
155 F.Supp. 521 (1957)
SECURITIES AND EXCHANGE COMMISSION, Plaintiff
and
National Association of Securities Dealers, Inc., Intervenor-Plaintiff
v.
THE VARIABLE ANNUITY LIFE INSURANCE COMPANY OF AMERICA, Defendant
The Equity Annuity Life Insurance Company, Intervenor-Defendant.
Civ. No. 2549-56.
United States District Court District of Columbia.
September 3, 1957.
*522 Thomas G. Meeker, General Counsel for SEC, Washington, D. C., Daniel J. McCauley, Assoc. Gen. Counsel, Philadelphia, Pa., Myer Feldman, New York City, Special Counsel for SEC, Pace Reich, Philadelphia, Pa., for plaintiff Securities and Exchange Commission.
John H. Dorsey, Bolling R. Powell, John W. Lindsey, Blum, Lindsey & Powell, Washington, D. C., for intervenor-plaintiff.
James M. Earnest and George R. Jacobi, Washington, D. C., Roy W. McDonald, Donovan Leisure, Newton & Irvine, New York City, for defendant The Variable Annuity Life Ins. Co. of America.
Brookhart, Becker & Dorsey, Benjamin H. Dorsey, Washington, D. C., for defendant-Intervenor The Equity Annuity Life Ins. Co.
WILKIN, District Judge.
This case came on for trial and was submitted on the pleadings, stipulations, evidence and briefs. Jurisdiction is based on 15 U.S.C.A. § 77a et seq., and § 80a-1 et seq. The defendants are chartered life insurance companies in the District of Columbia. The Equity Annuity Life Insurance Company, on its own motion, was made an intervenor-defendant. The National Association of Securities Dealers, Inc., (organized under 15 U.S.C.A. § 780-3 et seq.) on its motion, was made an intervenor-plaintiff.
Throughout the trial, the plaintiff was referred to as "SEC", and the intervenor-plaintiff was referred to as "NASD". The defendant was referred to as "VALIC", and the intervenor-defendant was referred to as "EALIC".
The Complaint prays for a preliminary and final injunction restraining VALIC from selling or offering for sale certain contracts denominated "variable annuity" contracts or policies, unless and until they are registered with SEC in accordance with the provisions of the Securities *523 Act of 1933, and the Company complies with the provisions of the Investment Company Act of 1940.
It is the contention of the plaintiff that the very nature, and the express provisions, of the variable annuity contracts make the companies and the contracts amenable to the enactments of Congress and the regulations of SEC with reference to the sale of securities or interests in securities.
The defendants oppose that contention and insist that they are insurance companies, that the variable annuity contracts which they issue are insurance policies, that the defendant companies are licensed and regulated by the District Insurance Superintendent and the State Insurance Commissioners where they operate, and that they are expressly exempt from the jurisdiction of the Federal agency established for the regulation of the sale of securities.
The defendants further assert that the McCarran-Ferguson Insurance Regulation Act (Act, March 9, 1945, 59 Stat. 33, as amended, Act, July 25, 1947, c. 326, 61 Stat. 448, 15 U.S.C.A. §§ 1011-1015) gives the State and District authorities exclusive jurisdiction over them and their business.
The issue in the case is,Are the defendants and their equity or variable annuity contracts subject to the State and District laws exclusively, or are they subject to the Federal regulations as administered by the SEC, or are they subject to both State and Federal regulations? That issue must be determined first by a consideration of the contracts. Are such contracts insurance policies, or are they securities evidencing investments or interests in investments?
The evidence in this case makes it clear to this Court that they cannot be classified as either, exclusively. The variable annuity contracts contain provisions which must be classified as insurance, and also provisions which bring them within the statutory definition of securities.
The contracts issued by the defendants differ in certain details. The amount and terms of payment are different; some contracts include decreasing term life insurance, others do not; some, but not all, include a waiver of further payments to the company in case of the permanent and total disability of the holder of the contract.
The essential characteristic of all the contracts, and the characteristic which gives rise to this litigation, is found in the provisions which create a reserve fund of the amounts paid by contract holders for the purpose of investing it mainly in common stocks under the management of the company, and from which annuity and other payments due to contract holders shall be made in amounts determined by the investment experience, i. e., profits and losses of the fund.
