Securities and Exchange Commission v. Variable Annuity Life Insurance Company of America

PETITIONER:Securities and Exchange Commission
RESPONDENT:Variable Annuity Life Insurance Company of America
LOCATION:Fargo, North Dakota

DOCKET NO.: 290
DECIDED BY: Warren Court (1958-1962)
LOWER COURT: United States Court of Appeals for the District of Columbia Circuit

CITATION: 359 US 65 (1959)
ARGUED: Jan 15, 1959 / Jan 19, 1959
DECIDED: Mar 23, 1959

Facts of the case

Question

  • Oral Argument – January 15, 1959
  • Audio Transcription for Oral Argument – January 15, 1959 in Securities and Exchange Commission v. Variable Annuity Life Insurance Company of America

    Audio Transcription for Oral Argument – January 19, 1959 in Securities and Exchange Commission v. Variable Annuity Life Insurance Company of America

    Earl Warren:

    Number 237 and 290, National Association of Securities Dealers versus Variable Annuity Life Insurance Company, et al., and Securities and Exchange Commission versus Variable Annuity Life Insurance Company of America, et al.

    Mr. Dorsey, you may continue.

    John H. Dorsey:

    Your Honor, I’ve exhausted my time.

    Earl Warren:

    Oh, you have, sir.

    Very well.

    All we know is the aggregate time you have on your side.

    So who is next in —

    Another Dorsey.

    Earl Warren:

    Oh, another Dorsey.

    [Laughter] Very well.

    Mr. Dorsey —

    Benjamin H. Dorsey:

    If Your Honor —

    Earl Warren:

    — you may proceed.

    Benjamin H. Dorsey:

    If Your Honor please.

    Despite similarity of the names, we are in quite the opposite side of the case.

    Earl Warren:

    Yes.

    [Laughs]

    Benjamin H. Dorsey:

    Mr. Chief Justice, Associate Justices, may it please the Court.

    A product of the life insurance industry is insurance because it assumes and distributes an insurable risk.

    This is as true of the variable annuity as it is — as it is true of any insurance policy issued by any company.

    The insurable risk in the variable annuity is the risk of excessive longevity.

    As the Court of Appeal’s said, “If everyone were to die at the time predicted by a mortality table, there would be no use in paying an insurance company to dollar out one’s funds.

    However, no one knows when he will die and the insurance product which guarantees him an income for life, regardless of how long that life may be is the annuity.”

    And investment risk on the other hand is not an insurable risk and whether annuity payments vary with investment experience has nothing to do with whether or not they are annuities.

    A variable annuity is an annuity.

    This fact has been determined by the Insurance Superintendent and legal authorities of the District of Columbia and several States.

    This fact was agreed to by all expert insurance witnesses testifying at the trial.

    This fact is agreed to by the three leading authors of life insurance textbooks.

    This fact has been agreed too by the two courts below.

    This fact has been accepted by the Internal Revenue Service which classifies a variable annuity as an annuity.

    Benjamin H. Dorsey:

    This fact finally was accepted by petitioners when they did not challenge Finding of Fact Number 30 made by the District Court.

    Finding of Fact 30 which is in the recorded at page 100 says that a variable annuity issued by these respondents is an annuity.

    A variable annuity is an annuity because it, like all other annuities and unlike any other economic device, provides a lifetime income over the life span of a group of annuitants in accordance with scientific actuarial principles.

    The Securities and Exchange Commission concede this is the proper definition of an annuity that states that whether or not an annuity shall be regulated by the Commission depends upon the degree of investment risk born by the individual policy holder.

    Variable annuities which assume no investment risk have been available for years for persons in the teaching profession and for the benefit of many large corporations.

    The College Retirement Equities Fund has made variable annuities available to many thousands of teachers and professors in the United States without challenge from the Securities and Exchange Commission.

    The immediate participation guaranteed annuity which guarantees no investment assumption to the policy holder is sold by many of the best known life insurance companies in the United States.

    Felix Frankfurter:

    You know — you know of the — speaking of teachers’ annuity, you know the Carnegie annuity?

    Do you know?

    (Inaudible)

    Benjamin H. Dorsey:

    Yes, sir, I do.

    Felix Frankfurter:

    May I ask you whether — from what you’ve said (Inaudible) has not been subjected to regulation or has not been deemed by the Securities Commission subject to the Investment Act, is that right?

    Benjamin H. Dorsey:

    That is correct, Your Honor.

    Felix Frankfurter:

    Now, may I ask you whether or rather to what extent, whatever that the variable annuity is comparable to the terms of the Carnegie teachers’ annuity, under which I don’t know how many professors and teachers hold their (Voice Overlap) —

    Benjamin H. Dorsey:

    I think —

    Felix Frankfurter:

    — securities and to what extent they are different from?

    Benjamin H. Dorsey:

    Yes, Your Honor.

    I think the number of teachers covered is now in excess of 40,000.

    Historically, Mr. Carnegie decided that many teachers in the United States were not adequately compensated in their retirement period.

    Consequently, around about the end of World War I, the Teachers Insurance and Annuity Association was founded in New York.

    This association called TIAA paid fixed dollar annuities to teachers and professors in the United States that wanted to participate by the universities in this plan.

    During the period of the 1920s and 1930s, they found that many teachers and professors had been reduced to gentile poverty because the fixed dollar payments were insufficient.

    Therefore, Mr. Carnegie came along and gave them some more money.

    And subsequent to that time, they decided that there was no reason why and the legislature of the State of New York agreed with them that a companion corporation called the College Retirement Equities Fund could not be set up.

    Now, what a teacher, who elects to participate in this plan, receives today is one half of these premiums that are put into a fixed dollar annuity.

    That’s called the TIAA.

    The other half is put into a variable annuity, which is called the College Retirement Equities Fund — Equities Fund or CREF.

    The distinguishable element between the variable annuity sold by these respondents and the TIAA-CREF plan is that in that plan, you must have both simultaneously, that is you must have a fixed dollar annuity and a variable annuity if you so desire.

    You may not have the variable annuity without the fixed dollar annuity.

    Felix Frankfurter:

    Otherwise — otherwise — assuming the otherwise is important or unimportant, whichever you assume, otherwise there was identity?

    Benjamin H. Dorsey:

    Not quite, Your Honor.

    In the College Retirement Equities Fund variable annuity, they do not assume any expense guarantee.

    These respondents do.

    The College Retirement Equities Fund assumes no mortality guarantee.

    They merely distributed over the group, whereas we do assume from the moment a policy has written the mortality guarantee.

    Felix Frankfurter:

    Am I right in assuming that the — the College Annuity Fund, whatever it’s called, I forget I was once a beneficiary, a (Inaudible) beneficiary, is not exquisitely exempted from the Act?

    Benjamin H. Dorsey:

    Oh, no, Your Honor.

    Felix Frankfurter:

    Or the category to which it could be said to belong?

    Benjamin H. Dorsey:

    No, sir.

    The Commission in its reply brief, I believe, states the case in this manner that because you have to have a fixed dollar annuity or along with your variable annuity from the College Retirement Equities Fund that somehow makes a difference.

    Felix Frankfurter:

    Have they — have they actually ruled on the College Retirement Fund category or has it assumed — has it been assumed that it doesn’t come within the terms of the legislation?

    Benjamin H. Dorsey:

    Your Honor, there is nothing in the record on the subject.

    However, as my understanding, which is subject to correction, if proper, from counsel for the Commission, that the matter of the College Retirement Equities Fund and its possible relationship to the Securities Act was discussed with the Commission along about the time in 1952 when the College Retirement Equities Fund was established.

    Earl Warren:

    Do the beneficiaries in the College Retirement Fund and in this — in this company that you represent assume the risk of loss in the same degree, in the same manner?

    Benjamin H. Dorsey:

    No, Your Honor.

    We assume the —

    Earl Warren:

    Would you please state the difference between them?

    Benjamin H. Dorsey:

    Yes, sir.

    Earl Warren:

    I think that’s somewhat important.

    Benjamin H. Dorsey:

    If I understand Your Honor’s question, it is whether or not the same risk of loss is assumed by the College Retirement Equities Fund is assumed by respondents.

    Earl Warren:

    Oh, I mean the beneficiaries of — to the beneficiaries, each assume the risk of loss.

    As I understand it, the people who — who abide these annuities assume some risk of loss in your company, do they not?

    Benjamin H. Dorsey:

    Yes, Your Honor.

    We call that insured.

