SEC Letter and Order Directing Private Investigation Held Not to Allege Wrongful Acts

The United States District Court for the District of Colorado, applying Colorado law, has granted summary judgment in favor of an insurer, holding that a letter from the SEC’s Division of Enforcement advising that the agency was conducting an inquiry into a company’s operations did not allege a Wrongful Act as defined by a D&O policy. Musclepharm Corp. v. Liberty Ins. Underwriters, Inc., 2016 WL 4179784 (D. Colo. Aug. 4, 2016).  The court also granted summary judgment for the insurer on the insured’s statutory and common law bad faith claims.

The insured company received a letter from the SEC’s Division of Enforcement stating that the agency was conducting an inquiry into the company’s operations and requesting voluntary production of documents. Two months later, the company received an “Order Directing Private Investigation and Designating Officers to Take Testimony” from the SEC, stating that the agency had “information that tends to show” various “possible violation[s]” of federal securities laws. The Order directed that a “private investigation be made to determine whether any persons or entities have engaged in . . . any of the reported acts or practices.” The insurer denied coverage for both the SEC letter and the Order on the ground that neither communication was a “Claim” against an insured. The insured filed suit seeking reimbursement for the defense costs it incurred in complying with the Order and alleging causes of action for statutory and common law bad faith denial of coverage.

In granting summary judgment in favor of the insurer, the court held that the policy did not afford coverage for the letter or the Order because the investigation did not allege a “Wrongful Act.” The policy provided coverage for Loss arising from a Claim “for a Wrongful Act,” which was defined to mean “any actual or alleged error, misstatement, misleading statement, act, omission, neglect, or breach of duty.” The court reasoned that the term “alleged” ordinarily means “‘declared or stated to be as described; asserted.’” Given that definition, the court determined that an alleged error or omission must “involve a positive assertion that the implicated error or omission is believed to have actually occurred, even if still subject to proof.” The court found that neither the letter nor the Order made such an assertion. The Order’s purpose, according to the court, was to authorize the SEC to determine whether hypothetical violations occurred. The court emphasized that the letter and the Order contained disclaimers that evidenced that the SEC “was not averring violations had occurred” but rather, “sought only to determine whether they had.”

Finally, the court granted summary judgment for the insurer on both the statutory and common law bad faith claims, reasoning that the insurer had a good faith basis rooted in the policy language to deny coverage.