One of the perennial D&O insurance issues is the question of coverage for costs incurred by the corporate organization in connection with responding to an SEC investigation – what is often referred to as entity investigative cost coverage. These coverage questions are so fraught because of the sheer magnitude of the expense that entities often incur when they find themselves subject to an SEC investigation. In the latest example of this recurring insurance coverage issue, a federal district court has held that the costs the auto rental firm Hertz Global Holdings incurred in connection with an SEC investigation are not covered under its applicable D&O insurance program. The court’s decision illustrates many of the recurring aspects of this frequent insurance coverage issue. Southern District of New York Judge Alison J. Nathan’s March 30, 2021 opinion in the case can be found here.



In November 2013, a plaintiff shareholder filed a securities class action lawsuit against Hertz and certain of its directors and officers in the District of New Jersey. In July 2014, Hertz received a demand from the SEC that the company provide the agency with documents pertaining to the company’s financial statements for several prior years. In September 2014, the SEC issues a formal order of investigation that specifically stated that the SEC had “information that tends to show” violations of the securities laws and authorized SEC officials to issue subpoenas for witnesses and documents. At a time unspecified in the subsequent insurance coverage litigation, three former executives signed tolling agreements with the SEC.


In December 2018, Hertz entered a settlement agreement with the SEC, which provided for a $16 million penalty. Hertz claimed to have incurred $27 million in connection with the investigation. Hertz sought to have its D&O insurers reimburse the company for its costs incurred in connection with the investigation. (Hertz also initially sought to have its insurers reimburse the company for the cost of the settlement as well, although the company later abandoned that claim.)


Hertz’s insurers denied coverage for the company’s investigative costs. Hertz initiated coverage litigation in which the company alleged that its D&O insurers had breached their contractual obligations. The defendant insurers filed a motion to dismiss the coverage lawsuit on the grounds that the company had failed to state a claim for breach of contract.



The March 30, 2021 Opinion

On March 30, 2021, Judge Nathan entered an order granting the defendants’ motion to dismiss. In granting the motions, Judge Nathan noted that the insurance policy permits the insured company to recover for “Securities Claims” against the insured Organization and for “Claims” against Individual Insureds. Judge Norton held that the SEC Investigation “does not fit into either category.”


Judge Nathan began her analysis by noting that the policy defines the term “Securities Claim” as “a Claim, other than an investigation of an Organization … alleging” violation of securities laws or regulations. This language, Judge Norton said, “unambiguously excludes an SEC investigation against Hertz from coverage, as the phrase ‘other than an investigation of an Organization’ is not susceptible to ‘more than one meaning when viewed objectively.’”


Hertz tried to overcome this obstacle by arguing that under the policy the term “Securities Claim” includes “an administrative or regulatory proceeding against an Organization” and that the SEC’s formal investigation constituted an administrative or regulatory proceeding. Judge Nathan rejected this argument, holding that the SEC’s order merely initiated an investigation, not an administrative proceeding, adding that while the SEC’s order showed that the agency was attempting to determine whether any persons or entities engaged in violations of the securities laws, it does not formally accuse Hertz of engaging in wrongdoing.


Judge Nathan called Hertz’s efforts to characterize the investigation as an administrative or regulatory proceeding “unconvincing,” adding that the because “the language of the contract is clear and unambiguous as to whether a formal SEC investigation is excluded, the Court will not rewrite the agreement to relieve a sophisticated contracting party like [Hertz] from terms that it later deems disadvantageous.”


Judge Nathan also rejected Hertz’s attempt to argue that the SEC formal order was a “Securities Claim” because, Hertz argued, it is a “Claim … alleging a violation of any” securities laws or rules. In making this argument, Hertz argued that the SEC’s order “was, in effect” alleging violation of federal securities laws. Judge Nathan said that “the Order did not accuse Hertz of violating federal securities laws, but instead used language to indicate that it had information suggesting that Hertz might have violated the securities laws, which is why it wanted to investigate.” But, Judge Nathan, added, this argument is in the event irrelevant, since the policy definition of “Securities Claim” excluded investigations, “regardless of whether those investigations include allegations of wrongdoing.”


