In Options Clearing Corp. v. U.S. Specialty Insurance Co., the Delaware Superior Court addressed the scope of related or interrelated wrongful acts policy language in connection with SEC investigations and enforcement actions involving the insured, Options Clearing Corp. (OCC). According to the opinion, OCC is a registered U.S. clearing agency and derivatives clearing organization, which provides clearing and settlement services to 18 exchanges. OCC is the sole registered clearing agency for exchange-listed option contracts in the United States and thus falls within the oversight responsibility of the SEC’s Office of Compliance Inspections and Examinations (OCIE).
From 2012 to 2014, OCIE sent letters to OCC identifying deficiencies and informing OCC that the SEC was investigating those deficiencies. The identified deficiencies included system control failures in OCC’s escrow deposit program, reduced effectiveness of the internal audit function, weaknesses in the risk management framework, insufficient written/formal policies and procedures, concerns regarding OCC’s overall commitment to establish a culture of regulatory compliance and responsiveness, systemic weaknesses in OCC’s risk management, and OCC’s failure to sufficiently identify and mitigate operational risk.
U.S. Specialty Insurance Co. provided primary directors and officers insurance to OCC starting in 2015 and continuing for consecutive policy periods until 2020. As is relevant to this case, these policies included D&O policies for the policy periods of March 15, 2017, to March 15, 2018, and March 15, 2018, to March 15, 2019. Indian Harbor Insurance Co. issued follow-form excess policies to OCC, which adopted the relevant terms, conditions, definitions, and exclusions of the 2017-2019 primary policies issued by U.S. Specialty.
In relevant part, the 2017-2018 primary policy contained an “event exclusion,” which excludes coverage for loss in connection with any claim arising, out of, based upon, or attributable to any wrongful act or underlying fact or circumstance in any way related to the 2012-2014 letters or interrelated wrongful act. Similarly, the “prior notice exclusion” excluded coverage for “Loss in connection with a Claim … arising out of, based upon or attributable to facts or circumstances alleged, or to the same or related Wrongful Acts alleged or contained, in any claim which has been reported, or with respect to which any notice has been given, under any policy of which this Policy is a renewal or replacement or which it may succeed in time.”
In 2017, the SEC informed OCC of an ongoing investigation into its compliance with specific SEC statutes and regulations, which later led to an order instituting proceedings against 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 account for risks/attributes of products cleared by OCC; (2) create policies and procedures to ensure the safety of its computer network and electronic systems; and (3) failure to file with 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 informed OCC that it was conducting an investigation and issued its own orders to institute proceedings based on the same violations alleged in the SEC enforcement action.
OCC provided notice to the insurers of the SEC and CFTC enforcement actions under the 2017-2019 policies. U.S. Specialty denied coverage for the SEC enforcement action based on the event and prior notice exclusions, contending that the violations alleged in the SEC enforcement action arose out of the events set forth in the 2012-2014 letters. U.S. Specialty reserved its rights as to the applicability of these exclusions to the CFTC enforcement action.
Thereafter, OCC filed suit against the insurers alleging that the insurers breached the 2017-2019 policies. In doing so, OCC maintained that the enforcement actions were unrelated to the 2012-2014 letters. OCC argued that the enforcement actions would have to be “fundamentally identical” to the 2012-2014 letters to be considered related and/or interrelated wrongful acts within the context of the event and prior notice exclusions.
The court rejected OCC’s invitation to apply a “fundamentally identical” standard to the relatedness inquiry, noting that the plain terms of the policy did not support such a standard. Instead, the court noted that the policy exclusions applied if the insurers established a “meaningful link” between the enforcement actions and the 2012-2014 letters or the wrongful acts alleged in those letters.
The court held that the insurers failed to meet that burden for several reasons.
First, the court reasoned that the type of investigation involved in the enforcement actions differed from the investigation of the 2012-2014 letters; whereas the 2012-2014 letters involved routine annual compliance examinations, the enforcement actions did not. Second, the court noted that the time periods for the respective investigations differed. Third, the regulations allegedly violated differed. In that regard, the court noted that most of the regulations allegedly violated in the enforcement actions were effective in 2015 and 2016 and thus post-dated the issuance of the 2012-2014 letters. Fourth, the court held that the enforcement actions and the 2012-2014 letters set forth different types of wrongful conduct and sought different types of relief. On the one hand, the enforcement actions alleged OCC failed to maintain policies for credit and liquidity stress testing, failed to file proposed rules with the SEC, and engaged in wrongful conduct during a 2018 volatility event. As a result of these alleged acts, the enforcement actions sought punitive damages and injunctive relief. The 2012-2014 letters, on the other hand, sought compliance and remediation for OCC’s failure to abide by general routine compliance obligations.
Based on this reasoning, the court found the event and prior notice exclusions did not apply to bar coverage. The court noted that a contrary finding construing the exclusions too broadly would render coverage under the policy illusory because, given the nature of OCC’s business, “there is bound to be some surface-level overlap between earlier enforcement actions and those for which OCC [sought] coverage.”
The court’s “meaningful linkage” reflects how the courts often undertake a fact-intensive review of the underlying allegations in order to term whether claims involve related wrongful acts.
