Appeals from the United States District Court for the Northern District of Illinois, Eastern Division, No. 82 C 4762, Marvin E. Aspen, Judge. Originally Reported at:
Bauer, Chief Judge, and Cudahy and Ripple, Circuit Judges.
The named plaintiff, Beverly J. Otto, brought this class action against Variable Annuity Life Insurance Company ("VALIC"), the Variable Annuity Marketing Company ("VAMCO"), a wholly-owned subsidiary of VALIC, certain other affiliated companies, and individual officers and directors of the corporate defendants. Otto alleged violations of the Securities Exchange Act of 1934 (the "1934 Securities Act"), 15 U.S.C.A. § 78 (West 1981 & Supp. 1986), the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. §§ 1001-1461 (West 1985 & Supp. 1986), and the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C.A. §§ 1961-1968 (West 1984 & Supp. 1986). Otto also alleged conspiracy, breach of contract and common law fraud. The district court granted the defendants' motion for summary judgment on the Securities Act and ERISA claims, dismissed the RICO and conspiracy claims for failure to state a claim upon which relief could be granted, and dismissed the state law claims of breach of contract and common law fraud for lack of jurisdiction. 611 F. Supp. 83. The court refused to reconsider its order or permit Otto to file an amended complaint. 107 F.R.D. 635. We affirm the judgment of the district court, except that we reverse the judgment with respect to the dismissal of the claims of conspiracy to violate ERISA and the 1934 Securities Act and instead grant the defendants' motion for summary judgment on those claims.
VALIC is in the business of selling, among other things, certain annuities which qualify for tax-exempt status under section 403(b) of the Internal Revenue Code. Typically, VALIC enters into a "group unit purchase contract" with a tax-exempt organization such as a public school or college under which the organization permits VALIC to offer its various annuity plans to the organization's employees. If an employee chooses to participate in one of VALIC's plans, he or she directs the employer to contribute a portion of the employee's salary (up to a statutorily prescribed maximum) to purchase an annuity.
VALIC offers participating employees two types of annuity contracts: the fixed annuity and the variable annuity. Under both plans, the principal and any return accumulate during the life of the contract. At the end of the contract, the employee may withdraw the accumulated monies or use them to purchase an annuity from VALIC.
Under the fixed annuity, VALIC guarantees the principal and an interest rate of 4 percent per year for the first ten years and 3 1/2 percent thereafter. "Excess" interest over the guaranteed rate is paid to fixed annuity participants at the discretion of VALIC. Funds are held in VALIC's unsegregated general account and are invested primarily in long-term debt-type instruments such as mortgages and bonds.
Under the variable annuity, neither the principal nor the rate of return is guaranteed; both fluctuate with VALIC's investment performance. Funds are placed in what is known as a Separate Account, an account segregated from VALIC's general assets. The Separate Account's funds are invested in a diversified portfolio of common stocks and other equity-type investments.
Otto purchased a fixed annuity from VALIC in 1975. On August 2, 1982, she brought this class action on behalf of herself and all Illinois investors who participated in VALIC's fixed annuity plan between October 17, 1975 and August 2, 1982. Otto claims that VALIC failed to disclose the manner in which interest was calculated under the fixed annuity plan -- specifically, that it used the "banding" or "new money" method for crediting "excess" interest to the fixed annuity account. Under the banding method, the current rate of excess interest is paid only on deposits made during the current period. All prior contributions continue to earn the rates of excess interest declared during the periods in which those contributions were made. Otto also claims that the defendants failed to disclose the method by which a participant in the fixed annuity plan could maximize his or her rate of return. According to Otto, an employee could earn the current rate of interest by transferring funds from the fixed account into a variable account for 120 days and then transferring them back into the fixed account. In Counts I, II and III of her amended complaint, Otto contends that the defendants' nondisclosure constitutes a violation of the 1934 Securities Act, a breach of their fiduciary duty under ERISA, and a violation of section 1962(c) of RICO. She alleges in Count IV that the defendants conspired to violate the 1934 Securities Act, ERISA and RICO. Counts V and VI allege breach of contract and common law fraud.
