The opinion of the court was delivered by: NORDBERG
JOHN A. NORDBERG, UNITED STATES DISTRICT JUDGE
This case concerns three of the most fecund sources of federal litigation: securities regulation, ERISA and RICO. The Court has determined that the securities and ERISA counts are stillborn; it orders further briefing of the RICO claims to see if they survive.
The plaintiffs are Associates in Adolescent Psychiatry, S.C. ("AAP"); AAP's owner, Marvin Schwarz, and his wife, Joanne, the trustees of AAP's defined benefit and defined contribution pension plans and trusts; and all of the participants in the plans and their beneficiaries. In 1977, AAP established a defined benefit plan to complement its previously established defined contribution plan. The plans then purchased insurance contracts from Home Life Insurance Company of New York to fund their benefit guarantees.
Complaining of various misrepresentations in the sale of these insurance products, plaintiffs brought a multi-count complaint against Home Life and several other defendants. The other defendants are two Home Life field underwriters, Robert Canapary and Ronald Aure, as well as Canapary's business, Canapary Financial Corp. ("Canapary defendants"); Rhode Island Hospital Trust National Bank ("HTNB"); Eric Kranke and his wholly owned company, Pension Actuaries, Inc. ("Kranke defendants"); and AAP's former lawyers, Levenfeld, Kanter, Baskes & Lippitz, and one of the firm's attorneys at the time, Jerry Biederman ("Levenfeld defendants" or "group").
Plaintiffs allege that all of the defendants breached fiduciary duties and related-party rules under §§ 3(21)(A) and 3(14) of the Employee Retirement Income Security Act, 29 U.S.C. §§ 1002(21)(A) and 1002(14). With respect to the defendants other than the Levenfeld group, plaintiffs allege violations of §§ 5, 12 and 17 of the Securities Act of 1933, 15 U.S.C. §§ 77e, 77l and 77q, as well § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and related Rule 10b-5, 12 C.F.R. 240.10b-5. Similarly, with respect to the defendants other than the Levenfeld group, plaintiffs allege various violations of the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. §§ 1962(a)-(d), as well as conspiracy to violate RICO. The Levenfeld defendants are named in a separate count of professional malpractice.
Each of the defendants has moved for summary judgment pursuant to Fed.R.Civ.P. 56. Plaintiffs have cross-moved for summary judgment, seeking a determination that one of the insurance contracts involved in the case is a security and that Home Life and HTNB are ERISA fiduciaries.
For the reasons explained below, the Court concludes that the insurance contracts are not securities under the 1933 and 1934 acts. It also concludes that none of the defendants is an ERISA fiduciary.
Under Rule 56, the Court may grant judgment as a matter of law provided that the material facts are not in genuine dispute. See generally Wolf v. City of Fitchburg, 870 F.2d 1327, 1329-30 (7th Cir. 1989); Spring v. Sheboygan Area School District, 865 F.2d 883, 886 (7th Cir. 1989). The rule requires that all reasonable inferences be drawn in favor of the nonmoving party; in the case of cross-motions for summary judgment, this means that the Court draws all reasonable inferences in favor of the party that is the nonmovant with respect to the particular motion being considered. Therefore, the facts (which will be supplemented as necessary in the Court's analysis of the law) are as follows.
Marvin Schwarz practiced psychiatry in the Chicago area through his wholly owned professional corporation, AAP.
In April or May 1977, prompted by recent changes in the tax laws, Schwarz began to consider setting up a defined benefit pension plan to supplement AAP's defined contribution and profit-sharing plans. In July of that year, after having received a written pension plan proposal from William M. Mercer, Inc., Schwarz ran into an acquaintance, David Cooper, a field underwriter for Home Life Insurance Co. of New York. This chance meeting led to a subsequent session later in the month with both Cooper and Robert Canapary, another field underwriter for Home Life (as well as a registered representative for the sale of securities).
At this meeting, Schwarz showed Canapary a copy of the Mercer proposal. Canapary suggested that a different plan might allow AAP to make larger contributions than the Mercer plan permitted. With Schwarz's agreement to look at any proposal he might put forward, Canapary arranged for Eric Kranke, president and sole shareholder of Pension Actuaries, Inc., to prepare cost-illustrations for a defined benefit pension plan that would allow the maximum tax-deductible contributions. After considering one of Kranke's cost-illustrations later in the month, Schwarz gave the go-ahead to Canapary, leading to AAP's adoption of the Home Life Prototype Defined Benefit Plan and Trust.