    Earl Warren:

    Now, what I’d like to know is, do they assume the same risk of loss under this — this College Retirement Fund and if — if not, what is the difference?

    Benjamin H. Dorsey:

    Yes, Your Honor.

    They assume the same risk of loss, the risk of loss being the end of benefits upon death.

    Earl Warren:

    I beg pardon?

    Benjamin H. Dorsey:

    They assume the same risk of loss, the risk of loss being the end of the annuity payments or benefit upon the death of the insured.

    Earl Warren:

    But let’s just don’t take the end result because there’s some variables in here from time to time.

    Earl Warren:

    Are those the same?

    Benjamin H. Dorsey:

    Your Honor’s question used the word “beneficiary”.

    Earl Warren:

    But — use any — any name you want, but I’m speaking about the individual who — who purchases a unit or — or a policy or an annuity or whatever you may choose to call it.

    Benjamin H. Dorsey:

    In the accumulation period which is basically the same in either case, in the College Retirement Equities Fund, the annuitant has no cash surrender value.

    All respondents and other commercial insurance companies are required by law to have a cash surrender value.

    In the College Retirement Equities Fund, they do not guarantee what the expenses of the equities fund will be.

    They merely find what they are and then spread them across the group.

    Conversely, in our case, we do guarantee what maximum expenses will be.

    And if the expenses exceed that, that is the risk of the stockholders and not the policy holders.

    Earl Warren:

    And how about the loss on — on investments?

    Benjamin H. Dorsey:

    The investment risk, Your Honor, which is not an insurable risk is identical on both cases.

    Employees of the State of Wisconsin may —

    Felix Frankfurter:

    Is the scope of allowable investment the same, that is the kind of thing in which — the kind of thing they can carry in their portfolios?

    Benjamin H. Dorsey:

    I believe that is true, Your Honor, although I cannot speak with authority on New York State law.

    The authority of the District of Columbia law is set forth in our — in our brief and it’s the same for all life insurance companies in the District of Columbia.

    I believe that basically, there would not be a great deal of difference between the investments permitted to the College Retirement Equities Fund and the investment permitted by a lot of these respondents.

    Felix Frankfurter:

    But the College Retirement is also operating in the district, is it not?

    Benjamin H. Dorsey:

    It operates generally speaking all throughout the United States.

    Felix Frankfurter:

    Yes.

    That’s what I thought.

    Earl Warren:

    Are the — is the College Retirement Fund regulated as insurance or as a corporation?

    Benjamin H. Dorsey:

    It is regulated as insurance by the Superintendent of Insurance of the State of New York.

    One of the issues presented in this case is, therefore, whether or not the general public may buy variable annuities if they so desire.

    It is not seriously questioned that only a life insurance company may issue a variable annuity policy.

    The Securities and Exchange Commission has based its plea for regulation of respondents on two premises.

    First, that the extent of the investment risk borne by an individual policy holder determines whether or not an annuity is also a security.

    In its reply brief, the Commission says, at the foot of page 3, we do not contend that the purchaser of traditional insurance assumes no investment risk.

    Our contention is that Congress presumably thought that that risk was of such a comparatively minor character particularly in view of state regulation that there would be no need to require compliance with the federal securities law.

    As to the investment risk, I believe it is clear that the degree of investment risk assumed, which is not an insurable risk, has nothing to do with the question of whether a particular annuity should be regulated by the Securities and Exchange Commission.

    Congress intended that all annuity should be regulated solely by the States.

    Benjamin H. Dorsey:

    Second, the Securities and Exchange Commission says that the public is not adequately protected from many possible abuses in the sale of variable annuities despite regulations of the District of Columbia and several States.

    This statement is simply incorrect.

    Life insurance regulation commences prior to the formation of a company and last until each and every obligation of the company to its policy holders has been discharged.

    It has been said that the business of life insurance is more regulated than any other business activity not a public utility.

    Insurance regulation is not solely of the disclosure variety, but is predicated on the assumption that the only way in which the public can be adequately protected by — through regulations so stringent that will ensure the fairness of every policy issued and every practice followed by the company.

    In the District of Columbia, the Superintendent of Insurance even has the authority to refuse to renew an annual license to an insurance company if he believe such renewal of license would adversely effect the public interest.

    Petitioner as in the accident and health cases does not argue that these statutes are mere pretense.

    Petitioner’s argument is the possibilities of abuse are inherit in sales of these contracts, while the same could be said of any policy of life insurance.

    The real question is with regard to all such contracts, what agency shall protect the public from the possibility of abuse.

    In the field of life insurance, the answer is now as it has been for generations.

    The state legislatures and state insurance supervisors shall protect the public in the public interest.

    Securities and Exchange Regulation, the respondents, would add nothing in the nature of public protection.

    Unless it should be deemed to be in the public interest to destroy respondents and to allow the Securities and Exchange Commission to regulate those insurance companies which it alone decides do not assume enough of the investment risk.

    With the passage of the —

    Felix Frankfurter:

    Why do you say destroy?

    Benjamin H. Dorsey:

    I beg your pardon.

    Felix Frankfurter:

    Why do you say destroy?

    Benjamin H. Dorsey:

    Your Honor, at Section 18 of the Investment Company Act, it applies to these respondents and the Commission does not differ with us on this, would make it legal, the present charters and policies issued by the respondents.

    Section 18, after the Investment Company Act, is a statute designed to deal with the situation of investment company and to prevent senior securities debt obligations from being issued by a mutual fund to the detriment of holders of mutual funds.

    A life insurance policy is a debt obligation.

    If our life insurance policies are debt obligations, and Section 18 applies to these respondents, then every policy we’ve issued has been illegal and no further policies we could issue would be legal.

    Felix Frankfurter:

    You say the Commission agrees to this?

    Benjamin H. Dorsey:

    Yes, Your Honor.

    They — I think, basically — if Your Honor would look at page 53 of the Commission’s main brief, I think the point is brought out there.

    Earl Warren:

    Mr. Dorsey, may I —

    Benjamin H. Dorsey:

    Yes, sir.

    Earl Warren:

    — ask you?

    Is this a new incursion of — of insurance business into the investment field or is this something that has — has gone along for a period of time and if so, has there been any effort on the part of SEC to bring it — bring this principle under control of the SEC?

    Benjamin H. Dorsey:

    To the best of my knowledge, Your Honor, this is a historical continuous development in bits and pieces in the life insurance business.

    As life insurance has grown and as its obligations to policy holders grow, it has become apparent that investment solely in the field of mortgages and balance will not suffice because the dollar, as a store of purchasing power, something you put aside today for use 25 years from now, has fallen down rather badly.

    Benjamin H. Dorsey:

    To my knowledge, there are — there has been no attempt either in the State of Wisconsin which provides annuities or variable annuities for its state employees to regulate by the Securities-Exchange Commission.

    In the College Retirement Equity —

    Earl Warren:

    You say there has been no effort.

    Benjamin H. Dorsey:

    That is correct, Your Honor.

    Earl Warren:

    Yes, yes.

    Benjamin H. Dorsey:

    In the College —

    Felix Frankfurter:

    Whether a state — a state conducted enterprise?

    Benjamin H. Dorsey:

    Yes, sir.

    State legislature created in 1957, the State of Wisconsin Retirement Fund.

    Felix Frankfurter:

    Let me — let me raise another question.

    (Inaudible) which I’m ignorant, namely, whether state — state investment, what might be deemed to fall under the term of the Investment Act, falls on (Inaudible) if conducted by the State.

    I don’t know.

    Maybe the answer is clear that it’s subject to the Act.

    But it may raise a different question.

    In other words, whether — whether the Investment Act was swept under the jurisdiction of the Securities Commission, state enterprise.

    I — I don’t know.

    There maybe already answer to that.

    Benjamin H. Dorsey:

    I don’t —

    Felix Frankfurter:

    All I’m suggesting is it might be a different question.

    Benjamin H. Dorsey:

    With the passage of the Securities Act in 1933, Congress extended federal regulation into the fields of interstate security transaction.

    Life insurance was already fully regulated at this time and Congress had no intention of commencing to regulate life insurance policies.

    Earl Warren:

    Is this the only one that you revert to my question?

    Is the Wisconsin practice, the only one that you cite as being —

    Benjamin H. Dorsey:

    No, Your Honor.

    I’m sorry.

    I’ve answered the question I set in my mind.

    We have the College Retirement Equities Fund in which the Securities and Exchange Commission has made no attempt to regulate.

