SEC v. UNITED BENEFIT LIFE INS. CO.
Legal provision: Securities Act of 1933, the Securities and Exchange Act of 1934, or the Williams Act
Argument of Marshall
Chief Justice Earl Warren: Number 428, Securities and Exchange Commission, Petitioner, versus United Benefit Life Insurance Company.
Mr. Solicitor General.
Mr. Marshall: Mr. Chief Justice, and may it please the Court.
The respondent in this case United of Omaha sells to the public or had been selling to the public what it called a Flexible Fund Annuity under which the value of the purchaser's ultimate interest depended in significant part upon the value of a regular portfolio of securities, largely common stocks and in which the respondent manages.
The Securities and Exchange Commission believing the Flexible Fund Annuity to be subject to the Federal Securities Act sought to enjoin the respondents from offering these securities and selling it out complying with the registration provisions of both the Securities Act of 1933 and 1940 Act.
To remember, both of these statutes contained exemptions for “insurance” and so the question in this case here on certiorari to the U.S. Court of Appeals for the District of Columbia Circuit is whether the Flexible Fund is within those insurance exemptions in both the 1933 and the 1940 Acts.
Justice William J. Brennan: Mr. Solicitor General, is there a -- or is there not a legislation before Congress on this matter now?
Mr. Marshall: Not that I know of.
It's about the mutual companies in general.
Justice William J. Brennan: It doesn't touch this problem?
Mr. Marshall: I don't know, sir.
Justice William J. Brennan: No?
Mr. Marshall: No sir, no sir.
The District Court ruled that this Flexible Fund was an insurance product within the exemptions and it therefore declined the grant the requested relief and the Court of Appeals affirmed viewing the fund is significantly different from the variable annuity contract which this Court held to be subject to the Federal Securities Law in the VALIC case.
And here we urged that the Flexible Fund contract like the contract in VALIC, is a kind of interest extended to be -- intended to be regulated by the Securities Act.
And conversely, that like the contract which was in VALIC, it is not the kind of product intended to be exempted on the grounds that they were insurance products.
The nature of the Flexible Fund contract like the one in VALIC requires that it's purchasers be given the investment protection that Congress designed for those who are offered in sole participation and a pool of equity securities and interests that fluctuates in accordance with the value of a portfolio securities managed by some other people.
Now under the Flexible Fund, the purchaser makes fixed periodic payments until the pre-selected maturity date, usually some 20 or 30 years from now.
After expenses are deducted from these premiums or anything from 50% in the first year to nine and a half for the next nine years, and 5% thereafter, the balance of the net premiums are put into a separate fund by the respondent.
This fund is reduced each month by an amount totaling 1% per year and by an allowance for the respondent's taxes.
The remainder is invested in a portfolio of securities as I mentioned before largely common stock securities, certainly equities.
During the pay-in period, the period prior to the selected maturity date, the purchaser may at any time withdraw their accumulated cash value of his share.
If he dies during the pay-in period, his beneficiary will receive that same amount or a refund of the total payments paid whichever amount is larger.
Now, once the maturity date is reached, the purchaser is no longer a participant in the Flexible Fund.
At that time, he may receive in the cash the accumulated value of his pro rata interest in the fund or he may purchase of any several conventional annuities with the accumulated value of his share.
In either case, we do not contend that the security laws have any application after the maturity date is reached and the purchaser ceases to participate in the fund.
So there's no substantial difference, we submit, between the VALIC contract and this one except that in VALIC, the purchasers interest in the variable fund there involved continued past the maturity date.
Before I compare more points of Flexible Fund to the investment contract in VALIC, first we should point out a single comparison between the Flexible Fund and ordinary deferred annuity life insurance and conventional savings accounts, a comparison which we have made in our brief at pages 24 and 25.
There it would appear that an annuity, let's say, a male at the age of 35, who pays a $100 per month for 30 years total of $36,000 for respondent's ordinary deferred annuity life insurance, he would have been guaranteed $54,828 at the maturity date.
But under the Flexible Fund contract, the same man making the same payment is guaranteed only $33,174 being the sum of the net premium, $2826 less than he would have had if he put the money in his mattress.
Over $21,000 less than he would have had from respondent's ordinary deferred annuity insurance and over $36,000 less than he would have had, had he put the $100 monthly in a conventional savings account.
In short, the purchasers of the Flexible Fund contract are foregoing some $20,000 to $30,000 in savings in the hope of gaining appreciably through participation in the stock market under respondent's management.
Indeed the inducement of purchase is the prospect of speculative gain rather than the certainties of insurance that is shown by the respondent's sales literature.
I have in my hand here one of the brochures which from beginning to end speaks about how much you can make in the market.
On the middle page, for example, it puts great emphasis on the Dow Jones average and other items.
As no regard at all to insurance, it's obviously urging people as they say to participate in the upsurge of our economy, and to them, that this is in the large record at page 10, the whole brochure there.
