Who pays for corporate investigations? Not the D&O insurance policy ... And it's a good thing for directors that it doesn't.

• Author: Rosenberg, Evan
• Position: RISK MATTERS

AS I VISIT WITH CUSTOMERS, agents and brokers, I have often been asked why insurance companies do not offer directors and officers liability coverage for the costs associated with internal corporate investigations. These costs are incurred when federal or state authorities launch broad investigations into corporate practices, and many companies, sensing that they might be swept into an inquiry, conduct internal investigations. Depending on its scope, costs for an internal investigation can range from as "little" as $2 million to more than $15 million.

These internal investigations are smart moves that could help mitigate future losses; however, the cost for such an investigation is not insurable under a directors and officers liability insurance policy. Nor should it be. Covering these costs under the D&O policy would create a situation where more coverage really means less, notably for outside directors.

Outside directors already have seen a significant dilution of their D&O limits. It began in 1995 when policies started covering corporate entities in securities class-action lawsuits. Outside directors continued to see more of their limits jeopardized as policies began covering employment practices, employed lawyers and fiduciary liability as well as executives' criminal defense costs. In all of these cases, only inside directors and officers benefited from the D&O coverage since outside directors rarely, if ever, face these risks.

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Similarly, if D&O policies begin covering internal investigations, only the corporate entity would benefit because regulators usually target organizations and not outside directors. D&O policies, originally designed to protect executives' wealth, would be reshaped into financial shields for corporate balance sheets. And, once again, the price for this coverage expansion would be greater dilution of outside directors' D&O limits.

Still, some corporate executives might ask, "How much could covering the cost of internal investigations really hurt outside directors?" The answer: Plenty.

Sweeping regulatory investigations have become a routine element of the business climate. For example, after its Division of Enforcement modified some investigative processes last year in the wake of the Bernard Madoff securities fraud scandal, the SEC has been far more aggressive. During 2009, the SEC opened 496 formal investigations, twice as many as it did the previous year. In addition, in an effort to...