Plaintiff's Exhibit No. 1, entitled "Deferred Variable Annuity Policy", was received in evidence as a specimen of all the contracts that employ such investment practice (Appendix 1). It was issued and sold by VALIC. For purposes of clarity and convenience, it and VALIC will be referred to with the understanding that what is said applies to all similar contracts and the companies issuing them.[1]
The contract provides for two periods: (1) the accumulation or pay-in period, and (2) the annuity or withdrawal period. During the first period, the contract holder makes "premium" payments for which he receives an equitable interest in VALIC's investment fund, and for which VALIC credits him with a number of "accumulation units". The number of units is determined by dividing the amount of the payment by the value of one accumulation unit as of the last day of the month in which the payment is received. The value of one unit is, of course, determined by dividing the amount of the fund (market value of *524 stock) by the number of accumulation units issued against it. The amount paid by the contract holder is subject to a deduction for management expense and the cost (premiums) of decreasing term life insurance and total permanent disability insurance, and the remainder is then applied to the purchase of accumulation units.
The variable annuity period (2) is the term during which VALIC makes variable annuity payments, according to the terms of the contract, to the contract holder who has elected to participate in the plan. The contract holder is credited with a sum of money determined by multiplying the number of accumulation units credited to his account by the value of one unit as of that time. The first annuity payment is computed on the sum so credited by using the Progressive Annuity Table with a rate of interest of 3½ per cent per annum, in the same way that any life insurance company would compute it. VALIC then credits the contract holder with a number of annuity units, the number being determined by dividing the amount of the first payment by the value of a unit. The number of units then remains constant for the term of the contract, but the value of an annuity unit varies thereafter according to VALIC's investment experience. And subsequent variable annuity payments are computed by multiplying number of units by the value of a unit at time of payment.
This analysis of the variable annuity shows that, while the contract has certain definite features of insurance, it has a marked difference from the conventional insurance contract. Whereas the money paid for conventional insurance becomes the absolute property of the insurance company, the money paid for a variable annuity goes into an investment fund which becomes, by operation of law if not by express terms of the contract, a trust fund for the equitable interests of the contract holders. And, whereas the conventional insurance policy obligates the insurance company to pay the policy holder a definite fixed amount at specified times, the variable annuity contract obligates the company issuing it to pay at stipulated times, not fixed dollar amounts, but only such amounts as are warranted by the investment experience of the company managing the fund.
The evidence was clear and undisputed that the variable annuity contract was devised for the very purpose of providing contract holders with payments adjusted to the fluctuating purchasing power of the dollar. The evidence revealed that the value of the dollar (measured by purchasing power) had declined about 70% in the last 70 years, and that holders of policies and securities yielding a fixed-dollar return were deprived of the security which they had expected. The variable annuity contract was based on the economic theory (questioned by some economists) that common stocks tend to fluctuate in value with business conditions, and to rise generally with price levels and the cost of living. It was, therefore, deemed advisable by some insurance companies to abandon the traditional practice of investing in debt securities which provide certain, but fixed, interest rates, and create instead a reserve fund segregated from other company assets, invested in diversified stocks, and offer to their annuitants an undivided interest in such fund, evidenced by annuity units, the value of which fluctuates with the rise and fall of common stock prices.
It seems clear to this Court that such an arrangement would, if the fund is well managed, tend to increase payments due to annuitants in general, in accordance with the rise in the cost of living at times of inflation. But contract holders whose annuity payments came due at a time of severe economic depression would realize that they had no insurance against the fate of stock, "securities" or "investments", that fail with the decline or collapse of the stock market. While the contract would provide a kind of hedge against the effect of inflation, it would give no insurance against the effect of depression.
Extensive testimony was offered at trial as to the nature and practices of *525 insurance business and of investment business for the purpose of incorporating in the record a basis for arguments regarding analogies and differences. Actuaries, economists, insurance specialists and publicists, and executive officers of insurance companies, investment companies and the New York Stock Exchange, were called as witnesses. The evidence was generally instructive and interesting, and revealed the great public interest in the issue of the case, but it need not be reviewed in this opinion because life insurance, life annuity and investment trust concepts, functions and contracts are generally understood, and, as stated at trial, the controlling facts are largely undisputed.
For that reason, the real issue must be determined by the law, and the controlling law is found in the applicable statutes. The plaintiffs contend that the variable annuity contract is a "security" as defined by the Securities Act of 1933, and cite Sec. 2(1), 15 U.S.C.A. § 77b (1):
"The term `security' means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, pre-organization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a `security', or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing."
And plaintiffs contend that each of the defendants is an investment company as defined in the Investment Company Act and cite Sec. 3(a), 15 U.S.C.A. § 80a-3:
"Sec. 3(a) When used in this title, `investment company' means any issuer which
"(1) is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities;
*   *   *   *   *   *
"(3) is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer's total assets (exclusive of Government securities and cash items) on an unconsolidated basis."