Schwarz and his wife, Joanne, completed documents for the prototype plan and trust, as well as a participation agreement, on the last business day of July 1977 in the Chicago offices of Levenfeld, Kanter, Baskes & Lippitz, who had been AAP's lawyers since 1968. The prototype plan named the Schwarzes as plan trustees, and AAP as plan administrator. The plan also provided for the appointment of an investment manager, but stated that if none were named in the participation agreement or trust agreement, this responsibility would shift to the named trustees. The first participation agreement listed the Schwarzes (in their role as trustees) as the "Plan Investment Manager." Final Pretrial Order, Agreed Statement of Uncontested Facts ("UF") paras. 73-74. The participation agreement further indicated that AAP planned to fund the plan through the purchase of life insurance and flexible or variable annuities (or both types of annuities). Upon adoption of the defined benefit plan, AAP terminated the profit-sharing plan.
Canapary and Cooper, along with Ronald Aure, another Home Life field underwriter and Cooper's supervisor, sold two Home Life contracts to fund the new AAP defined benefit plan. One was the Home Life Flexible Annuity ("FA"), a contract which allowed participants to accumulate retirement funds at guaranteed interest plus a variable rate to be set at the beginning of each year (the variable rate was later adjusted more frequently, as will be discussed below). The other was the Pension Series Whole Life ("PSWL") contract, a policy providing for a $ 10,000 death benefit and accumulating cash value for use upon retirement or withdrawal from the plan. The FA was used to fund AAP's defined contribution plan as well. Canapary and Aure received commissions on contributions made to the FA and premiums paid on the PSWL. Prior to July 1977, Schwarz, as trustee of the defined contribution and profit-sharing plans, had handled their investment portfolios, purchasing such investments as equity securities, bonds and real estate.
Home Life is a mutual life insurance company incorporated under New York law. Its development of the FA in 1974-75 was an attempt to meet competition in the tax-sheltered annuity market and respond to the demand for tax-favored retirement programs created by the passage of ERISA in 1974. UF 115. AAP's plans purchased the first version of the FA, offered in 1975. This version permitted two ways of making contributions under the contract. Under the "periodic contribution" form of the FA, contributions were made on a regular yearly basis; the minimum contribution was $ 240 and the maximum was 300% of the scheduled contribution stipulated in the contract. Each annual contribution bore an administration charge of 6.75% per year, $ 15 per year and $ 1 for each contribution payment. The alternate funding method permitted minimum lump-sum contributions of $ 2,000; there was a one-time charge of $ 25 per participant, plus 5% of the first $ 50,000 contributed, 2% of the next $ 50,000, 1% of the next $ 100,000, and 1/2% of any excess over $ 200,000. All contributions were held in Home Life's general asset account, rather than in separate accounts.
During this initial accumulation phase of the 1975 FA, Home Life guaranteed the principal amount of contributions (less sales and administration charges) made on behalf of pension plan participants and any interest credited upon these contributions. The FA provided a guaranteed minimum interest rate plus a variable excess rate. The guaranteed rate was set at 7% during the first year, 6% for the next two, 5% for the two years after that, and 4% for the remainder of the contract. UF 145; Joint Trial Exhibit ("JTX") 489; Plaintiffs' Exhibit ("PLX") 29. The variable rate, designed to take advantage of fluctuating returns on investments made by Home Life, was set at the beginning of each year and was guaranteed for contributions made during the entire year. JTX 489; PLX 29; Allan Dep., at 271-72, Plaintiffs' Summary Judgment Exhibit ("PSJX") A. Although the excess interest rate was not altered during the year on the 1975 version of the FA, the excess interest rate on new and accumulated deposits could change from year to year, based upon Home Life's predictions of investment return. Id. See also PLX 915 and 917-21. For example, a statement dated December 31, 1978, promised Schwarz interest of 7% on his FA during 1979; the following year, interest was to be credited in the amount of 8.45% on contributions made prior to January 1, 1980, and 9% on contributions made after December 31, 1979. PLX 915.
