Honorable William A. Harrison    Opinion No. WW-459
Commissionerof Insurance
State Board of Insurance         Re: What constitutesan under-
Austin, Texas                        writing transactionpro-
                                     hibited by Article 3.39,
                                     Section 2 of the Texas
Dear Sir:                            InsuranceCode?
          In your amended opinion request you ask whether
several types of transactionsare prohibitedby various pro-
visions of the Insurance Code among which is Article 3.39,
Section 2, which reads as follows:
         "No such~companyshall subscribeto, or patitlci-
    pate in, any underwritingof the purchase or sale of
    securitiesor property or enter Into any such trans-
    action for such purpose, or sell on account of such
    company jointly with any other person, firm or corpora-
    tion; nor shall any such company enter into any agree-
    ment to withhold from sale any of Its property, but
    the dispositionof Its property shall be at all times
    within the control of Its Board of Directors; . . ."
         The first two of the factual transactionsthat you are
concernedwith are summarizedfrom our correspondenceas follows:
         1. A contract between a life insurance company and
a subdivisiondevelopmentcompany provides as follows:
          "Whereas, It Is contemplatedand agreed that
     the XYZ Life Insuran‘ceCompany and the B Investment
     Company will build or cause to have built for sale
                            both In Odessa, Texas, and
     a number of~.*resldences
     Irving, Texas, to be jointly owned by both corpora-
     tions, and that the title to the property shall be
     carried in the name of the B InvestmentCompany for
     convenienceonly.
          "Now, therefore, be It resolved that the XYZ
     Life Insurance Company shall furnish all of the money
     through loans or provide the necessary credit-to the
     B InvestmentCompany for the purchase of the building
     sites, materials, labor and.all building construction
Hon. Wllllen~A. Harrison,   page 2 (W-459)


     costs; that the B Investment Company will furnish
     all of the supervision,let all contracts for
     building on a basis satisfactoryto the XTZ In-
     surance Company and will supervise the sale of said
     houses. When the houses are sold all the profits,
     after deductingthe entire cost of lots and bulld-
     lng plus any coumlsslonspaid for sale of property
     or any expensesof.any nature Incurred in the bulld-
     ing of said houses, shall be divided as follows:
           "85s   to the XYZ Life Insurance Company.
           "15% to the B Investment Company.

          “In arriving at the cost it Is understood that
     the interestpaid on the money borrowed shall be a
     part of the costs determiningthe profit."
          2. A developmentcorporation under a trust 'ogrocment
deeds fee title to real estate for subdivisionto a Trustee
under an escrow arrangementwhereby a life Insurance company
loans the Trustee large sums of money secured by a first lien
upon the real estate contributedby the developmentcorporation.
These funds held by the Trustee are advanced from time to time
to the developmentcorporationto build and develop the sub-
division. As the subdlvlslonIs developed and sold to the
public, the entire proceeds are deposited with the Trustee.
The Trustee In turn uses a percentage of these total proceeds
(agreedto in the trust instrument)to pay off:the indebtedness
to the life Insurancecompany. After the loan plus interestIs
paid off to the Insurance company, the Trustee then distributes
the profits between the Insurance company and the development
corporationaccordingto a formula agreed to in the trust ln-
strum&t.
          An "underwritingof the purchase or sale of . . .
property"would consist of a promise by the insurance company
that if property were not sold for a certain price It would
guaranteethat the insurancecompany would buy It for that price.
Or conversely,unless property could be acquired at a certain
price the Insurancecompany would acquire the property for the
guaranteedprice whatever the market price might be. (See 43
Words and Phrases,p. 124, et seq.) Thus, It is evident that
neither of the two above questioned transactionsresemblesa
prohibitedunderwritingtransaction.
          It Is our o@lnlon, however, that both of these trans-
actions are prohibitedon other grounds. The above quoted portion
of Section 2 which contains the restrictionson underwritingand
    :;~U!Ilam:.A.
Hon..-         Darrlson, page 3 (W-459)


joint accounts was not.ln the Texas law until 1909. The hls-
torlc AmIWtrOng Committee reported on February
                                          ..   22,    - to
                                               __ 1906,   .
the New York State Legislatureconcerningtne wlae scale atmses
by the management of I@v York Insurance companies. The Committee
found that the large companies had furnished their support to
numerous speculativefinancial ventures through participating
In the underwrltlngsof syndicates. In this manner, purchases
had been made, not for Investment,but for resale. See %aml-
nation of Insurance Companies,Volume 2, b the New Yorkme
InsuranceDepartment,New York, 1953, p. 2L , et seq. Often
.companiesfurnished all the money required for the speculative
venture while officers of the company and members of the finance
committeewould be parties&to a joint account and share In Its
profits. In order to eliminate these wide scale abuses the
fifth recommendationof the Armstrong Committee was as follows:
          "The statute should also forbid all syndicate
     participations,transactionsfor purchases and sales
     on joint account, and the making of any agreement pro-
     viding the company shall withhold from the sale at sny
     time, or subject to the discretionof others, any securl-
     ties which it may own or acquire."
          This recommendationwas adopted by the Legislatureof
New York on April 27, 1906, as a part of Section 100, Laws of
New York, ch. 326, p. 798 (1906).  This section Is almost ldentl-
cal word for word wlth the above quoted Texas provision originally
enacted In 1909 and brought unchanged Into the Texas Insurance
Code as Article 3?39, Section 2.
          From this statutoryhistory, It Is clear that the quoted
phrase of Article 3.39, Section 2, establishesthree distinct
and separate restrictionson all types of Investments: First,
prohibitingunderwriting;second, prohibiting sales on joint
accounts and, third, prohibiting the placing of the insurance com-
pany's property beyond the control of Its Board of Directors.
The evil sought to be remedied by the prohibitionof selling
on joint accounts was transactionsof the nature of partnership
or joint ventures for a speculationIn property by which others
than the Insurance company would share some control or the profit
or loss of such an "Investment".
          The profit sharing features of the first transaction
outlined above are clearly within this prohibition. Both the
first and second.transactlonsare essentiallysales of property
on joint account with another person, firm or corporation,In
which the insurance companyputs up the money In a joint account
to finance the developmentand resale of property. In both
:lnstancesthe Insurance company Is to receive not only the loan
 ‘>   *   Q;”




