Loyola University Chicago School of Law, J.D. 2019
Consistent with modern financial regulation, United States regulators are increasingly focusing upon individual accountability of corporate officers and directors. Once a regulatory agency contacts a corporation regarding an inquiry into the actions of its agents, it is the duty of the corporation to front the costs of legal defense and representation. Historically, corporate directors and officers liability insurance (“D&O”) covered the costs of legal defense and costs associated with the regulatory investigation. In light of the increasing government emphasis on individual liability within corporations, traditional D&O liability insurance is no longer guaranteed to protect corporate exposure to regulatory inquiry. As a result of these changes to corporate exposure, insurance agencies have begun to create novel insurance solutions to solve the problems created by the new regulatory policy.
Outlining the Policy Change to Government Regulators
A common criticism of corporate malfeasance prosecution is that regulators fail to correct wrongdoing at the level of the individual, corporate actor. In 2015, the Attorney General submitted a memo to the U.S. Justice Department emphasizing a policy change urging executive agencies and prosecutors to require corporations to cooperate with government investigations by identifying individual employees involved in the misconduct before the government would consider negotiating with a company.
A practical example of this policy application is found in the 2016 decision of a case where MusclePharm Corporation received a notice from the Securities and Exchange Commission (“SEC”) regarding an inquiry into the company’s operations. Under the SEC investigation, the agency requested voluntary production of many documents relating to the business operations resulting in nearly $3,000,000 in business expenses. Ultimately, the SEC submitted two Wells Notices, indicating that the SEC intended to bring enforcement actions against two of MusclePharm’s officers. MusclePharm subsequently notified their D&O insurance carrier and requested that their defense expenses and investigatory costs be covered.
Under a traditional D&O claim, MusclePharm’s costs incurred while complying with an SEC investigation would be fully covered. Prior to the service of the Wells Notices, reviewing courts held that the SEC’s investigation only amounted to an informal inquiry, and such an action is barred from recovery under a traditional D&O insurance policy. MusclePharm’s out-of-pocket expenses are only one example of the corporate exposure created by U.S. regulators’ newfound focus on individual liability.
Market Response to Policy Changes
In light of increased regulatory focus on individual accountability, shareholders are concerned with the possible costs created by board directors and officers being targeted by regulators for breach of fiduciary duty. In 2016, The Travelers Companies conducted a survey, which found that publicly traded companies are 60% more concerned with board members facing accusations of fraud than board members at non-public companies. Additionally, the survey found that less than a third of the survey responses felt that their company properly insures the board of directors.
The Travelers Companies created a solution to the problem exposed by the failure of MusclePharm’s D&O insurance. Historically, D&O liability coverage applies strictly to defense of formal investigations or charges regarding wrongful acts as an officer of a corporation. On September 14th of 2017, Travelers Companies announced a new form of D&O liability coverage intended to limit exposure for companies when directors and officers are asked to take part in a regulatory corporate investigation.
The truly novel component of this policy is that it reduces exposure to the cost of internal corporate investigation. Typical D&O policies provide coverage for defense expenses where officers respond and cooperate with regulatory bodies. Under this policy, investigatory costs of internal investigations are covered prior to any government involvement. The Travelers Risk Index revealed that many shareholders fear the potential costs to their company if the business is targeted by regulators. This fear is addressed directly by Travelers’s new policy, which insulates companies from the potential cost of regulatory investigations by allowing a company to proactively perform internal investigations of their officers where the cost of the inquiry will be covered under the D&O policy.
To ensure that the coverage of this policy is triggered, a company must perform two actions. Whenever a director or officer incurs any defense expenses as part of an internal investigation, Travelers must be notified. Additionally, whenever a corporation suspects any potential corporate wrongdoing, a regulatory agency must be notified.
Future Outlook Regarding this Policy
Given the recent regulatory shift towards holding individuals accountable for malfeasance, this well-designed insurance policy serves a dual purpose to society. On its face, this policy furthers the goal of all companies when purchasing insurance. The policy protects an essential gap not found in any pre-existing insurance plans. Under this coverage, a corporation will not incur the costs of an internal investigation necessary to determine whether fraud has occurred or fiduciary duty has been breached. For the shareholders of a publicly traded company, this can only be beneficial. A prominent fear in the eyes of shareholders is the cost of complying with a regulatory investigation, and this policy provides a means of ensuring transparency at the level of directors and officers.
This insurance policy also reinforces important governmental policies. Under Travelers’s new policy, corporations are given the tools and assets to functionally conduct internal investigation without suffering great business expenses. While this fact benefits shareholders, an essential component of the policy requires notification of government regulators whenever there is suspect activity at the level of directors. This requirement provides a greater amount of transparency to government regulators, notifying them of the exact individuals responsible for possible corporate fraud.
The future of corporate exposure and insurance is bright under this policy. If Travelers’s new policy is successful and reflected in the creation of similar policies across the United States, transparency to regulators and shareholders will be greater than before while managing to reduce regulatory costs for all parties involved.