AN UNFORSEEN IMPACT OF AN SEC COMPLAINT: NO D&O COVERAGE

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.

THE USAO, THE SEC AND STAYS: ENFORCING THE LAW FAIRLY

The SEC is facing another dilemma in Judge Rakoff’s courtroom in the Southern District of New York. The question this time does not involve SEC v. Bank of America, discussed here, which is on its way to trial. This dilemma involves its recently filed insider trading case against Galleon Group and Raj Rajaratnam. This time, the U.S. attorney’s office is involved along with its two insider trading cases against Mr. Rajaratnam and others, discussed here. Judge Rakoff, it seems, thinks the SEC filed its case to litigate. He has ordered the Commission to be ready for trial in five months.

The SEC probably has less interest in taking Galleon to trial in five months than it has in trying Bank of America. Typically, the Commission expects the U.S. Attorney’s Office to seek intervention in the civil enforcement action and request a stay in deference to the criminal case. The SEC does not object in this all very typical scenario. If done here, after all, the agency will have joined with the U.S. Attorney’s Office, filed a lengthy complaint accusing the defendants of insider trading, participated in a press conference and issued a press release, yet will not have to proceed to a trial until after the criminal matter is tried.

The government’s motion for a stay of a parallel SEC case is typically granted. Yet, permitting both actions to move forward has good and bad points for both sides. To be sure, if both cases go forward, the SEC defendants will use the broader civil discovery provisions to unveil part of the government’s criminal case. That may eventually aid them when the criminal case goes to trial.

There are however, disadvantages for the defendants. In the criminal case, they can invoke the Fifth Amendment and not testify. The defendants can also elect to watch the government put on its case before making a decision on whether to testify. In contrast, if there is civil discovery the SEC may take the deposition of the defendants, forcing them to make a decision on whether to testify before seeing the evidence in the criminal case. If the defendants may elect to invoke their Fifth Amendment rights, the SEC can seek an adverse inference which is not available in the criminal case. That inference can help the Commission establish liability in the civil case. Thus, parallel criminal and civil cases present opportunities and pitfalls for both sides.

All of this however, neglects the critical question at stake here which is fundamental fairness in law enforcement. The USAO and the SEC can choose when to bring their respective cases. If they do not want those cases to proceed simultaneously, they can elect to file them in sequence, one going forward to completion followed by the filing and litigation of the other. In most cases there is no reason for the USAO and the SEC to file their cases together and then move to stay the SEC case.

It is fundamentally unfair for a law enforcement agency to file a case which accuses a citizen of wrong doing, trumpet its claims in press conferences and a press release and then move to stay. This tactic silences the defendant, denying him or her the right to contest and refute the claims and charges. As the court stated in U.S. v. Reyes, No. 06-0556 (N.D. Cal. Oct 4, 2006) when denying a government request for a stay, it “appears to me that when the SEC decides they want to charge people with violations of the law . . . they invite . . . the defense to respond . . . I don’t really appreciate the fundamental fairness [of a stay] . . .”

If either the USAO or the SEC has no intention of litigating the charges brought in their respective complaints, then the actions should not be filed. Cases are filed in court to resolve claims, not make allegations which cannot be refuted while serving as vehicles for holding press conferences and issuing press releases. Law enforcement should be about enforcing the law and protecting the rights of citizens – all citizens including the accused – not headlines.