FCPA and Indemnification

Heightened enforcement has also led to increased penalties. In 2007, FCPA fines totaled approximately $87 million. Just two years later, FCPA fines increased to $627 million. And, in the first two months of 2010, approximately $1.2 billion in fines were assessed for FCPA violations. In February 2010, BAE Systems announced that it had reached agreements with the DOJ and UK Serious Fraud Office to resolve improper payment investigations. Pursuant to its agreement with the DOJ, in March, BAE pled guilty to one charge of conspiring to make false statements and was sentenced to pay a $400 million criminal fine. In April 2010, Daimler/AG and three of its subsidiaries resolved an FCPA investigation by agreeing to pay $93.6 million in criminal penalties and disgorge $91.4 million in profits. Also in April, Charles Paul Edward Jumet was sentenced to 87 months in prison ' the longest prison term imposed under the FCPA ' and ordered to pay a $15,000 fine for paying bribes to former Panamanian officials to secure maritime contracts. Release, “Virginia Resident Sentenced to 87 Months for Bribing Foreign Government Officials” (April 19, 2010).

There is no doubt that the federal government is aggressively investigating and prosecuting both individuals and companies that are engaging in acts of bribery ' either directly or indirectly ' in violation of the FCPA. The targets of these efforts ' directors, officers, and the corporation itself ' will, more likely than not, have indemnity agreements (or obligations) and a directors' and officers' liability insurance policy (D&O policy). Directors and officers are exposed to personal loss under the FCPA because not only does the FCPA expressly prohibit corporate indemnification, but also there are several D&O policy provisions that may serve to bar coverage for FCPA-assessed fines and penalties.

D&O Coverage

To avoid personal exposure for any loss, not just losses under the FCPA, directors and officers will first seek indemnification from the corporation under any relevant corporate documents, such as the corporate charter or bylaws, or any employment agreements. If that fails, directors and officers will likely turn to any available directors and officers insurance coverage. Neither indemnity nor insurance, however, may be sufficient to protect a director or officer from personal exposure created by the FCPA.

The FCPA expressly prohibits a corporation from indemnifying its directors or officers ' either directly or indirectly ' for FCPA-imposed fines and penalties. See 15 U.S.C.
” 78dd-2(g)(3), 78ff(c)(3), 78dd-3(e)(3) (2009). As for defense expenses, the FCPA is silent on whether a corporation may indemnify its directors and officers for the costs incurred to defend against a FCPA investigation or prosecution. Thus, a corporation may indemnify its directors and officers for any defense expenses incurred in such a proceeding (assuming such indemnification is allowed by state statute).

Given this, directors and officers, as well as corporations themselves, will turn to their D&O policy for insurance coverage for either FCPA-imposed fines or defense expenses in connection with such investigations and prosecutions. The directors and officers will likely seek coverage for any personal and unindemnifiable exposure, while corporations will seek reimbursement for any indemnification obligations owed the directors and officers. While coverage for any claim must be examined on a case-by-case basis, there are least two policy provisions that are relevant.

First, many D&O policies expressly provide that “Loss” does not include, except for defense expenses, civil or criminal fines or penalties, which effectively bars coverage for FCPA-assessed fines and penalties. Some policies, however, provide an exception for FCPA-related civil penalties. This exception is only intended to provide coverage for non-willful violations of the FCPA. Yet directors and officers ' and their insurers ' may not know if their actions constitute a “willful” violation of the FCPA until after trial. Most of the proceedings brought by the DOJ or SEC are resolved by way of settlement or non-prosecution agreement.

Regardless of whether the policy expressly excludes fines or penalties, some courts have rejected an insured's attempt to obtain coverage for fines and penalties on public policy grounds. In Mortenson v. National Union Fire Insurance Co. of Pittsburgh, P.A., 249 F.3d 667 (7th Cir. 2001), the Fourth Circuit explained that it is against public policy to insure against criminal or civil fines and penalties because the insurance creates an “acute moral hazard” that the insured will commit the act insured against. Id. at 671-72. Thus, even absent a specific provision addressing fines and penalties, insurers may successfully argue ' on public policy grounds ' that such loss should not be covered.

