Associates In Adolescent Psychiatry, S.C. v. Home Life Ins. Co.

• Decision Date: 03 October 1991
• Docket Number: No. 90-2800,90-2800
• Citation: 941 F.2d 561
• Parties: Fed. Sec. L. Rep. P 96,219, RICO Bus.Disp.Guide 7840, 14 Employee Benefits Cas. 2670 ASSOCIATES IN ADOLESCENT PSYCHIATRY, S.C., et al., Plaintiffs-Appellants, v. HOME LIFE INSURANCE CO., et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 561

941 F.2d 561

Fed. Sec. L. Rep. P 96,219, RICO Bus.Disp.Guide 7840,

14 Employee Benefits Cas. 2670

ASSOCIATES IN ADOLESCENT PSYCHIATRY, S.C., et al Plaintiffs-Appellants, v. HOME LIFE INSURANCE CO., et al., Defendants-Appellees.

No. 90-2800.

United States Court of Appeals Seventh Circuit.

Argued May 30, 1991.

Decided Aug. 23, 1991.

Rehearing and Rehearing En Banc

Denied Oct. 3, 1991.

Eugene L. Mahoney, Gregory A. Friedman (argued), Friedman & Holtz, Chicago, Ill., for plaintiffs-appellants.

Joseph J. Hasman, Ernest W. Irons (argued), Peterson & Ross, Chicago, Ill., for Home Life Ins. Co. of New York.

Diane I. Jennings, Don W. Fowler (argued), William T. Weaver, Lord, Bissell & Brook, Chicago, Ill., for Canapary Financial Corp., Robert Canapary and Ronald Aure.

Kurt L. Schultz, Philip L. Harris, Winston & Strawn, Chicago, Ill., for Physician Planning Service Corp. and Rhode Island Hosp. Trust Nat. Bank.

Robert Radasevich, Kenneth M. Brown, Neal, Gerber & Eisenberg, Chicago, Ill., for Pension Actuaries, Inc.

Robert Radasevich, Kenneth M. Brown, Neal, Gerber & Eisenberg, Kenneth R. Gaines, Jeffrey P. DeJong, Stephen R. Kubiczky, Freda J. Levenson, Altheimer & Gray, Chicago, Ill., for Eric Kranke.

Kenneth R. Gaines, Jeffrey P. DeJong, Stephen R. Kubiczky, Freda J. Levenson, Altheimer & Gray, Chicago, Ill., for Levenfeld, Kanter, Baskes & Lippitz, and Jerry H. Biederman.

John H. Gross, Lawrence Kill, John B. Berringer, Ann V. Kramer, Anderson, Kill, Olick & Oshinsky, P.C., New York City, for amicus curiae The UNISYS Pension Inv. Review Committee.

Before COFFEY, EASTERBROOK and MANION, Circuit Judges.

EASTERBROOK, Circuit Judge.

Associates in Adolescent Psychiatry, S.C., its owner, Marvin P. Schwarz, and his wife (collectively "AAP"), bought a variable annuity and seek relief against Home Life Insurance Company, a Rhode Island bank, and various accountants and lawyers involved in the process. They present claims under the securities acts, ERISA, RICO, and the common law. The district court first granted summary judgment to defendants on the securities and ERISA claims, 729 F.Supp. 1162 (N.D.Ill.1989), and later granted the defendants' motion for summary judgment on the RICO claims, 751 F.Supp. 727 (N.D.Ill.1990), leaving only the state claims, which it dismissed under United Mine Workers v. Gibbs, 383 U.S 715, 726, 86 S.Ct. 1130, 1139, 16 L.Ed.2d 218 (1966).

I

A defined benefit plan promises specified levels of benefits on retirement. The employer may set aside amounts actuarially necessary to fund these future payments. In 1977 Schwarz began looking into the possibility of establishing a defined benefit plan for AAP, the professional corporation through which he rendered psychiatric services. Professional corporations often serve principally as sources of tax benefits. Contributions made by an employer are deductible as ordinary and necessary business expenses. 26 U.S.C. § 404(a). As the deduction is limited to the amount necessary to keep the plan fully funded, § 404(a)(1)(A), it may be advantageous to purchase instruments with low stated rates of return. The lower the nominal return, the more the plan needs to remain fully funded, and consequently the higher the permissible deduction. If the investment actually earns more than the stated rate of return, permissible contributions (and deductions) in future years are lower, but the taxpayers have enjoyed benefits in the interim.

Home Life offered Dr. Schwarz a defined benefit plan that allowed for greater annual contributions, and hence greater deductions, than other plans he had seen. Home Life achieved this by using a "Flexible Annuity", an instrument with a relatively low guaranteed rate of return. Sums invested in the Flexible Annuity accumulate earnings at an annual guaranteed rate plus a variable excess rate. The Flexible Annuity that AAP ultimately purchased guaranteed a return of 7% during the first year, 6% for the next two years, 5% for the following two years, and 4% thereafter. The variable rate, referred to in the contract as the "annual dividend", is defined as the "excess, if any, of the interest credited to the Participant's Accumulated Account Value over the interest calculated at the Minimum Interest Rate." The contract provides further that "the interest rate ... applicable to all funds held under this contract [will be] declared annually by the Board of Directors of [Home Life]".

