In Options Clearing Corp. vs. US Specialty Insurance Co., the Delaware Superior Court addressed the scope of policy language on related or interrelated wrongdoing in SEC investigations and enforcement actions involving the insured, Options Clearing Corp. (OCC). According to the notice, the OCC is a US-registered clearing agency and derivatives clearing organization, which provides clearing and settlement services to 18 exchanges. The OCC is the only registered clearing agency for publicly traded options contracts in the United States and therefore falls under the oversight responsibility of the Office of Compliance Inspections and Examinations (OCIE) of the SEC.
From 2012 to 2014, the OCIE sent letters to the OCC identifying the deficiencies and informing the OCC that the SEC was investigating those deficiencies. Gaps identified included system control deficiencies in OCC’s escrow program, reduced effectiveness of the internal audit function, weaknesses in the risk management framework, insufficient written/formal policies and procedures, concerns about OCC’s overall commitment to establishing a culture of regulatory compliance and responsiveness. , systemic weaknesses in OCC’s risk management and OCC’s inability to identify and sufficiently mitigate operational risk.
U.S. Specialty Insurance Co. provided principal insurance to directors and officers at the OCC beginning in 2015 and for consecutive insurance periods through 2020. As relevant to this case, these policies included policies D&O for policy periods from March 15, 2017 to March 15. , 2018 and from March 15, 2018 to March 15, 2019. Indian Harbor Insurance Co. issued follow-up form excess policies to the OCC, which adopted the relevant terms, conditions, definitions and exclusions of the 2017-2019 primary policies issued by American Specialty.
In relevant part, the 2017-2018 Master Policy contained an “Event Exclusion”, which excludes coverage for losses relating to any claim arising out of, based on or attributable to any wrongful act or underlying fact or circumstance. underlying in any way related to the couriers 2012-2014 or related wrongdoing. Similarly, the “Notice Exclusion” excluded coverage for “claim losses…arising out of, based on, or attributable to any facts or circumstances alleged, or the same or related wrongdoing alleged or contained, in any claim which has been reported, or in respect of which notice has been given, under any policy of which this policy is a renewal or replacement or which it may succeed from time to time. »
In 2017, the SEC notified the OCC of an ongoing investigation into its compliance with specific SEC statutes and regulations, which subsequently led to an order commencing proceedings against the OCC. The alleged violations included OCC’s failure to (1) implement policies and procedures reasonably designed to provide a transparent legal framework, maintain risk management, and establish a methodology to address the risks/attributes of cleared products by OCC; (2) create policies and procedures to ensure the security of its computer network and electronic systems; and (3) failure to file with the SEC policies and practices that meet the definition of a proposed rule change under Section 19(b)(1) of the Exchange Act. The Division of Enforcement of the Commodity Futures Trading Commission (CFTC) also notified the OCC that it was investigating and issued its own orders to prosecute based on the same violations alleged in the SEC enforcement action.
The OCC notified insurers of SEC and CFTC enforcement actions under the 2017-2019 policies. U.S. Specialty denied SEC enforcement action coverage based on the event and notice exclusions, saying the violations alleged in the SEC enforcement action arose out of the events set forth in the 2012-2014 letters. US Specialty reserved its rights as to the applicability of these exclusions to CFTC enforcement action.
Subsequently, the OCC filed suit against the insurers alleging that the insurers breached the 2017-2019 policies. In doing so, the OCC argued that the enforcement actions were unrelated to the 2012-2014 letters. The OCC argued that the enforcement actions would have to be “substantially identical” to the 2012-2014 letters to be considered related and/or interrelated wrongdoing in the context of the event and notice exclusions.
The court rejected the OCC’s invitation to apply a “substantially identical” standard to the link investigation, noting that the clear terms of the policy did not support such a standard. Instead, the court noted that the policy exclusions applied if the insurers established a “significant connection” between the enforcement actions and the 2012-2014 letters or the wrongdoing alleged in those letters.
The court found that the insurers failed to meet this burden for several reasons.
First, the court held that the type of investigation involved in the enforcement action differed from the investigation into the 2012-2014 letters; while the 2012-2014 letters involved routine annual compliance reviews, the enforcement actions were not. Second, the court noted that the time periods for the respective investigations differed. Third, the regulations allegedly violated differed. In this regard, the court noted that most of the regulations allegedly violated in the Enforcement Measures were in effect in 2015 and 2016 and therefore post-date the publication of the 2012-2014 letters. Fourth, the court found that the 2012-2014 enforcement actions and letters set out different types of wrongful conduct and sought different types of relief. On the one hand, the enforcement actions alleged that the OCC failed to maintain credit and liquidity stress-testing policies, failed to file proposed rules with the SEC, and engaged in to wrongful conduct during a volatility event in 2018. As a result of these alleged acts, enforcement sought punitive damages and an injunction. The 2012-2014 letters, on the other hand, were intended to comply with and address the OCC’s failure to meet general routine compliance obligations.
Based on this reasoning, the court concluded that the event and notice exclusions did not apply to bar coverage. The court noted that a finding to the contrary interpreting the exclusions too broadly would render coverage under the policy illusory because, given the nature of OCC’s business, “there will necessarily be a superficial overlap between the previous enforcement actions and those for which the OCC [sought] blanket.”
The court’s “significant connection” reflects how courts often undertake a factual examination of the underlying allegations to determine whether the claims involve related wrongdoing.