Securities and Exchange Commission v. National Securities

PETITIONER:Securities and Exchange Commission
RESPONDENT:National Securities
LOCATION:United States District Court for the Northern District of Illinois, Eastern Division

DOCKET NO.: 41
DECIDED BY: Warren Court (1967-1969)
LOWER COURT: United States Court of Appeals for the Ninth Circuit

CITATION: 393 US 453 (1969)
ARGUED: Nov 18, 1968 / Nov 19, 1968
DECIDED: Jan 27, 1969

Facts of the case

Question

  • Oral Argument – November 19, 1968
  • Audio Transcription for Oral Argument – November 19, 1968 in Securities and Exchange Commission v. National Securities

    Audio Transcription for Oral Argument – November 18, 1968 in Securities and Exchange Commission v. National Securities

    Earl Warren:

    Securities and Exchange Commission, Petitioner versus National Securities, Inc.

    Mr. Solicitor General.

    Erwin N. Griswold:

    Mr. Chief Justice and may it please the Court.

    This case is here on a writ of certiorari to the Ninth Circuit Court of Appeals.

    It involves the construction and application of the McCarran-Ferguson Act and its interrelation with Section 10 (b) of the Securities Exchange Act of 1934.

    The text of those two statutes is given on pages 33 and 34 of the Government’s brief and this case.

    I would call attention to the provision in Section 10 (b) which makes it unlawful for any person to use or employ any connection with the purchase or sale of any security registered on the National Securities Exchange or any security not so registered.

    The net result of those two phrases is simply to apply to any security any fraudulent device as defined by the rules of the Securities and Exchange Commission and the relevant Rule 10b-5 is set out at the bottom of page 34 and on page 35.

    The text of the McCarran-Ferguson Act is on page 33 of our brief and the relevant portion there although it’s all relevant but the part that comes closest is Section 2 (b), no Act of Congress shall be construed to invalidate, impair or supersede any law enacted by any state for the purpose of regulating the business of insurance or which imposes a fee or tax upon such business unless such acts specifically relates to the business of insurance and I would suggest that the keywords in that provision of the McCarran-Ferguson Act are the business of insurance.

    The present case began in March 1965 when the Securities and Exchange Commission filed its petition in the District Court for Arizona.

    It sought to have that court enjoin the respondent here, the National Securities, Inc. and it subsidiary and certain officers and employees from violating Section 10 (b) and Rule 10b-5 on the ground of asserted fraud in connection with purchase or sale of securities.

    In due course the defendants filed a motion for judgment on the pleadings or in the alternative for summary judgment, the motion for judgment on the pleadings was granted by the District Court and this was affirmed by the Court of Appeals.

    As the Court of Appeals stated in its opinion in this situation, the allegations and the amended complaint must be presumed to be true.

    And these allegations may be summarized this way.

    It is alleged that the respondent, National Securities, Inc. is a holding company which owned two-thirds of the slightly more than a million shares outstanding of National Life which was in Arizona insurance company.

    Producers Life Insurance Company was another Arizona company.

    It had some 881,000 outstanding shares held by approximately 14,000 stockholders in many states.

    In other words, it was quite widely distributed.

    The allegation is that the defendants formed an illegal scheme contrary to Section 10 (b) under which National Securities would acquire control of Producers Life, National Life, and Producers Life would be consolidated and the consolidated company would pay a large part of National Securities cost of acquiring control of Producers Life.

    In carrying out the scheme, National Securities purchased the stock in Producers which was held by four of Producers’ directors and agreed to pay them a very large sum for there agreement not to compete with Producers Life or any successor company.

    The National Securities also purchased from Producers Life more than 50,000 shares of its treasury stock and assumed some $600,000.00 of liabilities of Producers Life arising out of previous agreements which had been made with other persons not to compete with it.

    It was further alleged that National Securities did not disclose to Producers Life or its stockholders that it intended to impose both of this liabilities with respect to agreements not to compete upon the corporation which would result from the plan consolidation of Producers Life and National Life.

    After obtaining control, the Producers Life according to the allegations again, National Securities cause the latter to mail to its stockholders materials soliciting them to approve the propose consolidation with National Life.

