Wells Notices and Subsequent Enforcement Action Deemed First Made at the Time when SEC Original Investigation Began

In a win for Wiley Rein’s client, a Texas state court, applying Texas law, has held that no coverage was available for Wells notices issued and an enforcement action brought by the United States Securities and Exchange Commission (SEC) because they were related to the SEC’s original investigation, which commenced prior to the claims-made policy period.  UniPixel, Inc. v. XL Specialty Ins. Co., (Tex. Dist. Ct., Harris Cnty. Aug. 23, 2018).

The insured company developed and sold display and touchscreen technologies for use in phones, tablets, notebooks, and other electronic devices.  On June 6, 2013, shareholders filed a class action against the company and its directors and officers for violating securities laws in connection with certain misrepresentations and omissions concerning one of its technologies, its readiness to ship that technology, and its license agreement with an unnamed computer manufacturer.  Shortly thereafter, on November 18, 2013, the SEC issued a formal order of investigation and served subpoenas on the company and its directors and officers, seeking testimony and documents for an investigation.  The SEC’s formal order asserted that the company or its directors and officers had made untrue statements or omissions in connection with the purchase or sale of securities, including concerning the viability and revenue potential of its technology products.  The formal order further contended that the company or its directors and officers might have failed to maintain accounting controls sufficient to provide reasonable assurance that transactions were recorded as necessary to permit preparation of financial statements.  On September 9, 2014, the company’s shareholders filed a derivative lawsuit alleging breaches of fiduciary duties due to the directors and officers’ false representations that the company’s technology was ready to be shipped to customers.

The insurance policy at issue incepted on April 1, 2015.  On June 15, 2015, the SEC sent Wells notices to the company’s directors and officers, in which the SEC stated it had preliminarily decided to recommend enforcement actions against them based on its investigation pursuant to the formal order.  On March 9, 2016, the SEC filed a lawsuit against the company and its directors and officers, alleging that they had made materially misleading statements and omissions about the company’s technologies and business products and had also violated accounting standards by failing to disclose the material terms of the company’s agreements with other technology companies.  The company and the directors and officers provided notice of the Wells notices.  The insurer denied coverage on the ground that the Wells notices were interrelated with the other lawsuits and the SEC’s investigation commenced prior to the claims-made policy period.  The company and the directors and officers then filed suit, arguing that the Wells notices and the SEC lawsuit constituted a new claim first made during the policy period.

The court held that the insurer had properly denied coverage because the Wells notices and the subsequent enforcement action alleged the same “Interrelated Wrongful Acts” as those at issue in the ongoing shareholder and derivative lawsuits and the SEC’s investigation.  Therefore, the Wells notices and the SEC enforcement action were deemed made prior to the inception of the claims-made policy and thus outside the scope of coverage.  In so holding, the court rejected the argument that the Wells notices and the subsequent lawsuit by the SEC constituted new claims first made during the policy period.  The court explained that, “[l]ike the homeowner whose house is already on fire when he buys fire insurance, the fact that the fire spreads to a new part of the house after the purchase of insurance does not mean there is a new fire; it is the same fire that existed before insurance was purchased.”