The Tenth Circuit held that inquiry notices sent to the insured by the Securities and Exchange Commission were not a claim under a claims-made Directors' and Officers' policy. MusclePharm Corp. v. Liberty Ins. Underwriters, Inc., 2017 U.S. App. LEXIS 20233 (10th Cir. Oct. 17 2017).
The SEC mailed a letter to MusclePharm stating it was "conducting an inquiry" and requested that MusclePharm voluntarily provide documents. SEC later issued an "Order Directing Private Investigation and Designating Officers to Take Testimony" to MusclePharm. The Order stated that the SEC had information tending to show that MusclePharm violated provisions of the Securities Act of 1933 and the Exchange Act of 1934 Then, the SEC issued 21 subpoenas to MusclePharm and to individual officers and directors. The subpoenas instructed MusclePharm to produce documents.
Finally, on February 13, 2015, the SEC issued a "Wells Notice" to MusclePharm officers. The Wells Notice stated that the SEC's Enforcement Division was close to recommending to the full Commission that an action be taken against the recipient. The parties eventually settled, but not before MusclePharm spent more than $3 million responding to the investigation, including more than $1.3 million in defense costs.
Liberty denied coverage except for the post-Wells notice costs. MusclePharm filed suit, asserting that the entire SEC investigation was a "claim" under the policy. The parties filed cross motions for summary judgment. The district court granted Liberty's motion, denied MusclePharm's motion, and dismissed its claims. The district court ruled that the notices prior to the Wells' notice did not allege a "wrongful act" within the meaning of the policy.
The Tenth Circuit affirmed. To obtain coverage under the policy, (i) there had to be a claim; (ii) the claim had to be made during the policy period; (iii) the claim had to be lodged against an insured; and (iv) the claim had to be for a wrongful act. Here, the four requirements were not met until the SEC issued the Wells notice. Prior to that time, the SEC had not alleged a "wrongful act."
MusclePharm argued that the SEC subpoenas were covered because they were written demands for non-monetary relief. The court disagreed. The SEC sought to determine, through documents and testimony, whether there would ultimately be any basis for seeking monetary and/or non-monetary relief from MusclePharm. By this action, the SEC was not seeking relief, but was only gathering information.
MusclePharm also contended that the prior Order seeking testimony was a formal administrative or regulatory proceeding covered under the policy. The policy did not define "investigation" or "proceeding." The dictionary definition of "proceeding" included "any procedural means for seeking regress from a tribunal or agency." "Investigation" was defined as "the activity of trying to find out the truth about something." The Order stated that it was an investigation "to determine whether any persons or entities had engaged in any of the reported acts or practices." This language made clear that the SEC was conducting an investigation, not a proceeding.
Therefore, the Wells Notice was covered, whereas costs for responding to the Order, which did not allege a "wrongful act," were not.
Thanks to Richard Mosher, Esq. for the heads-up on this case.