The defendants contend that their annuity contracts are exempt from the provisions of the Securities Act and cite Secs. 3(a) and (8), 15 U.S.C.A. § 77c:
"Sec. 3. (a) Except as hereinafter expressly provided, the provisions of this subchapter shall not apply to any of the following classes of securities:
*   *   *   *   *   *
"(8) Any insurance or endowment policy or annuity contract or optional annuity contract, issued by a corporation subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State or Territory of the United States or the District of Columbia;"
And defendants contend that they are not Investment Companies and quote as follows from Sec. 3 and Sec. 2 of that Act, 15 U.S.C.A. §§ 80a-3, 80a-2:
"(c) Notwithstanding subsections (a) and (b), none of the following persons is an investment company within the meaning of this title:
"(3) Any bank or insurance company; * * *."
Sec. 2
"(a) When used in this title, unless the context otherwise requires * * *
"(17) `Insurance company' means a company which is organized as an *526 insurance company, whose primary and predominant business activity is the writing of insurance or the reinsuring of risks underwritten by insurance companies, and which is subject to supervision by the insurance commissioner or a similar official or agency of a State; * *."
And defendants further rely on the contention that the McCarran Act, 15 U.S.C.A. § 1011, vests exclusive regulatory jurisdiction over them in the Insurance Superintendent of the District of Columbia and the Insurance Commissioners of the several states where they are authorized to do business, and cite the following material parts of that Act:
"Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That the Congress hereby declares that the continued regulation and taxation by the several States of the business of insurance is in the public interest, and that silence on the part of the Congress shall not be construed to impose any barrier to the regulation or taxation of such business by the several States.
"Sec. 2. (a) The business of insurance, and every person engaged therein, shall be subject to the laws of the several States which relate to the regulation or taxation of such business.
"(b) No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance: Provided, That after January 1, 1948, the Act of July 2, 1890, as amended, known as the Sherman Act, and the Act of October 15, 1914, as amended, known as the Clayton Act, and the Act of September 26, 1914, known as the Federal Trade Commission Act, as amended, shall be applicable to the business of insurance to the extent that such business is not regulated by State law.
*   *   *   *   *   *
"Sec. 5. As used in this Act, the term `State' includes the several States, Alaska, Hawaii, Puerto Rico, [Guam] and the District of Columbia."
The logic of the law applied to the established facts seems to bring the variable annuity contract within the purpose and intendment of the Securities Act, and the defendants within the terms and plan of the Investment Company Act. This Court would feel constrained to so hold if it were not for the clear and explicit language of the McCarran Act and the fact that the defendants are licensed and regulated by the insurance departments of this District and the States where they operate.
Because the variable annuities were not in existence or general use when the statutes mentioned were enacted, there is no definite expression of Congressional intention or opinion regarding them. When, however, the defendants produced and put into use a contract which abandoned the provisions of conventional insurance policies with fixed-dollar benefits, guaranteed by the company, and created a reserve fund for investment mainly in common stocks, with provision for payment of annuity benefits subject to gains and losses of the fund, they created a hybrid policy-contract with characteristics of both its insurance and its investment progenitors.
It was natural, then, for the officers of SEC to question whether this novel contract should be classified as insurance for an annuity, or as a security for an investment, and by what authority it should be regulated. As stated, if the companies issuing the novel contract were not chartered, licensed and regulated by District and State authorities, and if Congress had not passed the McCarran Act, the questions raised by SEC would *527 be answered by applying the rules of statutory construction to the Securities Act of 1933 and the Investment Company Act of 1940, and, in the opinion of this Court, such construction would bring the defendants within the purview and purpose of those statutes.
When, however, the Congress passed the McCarran Act and set at naught the decision of the Supreme Court in the case of United States v. South-Eastern Underwriters Association, 1944, 322 U.S. 533, 64 S.Ct. 1162, 88 L.Ed. 1440, it excluded all Federal agencies from regulatory jurisdiction over all insurance companies and insurance business except such agencies as it then excepted or might in the future except. SEC has not been made an exception.
In view of the fact that the defendants have been chartered as insurance companies by the District of Columbia and their questioned contracts have been approved by the Insurance Superintendent of the District, and by the insurance departments of certain states, this Court is constrained to hold that the broad, explicit and impelling language of the McCarran Act makes them exempt from Federal regulation unless and until Congress provides otherwise.
The arguments which plaintiffs advance here should be made to the Congress. The Supreme Court has recognized that it was the intention of Congress to give support to the existing and future State systems for regulating the business of insurance "by removing obstructions which might be thought to flow from its own power, whether dormant or exercised, except as otherwise expressly provided in the Act itself or in future legislation". Prudential Insurance Co. v. Benjamin, 1946, 328 U.S. 408, 430, 66 S.Ct. 1142, 1155, 90 L.Ed. 1342.