The contract is represented as providing, “A chance to share in the growth of the country's economy”, and in which the investments in this securities market is emphasized in various ways.
We think that when such an interest, one that fluctuates with the value of the fund of securities is being offered and sold, it is our position then that it was intended that the investors be afforded the protections of the Federal Security Laws.
The principal difference between the variable annuity in VALIC and the Flexible Fund is that the latter has a flaw; that is the Flexible Fund contract guarantees the purchaser a certain fixed minimum amount.
The court below found that difference in the light of the VALIC decision could be so persuasive that the insurance exceptions are applicable to the Flexible Fund.
So I would go into this minimum guarantee with so much reliance was placed upon.
Respondent guarantees that upon withdrawal from participation in the fund, the purchaser shall receive not less than a stated percentage of its aggregate purchased payments.
We have set that out on the charts on our brief on page 5, and also 34 and 37.
But it's undeniable that the guarantee involved the assumption of some risk by the respondents, certainly that's true, but at some, with emphasis on some, although as I'll show, it's not an investment risk as it has been understood in the insurance acts.
If that respondent contends the critical test is whether the issuing company assumes any element of “risk” by setting a flow no matter how low even one that is lower than the total payments made by the purchaser then I can see we're out of Court.
However, I think as respondent derives that test from too personal reading of VALIC.
Respondent's guaranteed minimum is always less than the aggregate payments made by the purchaser.
After ten years, it does reach the extent of the net premiums which at that point is equivalent to about 86.5% of the total claims.
And after 25 years, it approaches, but never reaches 90% of the total purchase payments.
In short, as the amicus curiae persuasively showed in pages 30 to 38 of its brief, the respondent actually assumes no investment risk in the general sense of the word in the insurance vernacular, nor does it begin to reach what was mentioned in the VALIC case as being controlling, or in the sense commonly accepted in the insurance field.
Investment risk involves the guarantee of some return on your capital, not merely the return of the capital itself.
And as the majority said in VALIC, investment risk in insurance sense involves the guarantee of a fixed return and assured yields in one's investment.
Neither the contract in VALIC nor the contract here has any such assured yield.
In lieu of the guaranteed yield on the normal annuity policy, the purchase of either the Flexible Fund or the old VALIC contract looks to the vicissitudes of the stock market and the respondent's investment acumen.
Of course, the hope is that the economy and the market, and the respondent's skill to produce a yield far exceeding the return available on an ordinary annuity policy.
But the short of it is that the touchstone of insurance, a fixed return or guaranteed yield on payments is entirely missing here and for the ultimate interest of a Flexible Fund contract, the purchaser depends on the value of the portfolio of securities which the insurance company manages.
Justice John M. Harlan: Well, I -- do I understand it correctly on your position General that part of this contract is subject to SEC regulations or part of it to a state regulation?
Mr. Marshall: We -- we take the position that until maturity, while there is participation in this portfolio, it is subject to SEC regulations.
After that, it would not be.
We also recommend in our brief that because of that, if the Court agrees with our position, if you go back to the District Court so that it could be worked out ways with some of the others.
There are quite a few of these that have been registered and are now operating under the regulations of SEC which certain modifications and certain exemptions are given by SEC so that it will work.
But in this particular one, we say after maturity, we don't believe the regulations will apply because the -- the money is then a fixed amount.
Justice John M. Harlan: Was there a -- is that result in VALIC have forgotten --
Mr. Marshall: Well, what actually --
Justice John M. Harlan: What -- what the --
Mr. Marshall: -- happened in VALIC, they went out --
Justice John M. Harlan: -- were the regulation the result there too?
Mr. Marshall: Yes sir, but they went back and they are now registered and they're not doing business.
They've been doing business ever since.
Justice John M. Harlan: But they're not subject -- their contracts aren't subject to any kind of state regulations?
Mr. Marshall: Well, I think they're both in there are.
They're both -- they both do.
Justice John M. Harlan: I'm sorry I didn't --
Mr. Marshall: The VALIC -- incidentally, the VALIC when registered on February of 1960, they registered with the Commission and they've been operating ever since.
But the insurance as we see it, there would be an annuity insurance policy on this side of the portfolio and on the other side would be the Flexible Fund.
The fund part would be regulated by SEC.
Once the maturity date is reached, there would have to be some decision made as to what's done with the SEC part.
But we don't -- we do not see that the regulations would cover once there's no more participation in the portfolio.
I might say that the records of SEC showed that there are quite a few, that are different in variable companies that are still operating under the regulations of SEC.
And indeed, Third Circuit had one which this Court denies certiorari, Prudential which did go back to the Commission and it was regulated and it's still operating.
