The SEC inquiry

Unbeknownst to the insurers, some months earlier, in May 2020, the SEC had sent an inquiry letter to Infinity Q indicating that the SEC was “conducting an inquiry [of Infinity Q] to determine if violations of the federal securities laws have occurred.” However, the letter also specified that it was a “non-public, fact-finding inquiry” and “does not mean that we have concluded that you or anyone else has violated the law.” The inquiry letter was accompanied by mandatory document requests to which Infinity Q was required to respond.

The facts produced in discovery in this case in response to the SEC inquiry appeared to indicate at least some level of concern among Infinity Q executives. When the SEC reached out to Infinity Q by voicemail seeking to discuss the “open inquiry,” Mr. Lindell messaged Infinity Q’s founder and chief investment officer, Mr. Velissaris, writing: “WTF? Open Inquiry.” In response, Mr. Velissaris reached out to Infinity Q’s outside counsel, seeking to set up a call. Outside counsel then formed a legal team that included an attorney with high-level SEC experience whose practice focused on trial, investigations, and securities litigation.

Around the same time, Lindell and Velissaris discussed whether they should “increase the insurance” given that they “had talked about it last year.” But Mr. Velissaris “forgot to follow up.” Mr. Lindell told Mr. Velissaris that the “policy renews in July/August. We should definitely increase it this year.”

Throughout late May and June, Mr. Lindell and Mr. Velissaris continued to communicate with each other concerning the SEC inquiry and the work of the outside counsel team, to which another attorney with high-level SEC experience had been added. In late June, the SEC sent an additional inquiry letter requesting additional documents from Infinity Q. After the submission of the second set of documents to the SEC was complete, Mr. Lindell wrote Mr. Velissaris that it was “unlikely, but I hope we never hear from them again.” In August 2020, in an update to the board of trustees of one of the funds managed by Infinity Q, Infinity Q indicated that the SEC inquiry was “ongoing” and that “the results of the SEC enforcement inquiry remain unknown.”

In the fall of 2020, after the issuance of the three excess policies, Infinity Q learned that the SEC would be commencing an investigation, which generally alleged that Infinity Q may have been employing schemes to defraud clients or prospective clients. In November 2020, the SEC issued a subpoena to Infinity Q as part of the SEC investigation. In February 2021, Infinity Q informed its investors of various discrepancies in its valuation calculations and of possibly questionable conduct, including that its chief investment officer, Mr. Velissaris, had been adjusting certain parameters. In the wake of these disclosures, the insureds were named as defendants in multiple legal actions. The insureds sought advancement of defense costs in several of these actions. The primary insurer agreed to advance costs under that policy, but Travelers, Axis, and Arch did not agree to do so.

Analysis

Upon cross-motions for summary judgement, the court found for the insurers, holding that the prior knowledge exclusions of the warranty letters barred coverage for the actions, all of which grew out of the SEC inquiry and/or the underlying acts that were the subject of the SEC inquiry.

Although at the time it was not yet an “investigation” but only an “inquiry,” the SEC sent multiple letters to Infinity Q prior to the execution of the warranty letters. Infinity Q responded to those SEC letters and represented to the board of its fund that the SEC “inquiry is ongoing” as late as August 14, 2021. Just days later, Infinity Q executed the warranty letters without disclosing the SEC inquiry. The court observed that neither party had contended, or demonstrated, that the language of the warranty letters was ambiguous. In the absence of ambiguity, the court must interpret these provisions in accord with their “plain meaning.” The court held that the plain meaning of the expansive language in the warranty letter – that “any knowledge or information . . . of any act . . . that may give rise to a claim . . . shall be excluded from coverage” – plainly covered the SEC inquiry. The undisputed facts showed that Infinity Q was well aware of the inquiry and was responding to it.

The court also rejected the insureds’ further argument that there were issues of fact as to whether the warranty letters were part of the policies. First, with respect to Travelers, the court found that the undisputed facts showed that Infinity Q understood that the warranty letter was required and intended it to apply to Travelers, based on the email correspondence between Infinity Q and its retail broker and the fact that Infinity Q updated one copy of the warranty letter to specify the policy coverage limits applicable to Travelers (although it failed to update the recipient name). With respect to Arch, there was a warranty letter specifically addressed to it. With respect to Axis, Axis clearly conditioned the policy on the receipt of a warranty letter and only issued the policy once the warranty letters had been sent to it.

The insureds still tried to maintain that the warranty letters did not apply because the excess policies themselves did not mention a prior knowledge exclusion. The court rejected this argument finding that “the fact that the Excess Policies do not specifically mention the words ‘Prior Knowledge Exclusion’ does not negate the applicability of the Warranty Letters[’] exclusionary language which is ‘specific,’ ‘clear,’ ‘plain,’ ‘conspicuous’ and ‘not contrary to public policy.” In other words, the court appeared to count as sufficient the combined undisputed facts that (i) the policies were conditioned upon warranty letters, and (ii) the warranty letters contained broad representations of no prior knowledge.

Finally, the court rejected the insureds’ suggestion that the warranty letters’ exclusion should be severable such that coverage would be preserved for “innocent” insureds (those individuals and/or entities who did not themselves have prior knowledge). The court rejected this suggestion as incompatible with the plain language of the exclusion, which is broad and applies to “any claim for, based upon, arising from, or in any way related to any act, error, omission, fact or circumstance of which any such person or entity has any knowledge or information.”

The insureds argued that a severability clause in section XII of the primary policy should apply because subsection XII(A) defines its “Application” as including any “warranty.” The insureds argued that the warranty letters fall under this definition of “warranty” and hence are controlled by the severability clause from the primary policy. The court rejected this argument because, among other things, it found that the severability clause in the primary policy was expressly applicable to subsection XII(B). Further, even if section XII did apply, subsection XII(c) expressly imputed any knowledge by a “Chief Compliance Officer” (one of Mr. Lindell’s titles) to “the Insured Entity and any of its Subsidiaries” – meaning that the “innocent” insureds would not be innocent because of their imputed knowledge.

Takeaways

• Delaware courts continue to interpret insurance contracts as contracts, and look to the “plain meaning” of contractual terms.
  • A prior knowledge exclusion that appears in a warranty letter upon which insurance coverage is conditioned can apply to exclude claims from coverage even through the insurance policy itself does not mention the prior knowledge exclusion.
  • Broad language in a prior knowledge exclusion (e.g., “any knowledge or information of any act, error, omission, fact or circumstance that may give rise to a claim”) will be read broadly, in accordance with the plain meaning of such terms, and will likely apply to knowledge of an SEC inquiry, even if there is not yet an SEC investigation.

Client Alert 2022-244