    We have a commercial company called the “Participating Annuity Life Insurance Company in Arkansas”.

    Securities and Exchange Commission has never attempted to make them be under its jurisdiction.

    Earl Warren:

    How long has that continued?

    Benjamin H. Dorsey:

    I believe in the case of Participating Annuity Life Insurance Company, since 1954, in the case of the College Retirement Equities Fund, since 1952.

    Now, in the field of group insurance, the insurance industry has provided since approximately 1950 a group annuity called the “Immediate Participation Guaranteed Annuity” which guaranteed absolutely no investment assumption to the policy holder and these things have developed in an orderly fashion in the life insurance industry.

    And this, I believe, constitutes the first and only attempt by the Securities and Exchange Commission to take the position that where the investment risk lies has something to do with whether or not a company organize under state law and regulated under state law and selling an annuity by state definition suddenly becomes subject to jurisdiction of the Commission under several acts.

    Felix Frankfurter:

    You said that respected authors dealing on insurance law have support your position.

    Do these authors to which you give references use specifically with your type of — of enterprise or arrangement?

    I use those neutral terms to avoid expressing a position.

    Benjamin H. Dorsey:

    Yes, Your Honor.

    Felix Frankfurter:

    Which are they?

    Benjamin H. Dorsey:

    Professor Huebner in — the current edition 1958.

    Felix Frankfurter:

    Well, that’s an old classic (Inaudible)

    Benjamin H. Dorsey:

    This is his current edition, 1958.

    It is an old classic, sir.

    Felix Frankfurter:

    All right.

    Benjamin H. Dorsey:

    Meyer and Osler which won a price in the field of life insurance writing, which, I believe, is 1956 edition and professor — I shouldn’t call him professor, Dr. Joseph McClain who was probably the Dean of Actuaries in United States who testified at the trial.

    Felix Frankfurter:

    (Inaudible) referred in your brief, is it?

    Benjamin H. Dorsey:

    Your Honor, it is referred to in the VALIC brief, that is the brief of the other respondent.

    And the page, I do not —

    Felix Frankfurter:

    It deal specifically with your annuity?

    Benjamin H. Dorsey:

    Yes, Your Honor.

    Are there any difference in the characteristics of your — your (Inaudible)

    Benjamin H. Dorsey:

    No, Your Honor.

    We stipulated at the time of the trial that any difference is between the policies were immaterial.

    Potter Stewart:

    Mr. Dorsey, a — a mutual company would not run a file of the provision of Section 18 of the Investment Company Act of 1940, would it?

    Benjamin H. Dorsey:

    No, Your Honor.

    Potter Stewart:

    It’s only because you are a — a stock company that you do.

    Benjamin H. Dorsey:

    Mutual Life Insurance Company?

    Potter Stewart:

    Yes.

    Benjamin H. Dorsey:

    The Mutual Life Insurance Company sends all its policies or debt obligations between — between policy holder and company would indeed run a file of Section 18 of the Investment Company Act.

    Potter Stewart:

    Why would the — I thought it was because you have stockholders that you would, that you have stockholders and annuitants.

    But a mutual company, the — the beneficiaries would also be the owners of the company, isn’t it?

    Benjamin H. Dorsey:

    I agree with you, Your Honor.

    That is correct.

    In a mutual life concerns company which has no stock, there cannot be any question as to what class of security if security it’d be they’re issuing.

    Potter Stewart:

    Yes.

    Let me ask you one other thing.

    You emphasized quite correctly, I think, the — the extent of the regulation of the States over the business of insurance, each State has very rigorous standards and a great deal of regulation, but doesn’t that regulation almost always invariably include severe limitations upon the nature of investments that insurance companies can make?

    Benjamin H. Dorsey:

    Yes, it does, Your Honor.

    Potter Stewart:

    And pretty much prohibit some from going very — very far into — into common stocks by way of investments?

    Benjamin H. Dorsey:

    Generally, that is so.

    The District of Columbia Life Insurance Act which was enacted by Congress many years ago doesn’t have such limitation.

    Potter Stewart:

    I see.

    Benjamin H. Dorsey:

    It wasn’t enacted for the benefit of these companies to spend on the books, statute books since 1934 and applies equally to every life insurance company organized in the District of Columbia.

    Potter Stewart:

    So in — in that respect at least, the District of Columbia regulation is not typical of the regulation which — of the — of the other State —

    Benjamin H. Dorsey:

    Insofar as the investment aspect of a life insurance company’s funds go, I think it would be correct to say that it is not typical of the major pattern in the United States.

    Potter Stewart:

    And therefore, there are not many States in which your kind of a company could operate, are they?

    Be incorporated, I mean.

    Benjamin H. Dorsey:

    Your Honor, this litigation has left that question somewhat unsettled as of now, but I think there’s —

    Potter Stewart:

    Assuming — assuming that you are, what you say you are, an insurance company.

    Benjamin H. Dorsey:

    Well, at the moment, I believe we can operate in several States.

    As a matter of fact, a lot of States simply will take no action until this case is decided.

    Earl Warren:

    I suppose if a — if a stock company could not get a license to do business in a — in a State certainly to the fact that — that it was permitted by the District of Columbia to do so and not authorize them to sell these annuities and these other States, would they?

    Benjamin H. Dorsey:

    No, Your Honor.

    You must obtain a license to do business —

    Earl Warren:

    Yes.

    Benjamin H. Dorsey:

    — in any State where you wish to operate on a general —

    Earl Warren:

    (Voice Overlap) —

    Benjamin H. Dorsey:

    (Voice Overlap) basis.

    Earl Warren:

    — license in place where you have conformed to the — to the state laws so far as your financial structure is concerned, is it not?

    Benjamin H. Dorsey:

    That is correct, Your Honor.

    Does the character of the state regulation of securities that can be dealt in or purchased with respect to variable annuity fund , does that — does the character of that regulation differ from the regulations pertaining to investments of reserve funds of insurance company or is it equally applicable as to — equally applicable to reserve funds as to investments in the variable annuity funds?

    Benjamin H. Dorsey:

    It pertains, Your Honor, to all investible assets of respondents.

    Irrespective of whether it’s —

    Benjamin H. Dorsey:

    Irrespective of anything.

    Charles E. Whittaker:

    How does the question of how States may regulate the matter of what securities and insurance company may find there on the question of whether these annuities are insurance or investments?

    Benjamin H. Dorsey:

    If Your Honor please, it has no bearing whatsoever on whether or not these companies are selling an annuity or whether they are selling a security and that where you invest your money is something the States set the boundaries on and that’s it.

    When Congress enacted —

    Felix Frankfurter:

    It may bear — it may bear the practical argument on policies that laid behind the legislation and the consequence is evil or good of making one construction rather than another of the Act.

    Benjamin H. Dorsey:

    Your Honor, Congress enacted the Securities Act, the legislative history particular House Report 85 which accompanied the bill became law.

    I believe it makes it clear that no insurance policy was intended to be within the purview of the Act.

    Felix Frankfurter:

    Well, if — if one agrees that it’s an insurance policy, I suppose, Mr. Meeker wouldn’t be arguing here.

    That’s the whole controversy, isn’t it?

    Benjamin H. Dorsey:

    Your Honor, in order to make this point crystal clear, the Congress put Section 3 (a) (8) in the Securities Act.

    And Section 3 (a) (8) says that any insurance policy or any annuity policy is exempt from Section 2 of the Act.

    Now, in the Securities Act, Congress did not undertake to define insurance or annuity, and I think there’s a very good reason for that, because insurance companies are formed under state law and not federal law, and insurance policies are issued by insurance companies after being approved by state regulatory authority.

    Felix Frankfurter:

    Well, that is equally true of the corporations issuing the securities which are controlled by the Securities Commission.

    Benjamin H. Dorsey:

    I think — I think that would be true, Your Honor.

    Felix Frankfurter:

    Yes, so that’s —

    Benjamin H. Dorsey:

    With regard to Section 3 (a) (8) of the Securities Act, I think the Commission, in page 56 of its brief, has expressed the proper view of that section and that is to say that when a single state insurance supervisor determines this question, the effect of the subsection is to create a nationwide exemption from Section 2 of the Act.

    Felix Frankfurter:

    Would you mind stating that proposition again?

    Benjamin H. Dorsey:

    Yes, Your Honor.

    The Commission says, in its brief at page 56 — now, they filed two briefs, a reply brief and a main brief.

    Charles E. Whittaker:

    Page 56.