It is a subtle teaching in this Court in deciding whether one comes within an exemption to the security laws, the focal point of the inquiry should be on the need of the investor for the protections afforded by the Security Acts, thus we feel that rather than approaching the issue from the standpoint of allocating the risk of the company assumes, an approach which invites further litigation, it is more fruitful to look to the financial realities of the product offered and sold if it is one like the Flexible Fund.
The public is invited to participate in the investment experience of a portfolio of securities managed by another and having no substantial assured yield.
Here as I early indicated, the public is invited to forego any guaranteed yield on their amount of money and the hope that the respondent's investment experiences will more than make up for the loss of that guarantee.
The Federal Security Laws were designed precisely to protect the public in such situations.
First, the Securities Act of 1933 provides for full disclosure of the information necessary to enable the purchaser of the security intelligently to appraise the risks involved.
The disclosure provisions might have required respondents in this case for example to indicate more clearly the tax status of the fund in the brochure.
The disclosure provisions might have required a statement in the perspectives more clear than that in the respondent sales brochure.
But since the substantial portion of the Flexible Fund is invested in fixed return securities, its performance could not be expected to parallel the performance of the Dow Jones average which it makes so much of, so prominently featured.
And the Securities Act requirement had a registration statement and perspectives contained a financial statement certified by an independent accountant with detail information on the financial status of the company would require a balance sheet for the Flexible Fund, totally absent from any of respondent's sales literature.
Then as to the Act, Securities Act of 1940, so called corporate democracy provisions, well, under that Act, the additional protection would be afforded to those whose interest takes the form of a participation in the pool.
The applicability of that Act to the respondent's fund would ensure the furnishing of information such as affiliation of the fund's directors, the semi-annual financial reports again, moreover, this substantial sales charge would be regulated and the participants in the fund would be accorded a measure of control for example since the Act prohibits investment companies from changing investment policies without shareholder approval.
The purchasers of the respondent's Flexible Fund contracts would be informed that it's invested in one-third to two-third ratio at fixed return securities to come in stock and would have to say -- should manage -- would have to say should management desire a change to a more conservative investment policy which might render the value of purchaser's interests far more akin to the return of an ordinary deferred annuity than warranted by the guaranteed savings were gone and the service charge was paid by the participant.
In short, when the investor is informed and induced to buy and in reality purchases an interest that fluctuates with the value of fund and securities, the protection of the Federal Securities Laws are vital and those afforded by the customer state regulations of insurance companies are just the opposite as to what is required as pointed out in Mr. Justice Brennan's concurring opinion in VALIC.
Moreover, as we pointed out in our brief starting at page 21, not only it's a fund similar to the variable annuity fund in VALIC but also it is substantially similar to the open-ended management company commonly called the mutual fund.
Indeed as the -- again as the amicus curiae points out in their brief, pages 26 to 30, it is essentially indistinguishable to presently offer so-called split-funded programs under which purchasers of investment company shares can convert a share into a fixed dollar annuity.
By recasting the Flexible Fund in the terms of a package composed of respondent's ordinary deferred annuity and mutual fund shares, no significantly different financial benefit or result occurs to the purchaser of that split-funded plan than to the purchaser of the respondent's Flexible Fund plan.
So, in view, the investor in the fund should obviously be afforded the same investor protection and as those same examples showed, the respondent may continue to provide virtually the same services it now offers.
There's nothing in the VALIC decision or the judgment of this Court or the records that would show what happened to VALIC and other companies in the future that even pretends to show that this same fund cannot continue to operate and operate under registration with the Securities and Exchange Commission.
And all we seek here is that the respondent be required to provide, to register of course, and to be -- provide the detailed information, comply with the other protective measures which Congress thought essential for those who entrust their money to others who for any return must depend on someone else's management of a portfolio of securities and if I could save my five minutes.
Chief Justice Earl Warren: You may Solicitor, you may.
Justice Abe Fortas: General, may I ask you --
Mr. Marshall: Yes sir.
Justice Abe Fortas: -- before you sit down, I suppose that under Investment Company Act, there are some things that the company would not be allowed to do than it would be permitted to do under the insurance regulatory schemes in --
Mr. Marshall: -- in the state.
Justice Abe Fortas: -- in the state.
And if that -- if that is so, if that is so, and I suppose that what we're faced with is a problem under the McCarran-Ferguson Act.
Mr. Marshall: Well, I don't see that all trend because the -- maybe I -- I don't quite -- because the --
Justice Abe Fortas: Well, the McCarran-Ferguson Act says that no Act of Congress --
Mr. Marshall: Yes --
Justice Abe Fortas: -- shall be construed to invalidate, impair, or supersede an insurance law of the state unless the law of Congress says specifically in terms of insurance.
Well, this isn't.
Mr. Marshall: Well, this --
Justice Abe Fortas: The Investment Company Act is not.
Now, the question is whether you fall within this prohibition in the McCarran-Ferguson Act when you say that a contract of this sort which has dual aspects, clearly as dual aspects, insurance and insurance aspect is subject to SEC regulation particularly when you take into account the hypothesis in a way that there are some things they could not do under the Investment Company Act that they would be allowed to do under the State Insurance Acts.
