A regulatory exclusion may be incorporated into the D&O policy form or added as an endorsement. The exclusion bars coverage for claims brought by any or a specific regulatory agency. Such regulatory exclusions have typically been found in policies issued to financial institutions or insureds whose activities are governed by various federal, state, or local regulatory agencies. Nonbanking examples include industries associated with public power generation and transmission or insurance company operations.

Historic Background

During the 1980s, responding to the crescendo of claims of mismanagement against financial institutions, underwriters all but ceased to offer D&O liability coverage to other than very solvent, well-run banks and other financial institutions. This class of business continues to be underwritten cautiously.

It is estimated that the Federal Insurance Deposit Corporation (FDIC) filed more than 1,500 claims in 1990 and 1991 against directors and officers and professionals involved in failed financial institutions. As the primary regulator of all federally insured depository institutions, the FDIC is the receiver, conservator, and liquidator of nearly all insolvent financial institutions.

One of the FDIC's primary obligations is to recoup assets of failed institutions. Using private counsel supervised by the FDIC General Counsel's Office, prosecution of claims is made directly against directors and officers of failed financial institutions when it is felt these individuals have breached their fiduciary duties. It is interesting to note that in instances involving failure or insolvency, it is the regulatory agencies that become the de facto beneficiaries of the insurance policy rather than the institutions and their directors and officers.

Prior to the development of regulatory exclusions, insurers claimed that the insured-versus-insured exclusion would prohibit coverage under the D&O policy for suits by such agencies against the individual directors and officers on behalf of or in the right of the corporation. The FDIC's position, generally upheld by the courts, was that their actions were brought against the insured directors and officers not only on behalf of the institution, but also on behalf of the shareholders, depositors, creditors, and others who were not insureds under the policy.

In response to the FDIC's successful circumvention of the insured-versus-insured exclusion, some D&O insurers imposed a regulatory exclusion applicable to financial institutions. The following is an example from an old policy form.

(A)The Insurer shall not be liable to make any payment under either Insuring clause 1(A) or (B) in connection with any Claim made against an Insured:

(13)by or on behalf of, or at the direction of, or with the participation of any federal or state regulatory agency, authority, or deposit insurance organization whether in its own capacity or as receiver, conservator, liquidator or in any other capacity, or based upon or attributable to any action or proceeding brought by such agency, authority or organization;

The FDIC also enjoyed success with the position that both the insured-versus-insured and regulatory-agency exclusions were void and unenforceable because they were against public policy. It is not surprising that the insured directors and officers overwhelmingly took a similar position regarding enforceability of such exclusions. When such exclusions are upheld, insured directors and officers may be left entirely unprotected, as indemnification from the insolvent institution would be unavailable.

During this early period courts took a mixed view of such exclusions, sometimes finding them either ambiguous or against public policy, and at other times upholding them.

Although development and implementation of the regulatory exclusions have their roots in the savings-and-loan and banking calamities of the mid-1980s, in many instances these exclusions extend beyond the banking regulators' domain. Notice that the example refers to “any federal or state regulatory agency” and is not limited to claims by or on behalf of banking or other financial institution regulators.

Some regulatory exclusions not only list a number of specific agencies, claims from which the insurer intends to exclude, but also references “any other Federal or State regulatory agency.” This wording could encompass any number of regulatory agencies such as the SEC, EEOC, FCC, ICC, and air-quality regulators.

Even regulatory exclusions that purport to bar claims from specific agencies can be deceptive. Consider the following endorsement:

Public Power Regulatory Agency Exclusion

I.The following definition is added to Section II of the POLICY:

(Q)AGENCY: The term “AGENCY” shall mean the Rural Utilities Service, the National Rural Electric Cooperative Finance Corporation, or any other agency having regulatory or supervisory authority over the COMPANY.

II.The following exclusions are added to Section III of the POLICY:

(M)by, or on behalf of, in the right of, at the request of, or for the benefit of, any AGENCY, including but not limited to, any CLAIM which any AGENCY makes in its regulatory or supervisory capacity, or as receiver, conservator, liquidator, trustee, rehabilitator, or otherwise; whether such CLAIM is made in the name of such AGENCY, in the name of any other entity, or solely in the name of any third party:

(N)by any entity or person against whom any AGENCY has asserted any claim or demand whatsoever and which arises out of, directly or indirectly results from, or is in consequence of, such claim or demand.

While the title of the endorsement appears to limit its applicability to public power regulatory agencies, notice that the term “agency” is defined to include “any other agency having regulatory or supervisory authority over the company.” This language could be liberally interpreted to apply as respects other agencies, to the extreme detriment of the insured.

The Regulatory Exclusion Today

Between the 1980s and through the aftermath of the financial crisis of 2008, D&O insurers had backed away from use of regulatory exclusions. During this period regulatory exclusions became a much less common feature of financial institution D&O policies.

Since 2008, however, the regulatory exclusion has become much more common, particularly with troubled institutions renewing coverage. Although the bank failures following the 2008 crisis have largely diminished, some banks continue to suffer financial dislocations and may be viewed by D&O insurers as bad risks. In addition, the FDIC continues to work through its caseloads, pursuing litigation related to banks that failed several years ago.

Although some cases in the 1990s cast doubt on whether courts could enforce the regulatory exclusion, more recent case law suggests that the regulatory exclusion is enforceable. In July 2013 the U.S. Court for the Central District of California upheld the enforceability of the regulatory exclusion against an action by the FDIC.

The FDIC also recognized enforceability of the regulatory exclusion when on October 10, 2013, it issued a statement that warned financial institutions to carefully examine D&O policies for existence of exclusionary language contained in regulatory exclusions.

As such, care should be taken to ensure that any such exclusion, if present, does not also preclude claims from unnamed or unidentified regulatory agencies on a blanket basis. If broad regulatory exclusions are part of the basic policy form or endorsement, the insured should attempt to negotiate a reduction in the scope of the excluded agencies