Otto v. Variable Annuity Life Ins. Co.

Decision Date15 June 1987
Docket NumberNos. 85-1816,85-1919 and 85-2410,s. 85-1816
PartiesFed. Sec. L. Rep. P 93,012, Fed. Sec. L. Rep. P 93,243, 8 Employee Benefits Ca 1593, 8 Employee Benefits Ca 1605 Beverly J. OTTO, individually, and on behalf of all others similarly situated, Plaintiff-Appellant, v. VARIABLE ANNUITY LIFE INSURANCE COMPANY, et al., Defendants-Appellees.
CourtU.S. Court of Appeals — Seventh Circuit

Craig E. Anderson, Lowell H. Jacobson, Jacobson, Brandvik & Anderson, Herbert I. Rothbart, Allen D. Choka (of counsel), Chicago, Ill., for plaintiff-appellant.

Randall L. Mitchell, Adams, Fox, Adelstein & Rosen, Chicago, Ill., for defendants-appellees.

Before BAUER, Chief Judge, and CUDAHY and RIPPLE, Circuit Judges.

CUDAHY, Circuit Judge.

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. Sec. 78a et seq. (West 1981 & Supp.1986), the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. Secs. 1001-1461 (West 1985 & Supp.1986), and the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C.A. Secs. 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 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.

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.

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. 1


Section 3(a)(8) of the Securities Act of 1933 exempts from its provisions "[a]ny 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. Sec. 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, 79 S.Ct. 618, 3 L.Ed.2d 640 (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, 79 S.Ct. at 620-21.  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, 79 S.Ct. at 622.  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, 79 S.Ct. at 623, 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...

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