Mr. Marshall: But the -- it's what they do want to the State Insurance Act which is insurance but they cannot under the guise of the word insurance set up a mutual company.
The reason is that the Congress exempted the insurance companies because Congress realized how they operate it.
There was no idea that they would be exempt for all purposes.
It was at that insurance activities would be exempted, because even the District Court was driven to use the phrase this is an insurance product --
Justice Abe Fortas: Well, you've got two approaches there.
When -- I suppose -- an approach is saying this is either insurance or its investment.
The other approach is to say that this has aspects of both and to reach a conclusion if it's possible that the -- it's subject to dual regulation.
Mr. Marshall: We --
Justice Abe Fortas: Suppose you could do -- and analytically, you could proceed down either avenue, but if you proceeded down the latter you might possibly run into the McCarran-Ferguson Act.
Mr. Marshall: We -- we do not say that this is within -- the argument we've made on the Flexible Fund, we say that is clearly not insurance.
It is clearly an investment procedure similar to the average mutual fund and therefore does not qualify for the exemption.
There is nothing in any State Insurance Law that requires the company to report to the -- it's -- its policyholder what have you.
It's because there is the fixed guarantee.
And the only thing the company -- the state is interested is the solvency of the company.
It's entirely opposite when we are selling securities and if I may add, we start -- we had in the beginning of our argument on page 13 and the footnote covers the point of the case in the footnote.
Chief Justice Earl Warren: Mr. McCauley.
Argument of Daniel J. Mccauley, Jr.
Mr. Daniel J. Mccauley, Jr.: Mr. Chief Justice, if the Court please.
It's our intention to discuss the contract, the statute under which there's an exemption, the decision of this Court in the VALIC case, the policy considerations involved with respect to state and federal regulation and the comparisons of values and what actually is being sold.
Justice William O. Douglas: Am I -- am I incorrect in -- in thinking that there is legis -- bills before Congress dealing with this matter.
Mr. Daniel J. Mccauley, Jr.: So far as I know sir, there are no such bills.
Mr. Loomis, the general counsel of the Commission is here and he would know.
Argument of Philip A. Loomis
Mr. Philip A. Loomis: There is nothing now, with some legislation has been acting upon facts in this instance, none with respect to the Court that I know of.
Rebuttal of Daniel J. Mccauley, Jr.
Mr. Daniel J. Mccauley, Jr.: The approach which the Securities and Exchange Commission takes through the Solicitor General is that in an analysis of this contract, you don't take the four corners of the document and all of its pages and the view what is the basic undertaking and what is the basic responsibility of the company and what are they selling and what is the purchaser getting.
But the -- the Securities and Exchange Commission prefers to take the contract and break it up into fragments as the Solicitor General has pointed out.
For example, the Commission takes the position that with respect to this contract, there is no yield and yet for the entire period after maturity, in which there is a payment of guaranteed fixed dollars to the annuitant, there is a yield which is set forth in the contract.
Then, it would seemed to us that to wipe out this entire phase of the contract which is -- requires the company to undertake substantial investment undertakings, tends to -- towards superficiality to ignore basically what are the obligations of the company.
The statute covers in its exemption provisions not only insurance and endowments and annuities, but the statute -- the statute also covers optional annuities.
So that in 1933 when the Securities Act was adopted, the Congress very clearly had in mind the whole concept of an optional annuity.
Now, in it's brief, the Commission, and in it's oral argument and the amici in the brief lend considerable time to emphasizing the possibility that a purchaser of such a contract is in a position to withdraw, to withdraw before maturity, to withdraw after maturity, or at maturity, and that there is no fixed and firm obligation to take the annuity.
I think we have to analyze that.
I think that the argument tends to give the impression that the contract ought to be fragmentized.
I think the argument tends to give credence to the idea that there are really two relationships here.
But on analysis, I'm considering that the Congress understood in the beginning in 1933 when they gave in the statute an exemption for an optional annuity that Congress understood clearly that a person buying such a contract would have at maturity the option to withdraw or the option to take the annuity.
And we have cited to the Court in our brief, text material by MacLean on this in the addition contemporaneous with the adoption of the securities law.
The basic guarantee which is here in this contract regardless of the argument about the brochure which is used is that what is being sold here by the company is a policy covering insurance and annuity under which the purchaser has the obligation in undertaking of the company from the very beginning to give him fixed values and to give him a guaranteed payout, a guaranteed lifetime income and fix calculable dollars under the contract.
In its brief, the Securities and Exchange Commission takes considerable time to review again the concepts of what are an investment con -- what is an investment contract, vis-à-vis what is this contract.
Now, if I may again bring the Court's mind back in focus to the fact that we suggest and urge that the whole undertaking has to be reviewed.