The plaintiffs base their complaint on the contention that the contracts issued by defendants are securities evidencing investments and, therefore, not within the exemptions granted to insurance policies, regardless of what the defendants and their contracts are called. The defendants base their defense on the contention that they are duly chartered insurance companies, that the contracts they issue are insurance policies, and that, therefore, they and their contracts are not subject to the Securities Act, the Investment Company Act, the regulations of SEC, and are under the full protection of the McCarran Act. This Court cannot sustain or overrule either contention, entirely. The contract is novel and will not fit exactly into either of the categories suggested. The judgment of the Court is, therefore, what in ring-side parlance would be called a "split decision". The contract in issue is like a horse on the range that has not been branded or corralled. In view of the language of the McCarran Act, it seems to this Court that Congress should do the branding. If the question should be asked: "Why Congress?", the answer would be: "It asked for it."
The legislative history of the McCarran Act, as well as its language, shows clearly that its purpose was to keep control of insurance business in the States. As one Senator said, "We want the business left in the control of the States, unless, by enactment in the future, we specifically state that we do not want something they are doing to be continued". (Hearings p. 159)
The plaintiffs contend that the defendants, with the approval of some District and State insurance officials, placed themselves in the insurance field, but that the business which they are doing does not warrant their continuance in that field. The Congress, however, has barred all Federal agencies from access to that field, except those specifically named, and SEC has not been named. The broad and exclusive effect of the McCarran Act has been sustained by the Supreme Court and by the Courts of Appeal. Maryland Casualty Co. v. Cushing, 1954, 347 U.S. 409, 413, 74 S.Ct. 608, 98 L.Ed. 806; American Hospital & Life Insurance Company v. Federal Trade Commission, 5 Cir., 1957, 243 F.2d 719; National Casualty Co. v. *528 Federal Trade Commission, 6 Cir., 1957, 245 F.2d 883.
The McCarran Act is not the only reason for Congressional action. The definitive classification of variable annuities will involve the consideration of broad principles of public policy, the effect of such classification on the insurance business and on the investment business, and on the balance of powers between State and Federal agencies,  all of which are matters that generally lie within the province of the legislative function. This Court may be considered old-fashioned, but it still looks upon our Constitutional separation of powers with great respect, and views with apprehension the usurpation of the powers of one branch of government by any other.
At trial, parties, counsel and Court seemed to recognize that there were issues involved in this controversy which would have to be determined by Congress, no matter what decision in this case was made by this or any other courtthat Congress might have to provide for new rules and regulations covering variable annuities. It was also recognized that there is urgent need for a prompt solution of the entire problem. If the trial and decision of this case is not conclusive of the issue, it is reasonable to hope that it may be conducive to a determination. In any event, a legal analysis had to be made and the conflicting interests had to be heard. The record of this case, including the transcript of testimony, exhibits and excellent briefs of able and experienced counsel, should be of great service.
The motion of NASD for leave to intervene should be, and is, sustained. It is apparent that its business may be affected by this case. The essence of the intervenor-plaintiff's contention is that all dealers in securities should be subject to the same regulations. It contends that a company which buys and holds securities for its own account, and issues annuity policies calling for payments in fixed-dollar amounts, is an insurance company, but that a company which buys and holds securities for the account of others, and issues to its customers grants of participation rights or interests in such securities, subject to profits and losses, is a securities dealer.
Reverting again to the simile of the range horse, an attractive new creature has been discovered on the financial range. It has some of the markings of the insurance herd and also some of the markings of the investment herd, but it has not been branded. It has sought shelter in the insurance corral. But the security dealers say it should be in the investment corral. The contending parties appeal to this Court to brand the creature for proper classification. This Court, however, finds that Congress has kept the only branding iron. It seems clear to this Court, therefore, that Congress should determine whether the creature should be branded INS or INV (Insurance or Investment), or whether it should have some other brand, such as INSV, and whether it should be placed in one or the other corral, or have a new corral of its own. Congress, it seems, is the proper agency to determine what classification would best enable the creature to serve the national economy.
In spite of the fact that the variable annuity applies the annuity principle directly to a new area of investment, common stocks, and pays to the annuitant, not fixed-dollar amounts, but amounts determined by investment experience, still the contract is denominated an annuity policy, and the companies selling variable annuities are chartered as life insurance companies. In view of the language and history of the McCarran Act, such contracts and companies are subject only to the regulations of the insurance departments of the District of Columbia and the States where such companies are licensed to do business. It is the judgment of this Court that Congress only can make such contracts and companies amenable to the regulations of SEC.
Judgment for defendants. Complaint dismissed. *529 *530 *531 *532 *533 *534 *535 *536 *537 *538
NOTES
[1]  EALIC stipulated that its contracts were in all material respects the same as those issued by VALIC.