Home Life wished to sell its Flexible Annuity throughout the country but did not want to submit the product for regulatory approval in every state. To accomplish both objectives Home Life entered into an agreement with Rhode Island Hospital Trust National Bank (HTNB) establishing a "Qualified Corporate Plan Trust". This trust is the sole buyer of Flexible Annuities, so Home Life had only to do what was necessary to qualify its offering in Rhode Island, provided that insurance regulators in other states did not balk. Home Life sells the Flexible Annuity to employers as a group annuity contract. An employer, as the sponsor of the defined benefit plan, sends contributions to Home Life, which wires these amounts to HTNB. The bank, as trustee of the corporate plan trust, uses the money to buy a Flexible Annuity from Home Life. The triple-transfer arrangement (employer to Home Life to HTNB to Home Life) entails some delay. HTNB wires funds to Home Life only on Mondays, so it enjoys the float on money received during the preceding week. Home Life credits employers' accounts as soon as it receives their funds, so it bears the cost of the float. Each employee designated as a beneficiary under the plan must sign an agreement enrolling in the trust; the employee receives a certificate memorializing his participation. Each beneficiary receives annual statements from Home Life of the amounts accumulated by virtue of the employer's contributions and the earnings allocated according to the terms of the Flexible Annuity.

The Employee Retirement Income Security Act (ERISA) requires that plan assets be held in trust. 29 U.S.C. § 1103(a). Home Life gave AAP documents establishing a plan trust, naming the two Schwarzes as trustees. Dr. and Mrs. Schwarz executed these documents in July 1977. At the same time, they signed a participation agreement listing them as "Plan Investment Managers". The participation agreement provided that AAP was to fund the plan with two financial instruments: whole life insurance policies and the Flexible Annuity. AAP made payments under the terms of the Home Life products until 1980. During this period interest rates skyrocketed. Home Life's "excess rate", derived from the return on the insurer's entire portfolio of assets (which was locked into long-term projects), lagged well behind the returns available from short-term investments such as money market funds. This shortfall eclipsed the tax advantages of the plan. AAP regretted its choice and brought this action.

II

The district court concluded that the Flexible Annuity is not subject to registration under the securities laws. We have no doubt that the Flexible Annuity is an "investment contract" and so comes within the broad definitional clauses of the statutes. See Reves v. Ernst & Young, 494 U.S. 56, 64, 110 S.Ct. 945, 951, 108 L.Ed.2d 47 (1990); United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 852, 95 S.Ct. 2051, 2060, 44 L.Ed.2d 621 (1975); SEC v. W.J. Howey Co., 328 U.S. 293, 298-99, 66 S.Ct. 1100, 1102-03, 90 L.Ed. 1244 (1946); Chicago Mercantile Exchange v. SEC, 883 F.2d 537, 545 (7th Cir.1989). Yet almost all insurance and annuity products are securities, broadly understood, because they entail entrusting money to the hands of others in pursuit of appreciation. The Securities Act of 1933 partitions investments between the world of securities regulation and insurance regulation via § 3(a)(8), 15 U.S.C. § 77c(a)(8), which exempts "[a]ny insurance or endowment policy or annuity contract or optional annuity contract, issued by a corporation subject to [state regulation]". AAP conceded at oral argument that the whole life policies come within this exemption. Home Life argues that its Flexible Annuity also falls within § 3(a)(8), and the district court agreed.

Both the district court and the parties devoted substantial energy to the SEC's Rule 151, 17 C.F.R. § 231.151, which establishes a "safe harbor" for some variable annuities. Only persons who rely on a regulation may claim the benefit of its safe harbor. 15 U.S.C. § 77s(a). Rule 151 became effective on June 4, 1986; Home Life introduced the first version of the Flexible Annuity in 1975; AAP purchased its Flexible Annuity in 1977. The SEC's rules may facilitate understanding of statutory law, see Otto v. Variable Annuity Life Insurance Co., 814 F.2d 1127, 1133 (7th Cir.1986), but the technical details of Rule 151 do not affect the disposition of this case, which we decide under § 3(a)(8).

An ordinary annuity is a promise to pay fixed amounts of money beginning at a time specified in the contract. The seller funds its performance by a combination of the purchase price and income earned by investing that sum. Sellers of annuities invest the receipts in diversified portfolios. All annuities therefore are pooled investment vehicles, but fixed annuities are characterized by a particular division of risk: the buyer obtains a payment stream reflecting assumptions about how well the portfolio will do, and the seller reaps the reward (suffers a loss) if the investments do better (worse). Annuities sometimes contain an element of insurance: they may, for example, promise a monthly payment from retirement until death, so that the total payments are larger the longer the purchaser survives. The seller then bears both investment and insurance risks. For simplicity we disregard the insurance component of annuities (although the Flexible Annuity has such an insurance component).

Traditional annuities in which the exact ...