Contributions to the FA totaling $ 683,797.51 were made on behalf of AAP's employees from August 5, 1977, to August 24, 1979. Premiums paid on the PSWL totaled $ 270,000 between August 1977 and July 1984. In 1980, Home Life discontinued the 1975 version of the FA, altering the sales and administration charges and reducing the guaranteed interest rates (7% in the first year; 4% thereafter). The 1980 version was subsequently discontinued in 1982, when yet another version of the FA was introduced. Sometime in 1980 or 1981, in response to volatile interest rates, Home Life reserved to itself the right to alter interest paid on new contributions as often as once per month, rather than annually. This current excess rate was declared in advance and was guaranteed to be paid on contributions made under that rate for the remainder of the year, regardless of subsequent changes in the current rate. Changes in the current rate, moreover, did not affect the rate paid on deposits that had already been made; rates on existing deposits were still declared in advance for the entire year. PLX 138; PLX 915; PLX 917-21; Smith Dep., at 53-58, PSJX M; Fabian Dep., at 105-05, PSJX G.
Home Life marketed the FA as a group annuity contract ("GAC") in order to avoid the delay and expense of submitting an individual contract to the insurance departments of all of the states. This also permitted Home Life to sell the contract without seeking approval from the New York Department of Insurance for a substantial modification of the company's plan of operations to provide for the new method of interest rate declarations to be used on the FA. UF 162.
The insurer originally wished to issue the FA through a trust established with a New York bank, which would hold the GAC. UF 163. Home Life had envisioned the GAC as a means of allowing individual employees whose employers or unions did not offer pension plans to obtain benefits similar to those offered in company- or union-sponsored plans. UF 166. The insurance department, however, by letter dated June 30, 1975, advised Home Life that the contract did not qualify under N.Y. Insurance Law § 223 (now § 4238), regulating issuance of group annuity contracts, because "the participants . . . do not qualify as a group under . . . Section 223." UF 169.
Thwarted in New York, Home Life turned to the Rhode Island Hospital Trust National Bank ("HTNB"), located in Providence. Home Life submitted copies of the GAC to the State of Rhode Island Department of Insurance. UF 171. Pursuant to negotiations between Home Life and HTNB, the bank declared the Home Life Qualified Corporate Plan Trust (as well as other group trusts not at issue here) and executed the trust document on October 1, 1975. PLX 35.
Under the terms of the trust, a corporation adopting the Home Life prototype defined contribution plan or the trustees of the corporation's pension trust could apply to participate in the Qualified Corporate Plan Trust. Such corporations or trustees were referred to under the Qualified Corporate Plan Trust as "applicants," and in the case of AAP, the "applicants" were the Schwarzes. Qualified Corporate Plan Trust, Art. I; UF 205. The Applicants would make contributions to the trust on behalf of the participants in their pension plans; the participants would enroll in the trust by filing a "participation agreement" with the Qualified Corporate Plan Trust. UF 190-91. The Qualified Corporate Plan Trust provided that upon HTNB's receipt of the contributions, "the Trustee shall cause to be issued to it a group annuity contract or contracts from Home Life." Qualified Corporate Plan Trust, Art. II. HTNB would then be the legal owner and holder of the FA on behalf of the applicants, participants and their beneficiaries. Id. Home Life would issue FA certificates, address them to the applicants, and then mail them to HTNB, which would forward them to the recipients. UF 196.
Under this arrangement, contributions on behalf of the AAP plan participants and other FA certificate holders were mailed to Home Life, which deposited them immediately to its general account. On the same day that Home Life received contributions it would wire an equal amount to HTNB, which would return-wire an equal amount the following Monday. HTNB thus had use of these funds from three and one-half to seven days without paying interest upon them; this float, of course, accrued to the benefit of the bank, though the funds were not set aside for any particular uses. UF 183-187; Butzier Tr., at 94-99, PSJX E; Frazier Dep., at 141-46, 148-51, PSJX I; Beattie Dep, at 25-30, 130-31, PSJX B. The float arrangement was not disclosed in the Qualified Corporate Plan Trust as one of the fees to which the bank was entitled, though a Home Life internal memorandum described it as "an additional operating margin for their trust services." PLX 9. But though the bank did not pay interest upon the wired funds, Home Life credited interest upon the contributions from the day of their receipt, even before the checks it received from the FA contributors had cleared. UF 251. In January 1984, Home Life estimated the annual cost of this "negative float" to have been about $ 50,000.
