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Deciding an issue for the first time nationwide, the 2nd U.S. Circuit Court of Appeals ruled that variable annuities are “covered securities” under the federal Securities Litigation Uniform Standards Act of 1998. Thus, the appeals court said, class actions alleging fraud in the sale of variable annuities brought under state law are preempted by the 1998 act, known as SLUSA. The court also became the first federal appellate court to address a second, related issue when it ruled that the McCarran-Ferguson Act, which gives states a dominant role in the regulation of the insurance industry, does not alter “the normal rules of preemption,” under SLUSA. Those two issues arose in the class action, Lander v. Hartford Life & Annuity Insurance Company, 00-7849. Variable annuities involve a contract in which a purchaser, or annuitant, makes a payment or series of payments to a provider, typically an insurance company, and has some control over how the money is invested. The annuitant begins receiving payments once the policy is mature. However, most of these policies also provide for a death benefit to be paid to a survivor if the annuitant dies before the policy matures, which makes the annuities a “hybrid product” because it has the characteristics of both insurance products and securities. Under the Internal Revenue Code, the annuitant or their beneficiary is taxed only once payment begins — but that tax advantage is not realized if the funds used to purchase the policy are already tax deferred through an investment vehicle such as a 401(k) plan or an Individual Retirement Account. Writing for the 2nd Circuit, Judge Chester J. Straub said “[t]he plaintiffs claim that they relied upon the advice and expertise of Hartford Life representatives who misrepresented the suitability of variable annuities and failed to warn consumers of the tax redundancy that occurs when the products are purchased with already tax deferred dollars.” The plaintiffs also alleged that fees charged in the use of variable annuities contracts resulted in a loss of as much as one-third of the value of their accounts when compared with other investment products. The case was initially brought under Connecticut statutory and common law, but Hartford Life prevailed in having the case removed to the U.S. District Court for the District of Connecticut. The plaintiffs moved for a remand before Chief Judge Alfred V. Covello, saying the removal was in error because variable securities are not covered securities under SLUSA. But Covello disagreed and dismissed the suit based on SLUSA’s preemption requirement: that no class action based on the statutory or common law of a state can be brought where it involves misrepresentations in the purchase or sale of a covered security. On the appeal, Judge Straub upheld the lower court ruling that dismissed the suit because of federal preemption. He said that Congress was responding to a loophole in the Private Securities Litigation Reform Act of 1995 when it passed SLUSA in 1998. “It did this by making federal court the exclusive venue for class actions alleging fraud in the sale of certain covered securities and by mandating that such class actions be governed exclusively by federal law,” he said. The U.S. Supreme Court, he said, has already determined that the variable annuity contracts are securities. In SEC v. Variable Annuity Life Insurance Company of America, (VALIC), 359 U.S. 65 (1959), the Supreme Court also said issuers of variable annuities must comply with the Investment Company Act of 1940. SEC REGISTRATION Moreover, Straub said, “although insurance companies like Hartford Life are not themselves investment companies registered under the 1940 Act, they may sell variable annuities only through separate investment accounts that must be registered with the [Securities and Exchange Commission] pursuant to the 1940 Act.” “Therefore, because variable annuities are securities, and because the separate accounts used for marketing these products are registered with the SEC under the Investment Company Act, the removal clause of the statute is satisfied,” he said. Straub said that such a ruling comports with the intent of Congress to have national, uniform standards for securities class actions involving nationally traded securities. “Moreover, both the statutory findings and the accompanying conference report make it clear that SLUSA targeted class action litigation intended to be reached by the PSLRA, but which evaded the procedural requirements of PSLRA by migrating to state court,” he said. SECOND ISSUE Turning to the second issue, Straub said that both Hartford Life and the SEC, which submitted a brief as amicus curiae, argued that the protections afforded the McCarran-Ferguson Act, which for the most part leaves insurance regulation to the states, are not implicated in this case. But both also acknowledged the hybrid nature of the variable annuities and the Supreme Court in VALIC recognized that variable annuities have at least some aspects of insurance. “As such, we are reluctant to hold categorically that for purposes of the McCarran-Ferguson Act, variable annuities are not the business of insurance,” Judge Straub said. “In any event, we need not decide whether variable annuities are part of the ‘business of insurance’ as defined by McCarran-Ferguson because, as stated below, we find clear indications from Congress that it intended the preemptive effect of SLUSA to reach variable insurance products.” Straub said that contrary to the plaintiffs’ argument, the 2nd Circuit’s ruling would not eviscerate state regulation of insurance. “Nothing in our holding today impedes a state’s ability to police fraud or other matters that may arise regarding variable annuities’ insurance characteristics,” he said. “SLUSA’s preemptive effects are narrow and limited, prohibiting only class actions brought by private individuals that are based on state law and allege fraud in the sale of covered securities.” Senior Judge James L. Oakes and Judge Rosemary Pooler joined in the opinion. Representing the plaintiffs were Michael C. Spencer, of New York-based Milberg Weiss Bershad Hynes & Lerach; Ronald A. Uitz, of Uitz & Associates in Washington, D.C.; Sheldon S. Lustigman, of the Lustigman Firm; James M. Newcomer, of James, Hoyer, Newcomer, Forizs & Smiljanich; and Elias A. Alexiades, of Hurwitz & Sagarin in Milford, Conn. Daniel McNeel Lane Jr., of Akin, Gump, Strauss, Hauer & Feld, represented the defendants.

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