    Benjamin H. Dorsey:

    Yes, Your Honor.

    Felix Frankfurter:

    I thought I heard you say a single — determination by a single insurance commission.

    Benjamin H. Dorsey:

    Yes, Your Honor.

    Felix Frankfurter:

    Determines the — the status of a character throughout the country.

    Benjamin H. Dorsey:

    That is correct.

    Felix Frankfurter:

    That means — does the Commission say that? (Voice Overlap) —

    Benjamin H. Dorsey:

    I will read you from the footnote at the bottom of page 56, if I may, “The Securities Act exemption Section 3 (a) (8) 15 U.S.C. 77aa provides a total countrywide exemption where the insurance is issued by a company licensed by any state authority.”

    Felix Frankfurter:

    But the precondition of that proposition is that it was an insurance within the terms of the Act.

    Benjamin H. Dorsey:

    Yes, Your Honor.

    And the precondition is that the State shall decide for itself what is insurance and what is an annuity.

    Felix Frankfurter:

    Well, does that mean — you don’t mean that the determination by the New York Superintendent of Insurance, I see a very admirable young lawyer who has just been appointed to that position in New York, does that mean that his determination to the — to the document is an insurance rather than an annuity and insurance rather than investment is controlling upon the construction of the Act?

    Benjamin H. Dorsey:

    It is controlling on the construction of the New York Life Insurance Act.

    It is also controlling and that is what the Commission is saying here on the determination under 3 (a) 8 of the Securities Act.

    Felix Frankfurter:

    So that means that — that the determination of a single state agency may determine whether it is or it isn’t an insurance.

    Benjamin H. Dorsey:

    Quite so, Your Honor.

    Felix Frankfurter:

    Is that right?

    That’s your proposition.

    Benjamin H. Dorsey:

    That is my proposition, and I believe that the Commission agrees with it.

    Earl Warren:

    Do understand you, Mr. Dorsey, to go as far as to say that if — if a State authorizes a company to do business as an insurance company that the SEC can have no jurisdiction regardless of what kind of business that — that company transacts?

    Benjamin H. Dorsey:

    Well, Your Honor, in an extreme —

    Earl Warren:

    Whether it — whether it is actually insurance or investment or whatever it might be?

    Benjamin H. Dorsey:

    Except in an extreme case, Your Honor, as in the Cambridge loan case which was presented to this Court.

    I believe what Congress intended was that one, the State shall define what it is an annuity.

    And two, as the Commission says, and I think they’re right, that when a single state insurance supervisor has made such a determination, effective his determination is to create a nationwide exemption from the Securities Act.

    Felix Frankfurter:

    (Voice Overlap) an insurance — an insurance enterprise on the New York law by the New York authority?

    Benjamin H. Dorsey:

    Could we?

    Felix Frankfurter:

    Have you been?

    Benjamin H. Dorsey:

    No, Your Honor.

    We have not — we —

    Felix Frankfurter:

    No — no state agency determined you to be an insurance company subject to its jurisdiction.

    Benjamin H. Dorsey:

    Oh, yes, Your Honor.

    Felix Frankfurter:

    Well, then — then you could if you chose to rest yourself on one proposition.

    What State?

    Benjamin H. Dorsey:

    District of Columbia, West Virginia.

    Felix Frankfurter:

    All right.

    And if — if you chose, if lawyers would say, “I would base my whole proposition, my whole case on a single argument,” you could say West Virginia and District of Columbia had determined we are an insurance company and that’s the end of the matter and sit down.

    I mean, you could, as a matter of logical argument, couldn’t you?

    Benjamin H. Dorsey:

    I suppose so, Your Honor.

    William O. Douglas:

    Except that the concept of insurance, I suppose, is a federal question not a question (Inaudible) the state court.

    Benjamin H. Dorsey:

    I believe the intention of Congress was to leave the determination with the state legislatures and the state insurance supervisors.

    William O. Douglas:

    Was there any indication of that?

    Benjamin H. Dorsey:

    Yes, sir.

    William O. Douglas:

    (Inaudible) the federal statute, Congress, of course, could take such definition as it chose —

    Benjamin H. Dorsey:

    Congress could.

    William O. Douglas:

    — state law or —

    Benjamin H. Dorsey:

    Professor Loss in his book Securities Regulation says the Commission has taken, this is page 19 of the brief, the Commission has taken —

    Felix Frankfurter:

    What brief is that?

    What —

    Benjamin H. Dorsey:

    The blue one, Your Honor.

    Felix Frankfurter:

    In your brief?

    Benjamin H. Dorsey:

    Yes, sir.

    Felix Frankfurter:

    All right.

    What page please?

    Benjamin H. Dorsey:

    19, sir.

    Felix Frankfurter:

    All right.

    I saw it.

    Benjamin H. Dorsey:

    The Commission — this is quoting from Professor Loss, “The Commission has taken the position that insurance or endowment policies or annuity contracts issued by regularly constituted life insurance companies were not intended to be securities.”

    And as McCormick says in his book, “Only those insurance or annuity policies are exempted, which are issued by corporations under the jurisdiction of a designated insurance supervisor.”

    I thought that all the Commission meant in his footnote was assuming that you are right that this variable annuity policy is not subject to SEC’s supervision that then even though one State may say it is and another State says it isn’t that they would agree in those circumstances that the Commission can step in.

    They don’t — they surely don’t say that if New York says that this a variable annuity policy, that ends a litigation, they’ve conceded themselves out of court on that premise?

    Felix Frankfurter:

    But that’s what you were saying, isn’t it?

    (Voice Overlap) —

    Benjamin H. Dorsey:

    That is why I read what they have said in their brief, Your Honor.

    If Your Honor please, I have more than used the time allotted to me, and I wish to thank the Court.

    Earl Warren:

    Mr. McDonald.

    Roy W. McDonald:

    May it please the Court.

    I should like, in the short time I have, to devote myself to about two or three questions, particularly the two that were asked by Mr. Justice Black on last Thursday.

    Before starting that, however, I should like to report one or two question that were asked during the first argument of Mr. — the — the preceding speaker.

    Roy W. McDonald:

    Mr. Justice Frankfurter asked if CREF could be claimed to be exempted under any other section besides 3 (a) (8).

    We are very good friends of CREF and we would not wish to leave them without their full defense.

    Of course, they were claimed to be exempt under 3 (a) (8), but they also, I think, would claim to be exempt from the 1930 Act under section 3 (a) (4) which exempts any security issued by a person, and that’s broadly defined, organize and operated exclusively for religious, educational, etcetera, purpose.

    Felix Frankfurter:

    That’s what I’m wondering about.

    Roy W. McDonald:

    Yes, sir.

    CREF is organized as a nonprofit organization, but it was put under the jurisdiction of the Insurance Department.

    With reference to Mr. Justice Stewart’s question about Section 18 (f), I may say that we have used that in all three courts as the most striking example, and it has never been answered.

    But we anticipated that someone would answer it by saying, “What about a mutual company?”

    And that gave us some concern until the SEC provided us with the answer to that on page 10 of their current reply briefs filed on the 15th of this month.

    They pointed out on page 10 of the small reply brief that the District of Columbia Life Insurance Act, it is provided in their full paragraph under second sentence, the District of — first — first sentence, “The District of Columbia Life Insurance Act illustrates that local regulation of insurance is patently not adopted to regulation of the investment aspects of the variable annuity.”

    Then the next sentence, “The sale of investment contracts or other securities is prohibited thereunder in connection with the sale of an insurance policy.”

    There is no question as Mr. Meeker has admitted and Mr. Dorsey of NASD has admitted that we are selling life insurance and disability insurance with it and even if we were a mutual company, as I read the SEC brief, that statute would make it impossible for us to issue variable annuities if they were securities.

    The two questions that I was particularly interested in discussing against the excellent background Mr. — of Mr. Ben Dorsey.

    First, who regulates us now and secondly, what does the purchaser get.

    We are now regulated and when I speak of “we”, I mean, VALIC.

    There are two — two respondents here.

    One is EALI, Equity Annuity Life Insurance Company for whom Mr. Dorsey spoke.

    The other is VALIC for whom Mr. Earnest and I will speak.

    We are presently under the regulation of the Insurance Superintendent or the Commissioner of the District of Columbia of West Virginia, of Kentucky, of Arkansas, of Alabama and of New Mexico.

    The extent of the regulation in the District of Columbia is set forth in our brief at page 59 to 64 where we have extensively summarized it.

