Prusky v. Reliastar Life Ins , 445 F.3d 695 ( 2006 )

Opinions of the United
2006 Decisions States Court of Appeals
for the Third Circuit
3-20-2006
Prusky v. Reliastar Life Ins
Precedential or Non-Precedential: Non-Precedential
Docket No. 05-1611
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NOT PRECEDENTIAL
IN THE UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 05-1611
PAUL M. PRUSKY, INDIVIDUALLY AND AS TRUSTEE,
WINDSOR SECURITIES, INC. PROFIT SHARING PLAN;
STEVEN G. PRUSKY, AS TRUSTEE, WINDSOR SECURITIES, INC..
PROFIT SHARING PLAN,
Appellants
v.
RELIASTAR LIFE INSURANCE COMPANY
Appeal from the United States District Court
for the Eastern District of Pennsylvania
District Court Civil No. 03-cv-06196
District Judge: The Honorable Herbert J. Hutton
Argued January 27, 2006
Before: RENDELL and SMITH, Circuit Judges,
and IRENAS, District Judge *
(Filed March 20, 2006 )
Arlin M. Adams
Bruce P. Merenstein [ARGUED]
Schnader Harrison Segal & Lewis LLP
1600 Market Street, Suite 3600
Philadelphia, PA 19103
Counsel for Appellants
*
The Honorable Joseph E. Irenas, Senior District Judge for the District of New Jersey,
sitting by designation.
Joseph P. Moodhe [ARGUED]
Debevoise & Plimpton LLP
919 Third Avenue
New York, NY 10022
Mathieu J. Shapiro
Obermayer Rebmann Maxwell & Hippel LLP
One Penn Center, 19 th Floor
1617 John F. Kennedy Boulevard
Philadelphia, PA 19103
Counsel for Appellee
OPINION OF THE COURT
IRENAS, Senior District Judge.
Paul and Steven Prusky (collectively the “Pruskys”) appeal from an order of the
United States District Court for the Eastern District of Pennsylvania denying partial
summary judgment on their breach of contract claims and entering summary judgment
sua sponte in favor of ReliaStar Life Insurance Company (“ReliaStar”). The District
Court had jurisdiction under 28 U.S.C. § 1332. We exercise appellate jurisdiction
pursuant to 28 U.S.C. § 1291. For the reasons set forth below, we will reverse the grant
of summary judgment to ReliaStar and remand the case to the District Court.
I.
Between February 1998 and March 1999, the Windsor Securities, Inc. Profit
Sharing Plan (the “Plan”), through its trustees, the Pruskys, purchased seven flexible
2
premium variable universal life insurance policies from ReliaStar. The policies, which
are identical for all purposes relevant to this appeal, each named the Plan as the policies’
owner and was payable on the last to die of Paul Prusky1 and his wife, Susan. As of
August 2, 1999, the Plan had paid almost $2.5 million in premiums for various death
benefits amounting to more than $42 million. However, it is the use of the policies as an
investment vehicle that is at the root of the dispute in this case.
Many traditional life insurance policies provided that a portion of the premium be
set aside in a policy reserve which accrued interest at a predetermined rate, set by the
terms of the policy, which is unrelated to the return on the investments made by the
insurance company. This reserve is, in effect, paid out to the beneficiary as part of the
face value of the policy when the insured dies, and, as the basis of the policy’s cash value,
can be used for borrowing or returned to the policy’s owner should a decision be made to
terminate the policy. See Joseph E. Irenas, Life Insurance Income Under the Federal
Income Tax, 21 Tax L. Rev. 297, 297-301 (1966). “[M]ost insurance policies are not only
contracts covering the risk of death, . . . but also vehicles of saving by which money is
deposited with the insurance company to accumulate at interest for the benefit of the
policy holder.” Id. at 297.
At some point certain segments of the life insurance industry recognized that a life
insurance policy which, like traditional whole life insurance, offered a fixed death benefit
1
Paul Prusky brought suit individually and as a trustee of the Plan.
3
and a substantial savings component and, unlike a traditional policy, offered the
policyholder a right to control in some fashion the investment of accumulated reserves,
might be attractive to individuals who believed they had superior investment skills. The
seven flexible premium variable universal life policies purchased by the Plan from
Reliastar contained this investment control feature.
Pursuant to the policies’ terms, ReliaStar maintained a unit investment trust, the
“Variable Account.” The Variable Account, in turn, was divided into various mutual
fund sub-accounts, in which the Plan was entitled to invest a portion of the net premiums
paid.2 Thus, the cash values of the policies were tied to the market value of the assets held
in the sub-accounts. The Plan’s trustees often communicated daily with ReliaStar,
directing the allocation of its assets among the sub-accounts in an effort to increase the
cash value of the policies.3
ReliaStar’s standard policies provided that (1) “written” transfer requests could be
made only four times in a policy year and (2) transfers would be made on the first
valuation date after the request was received. The policies also provided that Reliastar
could charge a fee for each transfer up to a maximum of $25.00. However, the Pruskys
2
Premiums needed to keep each policy in force could be paid by the Plan or deducted
from the Variable Account to the extent that its investment performance would not reduce
the account below the minimum required by a particular policy.
3
Each policy also provided that investments could be allocated to a “Fixed Account”
which would earn interest at a rate determined by the policy which was not tied to
ReliaStar’s actual investment performance. However, in all policies the Plan chose to
allocate 100% of its investments to the Variable Account.
4
specifically negotiated alternate terms. The amendments to each of the seven policies
were embodied in seven practically identical memoranda drafted by ReliaStar’s Second
Vice President, M.C. Peg Sierk (the “Sierk Memos”).
