose clients include reporting companies will undoubtedly refer to this suggested disclosure item as part of the professionals’ efforts to advise their clients with respect to insurance issues.


What to Watch Now in the World of D&O: In the latest issue of InSIghts, I examine the current hot topics in the world of D&O. As should be clear from this post, there is a lot going on now in the world of directors’ and officers’ liability, with many additional issues on the horizon. The latest InSights issue can be found here.