In many instances, the impact of the allegations in an SEC enforcement action reach beyond the immediate claims in the suit. Rivelli v. Twin City Fire Ins. Co., Case No. 08-1480 (10th Cir. Decided Oct. 26, 2009) is a case where the plaintiffs were not only named as defendants in a Commission fraud action, but were denied the advancement of fees and expenses under a D&O policy based on the claims in the SEC complaint.

In Rivelli, the court held that an insurance carrier properly refused to advance defense costs under an excess Directors and Officers liability insurance policy. Plaintiffs in this coverage case were defendants in an SEC enforcement action seeking to have their legal expenses paid by the carrier.

Plaintiffs in this case were directors and officers of Fischer Imaging Co. That firm had three layers of D&O coverage. The first, from Federal Insurance Company, was in the amount of $5 million. An excess policy was issued by defendant Twin City in the amount of $2.5 million. The company also purchased a “top” layer in the same amount from Twin City. At the time, the “top” layer was renewed in April 2002, Fischer gave the insurer a warranty letter representing that no person for whom coverage was being purchased had any knowledge or information of any “act, error, omission, fact or circumstance” which may give rise to a claim that would come within the policy.

Subsequently, in May 2005 the SEC filed a fraud action against the plaintiffs in the coverage case. SEC v. Rivelli, Case No. 05-cv-01039 (D. Colo.). Three years later, the complaint was amended to allege that from January 2000 through September 2002 the defendants in that case, plaintiffs here, engaged in a fraudulent scheme to improperly inflate the earnings of the company.

In defending the SEC’s enforcement action, the defendants used the $5 million provided by the primary layer of D&O coverage and the $2.5 million from the excess layer. The full amounts were paid from both policies under reservations of rights. Twin City admits it has a duty to pay out the “top” layer unless the knowledge exclusion applies. The company denied coverage under that clause.

In affirming the trial court’s ruling in favor of the defendant insurer, the court applied what it called the “Colorado complaint rule.” That rule provides that an insurer’s duty to defend is determined solely by considering the policy and the complaint filed against the insured. Here, the policy clearly provides under the 2002 amendment that there is no coverage if the insured has knowledge of facts which could give rise to the claim. The SEC’s amended complaint specifies that the defendants in that action, the plaintiffs here, participated in the fraudulent acts which gave rise to the securities fraud claims on which the action was based. The acts, according to the SEC, began in 2000 before the execution of the rider for the “top” policy. Accordingly there is no coverage.