But just for the purpose of analysis look to what the gov -- to the -- to what the SEC said.
They say that from the beginning, there is here a so-called mutual fund obligation for the pay-in period of the contract.
They say that the guarantees which are -- which exist here are insubstantial.
They say that there is here nothing more than a mutual fund for this part of the design.
On the contrary, if you examine the contract that has been issued by United Benefit Life and if you examine another exhibit in this record which is the conventional annuity which was issued by United Benefit Life, had always has been in is similar in form to the conventional annuity that other companies do issue in which there is clearly a yield, an undertaking -- an undertaking to invest money during the pay-in period on a guaranteed interest return basis.
Within those contracts you have the death benefit which you have in the Flexible Fund annuity, you have the cash value which is present in the Flexible Fund Annuity, and really you don't have to have a cash value to make an annuity.
Anyone can undertake on the payment of my -- of my payment to him of the sum of money by the application of actuarial tables, to payout that money to me for as long as I live and maybe end up with a profit and not have -- or not have a profit.
But he doesn't have to invest it, the mere fact that he would pay it out to me on a mortality basis is really the essence of an annuity and what was done originally when annuities were first written.
Those annuities aren't popular today.
Those annuities aren't popular because people came to realize that this type of tontine arrangement without them having an opportunity to get a return of investment was not a valuable economic thing.
So then the insurance companies had to move to another type of investment of -- of annuities, one which gave a return, one which appreciative by way of investment, the principle which had been paid in by the policyholder.
And as the concept in life insurance developed that a policy of insurance should have cash values and you should not have forfeitures and then these nonforfeiture laws were develop the same theory was applied to annuities and annuities now today, for the most part, to be saleable have to have cash values over the period of time.
And what does the company do in facing to the fact that if a person buys an annuity at age 30 or at age 35 and he comes in to benefit at age 65, and if he has to take -- if he has to take the annuity and has no election or choice to withdraw and he's had two (Inaudible) or he's told that he is at least had one operation for cancer and he maybe under a fear that -- that this will be terminable, the pure, simple practical aspects of it touched upon the salability so that because of the cash values which developed, the nonforfeitures which developed, the practical impact to make this saleable the company had to give to a policyholder an opportunity to withdraw.
But it gave him more, it gave him more, it gave him all of the options he alone can withdraw.
The company cannot withdraw.
The company is obliged from the day they entered into that contract, to give him under the terms of that contract, so long as he lives a fixed return on the basis of the money credited to him at maturity.
Now, in the majority opinion in the VALIC case, when it came before the Court, the basic issue was decided by the majority as we read it and as Chief Judge Bazelon read it that there had to be a true underwriting of risks in the insurance sense.
And with respect to that particular contract, Judge Bazelon read the majority opinion as saying that there must be a substantial investment risk throughout the term of the contract.
I don't think -- I don't think any reading by anyone literally will -- you will find in the opinion itself the words that clearly say that there has to be a substantial investment undertaking, but I think it's fair also to read the case in the terms that it was understood that what risk transfer occurred in defining the federal concept of insurance had to be a meaningful risk transfer.
Now, the language itself says that there should be an undertaking to pay some fraction of the benefits in fixed dollars.
The language says that there must be some return, income return.
And the language says there must be some investment risk taking on the part of the -- on the part of the company.
And it said here in VALIC, there is no such thing.
All you have really is an undertaking to pay whatever the value of that portfolio if securities may be and nothing has been shifted from the policyholder to the insurance company itself.
And I think correctly held and I think the circ -- Third Circuit correctly held that both the Prudential case and the VALIC case involving security.
But what is the situation in this case?
United Benefit Life says that on the basis of the payment of premiums and on allocation of those premiums to expense, loading, and investment, the company will over the period of the contract undertake to guarantee to the policyholder a percentage of the net premiums.
And that starts in the first year with 50% of the first premium, first year's premium, and it goes up until at the end of the 10th year, the company undertakes to guarantee the return to the policyholder, not a lot or little or nothing, which the majority held was the undertaking of VALIC but a lot more than nothing, what Chief had -- Chief Judge Bazelon referred to as the principal of the policyholder, his principal investment.
And from the 10th year forward, that company is obliged to carry out an investment policy which will assure regardless of what happens in the marketplace that that policyholder is secure, that he will have from the beginning or if he from the 10th year on into the 20th year but under a contractual obligation from the beginning, the undertaking of that life insurance company to pay him so long as he lives, so long as he lives, a lifetime annuity in fixed calculable -- calculable dollars, calculable under the contract, under the clear language of the contract, and that is the company's basic obligation from the beginning.
We believe to advert to it again that to take this contract as the Commission must do and try to push over on the side, try to deprecate, seek to ignore the basic undertaking of that company to pay out in fixed dollars throughout the whole term of the -- after the maturity of that -- of the contract that then, that man takes it at age 60 or 65 and he then lives to be 90 or a hundred, regardless, the company is obliged to pay him out the fixed dollars and to set that aside and say that's not important to this case and we ask this Court to ignore it.