    And it was then alleged that this material was false and misleading on four grounds: (a) That it did not disclose the liability on the agreements not to compete.

    (b) That it predicted substantial consolidated earnings without disclosing that Producers Life and National Life had each had losses in the prior year.

    (c) It set forth on the pro forma balance sheet for the consolidated company and asset shown as treasury stock in the amount of more than a million dollars that was alleged to be illusory and finally that it did not disclose in its report to the — that in its report to the Arizona Insurance Commission, the National Life had written down the value of its investment in Producers Life by more than a million dollars.

    The court allowed the defendants to submit the proposal to the Arizona Insurance Commission and to the stockholders.

    Both approved the plan and that was carried out.

    It was then that the Securities and Exchange Commission filed the amended complaint which is now before the Court seeking such relief as might be appropriate under the circumstances.

    In its answer to the amended complaint and in its motion for judgment on the pleadings, the defendant contended that the District Court has no jurisdiction because the matters complained of are entirely within state jurisdiction as provided in the McCarran Act, thus, raising the issue which is here.

    Erwin N. Griswold:

    The District Court accepted this contention as one of its grounds of decision and the Court of Appeals affirmed the District Court’s judgment on this ground alone.

    The opinion of the Court of Appeals is in rather sweeping terms.

    The relevant portion for this part of my argument appears on pages 156 and 157 of the appendix near the bottom of page 156, we are left then with a general intention to set the insurance business outside the scope of all existing and future legislation regulating interstate commerce without any more direct evidence that Congress had in mind in the Securities Exchange Act.

    However, Congress was apparently seeking to define an exemption for insurance and then the word is conterminous but I supposed we usually say co-terminus with its power to regulate interstate commerce.

    The Court is there saying that with respect to insurance in so far as Congress would have power to regulate any aspect of it under its commerce power, the effect of the McCarran Act is to say that that power is not being exercised.

    And over on page 157, just above the middle, the court said and equally vital purpose of the McCarran Act was to preserve intact from any federal intrusion based on the Commerce Clause existing and future state regulation of the insurance industry.

    Thus the sole issue is here whether this construction of the McCarran-Ferguson Act and determination of its effect are correct.

    Or whether the facts alleged are sufficient state of cause of action under Section 10 (b) of the Securities Exchange Act of 1934 despite the provisions of the McCarran-Ferguson Act which was passed in 1946.

    I will now turn to the legal questions involved in the case.

    It maybe that I have a somewhat narrow alleged stand on but I think the footing is firm.

    When Section10 (b) was enacted in 1934, there was no doubt that it applied to fraud and the purchase and sale of all securities, you’ll recall the phrase in the statute is any security including those in insurance companies.

    This was true despite the fact that it was the common understanding at that time that the federal government had no power to regulate “the business of insurance.”

    A clear distinction was evident between the business of insurance on the one hand and securities of a company which is engaged in conducting the insurance business.

    In 1944, the South-Eastern Underwriters case was decided followed in 1946 part of the enactment of the McCarran-Ferguson Act.

    The South-Eastern Underwriters case undoubtedly involved the conduct of the business of insurance the way in which insurance companies operate together in fixing their rates and had nothing to do with transactions in securities of an insurance company.

    The distinction was explicitly made in the McCarran-Ferguson Act itself for it said that no Act of Congress should supersede any law enacted by any state for the purpose of regulating the business of insurance.

    Now these was emphasized in the report of the House Committee set forth on page 24 of our brief where the Committee said, it is not the intention of Congress in the enactment of this legislation the closest states with any power to regulate or tax the business of insurance beyond that which they had been held to possess prior to the decision of the United States Supreme Court in the South-Eastern Underwriters Association case.

    In short, the function of the McCarran-Ferguson Act was to restore the status quo to put things back where they were before the South-Eastern Underwriters case was decided except that it was made explicit that the Sherman Act, the Clayton Act, and the Federal Trade Commission Act should apply to the business of insurance to the extent that such business is not regulated by state law.

    It was only with respect to these three statutes that there is any indication that federal law should apply only if there was not an applicable provision in state law.