Second, D&O policies typically exclude coverage for certain conduct by an insured: 1) dishonest or fraudulent acts; and/or 2) gaining of any profit to which they were not legally entitled. Claims arising out of FCPA investigations and prosecutions will necessarily include allegations that an insured engaged in dishonest or fraudulent acts and may also include allegations that the insured obtained profits as a result of the bribery. Such allegations ' if proven ' could trigger the policy's conduct exclusions.

The specific wording of the conduct exclusion can be critical in determining its applicability. Generally, conduct exclusions contain either “in fact” or “final adjudication” language: excluding coverage for claims arising out of the gaining “in fact” of any profit or advantage to which an insured was not legally entitled; or excluding coverage for claims arising out of the gaining of any profit or advantage to which a “final adjudication” adverse to an insured establishes that the insured was not legally entitled.

'Final Adjudication'

Where the exclusion contains “final adjudication” language, courts have consistently held that the adjudication must take place in the underlying liability action for which coverage is sought, not in a collateral proceeding such as insurance coverage litigation. See, e.g., Atlantic Permanent Fed. Sav. & Loan Ass'n v. American Cas. Co., 839 F.2d 212, 217 (4th Cir.), cert. denied, 486 U.S. 1056 (1988). Accordingly, if the claims alleging prohibited conduct are settled before their adjudication, the exclusion does not apply. See, e.g., PepsiCo Inc. v. Continental Cas. Co., 640 F. Supp. 656, 659-60 (S.D.N.Y. 1986). In contrast, the “in fact” language has been interpreted to mean that the exclusion is triggered if, in either the liability action or subsequent coverage litigation, an insurer can prove that the prohibited conducted occurred. Thus, if the claims are settled, the insurer can still litigate the applicability of the exclusion.

Given that the vast majority of conduct exclusions contain “final adjudication” language, and given that most cases settle, while an insurer should reserve its rights to deny coverage based on the conduct exclusions, as a practical matter, it is unlikely that the “final adjudication” will occur and thereby trigger the exclusion. That said, one line of cases ' commencing with Level 3 ' holds that claims for restitution and disgorgement are not insurable. Level 3 Commc'ns, Inc. v. Federal Ins. Co., 272 F.3d 908, 910 (7th Cir. 2001) (“'loss' within the meaning of an insurance contract does not include the restoration of an ill-gotten gain”). In the event the SEC or DOJ seeks disgorgement of profits based on purported bribery, then a court may find, based on a Level 3 analysis, that the claim is uninsurable.

Conclusion

These are only a handful of the potential D&O coverage issues arising out of FCPA investigations and proceedings. Other policy provisions, including the definitions of Claim, Wrongful Act, and even Securities Claim, will certainly be relevant in a coverage analysis. In any case, as the government continues its aggressive efforts at prosecuting individuals and corporations that engage in, or even tolerate, bribery of foreign officials, all participants, including D&O insurers, are just beginning to get their arms around the potential exposure from this increased enforcement. As fines and penalties are on the rise and as indemnification may be limited, it is inevitable that parties will turn to their D&O policies for cover.

Nancy D. Adams, CPCU, a partner in the litigation section in Mintz Levin Cohn Ferris, Glovsky and Popeo's Boston office, is a member of the firm's insurance/reinsurance and insurance/bankruptcy groups. Alec J. Zadek is a former Mintz Levin associate and rejoined the firm in June. The views expressed in the article are those of the authors and not necessarily those of Mintz Levin or its clients.

The Foreign Corrupt Practices Act (FCPA) prohibits any U.S. citizen, resident, national, or corporation from bribing foreign politicians or government officials. In the last five years, there have been two noticeable FCPA trends: 1) increased enforcement; and 2) increased sanctions. On Jan. 13, 2010, the Securities and Exchange Commission (SEC) announced the creation of five national specialized units to address complex areas of securities fraud, one of which will be dedicated to the enforcement of the FCPA. See Release, “SEC Names New Specialized Unit Chiefs and Head of New Office of Market Intelligence,” 2010-5 (Jan. 13, 2010). The Chief of the Foreign Corrupt Practices Act Unit, Cheryl Scarboro, also signaled an increase in enforcement actions, “[t]he [SEC] has brought landmark cases in recent years involving Siemens and Halliburton and the former CEO of KBR. Civil sanctions are at an all-time high. This is an opportune time for the Commission to dedicate more resources to this vital part of the Enforcement program ' A primary mission of this Unit is to devise ways for us to be more proactive in our enforcement of the FCPA.” Id.

