Eleventh Circuit Affirms Regulatory Investigation Not a Claim Under D&O Policies

In its recent decision in Office Depot, Inc. v. Nat'l Union Fire Ins. Co., 2011 U.S. App. LEXIS 20759 (11^th Cir. Oct. 13, 2011), the Eleventh Circuit Court of Appeals, applying Florida law, affirmed a lower court decision finding that Office Depot was not entitled to coverage under a primary and excess “organization insurance” policy for attorneys’ fees associated with an SEC investigation.

In July 2007, Office Depot gave notice to its insurers of an article from the Dow Jones Newswire reporting that Office Depot may have violated federal securities laws by selectively disclosing nonpublic information.  A week later, the SEC sent a letter to Office Depot advising that it would be undertaking an investigation into whether Office Depot had, in fact, violated federal securities laws.  A few weeks later, the SEC informally asked Office Depot to produce various communications relevant to its investigation. It was not until January 2008, however, that the SEC issued a formal order of investigation.  This investigation lasted over two years, and included subpoenas being issued to various Office Depot directors and officers, and  Wells Notices being issued.  In December 2009, the SEC filed a formal complaint and the matter was later settled.  At issue before the Eleventh Circuit was whether Office Depot was entitled to coverage for its attorneys’ fees associated with the SEC investigation during the period between the first letter in July 2007 and the issuance of the formal subpoenas and Wells Notices.

Office Depot argued, among other things, that its policies provided coverage for all defense costs incurred following its receipt of the SEC notice in July 2007, i.e., for the SEC’s informal investigation.  The policies’ insuring agreement applicable to organization insurance provided coverage for:

(i) Organization Liability. This policy shall pay the Loss of any Organization arising from a Securities Claim made against such Organization for any Wrongful Act of such Organization. . . .

Securities Claim was defined by the policies as:

…a Claim, other than an administrative or regulatory proceeding against, or investigation of an Organization, made against any Insured:

    (1)   alleging a violation of any federal, state, local or foreign regulation, rule or statute regulating securities . . .; or

    (2)   brought derivatively on the behalf of an Organization by a security holder of such Organization.

Notwithstanding the foregoing, 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.  (Emphasis supplied.)

Office Depot contended that it was entitled to defense costs dating back to the SEC’s July 2007 letter because the definition of Securities Claim did not expressly exclude informal SEC investigations.  Office Depot further argued that the carve-back provision of the definition of Securities Claim brought back into coverage an “administrative or regulatory proceeding.”

The Eleventh Circuit disagreed, explaining that the initial portion of the definition of Securities Claim, through the use of the disjunctive term “or,” eliminated coverage for two types of potential Securities Claims: those involving administrative or regulatory proceedings and those involving administrative or regulatory investigations.  The court determined that while the carve-back portion of the definition of Securities Claims gave back coverage for administrative or regulatory proceedings under certain circumstances, it did not restore coverage for investigations.  Thus, concluding that the SEC’s July 2007 was an investigation, the court held that Office Depot was not entitled to coverage for attorneys’ fees associated with responding to same.  It was not until the SEC issued subpoenas and Wells Notices to covered individuals that that the policies’ coverage was triggered.

The court considered several secondary arguments raised by Office Depot, most notably its argument that the policies’ notice provision operated to bring defense costs back into coverage.  This provision stated, in pertinent part, that if during the policy period Office Depot gave notice of circumstances that might result in a claim, then any future claim would be considered made at the time notice of circumstances was given.  Office Depot argued that by providing notice of the Dow Jones article to its insurers, it gave notice of circumstances, such that when the Claim was later made, “any costs incurred between the notice of circumstances and the date a Claim was made” was brought back into coverage.  The court rejected this bootstrapping argument, explaining that the notice of circumstances provision serves only to bookmark coverage under the policies for when a Claim is later made, even if outside the policy period, and does not operate to bring into coverage pre-Claim defense costs, particularly those relating to a non-covered regulatory investigation.