    Throughout their history, both before and after the enactment of the McCarran-Ferguson Act, the provisions of the securities law relating to securities and the security’s law don’t relate to the business of insurance.

    The provisions of the securities law is relating to securities have been regarded as applicable to securities and insurance companies.

    We have listed many of these instances in the footnotes on pages 16 and 17 of our brief.

    Thus, issues of insurance company securities have been registered under Section 6 of the Securities Act of 1933.

    Securities of insurance companies listed on National Exchanges have been registered with the Commission under Section 12 of the Securities Exchange Act of 1934.

    Persons who buy and sell insurance company securities have been registered under Sections 15 (b) of the Securities Exchange Act.

    Investment companies with portfolios consisting of insurance company securities have been registered under Section 8 of the Investment Company Act and persons selling insurance company securities and a fraudulent manner have been enjoined and convicted in a considerable number of cases.

    The decision of the court below which fails to recognize the distinction between the business of insurance to which the McCarran-Ferguson Act applies and dealings in securities which happen to be stocks and insurance companies would sweep all these away and broadly exempt all dealings and insurance securities from application of the federal laws.

    This is the effect of the decision below where the court said Congress was apparently seeking to define an exemption for insurance conterminous with its power to regulate interstate commerce.

    If Congress was intending to do that, obviously it swept away all applications of the insurance — of the securities laws to dealings and insurance securities.

    Potter Stewart:

    Mr. Solicitor General, one of my difficulties in reading the briefs and advanced argument in this case which continues now is that you and your adversary don’t really seem to argue as to what this case is about.

    Potter Stewart:

    Is that fair to say?

    Erwin N. Griswold:

    Well, I think there is something about that.

    Mr. Frank weighs a lot of other questions which present some difficulties which were not decided by the —

    Potter Stewart:

    Well, I’m not referring to the purchase and sale difficulties.

    I’m talking really about the if not the broad question to which you are now addressing yourself and you are quoting to us some very broad language of the Ninth Circuit Court of Appeals but the decision was not part of the District Court as affirm by the Court of Appeals simply that the McCarran Act foreclosed the undoing of a merger that had been approved by the Arizona Commission.

    That’s the holding in these cases, isn’t it?

    Erwin N. Griswold:

    Not exactly Mr. Justice Stewart.

    Potter Stewart:

    Tell me why.

    Erwin N. Griswold:

    We didn’t ask for the undoing of the merger in the exclusively as our only relief in the amended complaint.

    We ask for such relief as would be appropriated under the circumstances and it may well be that the merger should be left merged.

    But that individuals who have profited by the transaction should be required in some way to account either by disgorging to the merged company or by making payments to the shareholders who did not participate from it, all the questions of relief are left undecided both by the District Court and the Court of Appeals because they didn’t get to them having held that the McCarran-Ferguson Act eliminated the whole matter.

    Potter Stewart:

    I didn’t understand the District Court or the Court of Appeals really to have held that the neither the 1933 Act or the 1934 Act was completely inapplicable, or completely inapplicable to the dealings and securities of insurance companies.

    Erwin N. Griswold:

    Well Mr. Justice, I can’t read that language on page 157 or the Court of Appeals in any other way, and equally by it on purpose of the McCarran Act was to preserve intact from any federal intrusion based on the Commerce Clause existing and future state regulation of the insurance industry.

    And that would apply to any fraudulent sale of insurance stocks.

    Now it is true that this case does involve a merger of an insurance company and Mr. Frank argues that approving a merger is in some way analogous to the question of chartering and insurance company.

    I find it difficult even with that is fine anything in the McCarran-Ferguson Act which says that when this is done in a fraudulent way, that the provisions of the Securities and Exchange Act are superseded, are written off, are in effect repealed.

    I pointed out that the practice has been consistently to the contrary.

    Both before the McCarran-Ferguson Act was passed and I think that is very relevant before the South-Eastern Underwriters case was decided.