The defendants filed a motion to strike and dismiss Otto's amended complaint and for summary judgment. The district court granted summary judgment on the 1934 Securities Act and ERISA counts, finding these laws to be inapplicable because VALIC's fixed annuity did not constitute a security within the meaning of the federal securities laws or an employee benefit plan within the meaning of ERISA. The court dismissed the RICO count on the grounds that the complaint failed to specify an enterprise and each defendant's role in the alleged pattern of racketeering activity proscribed by that statute. The conspiracy count was dismissed for failure to allege any facts in support of such a claim. With the dismissal of these federal claims which had furnished the basis of pendent jurisdiction, the court dismissed the contract and common law fraud claims.*fn1
Section 3(a)(8) of the Securities Act of 1933 exempts from its provisions "any insurance or endowment policy or annuity contract or optional annuity contract" issued by a corporation subject to supervision by the appropriate insurance regulatory authority. 15 U.S.C. § 77c(a)(8) (1982). The issue before us is whether the fixed annuity plan sold by VALIC is an "annuity" under section 3(a)(8) or whether the plan is an "investment contract" subject to the requirements of the 1934 Securities Act. The district court held that VALIC's fixed annuity was more properly viewed as an insurance product than as an investment contract. Because we agree with the district court's determination that the annuity in question falls within the section 3(a)(8) exemption, we hold that the district court properly granted summary judgment on the 1934 Securities Act claim.
In S.E.C. v. Variable Annuity Life Insurance Co. ("VALIC"), 359 U.S. 65, 3 L. Ed. 2d 640, 79 S. Ct. 618 (1959), the Supreme Court considered whether a variable annuity was a security or insurance. The Court discussed the characteristics distinguishing the variable annuity from the traditional fixed annuity. Generally, the funds underlying the fixed annuity are invested according to conservative standards, and the fixed annuity pays a specified and definite amount to the annuitant. In contrast, the variable annuity's funds are invested primarily in common stocks and other equities, and the variable annuity's benefits vary with the success of the company's investment experience. The holder of a variable annuity, therefore, is not able to depend upon the annuity's paying a fixed return. Id. at 69-70. The insurance company in VALIC stressed the fact that, as with all insurance, the company assumed the mortality risks under both the variable and the fixed annuity plans. Yet the Court found this characteristic alone an insufficient basis for considering a variable annuity to be insurance. Insurance, according to the Court, "involves some investment risk-taking on the part of the company" and "a guarantee that at least some fraction of the benefits will be payable in fixed amounts." Id. at 71. An annuity contract that did not guarantee a fixed return thus places all of the investment risk on the policyholder and none on the company. Because there was "no true underwriting of risks," id. at 73, the VALIC Court concluded that the variable annuity was a security.
In S.E.C. v. United Benefit Life Insurance Co., 387 U.S. 202, 87 S. Ct. 1557, 18 L. Ed. 2d 673 (1967), the Court again explored the distinction between a security and insurance in considering a deferred, or optional, annuity plan. Under this "Flexible Fund" annuity program, the purchaser's premiums less a deduction for expenses (the net premium), and any money earned from investing the premiums, were held in a Flexible Fund Account, which United maintained separately from its other funds. The purchaser was entitled to withdraw the "cash value" of the policy before maturity. The "cash value" was equal to the higher of two amounts: the purchaser's proportional share of the fund or the "net premium guarantee," which was measured by a gradually increasing percentage of the purchaser's net premiums, from fifty percent of net premiums in the first year to one hundred percent after ten years. At maturity, the purchaser had the option of either receiving the cash value of the policy or converting that interest into a life annuity. Although the dollar amount of the fixed payments under the life annuity varied with the cash value of the policy, the net premium guarantee ensured that a minimum annuity would be available at maturity. Id. at 205-06.
