What Is A Securities Claim?

In addition to insurance for directors and officers, D&O policies for public companies provide balance sheet protection for the entity itself, but such coverage is generally limited to “Securities Claims” as defined in each policy, also known in the industry as “Side C” coverage. Typically brought in the form of class action and derivative lawsuits by shareholders, securities claims often allege breaches of disclosure or fiduciary duties, or misleading and deceptive conduct that resulted in a loss in market value of the company’s shares.

It stands to reason then that if your company is named in a class action lawsuit following a merger or acquisition, which of course involves the purchase or sale of securities, your company should be afforded D&O coverage, right? Unfortunately, this is not always the case.

The question of what constitutes a “Securities Claim” has been hotly debated in insurance coverage litigation, the outcome of which has been detrimental to many insureds who believed they would be protected in the face of all-too-common securities litigation.

The definition of “Securities Claim” was the subject of two recent rulings highlighted below, both of which relied on the same case law to reach different conclusions on coverage.

Verizon Communications Inc., Et Al. V. National Union Fire Ins. Co. Of Pittsburgh, Et Al.

Following Verizon Communications Inc.’s (“Verizon”) spinoff of a portfolio to FairPoint Communications Inc. (“FairPoint”), FairPoint filed for and later emerged from bankruptcy. Meanwhile, the bankruptcy trustee alleged that FairPoint was insolvent at the time of the transaction and pursued Verizon for actual and constructive fraudulent transfers in connection with the transaction, resulting in $24 million in defense fees.

Coverage litigation ensued after the insurers declined to reimburse Verizon for its defense fees. The insurers argued the trustee’s lawsuit did not constitute a “Securities Claim,” defined as a claim: “(1) alleging a violation of any federal, state, local or foreign regulation, rule or statute regulating securities (including but not limited to the purchase or sale or offer or solicitation of an offer to purchase or sell securities) which is: (a) brought by any person or entity alleging, arising out of, based upon or attributable to the purchase or sale or offer or solicitation of an offer to purchase or sell any securities of an Organization; or (b) brought by a security holder of an Organization with respect to such security holder’s interest in securities of such Organization; or (2) brought derivatively on the behalf of an Organization by a security holder of such Organization.”

Verizon, on the other hand, argued the trustee qualified as a “security holder” under the Bankruptcy Code and brought the action “derivatively,” thereby meeting the second prong of the definition.

In its analysis, the court examined a previous coverage dispute involving Verizon and substantially similar facts (In re Verizon Insurance Coverage Appeals) in which the Delaware Supreme Court ruled the underlying claim did not meet the definition of “Securities Claim.”

However, in the earlier case, the second prong of the policy’s definition of “Securities Claim” read as follows: “brought derivatively on the behalf of an Organization by a security holder of such Organization, relating to a Securities Claim as defined in paragraph (1) above.” Consequently, the court acknowledged the definition in the present case was “critically different” in that it did not incorporate the first prong of the definition and, therefore, did not contain a “regulating-securities element,” as further demonstrated by the disjunctive use of the word “or” in the definition.

In finding in favor of Verizon, the court concluded the notes at issue constituted “securities” and the action was “brought derivatively” because the “recovery would serve to increase the pool of assets available to all creditors.” In response to the insurer’s secondary arguments that Verizon’s defense fees were unreasonable and unnecessary, the court found Verizon was entitled to full coverage for its defense costs, suggesting the court was “not equipped to second-guess the ‘reasonableness’ the [i]nsurers now untimely bemoan,” particularly after “denying coverage and basically ignoring the [action] for six years.”

The Delaware Superior Court recently denied the insurers’ application for certification of interlocutory appeal in this matter, but the insurers are unlikely to accept this outcome as final.

Calamos Asset Management Inc. V. Travelers Casualty & Surety Co. Of America

Following Calamos Asset Management Inc’s (“Calamos”) announcement of a merger whereby it would be taken private, several stockholders alleged breaches of fiduciary duty against the company and its directors and officers. Calamos sought coverage from its primary and two excess follow-form D&O insurers.

The second excess insurer refused to cover the loss, claiming the lawsuits did not meet the primary policy’s definition of “Securities Claim.” Specifically, the primary policy was intended to cover “any actual or alleged violation of any federal, state, local regulation, statute or rule (whether statutory or common law) regulating securities, including but not limited to the purchase or sale of, or offer to purchase or sell, securities which is … brought by any person or entity based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving the purchase or sale of, or offer to purchase or sell, securities of the Company…”

In the resulting coverage litigation, similar to the case described above, the court relied on the Delaware Supreme Court’s decision in In re Verizon Insurance Coverage Appeals, which found “regulations, rules, or statutes that regulate securities are those specifically directed towards securities, such as the sale, or offer for sale, of securities.” Reasoning that breach of fiduciary claims are not specific to any rule, regulation, or law “regulating securities,” the court found in favor of the excess insurer in February of 2021.

Calamos subsequently sought an amendment to the court’s order, arguing the court inadvertently closed the case without ruling on all the disputes presented. In response, the judge vacated part of her ruling on April 30, 2021, finding that additional proceedings were necessary to determine whether certain executives should be covered under the policy.

Calamos then filed a motion for reconsideration on May 14, 2021, seeking clarification of the court’s April 30, 2021 order regarding defense costs incurred on behalf of individuals in the shareholder action, which Calamos suggested “could only be based on a misunderstanding of the parties’ positions, and the facts and law underlying those positions.” This latest motion may result in further modifications to the current ruling, which we will closely monitor.

What You Should Know

While the outcomes of these cases differed, so did the policy language, again demonstrating that words matter. However, the court did not opine on one critical difference between the two definitions at issue in these cases. In Calamos, the definition of “Securities Claim” included any “statute or rule (whether statutory or common law) regulating securities,” while the definition in Verizon (“rule or statute regulating securities”) did not reference common law.

While this further analysis may not have changed the outcome in these cases, it raises an important question: what common law regulates securities? If an alleged breach of fiduciary duty, fraud, or misrepresentation in connection with a securities transaction does not fall squarely in this category, what does? This language must have some meaning applied to it, and we expect it will be litigated at some point in the future. We reached out to Geoffrey Fehling of Hunton Andrews Kurth for his take on these rulings, and he offered the following thoughts:

“In holding that a breach of fiduciary duty was not a ‘Securities Claim,’ the court in Calamos failed to account for a material difference in the definition of that term not present in the Supreme Court’s earlier Verizon decision. Calamos purchased entity coverage that included violations of a ‘common law’ rule directed towards securities (like the alleged fiduciary breaches in connection with the go-private transaction at issue), but the court’s interpretation arguably rendered that language superfluous by finding it no different from the narrower definition in In re Verizon Insurance Coverage Appeals. The takeaway from both recent decisions is that all D&O policies are not created equal, and nuanced differences in critical terms like Securities Claim can have meaningful impact on the availability of coverage.

CAC Specialty will continue to monitor further developments, including likely appeals in both matters