Upon retiring or otherwise withdrawing from the program, a participant had the option of annuitizing the contract or receiving a lump-sum distribution. To annuitize the FA, the participant would surrender his GAC certificate to Home Life, which in return would issue a supplemental annuity contract. UF 216. By far the more popular option was the receipt of lump-sum benefits. From November 1975 through January 1986, only ninety-one certificate holders of the 10,000 who surrendered their certificates elected the annuity. UF 219-20.
Between April and June 1980, AAP hired new attorneys for advice on the company pension plans, among other matters. UF 270. Schwarz testified that he sought these lawyers' advice because AAP employees had complained of confusing information from Home Life and because the company accountant had informed him that some of the Home Life tax forms "didn't seem satisfactory." Schwarz Dep., at 511-12, Canapary MSJ Ex. A. During the course of the ensuing investigation, Schwarz concluded that various misrepresentations had induced his company to pay too much money to Home Life for too little benefit. Id. This lawsuit followed.
Plaintiffs' claims under the federal securities laws all fail for the same fundamental reason: Neither the FA nor the PSWL is a security. Because the closest question in this case is posed by the FA, the Court will explain first why that contract was not a security.
The federal securities laws require the courts to give effect to two competing policies. The first policy is set out by the broad statutory definition given to the term "security," which includes within its scope, among other instruments, "investment contract[s]." See § 2(1) of the 1933 Act, 15 U.S.C. § 77b(1); § 3(a)(10) of the 1934 Act, 15 U.S.C. § 78c(a)(10). The competing policy is codified in § 3(a)(8) of the 1933 Act, exempting from federal regulation "any insurance or endowment policy or annuity contract or optional annuity contract, issued by a corporation subject to [state regulation]." 15 U.S.C. § 77c(a)(8). As the Seventh Circuit has held, any instrument that qualifies as an insurance or annuity contract under § 3(a)(8) of the 1933 Act is insulated from private actions brought under the 1934 Act. Otto v. Variable Annuity Life Ins. Co., 814 F.2d 1127, 1130 (7th Cir. 1986), cert. denied, 486 U.S. 1026, 108 S. Ct. 2004, 100 L. Ed. 2d 235 (1988).
The basic principles were set forth in a pair of Supreme Court decisions, see SEC v. Variable Annuity Life Ins. Co. ("VALIC"), 359 U.S. 65, 3 L. Ed. 2d 640, 79 S. Ct. 618 (1959), and SEC v. United Benefit Life Ins. Co., 387 U.S. 202, 18 L. Ed. 2d 673, 87 S. Ct. 1557 (1967), establishing that insurance products can be treated as securities under the federal laws if the contracts place too much of the investment risk on policyholders. See also SEC v. C.M. Joiner Leasing, Inc., 320 U.S. 344, 88 L. Ed. 88, 64 S. Ct. 120 (1943). (Although Professors Loss and Seligman have questioned whether Congress ever intended this result, see L. Loss & J. Seligman, Securities Regulation, at 1000-02 (3d ed. 1989), it of course is not this Court's prerogative to ignore binding authority.) The SEC has wrestled with these questions as well; after extensive consideration, the agency promulgated Rule 151, 17 C.F.R. § 230.151, a safe-harbor provision that became effective on June 4, 1986 (and which the Court sets out in full later in this memorandum opinion). In putting forward Rule 151, the SEC promised that it would not treat as securities insurance products that met the rule's requirements. The Seventh Circuit carefully analyzed Rule 151 and Supreme Court precedent in Otto. Because this Court concludes that the analysis in Otto and the terms of Rule 151 control the result here, the Court will discuss that case at length.
The first point to observe about Otto is that it is really two opinions, decided upon different assumed facts concerning the insurance contract at issue. Initially, the court of appeals held that the contract was not a security, and thus affirmed the district court's entry of summary judgment in favor of the insurer. 814 F.2d at 1130-34. Upon rehearing, after the insurer disclosed further information concerning the contractual terms, the court of appeals reversed its previous decision to hold that the contract was indeed a security. Id. at 1140-42.
