The question of what constitutes a “securities claim” in the context of public company D&O policies is often debated in insurance coverage disputes, and the answer to this question can have significant effects on the scope of what insurance companies would be forced to cover under these policies. In In re Verizon Insurance Coverage Appeals, the Delaware Supreme Court reversed an earlier Superior Court ruling that, if upheld, would have considerably broadened that scope – requiring insurers to provide coverage for not only violations of the regulations, rules, or statutes that specifically regulate securities but also for any claims that “pertain to a law one must follow when engaging in a securities transaction.” The reversal from Delaware’s highest court provides some much-needed clarity (and at least $48 million in relief) to insurers subject to jurisdiction in Delaware.

The Underlying Case – Verizon Spends $48 Million on Successful Defense of $14 Billion Claim

In 2006, Verizon spun off its print and electronic directories to a newly formed subsidiary, Idearc Inc. In exchange for the directory business, Idearc gave Verizon 146 million shares of Idearc stock, $7.1 billion in Idearc debt, and $2.5 billion in cash. Verizon then distributed the Idearc common stock to Verizon shareholders. Idearc launched as a separate business with $9.1 billion in debt and operated as an independent, publicly-traded company until it filed for bankruptcy in 2009.

When Idearc filed for bankruptcy, the bankruptcy court-appointed U.S. Bank as trustee of a litigation trust to pursue claims against Verizon and others on behalf of creditors. In 2010, U.S. Bank sued Verizon and others in Texas federal court, saying that Verizon engineered the spinoff to benefit Verizon to Idearc’s detriment. U.S. Bank sought to recover approximately $14 billion in damages, alleging violations of fraudulent transfer statutes, payment of unlawful dividends in violation of Delaware General Corporation Law, and common law counts for breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, promoter liability, unjust enrichment, and alter ego liability.

After nearly five years of litigation, Verizon won a bench trial in Texas federal court, which was subsequently affirmed by the Fifth Circuit Court of Appeals. Over the course of the litigation, Verizon incurred more than $48 million in defense costs.

The Coverage Dispute – Insurers Deny Recovery of Verizon’s Defense Costs

In connection with the 2006 spinoff, Verizon and Idearc purchased primary and excess D&O policies from various insurers to insure against litigation risks and potential liabilities arising from the transaction. The policies covered claims made against the insureds during the six-year policy that exceeded a $7.5 million retention. However, an endorsement to the policies (Endorsement 7) limited recovery only to losses arising from a “securities claim” brought against the insured.

The policies defined “securities claim” as a claim against an insured person:

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:
   
   1. 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
   2. 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, relating to a Securities Claim as defined in subparagraph (1) above.

The policies also allowed Verizon to recover its defense costs when a securities claim was brought against both the company and insured directors and officers, and where Verizon indemnified those directors and officers.

After successfully defending its suit against U.S. Bank, Verizon sought to recover its $48 million defense costs from its insurers under the D&O policies. Verizon’s insurers refused to pay for the company’s defense, arguing that the U.S. Bank complaint did not constitute “securities claims” as defined by the policies. Verizon then brought suit against the insurers in Delaware Superior Court.

Verizon Succeeds in Superior Court

In the Superior Court litigation, the parties cross-moved for summary judgment on whether the U.S. Bank action fell within the policies’ definition of a “securities claim.” Judge William C. Carpenter Jr., in what he acknowledged was “not an easy decision,” found that the definition of “securities claim” was sufficiently ambiguous, and the doctrine of contra proferentem required that such ambiguity be construed in favor of the insured against the insurer.

In doing so, Judge Carpenter agreed with Verizon’s argument that U.S. Bank’s lawsuit alleged “violations of regulations, rules or statues regulating securities” because the word “rule” should be read broadly enough to encompass judicial rules of law or common law rules that “must be followed to properly engage in a securities transaction.” Rejecting the insurers’ contention that “securities claims” are limited to those expressly alleging violations of federal securities and state blue-sky laws, Judge Carpenter held that “[n]othing in the Policies’ definition of Securities Claim purports to exclude common law rules or to limit coverage to only those Claims alleging violations of enumerated state or federal securities statutes and regulations.”

Partial summary judgment was entered for Verizon, and the insurers subsequently appealed.

Reversal in the Supreme Court

On appeal, the Delaware Supreme Court reversed, holding that the definition of “securities claim” was unambiguous and that the U.S. Bank action did not involve a “securities claim” within the meaning of the policies.

In arriving at its decision, the three-judge panel engaged in a two-step inquiry: first, to interpret de novo the policy language according to its plain meaning; and second, to apply that definition to the claims brought by U.S. Bank against Verizon.

To interpret the policy language, the court started with a basic understanding that the definition of a “securities claim” is “aimed at a particular area of the law, securities law, and not of general application to other areas of the law.” According to the panel, “regulations, rules, or statutes that regulate securities are those specifically directed towards securities, such as the sale, or offer for sale, of securities. They would not be directed at the common law or statutory laws outside the securities regulation area.” To hold otherwise would make any unlawful conduct during a securities-related transaction fall within the definition of “securities claim,” which the court felt was casting “too broad a net.”

Applying this definition to the claims brought by U.S. Bank against Verizon, the court found that none of U.S. Bank’s allegations – fiduciary duty violations, unlawful dividends under Delaware law, statutory fraudulent transfer claims, and unjust enrichment and alter ego common law claims – implicated a “regulation, rule or statute” specifically directed toward securities law, and thus none of the claims fell under the “securities claim” definition of the policies. Judgment was reversed, and Verizon was denied recovery of more than $48 million in defense costs from insurers.

The Delaware Supreme Court’s ruling should provide comfort to insurers who may have feared an expanse of D&O policy exposure in the wake of the trial court’s decision. It also suggests that insureds seeking broader coverage in D&O policies carefully consider the wording of the policy definitions and seek to expand them to include common law and other relevant statutory laws, if applicable.

In re Verizon Ins. Coverage Appeals, Nos. 558, 2018; 560, 2018; 561, 2018 (Del. Oct. 31, 2019).