Hertz also argued that investigation fell within the policy’s definition of “Claim” which includes “a civil, criminal, administrative or regulatory investigation (including but not limited to an SEC, DOJ …investigation.” Judge Nathan noted that even if this is true, under the policy “Hertz the organization is only entitle to recover for ‘Securities Claims’ against it.” The term “Securities Claim” does include Claims, but, Judge Nathan noted, only if they are (a) not investigations and (b) alleges violations of securities laws.


Judge Nathan also rejected Hertz’s argument that the insurer should pay for the company’s investigative costs because the investigation was part of the separate securities class action lawsuit. Judge Nathan noted that the SEC’s investigation did not “arise from” the securities lawsuit and the costs associate with defending the investigation did not “result solely from” the securities lawsuit.


Finally, Judge Nathan rejected Hertz’s attempt to argue that the investigative costs were covered because the investigation represents a “Claim” against “Insured Persons,” noting that the definition of “Claim” includes a written request to toll or waive a period of statute of limitations. Hertz argued that that at least three individual former Hertz executives had signed tolling agreements with the SEC. Judge Nathan said that Hertz had provided insufficient detail to support this argument, noting even if it were true that three executives signed tolling agreements, Hertz had not identified the content of the agreements, whether they were signed at the relevant time period, or even who signed them.


Without these allegations, Judge Nathan said, “there is no basis to concluded that the agreements constitute ‘Claims’ or that they were against ‘Insured Persons.’” Further, even if there were sufficient factual allegations to establish that there had been a Claim, Hertz “does not allege that it ever submitted a claim for reimbursement to Defendants for any ‘Claim’ against an ‘Insured Person,’ let alone that Defendants denied that claim.”



As I noted at the outset, the question of coverage for entity investigative costs is a recurring one. The factual background in this case provides some explanation of why; Hertz allegedly incurred $27 million in fees and costs related to the SEC investigation.


The D&O insurers are well aware of the extent of these kinds of costs and that explains why their policies are constructed in a way to put them in a position to try to argue that the costs are not covered. To be sure, as this case also shows, the policy does provide investigative costs coverage for individuals, subject to all policy terms and conditions. In this case, Judge Nathan found that Hertz had not alleged sufficient facts to establish there had been a “Claim” against an “Insured Person” as necessary to establish that coverage for individual investigative costs.


It is probably worth noting that even if Hertz had included sufficient allegations to establish these predicates, it isn’t clear how much of the $27 million Hertz spent on the investigation would thereby be covered, as having established entitlement to individual investigative costs coverage would only secure coverage for the costs of defending the individual Insured Persons, not for the costs of defending the entity.


There is an added concern that did not arise here, but that could have been become involved even if Hertz had been able to plead sufficient facts to establish that the investigation constituted a “Claim” within the meaning of the policy, Hertz would have faced the further hurdle of showing that it constituted a “Claim” for a “Wrongful Act.” While the SEC’s formal investigative order said that the agency had “information that tends to show” violations of the federal securities laws, Judge Nathan was clear that all the order did was to establish an investigation “in order to determine whether any persons or entities” engaged in wrongdoing.


While the policy at issue in this case did not provide for entity investigative cost coverage, in recent years there have been products available in the marketplace providing entity investigative cost coverage. At least where they are available, these insurance products are sold either as stand-alone policies or as accessories to the primary D&O insurance policy. Under either of these arrangements, and when they are available, the policy or extension are underwritten and priced separately from the cost of the D&O insurance itself.


Even before the D&O Insurance marketplace entered the current hard market phase, these entity investigative cost policies or extensions tended to be perceived as expensive, particularly in light of the hefty retentions that the carriers typically require for the policies.


In the current hard market for insurance, where almost all public company D&O insurance buyers are seeing hefty premium increases and facing a massive overall insurance tab, there may be relatively little interest in this type of option, even if it were otherwise available. Nevertheless, as this case shows, while these entity investigative cost products may be costly, the cost of not having the coverage can be substantial as well.