Well, they ask the same thing as Chief Judge Bazelon, his view was in the opinion in the court below that with respect to that major portion of the contract, we assume all of the risk and with respect to the accumulation period in the contract where we undertook to guarantee after ten years 100% of the net premiums he said that's a substantial risk.
And when he looked at the whole contract as we urged this Court it should do when you look at the whole contract, I think that you can conclude as Chief Judge Bazelon did, that we assume by far the major part of the investment risk.
Now, if you look at the Commission's brief at page 36 and 37 although they said in the Court of Appeals that they thought this case was the -- the guidelines in the VALIC case where the basis on which the decision should be made here, you will find at page 36 and 37 an indication by the Commission that deciding these problems on the basis of allocation of risk, is not a satisfactory mode for treating the problem and I suppose it's quite clear that what the Commission seeks is really to have this Court walk away from those tenets which were laid down --
Justice John M. Harlan: How do you distinguish --
Mr. Daniel J. Mccauley, Jr.: -- in the VALIC opinion.
Justice John M. Harlan: -- this contract from the -- (Inaudible)
Mr. Daniel J. Mccauley, Jr.: I distinguish this contract from what you can get from a mutual fund in this way sir.
If you buy a contract from a mutual fund and it's on a periodic payment basis and if that contract at the end of ten years is worth 50% of what you have invested as net premiums then all you'll get is the market value, your share in the portfolio of those securities, whereas under this contract, this company has guaranteed to return 100% of the net premiums at the end of ten years.
And I would say this one other thing sir that under the -- under the securities law and under the common law I would think that when you buy a share of a mutual fund whether it's a Massachusetts investment type or some other -- a trust type or some other trust arrangement, you do become really legally under federal law and under any state law a -- a, an owner of an undivided interest in the whole of that portfolio.
But the statute in the State of -- of Nebraska says that this company shall be the owner, the company under the state law is the owner.
It says also that the company shall not hold itself out to be a trustee.
So that as -- as the state of Nebraska has laid the ground work for and laid down in the statute the criteria as to the relationships between the parties that at least in so far as the state is concerned and in so far as the basic property rights of the parties is concerned and I understand clearly that the majority in and I -- and in the -- in the VALIC case took the view that it was insurance under this statute as a federal concept.
Well, I think it's not without meaning to point out that the state law and the basic property rights between the parties are essentially different between the mutual fund and between the policyholder, that's the company who owns it, the company who has the obligations.
Justice Abe Fortas: In how many states does this company qualified as an insurance company?
Mr. Daniel J. Mccauley, Jr.: This company is qualified as an insurance company in every state except New York and in -- this company, is the life assurance -- life insurance company affiliated with Mutual of Omaha which is a mutual, health, and accident company.
And Mutual of Omaha has another affiliate which sells life insurance in the State of New York.
United Benefit is one of those 15th or 16th largest stock insurance companies in the United States and well within the Fortune review of the first 50 life insurance companies.
Justice Abe Fortas: Had there been any rulings by insurance -- by state insurance commissions as to whether this -- these contracts are contracts of insurance?
Mr. Daniel J. Mccauley, Jr.: We are entitled to sell -- and we're entitled to sell this contract at the time the SEC brought its action in four states.
Justice Abe Fortas: Are there some states --
Mr. Daniel J. Mccauley, Jr.: And it had been approved at that time if my recollection is right -- correct in 17 states.
I'll tell you frankly --
Justice Abe Fortas: Are there some states who disapprove it?
Mr. Daniel J. Mccauley, Jr.: Sir?
Justice Abe Fortas: Are there some states that don't allow you to sell it as contract of insurance?
Mr. Daniel J. Mccauley, Jr.: There are states -- we do not concede that there is any state which has absolutely refused.
There are some states which have ac -- ask for additional information and have thrown up caveats and to be honest with you, Justice Fortas, when this litigation began, the company through -- with the counsel, made the election not to go on a big selling program because --
Justice Abe Fortas: Well, there's no -- no compilation of that state situation in your brief, is there?
Mr. Daniel J. Mccauley, Jr.: Not in the brief sir.
It is in the record, I believe, in an answer to an interrogatory.
Justice William J. Brennan: Well, Mr. McCauley.
Mr. Daniel J. Mccauley, Jr.: Yes sir.
Justice William J. Brennan: I -- I gather the purchaser of one of these may look to some accumulated values beyond this minimum guarantee, may he not?
Mr. Daniel J. Mccauley, Jr.: He may, yes sir.
Justice William J. Brennan: And I take that state regulation would deal only with the reserves necessary to protect the guarantee?
Mr. Daniel J. Mccauley, Jr.: I don't think that's right sir.
