With all the news surrounding the SEC’s headline-grabbing prosecution of Lynn Tilton and her firm, Patriarch Partners LLC, it is easy to miss the insurance coverage element of the case.  It is no secret that in recent years, and particularly following the enactment of the Dodd-Frank Act in 2010, the SEC has dedicated more resources to investigating and targeting, among others, private equity firms, hedge funds, and mutual funds.  Responding to an SEC subpoena or investigation can be extremely expensive and disruptive.  Importantly, in some instances, these costs may be covered by a company’s liability insurance policies.

Patriarch Partners is seeking coverage from AXIS Insurance (“AXIS”) for an SEC subpoena and subsequent enforcement action. Patriarch Partners LLC v. AXIS Insurance Company, No. 1:16-cv-02277-VEC (S.D.N.Y. filed March 29, 2016).  AXIS has denied coverage and is seeking a court ruling that there is no coverage because (1) Patriarch allegedly did not disclose in a warranty for the AXIS policy that it had received an informal request for documents from the SEC; (2) the claim was barred by a prior acts exclusion; and (3) the SEC claims at issue constituted a “claim” made prior to the policy period.

In short, AXIS is arguing that, because the SEC allegedly requested certain documents from Patriarch and started an inquiry prior to the policy period, no coverage is available for the SEC’s subsequent claims.  Notably, although AXIS is contesting its coverage obligation, the primary insurer and the lower-layer excess carriers agreed to fund Patriarch’s defense and already have exhausted their limits.

The case raises a number of issues that all sophisticated buyers of insurance need to anticipate to increase the likelihood that coverage will be available for SEC claims:

  1. Be careful in completing applications and executing warranties. In purchasing insurance, policyholders are often required to complete applications or execute warranties.  Insureds, of course, must be honest in these applications and warranties because, as the Patriarch case demonstrates, insurance companies may attempt to avoid their coverage obligation based on purported misrepresentations.  But, as the Patriarch case also shows, responding to insurance applications is often easier said than done.  For example, to challenge coverage, AXIS is relying on a warranty by Patriarch stating that it was not “aware of any facts or circumstances that would reasonably be expected to result in a Claim” covered by the AXIS policy.  At the time Patriarch executed its warranty, however, its representation likely was accurate:  it likely did not know that a limited investigation by the SEC would result in a claim leading to more than $20 million in fees.  Nevertheless, Patriarch now faces an obstacle to coverage that could have been avoided.
  1. How the term “Claim” is defined. Most management liability insurance policies are written on a claims-made basis, which means that they are triggered by claims made during the policy term.  The definition of “Claim,” however, varies significantly from policy form to policy form.  In virtually all policies, the definition of “Claim” will include civil lawsuits, but, as reflected in the Patriarch case, it may also include a subpoena, an order of investigation, or an SEC Form 1662.  Policies also generally tie the definition of “Claim” to instances where there are allegations of “wrongful acts.”  The definition of “Claim” can have broad consequences for coverage and will affect the policyholder’s notice obligations, which policy period(s) is triggered, and how exclusions are applied.
  1. Understand the ramifications of prior acts and prior litigation exclusions. The vast majority of D&O policies contain prior acts or prior litigation exclusions that bar coverage for claims arising out of acts, or “related” lawsuits, that took place prior to the policy period.  The language of these exclusions again differs from policy to policy.  Where possible, seek a narrower and clearer exclusion, so that there is little doubt regarding what is excluded.  For example, in the Patriarch case, the policy contains a somewhat expansive exclusion barring coverage for claims “based upon, arising out of or attributable to any demand, suit or other proceeding pending” against Patriarch on or prior to July 31, 2011, “or any fact, circumstance or situation underlying or alleged therein.”  AXIS still will be required to show that this exclusion clearly and unambiguously bars coverage for the claim at issue, but this type of language gives insurers too much room to try to contest coverage.

There is no way to guarantee that all SEC claims will be covered, but by being proactive and anticipating key issues, you will put your firm in the best possible position to obtain coverage and manage this critical risk.  We will be monitoring the Patriarch case as it develops.

* Joseph Saka is a member of Lowenstein Sandler’s Insurance Recovery Group.  Zachary Rosenbaum, Chair of the Capital Markets Litigation Group, contributed to this post.