When Otto was first decided, the facts were understood as follows. Variable Annuity Life Insurance Co. ("VALIC") had issued a contract which it termed a fixed annuity. It guaranteed the principal paid into the annuity, as well as interest at a minimum rate of 4% per year for the first ten years, and 3 1/2% thereafter. The insurer held funds paid by annuitants in its general account and invested them in a variety of long-term instruments, generally in the form of debt, such as mortgages and bonds. Upon retirement, the beneficiary could either withdraw the amount accumulated in a lump sum or use it to buy an annuity. Id. at 1129.
The distinguishing characteristic of the fixed annuity was its excess interest provision, allowing the insurer, at its discretion, to pay interest on top of the guaranteed rate. Id. The plaintiff class alleged that the insurer had failed to disclose the manner in which it calculated the excess interest. This method, known as "banding" or "new money," paid the current rate of interest on current contributions only; previous contributions (so the court of appeals had been led to believe) would continue to earn interest at the excess rates declared at the time the previous contributions had been made. Id. at 1130. The current excess rate, however, could be changed at any time.
The court of appeals analyzed the question in two stages. First, the court considered the matter under the law developed in the Supreme Court's decisions, as well as the Seventh Circuit's own decision in Peoria Union Stock Yards Co. v. Penn Mutual Life Ins. Co., 698 F.2d 320 (7th Cir. 1983). The court noted that the fixed annuity had been promoted as a method of saving for retirement, rather than as an investment device. Funds paid into it were held in the insurer's general account, and were invested in safe securities, largely debt. Principal was guaranteed, as was the base amount of interest, which though low, "was not so low that . . . it placed the investment risk on the policyholder in a way substantial enough to make the fixed annuity a security." Otto, 814 F.2d at 1132.
The court further contrasted the fixed annuity with the insurer's variable annuity, which all agreed was a security. The variable annuity guaranteed neither principal nor interest, id. at 1129, and the amounts invested were kept in a special account, id. at 1133. The contractholder's investment was directly tied to the success of the investment portfolio, which consisted of equity securities. Id.
In the second stage of its analysis, the court of appeals examined the fixed annuity under the test set out in SEC Rule 151, and concluded that Rule 151 "supported" the court's holding that the contract was not a security (though the court noted that the rule did not literally apply because it was adopted after the sale of the fixed annuity). Id. Rule 151 provides:
(a) Any annuity contract or optional annuity contract (a "contract") shall be deemed to be within the provisions of section 3(a)(8) of the Securities Act of 1933 [citation], Provided, That
(1) The annuity or optional annuity contract is issued by a corporation (the "insurer") subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State or Territory of the United States or the District of Columbia;
(2) The insurer assumes the investment risk under the contract as prescribed in paragraph (b) of this section; and
(3) The contract is not marketed primarily as an investment.
(b) The insurer shall be deemed to assume the investment risk under the contract if:
(1) The value of the contract does not vary according to the investment experience of a separate account;
(2) The insurer for the life of the contract
(i) Guarantees the principal amount of purchase payments and interest credited thereto, less any deduction (without regard to its timing) for sales, administrative or other expenses or charges; and
(ii) Credits a specified rate of interest (as defined in paragraph (c) of this section) to net purchase payments and interest credited thereto; and
(3) The insurer guarantees that the rate of any interest to be credited in excess of that described in paragraph (b)(2)(ii) of this section will not be modified more frequently than once per year.
(c) The term "specified rate of interest," as used in paragraph (b)(2)(ii) of this section, means a rate of interest under the contract that is at least equal to the minimum rate required to be credited by the relevant nonforfeiture law in the jurisdiction in which the contract is issued. If that jurisdiction does not have any applicable nonforfeiture law at the time the contract is issued (or if the minimum rate applicable to an existing contract is not longer mandated in that jurisdiction), the specified rate under the contract must at least be equal to the minimum rate then required for the individual annuity contracts by the NAIC Standard Nonforfeiture Law.