Justice William J. Brennan: Well now what, what state makes provision for any protection of the purchaser?
Mr. Daniel J. Mccauley, Jr.: Well, in the --
Justice William J. Brennan: In the first of those who accumulated values incidentally if -- if there isn't a state insurance protection because they're not necessary to secure reserves to take care of the minimum.
Mr. Daniel J. Mccauley, Jr.: I'm sure --
Justice William J. Brennan: Let's make it up they're not regulated, if you prevail, then there would be any regulation of them at all, any protection for the purchaser of the accumulated value.
Mr. Daniel J. Mccauley, Jr.: Well, that'd be, yes, I think there would sir.
Justice William J. Brennan: Well -- well what would that be?
Mr. Daniel J. Mccauley, Jr.: May I address myself to that?
Justice William J. Brennan: Yes.
Mr. Daniel J. Mccauley, Jr.: In the first place, the accumulated value under the -- in the separate account is itself from the point of view of the insurance commission's a reserve.
Justice William J. Brennan: It is by --
Mr. Daniel J. Mccauley, Jr.: It is --
Justice William J. Brennan: -- the state insurance commission?
Mr. Daniel J. Mccauley, Jr.: Yes sir.
Justice William J. Brennan: At that --
Mr. Daniel J. Mccauley, Jr.: That is --
Justice William J. Brennan: Have they -- is that -- is that from your experience?
Mr. Daniel J. Mccauley, Jr.: Yes sir.
We have --
Justice Hugo L. Black: What's a reserve part?
Mr. Daniel J. Mccauley, Jr.: It's a reserve against the -- company's obligation against the policy, hen the obligation under the policy.
Justice Hugo L. Black: Against the net?
Mr. Daniel J. Mccauley, Jr.: Against the accumulated value if it exceeds the guaranteed minimum.
Justice Hugo L. Black: No, there's above that?
Mr. Daniel J. Mccauley, Jr.: Yes sir, yes sir.
Justice Hugo L. Black: And that's on a different -- different accounting of the --
Mr. Daniel J. Mccauley, Jr.: The --
Justice Hugo L. Black: -- net premiums --
Mr. Daniel J. Mccauley, Jr.: It would be --
Justice Hugo L. Black: -- become separated from --
Mr. Daniel J. Mccauley, Jr.: They -- they are in a separate account which the company carries on its books and for which it buys investments just as advised every other investment in --
Justice William J. Brennan: Well, I take -- I take it --
Mr. Daniel J. Mccauley, Jr.: I want to get back to --
Justice William J. Brennan: There's no question about that fund that's subject to state regulations, is it?
Mr. Daniel J. Mccauley, Jr.: No question about that at all.
Justice William J. Brennan: That is subject and I -- I would expect the state insurance authorities would keep putting vigilant eye allotted to reserves and everything else.
But now there's a -- the accumulated value that were speaking of is in a separate fund, was it?
Mr. Daniel J. Mccauley, Jr.: It's in a separate account, yes sir.
Justice William J. Brennan: In a separate account?
Mr. Daniel J. Mccauley, Jr.: Yes.
Justice William J. Brennan: And you -- and you're telling me the state insurance authorities are watchful of that --
Mr. Daniel J. Mccauley, Jr.: Yes sir.
Justice William J. Brennan: -- (Voice Overlap)?
Mr. Daniel J. Mccauley, Jr.: The -- the National Association of Insurance Commissioners recently had a Form 1 which was used to -- for the annual filing of reports by insurance companies.
They're filed in every insurance commissioner's office in the county where the company is authorized to the business and you may be permitted with that.
That form has been amended.
And attached to it is a Form 1S to cover separate account business and it's in the record in the large volume and as Exhibits 8A and 8B and the insurance we report every year with respect to our separate account business and answer all the questions of the Blanks Committee of the NAIC have there, and then of course we're subject, as you probably know sir, to the triennial examination by regional representatives of the National Association --
Justice William J. Brennan: Well, what -- what kind of controls on the investments on that separate fund do the states?
Mr. Daniel J. Mccauley, Jr.: The control is set up first in the state law that --
Justice William J. Brennan: Well that is the same limitations on -- on what the investments may include?
Mr. Daniel J. Mccauley, Jr.: Yes sir.
We have -- we have to -- the only exemption we have from the state law with respect to our investment is that under the law for our as it was prior to a separate account statute.
Under the law we can only invest up to 15% in Commerce Act.
But thereafter, thereafter we are entitled now -- about entitled to invest up to a 100%.
But the same criteria for the types of securities that can be used with respect to -- or purchased in connection with this, is still controlled by the state law.
And this is important to the company, if I may say so, because if I -- if I am a -- an investment adviser for a mutual fund and I don't know any of the management company stock on which I can make up profit if I sell it, I don't care what happens, I can have any kinds as long as I fall within the general purview of that investment company's statement of policy.
