A Newly Assertive SEC, Backed By Whistleblowers, Means Rise In Investigations—And Risks

The answer: As the SEC dangles new incentives and ratchets up pressure to cooperate, the impact on insurance coverage may be profound.

So what's a savvy risk manager to do?

Robust internal controls may help avoid or reduce the cost of responding to investigations, but they cannot prevent them entirely. The good news is that investigation coverage, while no panacea, is rapidly evolving and now offers significant help. These new solutions warrant a fresh review of the portfolio of insurance products that companies purchase.

Formal VS. Informal Investigations

Before launching a formal investigation, the SEC often first vets tips and suspicious information through an informal process known as a "matter under inquiry" (MUI). The purpose of a MUI, according to the SEC, "is to gather additional facts to help evaluate whether an investigation would be an appropriate use of resources."

At this stage, the investigation has not yet become "formal." For that to occur, the SEC needs to issue a formal order of private investigation.

A MUI is automatically converted to an investigation after 60 days if not closed or converted before then. The SEC can also skip the MUI process entirely and open an investigation directly.

What are the insurance issues related to MUI? A key consideration in purchasing investigation coverage is whether it will trigger early enough to be meaningful. Policies that require a "claim" before investigation coverage triggers may fall short here.

The fact that the SEC is "gathering additional facts" will likely not qualify as a required "claim," and some policies will not trigger investigation coverage until the investigation becomes "formal."

And much resources-draining activity can happen before then; indeed, the expenses associated with "informal" inquiries can mount quickly, well before a formal order is issued. (See accompanying textbox, "Cost Drivers.")

As late coverage may be little better than no coverage, check carefully your policy wording to see how it handles MUIs and informal investigations. Is the trigger clear enough and early enough for you?

The Prisoner's Dilemma

Suspects in an investigation—even those not officially named as targets—may have conflicts of interest that can multiply costs and complicate responding to an investigation.

This dynamic is illustrated well in the classic game-theory problem of the "Prisoner's Dilemma." You may have seen it play out in a "Law and Order" episode.

Assume two suspects are separated and held by police for questioning. If the two remain silent, the police will not have enough evidence to convict either of a crime, and they will both go free. If one cooperates with authorities and the other remains silent, the betrayer is off the hook, and the silent accomplice receives the full sentence. If each betrays the other, each receives a sentence and only the government wins.

With the SEC's new tools designed to "foster cooperation," we can expect potential targets of an SEC investigation to behave in much the same way—and to be more motivated than ever to race to cooperate with authorities to save themselves and/or receive the Dodd-Frank bounties (did I mention that whistleblowers are not required to have clean hands in order to collect?).

Investigation coverage should not be put in jeopardy by potential conflicts of interest or by co-insureds looking for credit for cooperating. Make sure your coverage will not disappear due to the behavior of other insureds. Check to make sure that the insured-vs.-insured (IVI) exclusion does not overreach. It can be replaced with an entity-vs.-insured exclusion or be limited with suitable exceptions.

Also, review the policy's requirements for cooperation with the insurer. Are they severable, or would one insured's cooperation with the SEC or DOJ put everyone's coverage at risk?

With conflicts like these, should the company and its executives share investigation limits? It is hard to see how that makes sense when the company's own internal investigation is likely to examine director or officer behavior, while at the same time eroding the limits available to cover the personal costs of those directors or officers.

Historically, coverage for the company's investigation costs was not available, and D&O policies were not designed to properly cover informal inquiries or investigation costs of executives. D&O policies typically expressly exclude company investigation costs entirely. Some new coverage in our market responds to those issues.

Companies can now purchase D&O coverage designed from the stem to stern to address executives' costs from inquiries and investigations. They can also buy new coverage for their own SEC-investigation costs. With these new options, the opportunity exists to specifically address D&O and company exposure separately.

Competent Counsel

Incomplete, inaccurate, misleading or evasive responses to an investigation can result in criminal prosecution—even for an otherwise innocent defendant.

Given that an informal inquiry or investigation can have criminal consequences, it becomes all that much more important for insureds to have access to competent counsel and for coverage to respond to those costs.

If your insurance policy or carrier provides access to experienced panel counsel, that may help ensure success. Panel counsel is typically pre-vetted by the carrier as battle-tested experts with a proven track record.

If each of the co-insureds is required to use panel counsel, that can help avoid having one inexperienced counsel make things unnecessarily worse for all.