17 C.F.R. § 230.151. The rule is a safe harbor only; failure to meet its requirements thus would not necessarily cause an insurance product to be treated as a security, but merely would open it to analysis under the law interpreting §§ 2(1) and 3(a)(10). See Definition of Annuity Contract or Optional Annuity Contract, Exchange Act Release No. 6645 [1986-87 Transfer Binder]Fed.Sec.L.Rep. (CCH) P84,004 (May 29, 1986).
Although VALIC does not guarantee that it will leave the excess interest unchanged for a year, it does use the "banding" method of computing interest. Under this method, VALIC in effect guarantees the excess interest rate on every deposit for the life of the annuity contract. In its discussion of Rule 151 that was released with the rule's enactment, the SEC made clear that it considered the banding method, or in the SEC's words, the "payment basis" of computing interest, as satisfying this second requirement of Rule 151.
But the court of appeals had been misinformed as to the nature of the fixed annuity. Upon rehearing, VALIC informed the court that it retained the "unfettered discretion" to alter (or even eliminate) the amount of excess interest on past contributions at any time. Id. at 1140-41. In its brief on rehearing, the insurer told the court: "'Excess interest is wholly discretionary; with its unfettered discretion, VALIC can calculate excess interest by any method it chooses, it can elect to change the current interest rate paid on deposits, it can change the rates on past contributions, and (although competition makes it unlikely) it can stop paying excess interest altogether -- at any time.'" Id. at 1141. VALIC argued that despite the uncertainty of the excess interest, the "substantiality" of the guaranteed rates sufficed to make the fixed annuity an exempt insurance product. Id.
VALIC's argument failed to persuade the court of appeals, which concluded that the fixed annuity placed too much investment risk on the contract buyer to escape classification as a security. The excess interest rates of 4% and 3 1/2%, though slightly above the 3% required under Rule 151, could not by themselves insulate the fixed annuity from the federal securities laws. Payment of some excess interest was necessary, and the fixed annuity's promise was too contingent. Id. at 1142. In reaching this decision, the court dwelled on VALIC's right to change the rate of excess interest at will: "A claimed right to change established excess interest rates and to eliminate excess interest payments entirely at any time surely tends to shift the investment risk from VALIC to the plan participant." Id. at 1141. The emphasis in the quoted passage was the court of appeals' own.
A number of points are fairly derived from Otto. The most important here is the propriety of referring to Rule 151 in considering whether any insurance contract is a security, including the contracts at issue in this case. In this Court's view, it is of no consequence that the SEC adopted Rule 151 after the plaintiffs began investing in Home Life's FA (the FA was first offered in 1975 and the plaintiffs paid into it from 1977 to 1979). The requirements set forth in Rule 151 for a guaranteed exemption from federal securities regulation represent the carefully considered views, developed in the course of notice and comment rulemaking, of the federal agency with the greatest expertise in this matter; the principles established are timeless, and ought to be followed by the courts even though not binding upon them.
The next point that must be considered is how to tell a security from a non-security under the rule of Otto. The distinction appears to rest on the frequency with which the insurer can alter the rate of excess interest on existing contributions under the contract. It seems clear that an annuity contract which allows the insurer to alter the rate of excess interest on past contributions at any time will be deemed a security under Otto. On the other hand, a contract that allows the excess rate to be periodically readjusted for new contributions, but which guarantees that for the life of the contract each contribution will continue to receive the rate prevailing at the time it was made, will not be deemed a security. As will be seen below, Home Life's FA does not clearly fall into either category of instrument. But though Otto does not absolutely dictate this Court's conclusions one way or the other, the Court believes that the case, properly understood, supports the conclusion that the FA is not a security.
The Court now considers the requirements of Rule 151 as applied to the FA. Initially, the Court observes that the FA qualifies under the preliminary requirement that it be "an annuity contract or optional annuity contract." Rule 151(a). The FA began with an accumulation phase in which participants contributed toward their retirement income; upon withdrawal, the participants could either purchase an annuity from Home Life or receive a lump-sum payment of their accumulated contributions. Though relatively few participants may have chosen the annuity option (according to UF 219-20, only ninety-one of the ten thousand FA certificate holders who surrendered their certificates between 1975 and 1986 chose the annuity option), this fact alone does not affect the FA's status as an annuity or optional annuity contract under Rule 151. It is similar in this ...