To demonstrate this resolve, there are approximately 150 ongoing FCPA investigations, eight full-time Department of Justice (DOJ) FCPA prosecutors (in addition to more than 50 other prosecutors in the fraud section of the DOJ) and 10 FBI agents dedicated exclusively to FCPA enforcement. Indeed, just this past January, 150 FBI agents arrested 22 individuals and executed 14 search warrants across the country resulting from an undercover operation relating to alleged foreign bribery in the military and law enforcement products industry. “This ongoing investigation is the first large-scale use of undercover law enforcement techniques to uncover FCPA violations and the largest action ever undertaken by the Justice Department against individuals for FCPA violations,” said Assistant Attorney General Lanny A. Breuer. See Release, “Twenty-Two Executives and Employees of Military and Law Enforcement Product Companies Charged in Foreign Bribery Scheme” (Jan. 19, 2010). “The fight to erase foreign bribery from the corporate playbook will not be won overnight, but these actions are a turning point. From now on, would-be FCPA violators should stop and ponder whether the person they are trying to bribe might really be a federal agent.” Id.

Increased Penalties

Heightened enforcement has also led to increased penalties. In 2007, FCPA fines totaled approximately $87 million. Just two years later, FCPA fines increased to $627 million. And, in the first two months of 2010, approximately $1.2 billion in fines were assessed for FCPA violations. In February 2010, BAE Systems announced that it had reached agreements with the DOJ and UK Serious Fraud Office to resolve improper payment investigations. Pursuant to its agreement with the DOJ, in March, BAE pled guilty to one charge of conspiring to make false statements and was sentenced to pay a $400 million criminal fine. In April 2010, Daimler/AG and three of its subsidiaries resolved an FCPA investigation by agreeing to pay $93.6 million in criminal penalties and disgorge $91.4 million in profits. Also in April, Charles Paul Edward Jumet was sentenced to 87 months in prison ' the longest prison term imposed under the FCPA ' and ordered to pay a $15,000 fine for paying bribes to former Panamanian officials to secure maritime contracts. Release, “Virginia Resident Sentenced to 87 Months for Bribing Foreign Government Officials” (April 19, 2010).

There is no doubt that the federal government is aggressively investigating and prosecuting both individuals and companies that are engaging in acts of bribery ' either directly or indirectly ' in violation of the FCPA. The targets of these efforts ' directors, officers, and the corporation itself ' will, more likely than not, have indemnity agreements (or obligations) and a directors' and officers' liability insurance policy (D&O policy). Directors and officers are exposed to personal loss under the FCPA because not only does the FCPA expressly prohibit corporate indemnification, but also there are several D&O policy provisions that may serve to bar coverage for FCPA-assessed fines and penalties.

D&O Coverage

To avoid personal exposure for any loss, not just losses under the FCPA, directors and officers will first seek indemnification from the corporation under any relevant corporate documents, such as the corporate charter or bylaws, or any employment agreements. If that fails, directors and officers will likely turn to any available directors and officers insurance coverage. Neither indemnity nor insurance, however, may be sufficient to protect a director or officer from personal exposure created by the FCPA.

The FCPA expressly prohibits a corporation from indemnifying its directors or officers ' either directly or indirectly ' for FCPA-imposed fines and penalties. See 15 U.S.C.
” 78dd-2(g)(3), 78ff(c)(3), 78dd-3(e)(3) (2009). As for defense expenses, the FCPA is silent on whether a corporation may indemnify its directors and officers for the costs incurred to defend against a FCPA investigation or prosecution. Thus, a corporation may indemnify its directors and officers for any defense expenses incurred in such a proceeding (assuming such indemnification is allowed by state statute).

Given this, directors and officers, as well as corporations themselves, will turn to their D&O policy for insurance coverage for either FCPA-imposed fines or defense expenses in connection with such investigations and prosecutions. The directors and officers will likely seek coverage for any personal and unindemnifiable exposure, while corporations will seek reimbursement for any indemnification obligations owed the directors and officers. While coverage for any claim must be examined on a case-by-case basis, there are least two policy provisions that are relevant.

First, many D&O policies expressly provide that “Loss” does not include, except for defense expenses, civil or criminal fines or penalties, which effectively bars coverage for FCPA-assessed fines and penalties. Some policies, however, provide an exception for FCPA-related civil penalties. This exception is only intended to provide coverage for non-willful violations of the FCPA. Yet directors and officers ' and their insurers ' may not know if their actions constitute a “willful” violation of the FCPA until after trial. Most of the proceedings brought by the DOJ or SEC are resolved by way of settlement or non-prosecution agreement.