    The West Virginia regulation is set forth in the second volume of the — of the record at page 824, and I should like to mention just one or two of the things in that regulation which strike me as rather unusual.

    At page 825 in Section 25, among the other things which can — which is regulated by the Insurance Superintendent of West Virginia is a limitation on profits that can be paid to stockholders.

    Now, this is no fly-by-night company which out to sell the kind of policy Mr. Dorsey described, there, as well as in Arkansas, which is the next exhibit, there is a provision.

    The Arkansas provision applying — appearing on page 830 in Section 9 that the Insurance Commissioner, in reviewing our annual statements, can determine whether our operations are resulting in excessive profits to our stockholders.

    Felix Frankfurter:

    Is that — you — do I understand that limitation of West Virginia to be a finding by that authority, by the Commissioner in West Virginia, whatever he is called that that is true of your operations throughout the country, not merely with reference to what you write or the annuity you issue in West Virginia?

    Roy W. McDonald:

    No, sir.

    We would not go so far as Mr. Dorsey on his — on behalf of his client.

    It is our contention, Your Honor, that each State must decide what constitutes insurance in that State.

    Now, this is a finding we have set forth in our brief on page 81, the finding of the Insurance Commissioner which were —

    Felix Frankfurter:

    The total findings are based on your total operations and not merely as allocated to West Virginia.

    Roy W. McDonald:

    Yes, sir.

    The — and in that connection elsewhere in our brief, the West Virginia Superintendent has stated that he has twice examined ours and found they adequately protect our policyholders.

    Does that mean that as a practical matter, your most stringent state regulatory language, as a practical matter, goes to (Inaudible)

    Roy W. McDonald:

    That is correct, Your Honor.

    And in that connection, without trying to pick the page at the moment, one of the SEC experts who was the only one who knew anything about insurance, testified voluntarily, nobody asked a question.

    He testified though, and we have quoted in our brief that, of course, a mere disclosure or a mere report will not provide protection for solvency as well an examination.

    Now, we have been examined, as the record shows, annually by the District of Columbia Superintendent of Insurance, twice by the West Virginia Superintendent of Insurance and are subject to examination by any of the other superintendents and — at three intervals by what is called a convention examination of a group of insurance commission.

    Felix Frankfurter:

    Mr. McDonald, do your answer to Justice Harlan’s question is quite so?

    Does it mean that or it doesn’t mean you may not be allowed to do business in that particular State on concept that other States may have lack standard?

    Roy W. McDonald:

    I may have misunderstood, Mr. Justice Harlan’s question.

    I thought I filed it.

    Did I miss it?

    No, I — I think Mr. Justice Frankfurter is quite correct that the consequence should be, if you didn’t comply, you wouldn’t be allowed to do business in the more stringent State.

    Roy W. McDonald:

    It — that is precisely —

    (Voice Overlap) —

    Roy W. McDonald:

    — so, sir, and that is —

    Felix Frankfurter:

    In the most — you wouldn’t be allowed to do business in that State.

    Roy W. McDonald:

    We would not be allowed to do —

    Felix Frankfurter:

    But you — you could continue to do business in 47 other States if they let you.

    Roy W. McDonald:

    That is correct.

    And take New York — well, let us take Connecticut for instance, because the SEC makes a great play of the Spellacy case in Connecticut.

    The Spellacy case held that under the Connecticut law, a fraternal benefit society would not be allowed to issue what was called a variable endowment policy.

    They held that under the Connecticut law, that was not insurance.

    As a dictum, they paid a passing comment to the variable annuity so-called “option” in that policy.

    Seven questions had been reserved for the Superior — Supreme Court.

    One of which was, is this a security?

    They did not answer that.

    Now, the another fact was that in Connecticut, they said this is not an insurance under our statute.

    And of course, we would think that under the present statute in Connecticut, we could not be admitted there.

    Felix Frankfurter:

    May I suggest that this whole line of argument is legally rather irrelevant because if you’re out of the statute, whether the States choose to regulate you effectively is none of the Federal Government’s business.

    Felix Frankfurter:

    If you’re within the statute, then the effective regulation is immaterial.

    Roy W. McDonald:

    Yes, sir.

    And that brings us to the question of what the man gets, and that is the question of whether this is insurance.

    The business of life insurance, and this is all from the record, incidentally, Mr. McClain from — the author quoted, testified at the trial.

    Mr. Meyer, the author quoted, testified at the trial.

    Both of them agreed that this was the life insurance business.

    And on your question, Mr. Justice Warren, with respect to CREF, in CREF, as Mr. Dorsey pointed out, the group, that is the policyholders, carry the risk of expense, of death and of investments.

    In our case, as he also pointed out, the policyholder has the incidental — the risk of the investment results, but not of the mortality or the expense.So that was a greater sharing of the — of what you might call the variables in CREF than in our case.

    Earl Warren:

    That’s quite a substantial difference, isn’t it, as to whether the — the policyholder assumes the investment risk?

    Roy W. McDonald:

    Well, he does it in both of those.

    Both in CREF and in ours, he assumes the investment risk.

    He does — in ours, he does not assume the debts risk.

    In other words, that the whole group lives excessively long, excessively being used in the sense of beyond the mortality table.

    Earl Warren:

    Yes.

    Roy W. McDonald:

    Our company bears that risk.

    In —

    Earl Warren:

    Oh, I see.

    Roy W. McDonald:

    — CREF, it would cut down everybody’s — it seems to us, if the Court please, that one of the crucial findings in the case on one of the questions asked is Finding Number 28.

    Finding Number 28 points out —

    (Inaudible).

    Roy W. McDonald:

    Yes, it’s on page 100, most conventional annuity policies, contracts provide for periodic payments in fixed dollar amounts.

    Now, this is the one that we are all accustomed to deal with.

    Such policy contracts may guarantee that the periodic amounts determinable in accordance with the provisions contained therein will be paid regardless of the investment mortality or expense rates — expense experience of the company.

    Under participating annuity policy contracts, the amount of the payments to the annuitant may vary due to the declaration by the insurance company of dividends to the annuitant arising from experience more favorable than anticipated.

    The plaintiff, SEC, does not contend neither has it shown that it has ever instituted any action to hold a participating policy to be a security.

    We have used the participating policy as the most supple approach to discuss what this man gets.

    This variable annuity, if you cut through everything else, is nothing but a life annuity contract issued by an insurance company that — that provides completely for participation.

    Now, the difference is, and the — and the — really the sole difference is that the participating annuity contains a nominal minimum payment.

    That nominal minimum payment is based upon an assumed interest rate of 2% to 2.5%.

    We have set forth in our brief the history of that development largely from SEC sources.

    Roy W. McDonald:

    Prior to 1935, the insurance companies were assuming a larger amount.

    About 1930, and along in that period, the insurance companies discovered two things.

    They discovered people were living longer, which was a delightful discovery from the standpoint of life insurance, but which involves certain risks from the standpoint of annuities which had been based upon actuarial studies as to when the group would die.

    And they found also that the investment assumptions they were making were excessive.

    This is all set forth in TNEC Monograph 28.

    The net result of those two factors was to put pressure on the life insurance annuity business.

    Not only were people living longer, but the assumptions which they had made as to earnings were proving too much.

    They solved, we hope, because if they haven’t, 50 years from now, we shall have certain troubles, they solved the mortality problem by a series of new mortality tables.

    The SEC expert testified that in the past 70 years, there had been a whole series of new mortality tables.

    Each one taking into account the fact that we do live longer.

    They solved the investment problem by — and this is SEC itself saying it in TNEC Monograph, by reducing the assumed interest rate to 2% or 2.5%.

    Now, in the past 50 years, there have been only three years in which the insurance companies overall have made less than 3%.

    The average interest rate — and as the NASD has explained to us, interest rate in the insurance world means the investment earnings, whether from rents, dividends or anything else.

    The average interest rate has been about 4% and they took care of the — of the whole situation by putting in this nominal minimum, which was so low that only a catastrophe could ever reduce the company to it, and providing for participation in the excess earnings to that dividends to participating policyholders.

    Now, that is precisely what this man buys.

    When he is 35, and we have used him for an example, and we have given these figures on page 19 of our brief.

    We take a 35-year-old man as the most logical candidate for a deferred annuity.

    And we start from the rate book, which is in evidence, and is plaintiff’s Exhibit 2.

    And the page in question, if we could just take one second to look at this, we — we will have the answer to what the man gets.

    The page in question is record 619.

    He is 35 years old.