    It was then regarded as the appropriate construction of the Securities Acts that they were applicable to transactions of purchases and sales as the language of the statute with respect to insurance companies as to any other securities and we think that the effect of the decision of the Ninth Circuit is to make the insurance — is to make the security statutes inapplicable to transactions to dealings, to actions with respect to securities in insurance companies and it is our contention that that is not the proper construction of the McCarran-Ferguson Act which relates to the business of insurance to the things done by insurance companies with respect to their policyholders but not to transactions done by other persons with respect to securities in insurance companies.

    There are obviously other federal statutes of general application which were applicable to insurance before the McCarran-Ferguson Act was passed and which continued to be applicable to insurance thereafter.

    This includes the copyright and patent laws and insurance company is not exempt from the telephone tax or the social security tax.

    It’s not free to issue counterfeit money if it doesn’t have enough to meet its legitimate claims.

    It’s subject to the postal laws including those making at a crime to use the mails for the purposes of fraud.

    And I would point out that Section 10 (b) is based on the postal laws as well as on interstate commerce and that the mails were so used.

    And that there are a sizeable number of prosecutions both before and after the McCarran-Ferguson Act for using the mails to defraud with respect to the sale of insurance securities.

    These matters are not referred to in the McCarran-Ferguson Act but it cannot be supposed that Congress contemplated any change in the law with respect to them.

    As I’ve said, we’re dealing here with the statute which is based in part on the postal power.

    There’s no reason to think that Congress in passing the McCarran-Ferguson Act intended to allow an insurance company to use the mails to defraud stockholders.

    Byron R. White:

    Mr. Solicitor General, I take it then you would say because this is a — this is not a matter of regulating insurance but neglecting stock transactions that if there are federal regulations as to which should be in a proxy statement in connection with the merger conflict between the federal regulation, the state regulation.

    The state regulation approves a proxy statement and the federal authorities disapprove that Federal Act govern.

    Erwin N. Griswold:

    At this particular time, there was no —

    Byron R. White:

    Yes.

    Erwin N. Griswold:

    — federal provision with respect to —

    Byron R. White:

    But you would say that the federal law would?

    Erwin N. Griswold:

    The federal law would govern to the extent that the fraud was proved and found by the court.

    Byron R. White:

    That it was a stock formed by the insurance.

    Erwin N. Griswold:

    Yes, Mr. Justice.

    Hugo L. Black:

    Oh!

    There had been no northeast — southeastern case?

    None at all?

    Is it your belief that under the law there’s a then existent Congress could have passed bill regulating this very thing under the Commerce Clause?

    Erwin N. Griswold:

    Yes, Mr. Justice.

    It is our view that that’s just what Congress did do in 1933 and 1934, that it passed a law regulating transactions of purchase and sale of any security and that that included securities in insurance companies and was so construed by the Commission and in a very few cases by the courts between 1933, 1934, and 1944 when the South-Eastern Underwriters case was decided.

    Hugo L. Black:

    I asked you that question because I have been under the impression having some little addresses in South-Eastern Underwriters case that was the purpose of Congress to do away and time they would expect so long as relying on the Commerce Clause’s concern and in insurance business, I admit that I agree with that, and would you not have to if that was the case.

    Would you not have to show that even without that will, if that case had never been decided would not change the rule.

    That Congress could have and would have passed this Act.

    Erwin N. Griswold:

    Yes, Mr. Justice that’s exactly the argument we do make that Congress had this power and exercise it before 1944 and that for that reason, the enactment of the McCarran-Ferguson Act which was intended to restore the status quo did not and was not intended to take away the effect of the statute which Congress had previously passed with respect to securities.

    Hugo L. Black:

    Had there been any cases before the South-Eastern which so held?

    Erwin N. Griswold:

    No cases in this Court.

    Certainly, there was a modestly considerable amount of practical experience in the Securities and Exchange Commission including registration of securities and things of that sort.

    Hugo L. Black:

    It had not been challenged on that ground?

    Erwin N. Griswold:

    Never had been challenged on that ground that I’m aware of.

    Now, —

    Abe Fortas:

    But Mr. Solicitor General, I’d like to direct your attention again in this line of thought.

    As I understand your adversary, it says that the merger, the merger itself of these companies was proved by the insurance commissions.

    Now, arguably I supposed he would say that the merger is certainly insurance company talking about the merger of two insurance companies here.