The Court assessed the Flexible Fund portion of the contract independently from the annuity portion of the contract and concluded that the Flexible Fund contract did not fall within the insurance exemption of the federal securities laws. The test to determine whether an instrument is an investment contract, according to the Court, "is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect." Id. at 211 (quoting S.E.C. v. C.M. Joiner Leasing Corp., 320 U.S. 344, 352-53, 88 L. Ed. 88, 64 S. Ct. 120 (1943)). The Court noted that the Flexible Fund completely reversed the role of the insurer during the accumulation period. Instead of offering the inducements typical for insurance, such as "stability" and "security," United proposed to serve as an investment agency and promised the policyholder "growth." Id. at 211. At maturity, the insurer was obligated to produce only the guaranteed minimum, an amount "substantially less than that guaranteed by the same premiums in a conventional deferred annuity contract." Id. at 208. Although the minimum guarantee "substantially" reduced the investment risk of the purchaser, the Court pointed out that there was a "basic difference between a contract which to some degree is insured and a contract of insurance." Id. at 211. The Court found the minimum guaranteed in United Benefit to be so low that the risk to the insurance company was insignificant.
This court considered whether a "group deposit administration annuity contract" constituted a security or insurance in Peoria Union Stock Yards Co. v. Penn Mutual Life Insurance Co., 698 F.2d 320 (7th Cir. 1983). Under the contract at issue in Peoria Union, the employer contributed annually to a deposit account at Penn Mutual to fund a defined-benefit retirement plan for its employees. When an employee retired, the employer could purchase the annuity from the insurance company with a portion of the funds on deposit or it could withdraw funds and purchase the annuity for its employee from another insurance company. Id. at 321. The income available to fund the employer's obligations to its employees for the fixed benefit annuity fluctuated with the investment experience of Penn Mutual. Penn Mutual guaranteed interest on the employer's contributions made during the first three years of the contract at a rate declining from 7 1/2 percent the first year to 3 1/2 percent the third year. Although there was no guarantee of interest after the first three years, any interest earned by the deposit account beyond the interest guarantee was required to be credited to the deposit account. Id. at 322. It is unclear from the opinion whether or not the funds for these contracts were held by Penn Mutual in a separate account segregated from its general assets.
This court observed that the contract in Peoria Union was similar to the deferred annuity contract in United Benefit in that the insurance company actually served as an investment agency and permitted the pension plan to share in the company's investment experience. Id. at 325. Moreover, in both cases, the insurance company guaranteed a minimum return so low as to place the investment risk on the investor rather than on the insurance company. Id. Based on these characteristics of the plan, the court concluded that during the accumulation phase the annuity plan was an investment contract.
Unlike the plans evaluated in Peoria Union, United Benefit, and VALIC, the defendant VALIC's fixed annuity plan in the present case appealed to potential participants on the usual insurance bases of stability and security. VALIC promoted the fixed annuity as a long-term accumulation of funds for retirement through compound interest. Contributions were mingled with the company's general assets and invested primarily in debt-type securities. Regardless of the investment success of VALIC's general account, VALIC was required to pay a guaranteed rate of interest on all fixed annuity contributions of 4 percent during the first ten years and 3 1/2 percent thereafter. Although this was a low rate of return, it was not so low that we can say it placed the investment risk on the policyholder in a way substantial enough to make the fixed annuity a security. VALIC advertised that, although the earning power of the participant in the fixed plan might not be as great as anticipated due to inflation, the participant had the peace of mind that the investment was guaranteed regardless of economic conditions. Although VALIC boasted that the company's funds were managed by experienced and trained investment managers, as we stated in Peoria Union, investment management is the "life blood" of life insurance companies, Peoria Union, 698 F.2d at 322, and thus it was not inappropriate for VALIC to tout its investment experience even in relation to an insurance product. The difference between the plan before us and the one considered in Peoria Union is not enormous, but the balance of the investment risk has been sufficiently shifted to the insurance company to justify a different result here.
In addition, that VALIC promoted its fixed annuity as insurance is especially apparent when contrasted with its promotion of its variable annuity. VALIC advertised its variable annuity as having a principal objective of long-term capital growth of tax-deferred investments. The contributions of all participants in the variable annuity were held together in a Separate Account, segregated from VALIC's other investments. This Separate Account was invested in common stocks and other equity-type investments. The value of the variable annuity varied with the investment results of the stocks held in the portfolio. VALIC emphasized in its literature that a significant difference between the fixed and the variable annuity was that VALIC assumed the investment risk for the fixed annuity to the extent of guaranteeing minimum fixed rates of compound interest and providing for excess interest credits. The ...