Hon. William A. Harrison, page 4 (WW-439)


money back with Interest but then it will also share in the
profits with the developer. The profit sharing feature as
a bonus Is prohibited. Such a transactionIs characteristic
of.some form of joint venture rather than an ordinary loan
upon first liens upon real estate. The first transactionIs
further defective for the reason that title to the real estate
Is In the Insurance company and thus would be forbidden by
Article 3.40.
          The statute Itself nrovldes that: "A life insurance
company organized . . . may Invest In or loan upon the following
securities,and none others, viz: . . ." (Bnphaslsours) In
this connection It should be noted that these transactionsInvolve
property acquired for speculativeresale rather than loans or
Investmentsthat are held for their yield In the form of Interest
or dividends. The acquisitionof such property for speculative
resale is not authorizedby Article 3.39 and therefore ultra vlres.
          The third factual situationon which you request an
opinion as to whether or not It is a prohibited transactionis
stated by you as follows:
                 3. A "life Insurance company . . . issued shares
            of its steak to a subsidiaryunderwritingcorporation
            with an agreement that the underwritingcorporation
            would sell the shares of stock to the public, and that
            all profits over and above 30s of the realized gross
            profit on the sale of the stock would be contributed
            by the underwriterscorporationto the life Insurance
            company as ~urplus.~
          This third transactionby which a corporationacts as
an underwriterupon shares Issued to It by an insurance company
is somewhat anomalous. For a small considerationthe under-
writing corporationonly commits itself to use Its best efforts
to market the insurance company88 securities.  The Insurance
company-isnot Itself acting as an underwriter. Certainly,
however, If the Insurance company were to participate in such
an arrangementconcerning stocks other than that of Its own
issue, It would be participatingin an underwritingtransaction
which would be clearly forbidden. However, taken in context,
the statutoryunderwritingprohibition applies only to lnvest-
ments by life Insurance companies. In the instant case there
is no'lnvestmentby the insurance  company In any sense when the
insurancecompany attempts to market its own securitiesanymore
than when it attempts to sell Its own policies. For this reason
we do not feel that the above quoted restrictionsof ArtlcXe
3.39, Section 2, apply to this transaction. We have assumed under
the facts of this transactionthat the underwritingcorporation
waaactlng as a disinterestedunderwriterIn an arms length
Hon. William A. Harrison,.page5.(WW-459)


transaction. However, if the Board should ascertain that
the directors in the Insurance company are "pecuniarilylnter-
ested In" the underwritingsubsidiarycorporation,then It Is
the Board's duty to subject to the strictest scrutiny the under-
writing contract with the subsidiarycorporation. From the
legislativehlstory'as stressed lh the Armstrong Committee
Report, It Is abundantlyclear that any self deallng'on the
partof the directors is prohibited. Insurance Code, Article
3.67, Article 1.15 (formerlyArticles 4727 and 469) were
cohstrued in Attorney General Opinion O-1889 to~allow the
Board to revoke or modify any certificateof,authorltyissued
If a suspect transactionfalls to meet the test of fairness,
fiduciary relationship,and the standardsof soundestmorality.
It should be noted In this regard that the retention of a thirty
(30%) percent commlsslonby the underwritingcorporationmay
well be a violation of The SecuritiesAct which limits the.
total expenses of marketing securitiesIncluding commission.
The commlsslon retained by the underwrltln subsidiarycorpora-
tion may exceed the maximum of twenty (20%7 percent of the
price at which the stock was sold to the public If the 'pr$ce"
paid by the underwritingcorporationto the lnsurance~company
were nominal. In summary, both the first and second transactions
are sales of property on the account of the insurance company
jointly with another person, firm or corporationand are clearly
prohibited by Article 3.39, Section 2, as well as other sections
of the Insurance Code. The third transaction,although it Is
not a prohibited underwritingtransaction,may be a suspect on
other grounds.




         A transactionby which an insurance company
         advances capital for real estate development
         In return for a share of the profits is
         prohibited by Article 3.39, Section 2, Texas
         Insurancb Code. An insurance company may
         utilize an underwriterin order to market
         Its own securitiesunless the Insurance com-
         pany directors are so "pecuniarilyinterested"
Hon. Wil1iarp.A.
               Harrisbn;page 6   (WW-459)




              lh the transactionas to violate Article
              3.67’ of the Insurance Code.

                                 Yours very truly,
                                 WILL WILSON
                                 Attorney General of Texas


                                     Mao0 Stewart
MS:ph                                Assistant
APPROVED:
OPiNION COMMITTEE:
&xi. P. Biackbirn, Chairman
LeoxiardPassmore
Wayland C. Rivers, Jr.
H&ry (1.Braswell
REVIEWEDFORTHBATTORNEYGENERAL
.B!t:
     W. V. Geppert.