    Now then along comes the SEC and says that this aspect of that merger is subject to federal law namely the terms of the offer of exchange the solicitation of the stockholders.

    It says that therefore it’s in conflict with the McCarran Act because this is something, the merger that is insurance business.

    It’s a merger of two insurance companies.

    I don’t profess to state —

    Erwin N. Griswold:

    Mr. Justice, I think you stated —

    Abe Fortas:

    — that’s my understanding of it?

    Erwin N. Griswold:

    I think you stated the issue and very clearly and very precisely.

    There is of course some overlap here.

    I think a considerable part of our concern is with the sweeping nature of the opinion of the Court of Appeals which says that the McCarran-Ferguson Act wiped out completely all aspects of the securities regulation with respect to insurance.

    When you come to the question of a merger, I think it is a nice question as to what is meant by the business of insurance and I think an argument can be made which is the one we stand on that the business of insurance relates to the internal operations of insurance and not to dealings in securities which Congress has so clearly taken over for a federal authority.

    Abe Fortas:

    Let me see if I understand it because I do believe that this is where the argument of the two parties comes in collision.

    What you’re saying is perhaps a merger of two insurance companies is the business of insurance for signs in some respects.

    But to the extent that it involves a solicitation of stockholders consent that a security holder’s consent said that that is not.

    That aspect of it is not the business of insurance.

    Erwin N. Griswold:

    The dealing with the security holders we would contend is not “the business of insurance” as was meant by Congress when it used those words in the McCarran-Ferguson Act.

    Let me — there is one decision of this Court which is pretty close in many ways which is the United Benefit Life Insurance Company case decided only a short while ago.

    There the company was undoubtedly an insurance company and the decision of the Court that it could not sell variable annuity policies without registering them with the SEC is directly that the securities of an insurance company are subject to the securities laws and are not taken out of the provisions of the securities laws by the McCarran-Ferguson Act.

    In that case the —

    Potter Stewart:

    But the holding of that case was that that company was engaging in selling securities not insurance policies.

    Suppose, if an insurance company went to the telephone business, they have to pay the tax on telephones.

    Erwin N. Griswold:

    Mr. Justice that would be applicable to the Variable Annuity Life Insurance Company which sold nothing but variable annuities.

    But the United Benefit Life Insurance Company was undoubtedly an insurance company.

    It sold large quantities of what everybody would agree was insurance.

    It also sought to sell variable annuities.

    And this Court held that it couldn’t do it without registering them with the SEC and that it seems to me is inevitably a direct decision that the securities of an insurance company are subject to the registration provisions of the securities laws despite the fact that Congress has passed the McCarran-Ferguson Act or to put it in other way that dealings in the securities of an insurance company are not “the business of insurance” within in the McCarran-Ferguson Act.

    That there are other cases which are close but I think that the United Benefit case comes very close to supporting our position.

    The decision of the court below would wipe out every application of the securities laws to securities and insurance companies.

    This is contrary to the long continued understanding in this area.

    It’s not required by the language of the McCarran-Ferguson Act and it’s inconsistent with that Act’s purposes.

    Accordingly, the judgment below should be reversed and the case remanded for consideration there of the other questions involved in the case.

    Potter Stewart:

    Good many insurance companies particularly life insurance companies these days are owned not by stockholders not by shareholders but are owned by the policyholders.

    I suppose the merger of two mutual companies would be I suppose these policyholders as owners would happen there.

    I guess there specifically _ on the —

    Erwin N. Griswold:

    We would have to find something Mr. Justice if we constitute securities in such companies before Section 10 (b) would apply because it applies only to purchases and sales of any security.

    Erwin N. Griswold:

    Now, conceivably in a mutual company, you could say that the policyholders are security holders —

    Potter Stewart:

    Except I believe they are expressed exemptions in the Securities Acts, aren’t they?

    Erwin N. Griswold:

    With respect to mutual companies?

    There may be, I’m not sure.

    Potter Stewart:

    There may be I’m not sure either.

    Earl Warren:

    You may start your argument tomorrow Mr. Frank.

    We’ll adjourn now.

    John P. Frank:

    Thank you Mr. Chief Justice.