    He’s a very prosperous man, I presume, because he decides he will pay $1000 annual premium, and he will take a policy that will provide him for his retirement — provide for his retirement when he is 65.

    He pays $30,000.

    On page 618, the top line is annuity premium without waiver.

    I’m using 10 times those figures.

    Now, if he had wanted to have a waiver of premium in the event of his total disability, instead of $1000, he would have paid $1035.

    That’s about five lines down.

    For the extra $35, he would have no one that should he become disabled anytime in the next 30 years, the company would waive his premiums, that is it would be made up from the other reserves.

    The SEC concede that is strictly an insurance function.

    Now, in addition, if he were insurable physically, he would have been required to have a minimum of life insurance in this contract.

    Roy W. McDonald:

    Why that minimum?

    For obvious reasons, I think it provides a protection during the early years of the policy when, as in all life insurance business, the expenses tend to center.

    All life insurance is based on what is called the acquisition cost which is higher in the first years.

    And so, he — if he is insurable, we say you must have enough life insurance for the first five years to know that you have in case of catastrophe and death, you are protected there.

    He may take more.

    We have a family protection policy without top limit, which has been approved by the Insurance Commissioner and which will carry him insured without reduction until he is 65.

    But let’s set that aside.

    Now, the total premium for his five years of reducing time life insurance is only $105.

    That has been according to the actuaries of the SEC.

    That is a perfectly normal premium.

    In the — on page 618 in the lower right-hand corner, there is a table which shows the percentage of basic annuity premium which is applied to provide the deferred annuity benefits.

    And with life insurance, the first year is 46.07% and without life insurance, it’s 48%.

    The next year, it jumps to 88% and so on.

    Now, the difference between the 46.07% and the 48% is the life insurance premium.

    That’s where we get our life insurance premium, by that small percentage difference.

    Now, when you calculate out the percentages, which you applied, and when this man approaches 65, he has paid $30,000 of that amount, $26,745 has been allocated to the reserve for his policy.

    He has, at that point, if there was zero adjustment on his policy, $26,745.

    $105 were used for his life insurance.

    $600 is the average amount of state taxation on this form of thrift.

    The SEC expert told us that the average premium tax is 2%.

    And that leaves $2550 of his $30,000 of premiums, which has gone to this company against its expenses, its contingencies and perhaps, its profits, if it makes any.

    Now, during the period when he has been accumulating this $26,745, the only difference between this policy and any annuity which anyone else has, is that the company adjust the — the old annuity adjust by an assumed rate which was 2%, and perhaps, adds to what it calls your cash value the — from excess interest.

    When he reaches 65, he, like anyone else, has a cash value.

    And we have shown from the record in our brief, a comparison of the accumulated cash values of a VALIC policy on the assumption we make 3.5% interest, a Lincoln National Life Insurance Company — where is that thing — and a Canada Life Insurance Company.

    The latter two companies are all lined companies and the only thing we have done is take the cash value which is provided in that policy of this and add to it the amount that that cash value would be increased by their continuing participation at — at the present rates.

    That table is summarized on page 13 of our brief.

    This man becomes 64.

    He then loans.

    He has cancer, and he is going to die in five years.

    West Virginia says, “We cannot issue one of these policies,” it’s in the regulations I pointed out, “unless we provide that he has the option to take his cash value before entering on his annuity”.

    Roy W. McDonald:

    The District of Columbia has the same provision in essence.

    At that point, before he becomes an annuitant in this policy as in any other policy, if there is some contingency in his life, he may take his cash value.

    But if he does not, if he stands tough, we have no option, that they — that we issue this policy.

    We have agreed that when this man becomes 65, unless he exercises an option, we will begin to pay him an annuity which will run for his life.

    Now, in this assumption, we have a man with $46,900 of cash value.

    At 65, he must decide, he may take —

    Earl Warren:

    Is that the 25-year man?

    Roy W. McDonald:

    Yes.

    This — this is a man who is — he took it at 35 and —

    Earl Warren:

    At 35.

    Roy W. McDonald:

    Yes, sir.

    Earl Warren:

    Yes.

    Roy W. McDonald:

    And — and paid for 30 years.

    Earl Warren:

    Yes.

    And then what — what does his annuity amount to —

    Roy W. McDonald:

    Yes, sir.

    Earl Warren:

    — when he’s 65?

    Roy W. McDonald:

    At that time, he must decide.

    He has three options on the plaintiff’s Exhibit 1 on page — on the third page under — no, it starts on the first page of General Provisions.

    The benefits payable to the annuitant, he — that is here, Mr. Justice Warren.

    It looks like this.

    Earl Warren:

    Oh, yes.

    William J. Brennan, Jr.:

    Excuse me, Mr. McDonald.

    Before you get to that, you just say that the cash surrender value of $46,902 —

    Roy W. McDonald:

    Yes, sir.

    William J. Brennan, Jr.:

    — is the amount which that sometime before the annuity characterize, he may demand and receive —

    Roy W. McDonald:

    Yes, sir.

    William J. Brennan, Jr.:

    — without regard to any investment risk or anything else?

    Roy W. McDonald:

    He made — he — no.

    He may — he may demand and receive before he starts on his annuity whatever his cash value is.

    Roy W. McDonald:

    The company does not purport, and of course, we have — we face all these facts.

    We don’t argue any of the fact.

    The company would not know now, to date, what his cash value will be at 65.

    William J. Brennan, Jr.:

    Well, then, what is this $46,900?

    Roy W. McDonald:

    That was a — an exhibit that is taken from one of the exhibits in evidence in which we did this.

    It’s — it’s rather a long exhibit on page 853 of the record.

    What we wanted to do for the trial court was to show that what we are doing in essence, I think Mr. Justice Stewart you would deference a degree, but in essence, it’s what any life insurance company does.

    So we took the Lincoln National and the Canada Life Insurance Company and we took policies on the same age, same sex and same premium.

    We took from their table what their cash value would be.

    William J. Brennan, Jr.:

    That’s the insured cash value.

    Roy W. McDonald:

    Yes, sir.

    But we knew that was not the true cash value.

    It never is in any participating policy.

    So we then determined what their current dividends were, which they pay to their policy holders from their investment and other gains.

    And we assume that this man exercised his right, which he has with Lincoln National, to leave those in to increase his annuity.

    Now, when he did that, he increased his guaranteed cash value from $37,000 to $43,000 and that was in Lincoln National.

    Similarly with Canada Life, he increased it to $43,000.

    Now, in the case of the Variable Annuity Life Insurance Company, we understated ourselves, our hope, but we assumed that we would make 3.5% per year in the net investment factor to adjust his reserves by and we adjusted by that each year.

    William J. Brennan, Jr.:

    But what I don’t quite get to understand is did the right degree of conjecture about whether he’d get $46,902 —

    Roy W. McDonald:

    Yes, sir.

    William J. Brennan, Jr.:

    — in your case not present in the case of the Lincoln or Canada Life.

    Roy W. McDonald:

    There is a greater degree of conjecture in our cases.

    In the Canada Life or Lincoln, the only degree of conjecture would be the — the amount of the excess dividends he would have.

    In our case, it depends upon our performance from the beginning.

    That is correct.

    William J. Brennan, Jr.:

    Well, then, I don’t quite understand why — how can they draw the power.

    Roy W. McDonald:

    Well, we were assuming 3.5%.

    We — we stated our assumption, then we draw the parallel because we wanted to be able to get to the point of explaining what the man has when he retires.

    Felix Frankfurter:

    Is the contingency only whether you’d make 3.5%?

    Roy W. McDonald:

    That’s the only contingency, yes, sir.

    Roy W. McDonald:

    Now, when he retires if he says a widower then his children are educated —

    Earl Warren:

    May I ask you this question?

    Suppose though that you bought them wisely or — or suppose that we had depression and some kind and your securities fell off and it — it was a very great departure from — from the way you projected it here, the policyholder would bear that loss, would it not?

    Roy W. McDonald:

    He would bear that risk, yes, sir.

    Earl Warren:

    Yes.

    Roy W. McDonald:

    That is also — for illustrative purposes in the record, the witness on that was the head of research on investments at Prudential Land.

    They have made a few — Prudential Insurance Company, and they took the worst possible situation of a man who paid premiums 15 years.

    They thought it was retiring at the bottom of the depression and they have the chart in here showing how he came up.

    Felix Frankfurter:

    Well, he — in the old line company, participating dividends which affects what he may allow to aggregate to his annuities is also contingency.

