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Insider trading crackdown may trigger claims

Whether insurance covers SEC targets remains unclear

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Insider trading crackdown may trigger claims

NEW YORK—The government is cracking down on insider trading, and some firms are turning to their management liability insurers to pay the costs associated with such investigations.

The success rate for those claims, though, varies, experts say.

Regulators have announced more insider trading investigations in the past two years.

For example, Raj Rajaratnam, who founded the now-defunct Galleon Group hedge fund, is fighting claims made in late 2009 that he ran an insider trading ring that racked up tens of millions of dollars in illegal investment gains. The Securities and Exchange Commission also alleged in February that six technology company employees sold insider information as consultants to expert network firm Primary Global Research L.L.C.

These developments have taken place as the Wall Street regulator extends its insider trading crackdown.

In recent months, a New York judge reportedly ruled that the SEC can use wiretap evidence in Mr. Rajaratnam's case. Assistant U.S. Attorney General Lanny Breuer said during a Senate committee hearing last September that the Justice Department had tripled the number of people who review wiretaps.

How insurance coverage would respond to claims from targets of SEC investigations is unclear.

James O'Brien, managing director at Marsh FINPRO-PEMA in New York, a unit of Marsh & McLennan Cos. Inc., said professional liability policies could cover people such as Mr. Rajaratnam for legal expenses related to insider trading allegations, unless it's proven that the hedge fund manager committed fraud, which is excluded from coverage.

If an insured settles without admitting guilt—as often happens in such matters—then the settlement costs could be covered.

If the investment firm had insurance for employees, they typically also would be covered under the same policy, Mr. O'Brien said.

Mr. Rajaratnam's spokesman did not provide information about the hedge fund manager's insurance.

Although coverage may be available under professional liability policies, few policyholders are successfully making claims for legal expenses related to insider trading investigations, experts say.

Insurer attorney Dan Bailey, a member of Bailey Cavalieri L.L.C. in Columbus, Ohio, said he's seen “some uptick” but not “a huge one” in claims related to insider trading during recent months. “We haven't seen a huge amount of losses being paid out, and (the issue) hasn't affected pricing or the market,” he said.

John McKenna, a broker with ARC Excess & Surplus L.L.C. in Garden City, N.Y., said he hasn't seen “a lot” of cases similar to Galleon's among his financial services clients. He estimated that possibly 15% of his clients had claims in the past year, about half of which included insider trading allegations.

Mr. O'Brien said Marsh has seen a “significant number of claims” from clients receiving subpoenas, and those related to investigations of insider trading are up around 100% compared with last year.

The claims process can be complicated.

“A lot of the insider trading charges involve acting for personal gain as opposed to the employer's, so when people do things outside the scope of their employment, the insurance policy doesn't cover it,” said Robert Heim, a partner at Meyers & Heim L.L.P in New York and a former SEC prosecutor. When the SEC settles with an individual defendant, it often includes a condition not to seek reimbursement from insurance policies that might apply, he said.

Mr. O'Brien said insurers sometimes can argue that someone acted outside of professional capacity, but it would depend on the specifics of the case. If a complaint is against an officer, “the insurance company would have a difficult argument to say he's not operating in that capacity,” Mr. O'Brien said. In addition, he said he has not seen instances with his clients in which the SEC imposed settlement conditions that limit reimbursement.

Court rulings on the issue of claims for insider trading investigations have already taken place. Adding fodder for new battles, insurers introduced coverage last year for informal inquiries. For example, a director might have asked lawyers for advice on responding to investigator questions about an insider trading case.

American International Group Inc.'s property/casualty unit Chartis Inc. and many others now provide policies offering to pay such costs, depending on the circumstances.

In June 2007, a Dow Jones Newswires article reported that Office Depot Inc. may have improperly disclosed material information to financial analysts. An SEC investigation ensued, which Office Depot settled last October.

When Office Depot claimed more than $23 million from National Union Fire Insurance Co. of Pittsburgh, Pa., under its D&O policy, the Chartis unit acknowledged its obligation to pay the defense costs for SEC subpoenas and Wells Notices served to officers and directors, and for costs incurred in defending the various securities lawsuits, but not for an earlier internal investigation and audit costs.

Last October in West Palm Beach, Fla., U.S. District Court Judge Kenneth A. Marra ruled that the policy's definition of loss didn't cover those claims, according to court documents.

Brian J. Kovack, president of the investment advisory firm Kovack Securities Inc. in Fort Lauderdale, Fla., said he doesn't expect his insurance to protect against fraud.

Insurance is for accidents, not intentional actions, he said. His team uses computer models and programs that provide exception reports so their compliance department can determine whether any employees were involved in insider trading.

“To buy coverage for which you can go out and commit fraud and essentially double-dip defies logic,” said Mr. Kovack, whose firm has never been subject to insider trading allegations.

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