Regardless of whether the policy expressly excludes fines or penalties, some courts have rejected an insured's attempt to obtain coverage for fines and penalties on public policy grounds. In Mortenson v. National Union Fire Insurance Co. of Pittsburgh, P.A. , 249 F.3d 667 (7th Cir. 2001), the Fourth Circuit explained that it is against public policy to insure against criminal or civil fines and penalties because the insurance creates an “acute moral hazard” that the insured will commit the act insured against. Id. at 671-72. Thus, even absent a specific provision addressing fines and penalties, insurers may successfully argue ' on public policy grounds ' that such loss should not be covered.

Second, D&O policies typically exclude coverage for certain conduct by an insured: 1) dishonest or fraudulent acts; and/or 2) gaining of any profit to which they were not legally entitled. Claims arising out of FCPA investigations and prosecutions will necessarily include allegations that an insured engaged in dishonest or fraudulent acts and may also include allegations that the insured obtained profits as a result of the bribery. Such allegations ' if proven ' could trigger the policy's conduct exclusions.

The specific wording of the conduct exclusion can be critical in determining its applicability. Generally, conduct exclusions contain either “in fact” or “final adjudication” language: excluding coverage for claims arising out of the gaining “in fact” of any profit or advantage to which an insured was not legally entitled; or excluding coverage for claims arising out of the gaining of any profit or advantage to which a “final adjudication” adverse to an insured establishes that the insured was not legally entitled.

'Final Adjudication'

Where the exclusion contains “final adjudication” language, courts have consistently held that the adjudication must take place in the underlying liability action for which coverage is sought, not in a collateral proceeding such as insurance coverage litigation. See, e.g., Atlantic Permanent Fed. Sav. & Loan Ass'n v. American Cas. Co. , 839 F.2d 212, 217 (4th Cir.), cert. denied, 486 U.S. 1056 (1988). Accordingly, if the claims alleging prohibited conduct are settled before their adjudication, the exclusion does not apply. See, e.g., PepsiCo Inc. v. Continental Cas. Co. , 640 F. Supp. 656, 659-60 (S.D.N.Y. 1986). In contrast, the “in fact” language has been interpreted to mean that the exclusion is triggered if, in either the liability action or subsequent coverage litigation, an insurer can prove that the prohibited conducted occurred. Thus, if the claims are settled, the insurer can still litigate the applicability of the exclusion.

Given that the vast majority of conduct exclusions contain “final adjudication” language, and given that most cases settle, while an insurer should reserve its rights to deny coverage based on the conduct exclusions, as a practical matter, it is unlikely that the “final adjudication” will occur and thereby trigger the exclusion. That said, one line of cases ' commencing with Level 3 ' holds that claims for restitution and disgorgement are not insurable. Level 3 Commc'ns, Inc. v. Federal Ins. Co. , 272 F.3d 908, 910 (7th Cir. 2001) (“'loss' within the meaning of an insurance contract does not include the restoration of an ill-gotten gain”). In the event the SEC or DOJ seeks disgorgement of profits based on purported bribery, then a court may find, based on a Level 3 analysis, that the claim is uninsurable.

Conclusion

These are only a handful of the potential D&O coverage issues arising out of FCPA investigations and proceedings. Other policy provisions, including the definitions of Claim, Wrongful Act, and even Securities Claim, will certainly be relevant in a coverage analysis. In any case, as the government continues its aggressive efforts at prosecuting individuals and corporations that engage in, or even tolerate, bribery of foreign officials, all participants, including D&O insurers, are just beginning to get their arms around the potential exposure from this increased enforcement. As fines and penalties are on the rise and as indemnification may be limited, it is inevitable that parties will turn to their D&O policies for cover.

Nancy D. Adams, CPCU, a partner in the litigation section in Mintz Levin Cohn Ferris, Glovsky and Popeo's Boston office, is a member of the firm's insurance/reinsurance and insurance/bankruptcy groups. Alec J. Zadek is a former Mintz Levin associate and rejoined the firm in June. The views expressed in the article are those of the authors and not necessarily those of Mintz Levin or its clients.