    Roy W. McDonald:

    Yes, sir.

    And of course, we have pointed out in our brief the very bad experience with a number of companies during the depression.

    If a company goes broke, it goes broke.

    Tom C. Clark:

    That’s a guaranteed —

    Roy W. McDonald:

    Sir?

    Tom C. Clark:

    That 2% would be in (Inaudible) wouldn’t it?

    Roy W. McDonald:

    Well, not if the company cannot.

    Tom C. Clark:

    (Voice Overlap) —

    Roy W. McDonald:

    For instance, in — in the Southwest, we were very familiar during the depression with the Missouri State Life Insurance Company where each policyholder received a lien against this policy because the company had — had gone broke.

    Some of those liens were as high as 100% of your accumulated value and not on the Missouri State but others.

    To — to rush so that I won’t absorb Mr. Earnest’s time, I wanted to show what this man gets.

    Let us assume that he does — that the company does under the supervision of the Insurance Commissioner and investing solely in legal investments have a reserve for his policy of $40,000.

    He is now 65.

    Earl Warren:

    65?

    Roy W. McDonald:

    Yes, sir.

    Earl Warren:

    Yes.

    Roy W. McDonald:

    He is — he’s had a medical examination.

    He’s a smart operator.

    He’s at the medical examination and the doctor said, “Boy, you’re as good as — as a kid.

    You will live forever.”

    So naturally, he wants his annuity.

    Roy W. McDonald:

    He’s got a right to it.

    He’s — he’s contracted for that when he was 35.

    And he said, “I will take a straight life annuity.”

    Then the company says, “All right, you have $40,000.

    Your first payment will be 40 times $6.81, which will be roughly — roughly $270 for the first month.”

    Now, Mr. Dorsey has said, and how he could say it, I don’t know, that we guarantee nothing after that.

    This man has paid $30,000 and all we’ve guaranteed to do is to pay him $270.

    If that were true, I’m sure that we would be looking for a new insurance superintendent of the District of Columbia.

    So long as this gentleman lives, he will get $6.81 every month so long as our net investment rate is 3.5%.

    Now, if we make 4%, he would get slightly more than $6.81.

    And if we make 3%, he will get slightly less.

    In CREF, the man who retired in 1952 with a $10 payment are getting $18.

    But that’s been a good year, a good period.

    Now, if he were not a widower, but he had a wife and he wanted to be sure to protect her and say she were at that time 60, he would then go over to the next page and see the option of a joint and survivor annuity.

    And if he were alone and did not have a joint and survivor but wanted to be assured that 10 years certain would be paid to him, he would use option B.

    The net effect is that he would have an annuity which would be precisely like any other annuity, except that he has consciously and deliberately said, “I want an annuity that will tend to keep pace with the cost of living by reason of the fact that the reserves are invested in equities.”

    Charles E. Whittaker:

    May I ask you?

    What happens on (Inaudible)

    Roy W. McDonald:

    It would go to a designated beneficiary or his estate.

    Yes, sir.

    Just like any other.

    And in closing, may I call your attention to three things which have been in the newspapers in recent days.

    First, of course, was the President’s address dealing with inflation, but secondly and more significant, it seems to — and I — I can’t say more significant, but — but more current, was something that was in the paper today.

    On one page of the post, there is an article, adjusted income figure showed the inflation drained which points out that millions of people who had $170 billion of financial savings at the end of 1950 now find that $30 billion had been wiped out.

    And on the other side of the page, a reference to an article by Mr. Roswell McGill that if we keep on in 25 or 30 years our present 48% dollar may well be worth only a dime.

    The trial court has found that the variable —

    Felix Frankfurter:

    That’s advertised news, wasn’t it?

    Roy W. McDonald:

    Sir?

    Felix Frankfurter:

    This morning’s paper, that was advertised news, not only news but advertised —

    Roy W. McDonald:

    Advertised by the Reader’s Digest, yes, sir.

    Roy W. McDonald:

    The trial court has found that this policy is based upon studies designed.

    It — nobody can guarantee, no one would guarantee that it will precisely match the cost of living.

    But all history has shown that it will tend to do so and the economist testifying at the trial said this.

    He said, “Value to me is purchasing power.”

    And I am not sure that a man who 30 years ago contracted to have $200 a day and receives $200 a day is getting value.

    We believe that if he is — if the — if the insurance industry is allowed to develop this contract without harassment within the legal investments provided for insurance companies, we can offer a solution for his difficulties.

    Potter Stewart:

    Mr. McDonald —

    Charles E. Whittaker:

    (Voice Overlap) —

    Potter Stewart:

    Excuse me.

    Charles E. Whittaker:

    (Inaudible)

    Roy W. McDonald:

    No, sir.

    They had that opportunity about a year ago.

    The — but they didn’t take it.

    The Life Insurance Act was being severely amended to increase the Insurance Superintendent’s powers.

    This was after the trial in this case when the trial court had said these arguments should to Congress, but no effort was made.

    Potter Stewart:

    Mr. McDonald, just so — I’m sure that I understand your footnote on page 13 to which you refer to us a few minutes ago, comparing the cash values of Lincoln National, Canada Life and of your —

    Roy W. McDonald:

    Yes.

    Potter Stewart:

    — company at the end of 30 years.

    Roy W. McDonald:

    Yes, sir.

    Potter Stewart:

    Now, am I right in thinking that there is, as a contractual matter, this basic difference that in Lincoln National or Canada Life or any of the traditional kind of annuity policies, there is a contractual right to a cash value of a minimum number of dollars?

    Roy W. McDonald:

    Yes, sir.

    Potter Stewart:

    Whether that’d be $30,000 or whatever.

    Roy W. McDonald:

    Yes, sir.

    Potter Stewart:

    It’s a contractual right to X dollars —

    Roy W. McDonald:

    That is right.

    Potter Stewart:

    — as contrasted to your company where there is a contractual right as a matter of fact to nothing —

    Roy W. McDonald:

    That is right.

    Potter Stewart:

    — in — in terms of dollars.

    Roy W. McDonald:

    That is right.

    Yes, sir.

    Roy W. McDonald:

    In the case of the Lincoln National, the contractual right is $37,000.

    In the case of the VALIC, the contractual right is the reserved that’s been set up.

    James M. Earnest:

    May it —

    Earl Warren:

    Mr. Earnest.

    James M. Earnest:

    — please the Court.

    After the rather full arguments of Mr. Ben Dorsey and my associate, Mr. McDonald, I feel that further label on this case perhaps is not necessary, but I do have two or three observations which I think might be of some aid to the Court.

    The distinguished general counsel of the Securities and Exchange Commission devoted some considerable time here on Thursday, enjoying a comparison between plaintiff’s Exhibit 21 and some unidentified information of United Funds.

    With respect to plaintiff’s Exhibit 21 and I’m sure that this is an inadvertence on his part, may I invite this Court’s attention to the fact that that was a preliminary so-called “sales kit” used by VALIC in its early formative stages that its use was discontinued wholly before the institution of this lawsuit and it has never been used since.

    And I saw that there can be no mistake about what I said.

    May I read from the deposition taken on February 19th by the then trial attorney of the SEC, whom I confess was not the distinguished general counsel, from page 338, the witness Marsh (ph) was on the stand and he was asked this question, “Was there a sales kit used in connection with the sale of policies?”

    Marked plaintiff’s Exhibit 6A through 6H answer, “There was a sales kit prepared for use, and we had — we had conducted an experiment with one man and had him call on approximately 50 people.

    And as a result of his activity, we abandoned the kit as worthless.”

    And then when we came to the —

    Is that on page 338?

    James M. Earnest:

    Of the deposition of the witness —

    Oh, no —

    James M. Earnest:

    Marsh (ph) which was not printed, Your Honor.

    It is before, Your Honor, the entire record being up here.

    Then during the trial, when this whole obsolete sales kit was offered in evidence, I objected.

    And at page 620 of the original transcript of the proceedings in the lower court, likewise before this Court, but not printed, and I neglected to make one statement and the deposition of the witness Marsh (ph) clearly shows it that the old sales kit was identified in the depositions as Exhibit Number 9, whereas when it was offered in evidence, it became 21.