All I have to worry about is buying and selling securities and I don't care whether it goes up or down --
Justice William J. Brennan: Is there uniformity of state regulations, Mr. McCauley?
Mr. Daniel J. Mccauley, Jr.: Is there?
Justice William J. Brennan: Yes.
Mr. Daniel J. Mccauley, Jr.: I say to you sir that there is uniformity with respect to the Form 1S that has to be filed.
And I will say to you that this is a new concept, the whole thing of separate accounts whether you deal in group business or in individual business is something new and it's the insurance industry is alive to this.
And they're keeping on top of it and they're aggressively going forward as they have already.
Justice William J. Brennan: Is there much of this in your brief?
Mr. Daniel J. Mccauley, Jr.: Yes sir.
I can't -- I can't let go by the comments with -- with that comment -- the comments with respect to our sales literature.
I don't think you can take the standard annuity and I was suggesting this Court that the standard annuity which everybody can see as in the exempt annuity and if you put out sales literature and say it's a security, that that makes it a security.
And I think what the -- I know what the Court will do as is fairly read and not just take the excerpts which have drawn -- been drawn out of the context out of -- out of our sales literature because when the District Court look at it and the Court of Appeals look at it, you will find in that sales literature had substantial emphasis with respect to the guarantees, with respect to the annuity feature of this contract, and after all, it is a new instrument, it is a new type instrument, it differs from what we have been selling before and we have to say something about it, and what we have said about it is that it is does -- does present an opportunity for appreciation.
Well, in summary, if the Court pleases, we believe that in our brief and in this argument the emphasis that we want to get across is that what is being issued here is a document which is the document and the undertaking of the company and not of some separate fund.
The guarantees are the company's guarantees.
The need for the so-called protections under the Investment Company Act for shareholders are not nearly so germane here as they were in VALIC or as they are under the Investment Company Act, because here, the company should have control of it's investment policy because it has undertakings which it must meet under that policy, that this is a document when viewed as a whole, gives guaranteed fixed dollars throughout the life of the annuitant and is therefore well within the exemption as this Court has up to this point in VALIC to find insurance in the federal sense and is it may further extend those guidelines in this case.
This is not Howey, this is not Joiner in which the Commission has relied so heavily where you have some type of an arrangement.
This is a -- which, which you -- you really don't know, you take the whole thing, you look at it, and you say it's a security.
Here, you have the undertaking of an insurance company, you have the theory under the law that insurance within the statute means something, you don't have to go back to an investment contract, in the broad general sense under what is a security.
You -- what you do, if you will, is evaluate what is insurance under the exemption, define what is insurance, if it's defined as it has been by the majority in this case, we believe that the Court affirm the judgment of the Court of Appeals, the opinion of Chief Judge Bazelon in which he said that if you view this undertaking as a whole, this is insurance within the federal sense because this company has assumed all of the obligations in the pay-out period, substantial obligations in the pay-in period, and by far the major part of the investment risk undertaking, the investment risk shifted from the individual just as you shift life property in another company.
Thank you, Mr. Chief Justice.
Chief Justice Earl Warren: Mr. Solicitor General.
Rebuttal of Marshall
Mr. Marshall: May I have just one or two minutes if it please the Court.
This brochure, I agree, we will have to leave it here, it's in the record, it's the second document.
I think the biggest mistakes that the two courts made below was not to read this brochure and despite what is said here, the Joiner case does say that enforcement of an Act such as this, it is not inappropriate that promoters offerings be judged as being what they were represented to be.
I think that this argument shows exactly the difference between state insurance laws and the securities law.
Justice William J. Brennan: Well what -- what about Mr. McCauley's answer to me Mr. Solicitor General that in fact, the accumulated value was also subject to, now, to state regulation, what about that?
Mr. Marshall: The state regulation is entirely different.
There's nothing in the state regulation that prevents them from issuing brochures of this type.
Justice Byron R. White: But Mr. Solicitor General isn't it -- isn't that almost a complete answer that the state regulation does not attach unless there is some augmentation.
Mr. Marshall: Well, there is --
Justice Byron R. White: Let's assume there wasn't.
Mr. Marshall: It's not that -- either all --
Justice Byron R. White: Let's assume there was no earning -- let's assume there were no earnings or no increase in value.
Mr. Marshall: Yes.
Justice Byron R. White: State regulation wouldn't help the investor, would it?
Mr. Marshall: It wouldn't help the investor at all.
The -- the only way the investor is helped is by a fixed money dollar return.
That's the only way that he is protected and the state law is to protect the solvency of United.
And I would point out that in our brief on pages 16 and 25 to 26 we do explained the features in this perspectives and I say, that in all fairness, this is not insurance and I return to the point that the two be spread up that the district or the Court of Appeals be reversed and the case remanded to the District Court on the breaking down of the two policies.
Chief Justice Earl Warren: Very well.