    And so I ask this question or request this stipulation after I objected to the introduction of plaintiff’s 21, I’m reading from page 620, “I would request Mr. Feldman, he was the Chief Trial Attorney for SEC, to stipulate what appears in the depositions in respect to plaintiff’s Exhibit Number 21, which was identified in the deposition as Exhibit 9, namely that this was the first so-called sales kit of VALIC, that it was shown to a limited number of people, as I recall not, exceeding 50, that it very soon became apparent to VALIC that it was impertinent and could be considerably improved upon, and that it was discontinued only after having been subjected to a very limited use, that it is not now used and has not been used.”

    Mr. Feldman responded, “I will stipulate that it was shown to a number of people not exceeding 50.

    I will further stipulate that it is not now being used.”

    And so while the purpose of drawing this comparison, it was rather obscure to me, at least it is wholly based upon something which we did not use, haven’t — we’re not using at the time of the institution of this lawsuit.

    Hugo L. Black:

    Was there any inaccuracy (Inaudible)

    James M. Earnest:

    Sir?

    Hugo L. Black:

    I don’t quite understand your argument, Mr. Earnest.

    Are you saying that the first kit was inaccurate in his description of (Inaudible)

    James M. Earnest:

    I don’t say that it was inaccurate, Your Honor.

    In the formative stages of this company in trying to describe our business, we had a sales kit which incidentally doesn’t go to the perspective purchase.

    James M. Earnest:

    So this is purely an interoffice communication that we give to our agents.

    But when he took it and attempted to make a presentation on certain prospects, he got no response and we concluded there was something with the descriptive and therefore we abandoned it.

    It had no appeal.

    Hugo L. Black:

    Well, I understood that he offered to show the — the type of contract, this or much like that of another company.

    James M. Earnest:

    Yes, Your Honor.

    Hugo L. Black:

    Well, is there something about your purchase program there or (Inaudible) which presented and gave an inaccurate showing?

    James M. Earnest:

    I don’t think so for the moment.

    We just — our experience was that it was ineffectual —

    Hugo L. Black:

    Yes.

    James M. Earnest:

    — to accomplish a sale, but it is not inactive.

    Now, secondly, if Your Honor pleases, if I understand distinguished general counsel, he is still somewhat silently, at least, complains about the refusal of the lower court to permit an amendment.

    He had to charge misrepresentations and then proceeds to imply, at least, in his argument, if I understood him correctly, that there was something wrong about the way that we presented this product to our perspective purchasers.

    And may I say this.

    This lawsuit, Your Honors, didn’t spring up overnight.

    They called us down there or the predecessor company in September of 1955 and we were before them constantly for nine long months in which we voluntarily presented to them every policy, every piece of sales, literature, our books and records and everything that we had, and in October of 1955, prepared and filed a 110-page brief with them so that — and we also, in a spirit of cooperation, agreed to voluntarily refrain from writing any policies until they should have made a determination as to whether or not they should attempt to superimpose federal on state regulation.

    And I waited patiently, September, October, November and December.

    Come December 30 and having met with these gentleman three, four, five as many as 14 at the time, we felt that the time had come when we should start writing the verbal policy and so we’d notify them we are going to start that effective December 30.

    Earl Warren:

    (Inaudible)

    James M. Earnest:

    Thank you, Your Honors, very much.

    Thomas G. Meeker:

    Mr. Chief Justice, may it please the Court.

    In the few minutes —

    Earl Warren:

    Mr. Meeker.

    Thomas G. Meeker:

    — left to me, I would like to make one or two references to certain remarks that have been made by my distinguished colleagues for —

    William J. Brennan, Jr.:

    Mr. Meeker, are you going to include a reference to the argument that they come within the Investment Act that puts them out of business?

    Thomas G. Meeker:

    Well, I believe our brief concedes that if they come within the Investment Company Act, that there will certainly be problems that they will have to resolve with —

    William J. Brennan, Jr.:

    That’s not my question.

    Thomas G. Meeker:

    I don’t believe it would put them out of business.

    I think the thing can be worked out, Your Honor.

    William J. Brennan, Jr.:

    How?

    Without the (Voice Overlap) —

    Thomas G. Meeker:

    I think that — that — as Section 60 of the Act implies and provides for in fact that they can present their peculiar problems to the Commission and seek some exemptive treatment.

    But if they are an investment fund, if they are selling a security, they should be treated like everybody else that’s selling a security.

    It —

    Felix Frankfurter:

    Is it — is it — may I ask, time is short, whether the fact that the annuity, the amount of dollars and cents a fellow gets is entirely contingent as against the old line fixed dollar amount, whatever the dollar may shrink, is that very decisive in your view that differentiating this thing, it’s not an — it’s not as investment, not an insurance?

    Thomas G. Meeker:

    I would say that it is one of the two main things that are decisive.

    I’d say that —

    Felix Frankfurter:

    Therefore, they — that they couldn’t — that particular thing, I like to tell (Inaudible) that that they couldn’t change, they kept on making a fixed (Inaudible) contingent.

    Thomas G. Meeker:

    But if they would come in and register and disclose what they’re doing and comply in the sale of a security like anyone else who is selling a security, that’s the answer to this.

    In the first instance, there’s — there’s an innuendo here throughout both oral argument and written argument that the Securities Act is a regulation similar to the Public Utility Holding Company Act or the Investment Company Act.

    Securities Act is a Disclosure Act.

    What we want to do —

    William O. Douglas:

    Let’s go further here.

    They couldn’t combine the investment contract with the insurance policy qualified (Voice Overlap) —

    Thomas G. Meeker:

    There is a problem there.

    Yes, sir.

    William O. Douglas:

    Well, isn’t more (Inaudible)

    Thomas G. Meeker:

    There is, of course, an exemptive power that the Commission has to make it — to make — after all, we — this is not the first time, Your Honors, that we have been faced in the five years I’ve been at the Commission with the problem of how to treat with what appears to be a new security.

    For example, American Depository Receipts which are traded in quite extensively in New York.

    The Commission came along and adopted a special form of registration statement to make it possible for banks in New York and still have protection for investors in New York to trade in receipts which were receipts or evidence of an interest in securities which are sold abroad wholly and which, as in European practice, have no — no identifying numbers.

    They’re just bare instruments and so you can’t tell from time to time who holds these securities, but the Commission met that problem after hearings and conferences with a special form.

    Felix Frankfurter:

    May I — may I first — Mr. Justice Brennan’s question if you will let me and asked whether assuming they make disclosure, assuming they satisfy the Securities Act, could they write merely by making the disclosure that’s an annuity policy (Inaudible)

    Thomas G. Meeker:

    Well, that’s a very difficult question.

    I — I can’t answer that definitively.

    In the first place, any decision that the Commission would make on this would be made in its quasi-judicial or rule making areas and I couldn’t commit the Commission.

    I would say this to Your Honor that the pattern of the Investment Company Act plus the flexibility and the willingness of our people to try to — to meet new problems as they come along make it only possible for these companies to come before our agency, try administratively first and then by application to take the same — to seek the same exemptive treatment that other companies, from day-to-day, are coming before us for.

    Felix Frankfurter:

    Is it fair to say they — that what we call one of the two decisive feature making this not an insurance would be presumed once they registered as an investment company.

    Is that right?

    Thomas G. Meeker:

    Well, may I say what the two are.

    In the first place — oh, my time is up.

    If I may finish this.

    Thomas G. Meeker:

    I think the risk of loss is equally as important.

    And I think that the — the salutary thing that would occur from not only registration under the Securities Act but registration under the Investment Company Act is one that there would be disclosure as to what it was they were investing in.

    And two, what it — what their actual experience is.

    And three, they would have to disclose in advance into perspectives what their investment policies are before they go seeking purchaser for one of these documents.

    Tom C. Clark:

    I wonder if I could ask you one question, that is do you know of any exemption the Commission has ever made or (Inaudible)

    Thomas G. Meeker:

    I have been there five years.

    I’ve read Mr. Loss’ remarks and I’ve heard the remarks about CREF.

    CREF is a very different situation.

    I know of no exemption.

    I know of no ruling.

    I was the first man to give a letter of opinion on whether a variable annuity was a security, and I gave it to the National Association of Investment Companies.

    It was used in the State of New York.

    And I’d say this in all modesty, the claimant was used to help defeat the bill in the State of New York.

    And I would like to call the Court’s attention to a very good note in the New York University Law Review Volume 33, January 1958 which will clear up once and for all, all of the confusion that’s been generated here about what really happened in New York.

    Felix Frankfurter:

    What page?

    The page.

    Thomas G. Meeker:

    Volume — oh, page 76, I’d say.

    Felix Frankfurter:

    33 New York 76.

    All right.

    Thank you.