First, the Sierk Memos gave the Plan the right to make daily transfers by
telephone, facsimile, or other electronic means in unlimited amounts without any transfer
fee. Thus the provisions facilitated the Pruskys’ preferred investment strategy of making
frequent trades to take advantage of short-term variations in mutual fund pricing, a
practice commonly known as “market timing.” 4
Second, the Sierk Memos allowed the Plan to execute trades until 4:00 p.m.
Central Standard Time (CST) -- one hour after the New York Stock Exchange (NYSE)
closes at 4:00 p.m. Eastern Standard Time (EST) -- and mandated that those after-closing
transfers receive unit values calculated for that day. This practice is known as “late
5
trading.”
4
Market timing seeks to take advantage of information that has not yet been
incorporated into the price of a security held in a mutual fund’s portfolio. Because net
asset values (“NAVs”) are typically calculated once daily, market timers must conduct
transactions frequently to obtain the advantage of the price / value discrepancy. See
generally Disclosure Regarding Market Timing and Selective Disclosure of Portfolio
Holdings, 68 Fed. Reg. 70,402 (Dec. 17, 2003). The parties do not dispute that market
timing is legal.
5
The term “late trading” is somewhat misleading because trading after the close of the
market is entirely permissible so long as the trades are priced using the NAV set the next
day. See Pricing of Redeemable Securities for Distribution, Redemption and Repurchase,
17 C.F.R. § 270.22c-1 (“No registered investment company issuing any redeemable
security . . . shall sell, redeem, or repurchase any such security except at a price based on
the current net asset value of such security which is next computed after receipt of a
5
Beginning in March 1998, Paul Prusky placed sub-account transfer requests, by
telephone or other electronic means, often on a daily basis, and ReliaStar made the
transfers. Many of the transfer requests were made between 3:00 p.m. and 3:30 p.m. CST
(after the NYSE had closed for the day) but were valued at the current day’s price.
In November, 2002, ReliaStar informed the Plan that it would no longer implement
transfer instructions as of the date received unless the requests were received by the close
of the NYSE (3:00 p.m. CST). ReliaStar’s stated reason for the change was to comply
with applicable law and regulations requiring transfer requests made after the close of
NYSE to be valued at the next day’s price. The Pruskys objected to this unilateral change
of the agreement, but nonetheless continued dealing with ReliaStar, and ReliaStar
continued to honor all trades made by electronic means (so long as they were placed
before 3:00 p.m. CST) until October 8, 2003, when it notified the Plan that, after
receiving a complaint from the Pioneer funds, it would no longer accept trades “via
facsimile, phone or internet” in those funds. Effective November 7, 2003, that restriction
tender of such security for redemption or of an order to purchase or sell such security.”)
(emphasis supplied). The Rule’s requirement that prices be based on the next computed
NAV is referred to as “forward pricing.” Disclosure Regarding Market Timing and
Selective Disclosure of Portfolio Holdings, 68 Fed. Reg. 70,402 (Dec. 17, 2003). Thus,
late trading may be more aptly described as violating the forward pricing rule. Appellants
do not seek to enforce the late trading provisions of the Sierk Memos, which explicitly
provided that the price of the securities transferred would be based on the current day’s
NAV, contrary to the forward pricing rule.
6
was applied to trades in all funds, thereby effectively eliminating the Pruskys’ ability to
execute daily transfers in accordance with their market timing strategy.
This diversity suit followed, seeking damages for breach of contract and specific
performance of only the market timing provisions. Neither damages nor specific
performance was sought for the elimination of the late trading provisions of the Sierk
memos. The Pruskys moved for partial summary judgment on liability only. ReliaStar
opposed the motion asserting, among other things, that because the late trading provisions
were both illegal and an integral part of the contract between the parties, the policies were
void in their entirety. The District Court accepted this argument, denied the Plan’s
motion for partial summary judgment, and, sua sponte, entered summary judgment in
favor of ReliaStar. Because of this ruling the trial judge did not consider other defenses
raised by ReliaStar in opposition to the partial summary judgment motion. The Pruskys
filed this timely appeal.
II.
Because we are reviewing a grant of summary judgment, our review is plenary.
Am. Flint Glass Workers Union v. Beaumont Glass Co., 62 F.3d 574, 578 (3d Cir. 1995).
Drawing all reasonable inferences in favor of the party against whom judgment is sought,
judgment pursuant to Federal Rule of Civil Procedure 56 should be granted only when no
issues of material fact exist and the party for whom judgment is entered is entitled to
7
judgment as a matter of law. Id.The Pruskys assert that the District Court procedurally erred by sua sponte entering
summary judgment in favor of ReliaStar without adequate notice, and substantively erred
by concluding that the late trading provision voided the life insurance contracts in their
entirety, thereby precluding the Pruskys from enforcing the market timing provisions. We
hold that the District Court erred on the merits6 and will reverse and remand.
III.
The District Court held that the undisputed evidence demonstrated that the illegal
late trading provisions were “an essential and non-severable part of the [life insurance]
contracts.” We disagree.
6
We also note that “‘A district court may not grant summary judgment sua sponte
unless the court gives notice and an opportunity to oppose summary judgment.’ . . . orders
granting summary judgment sua sponte endanger important rights, and . . . are likely to
result in judicial inefficiency and deprivation of the rights of one of the parties.” Am. Flint
Glass Workers Union , 62 F.3d at 578 n.5 (quoting Otis Elevator Co. v. George
Washington Hotel Corp., 27 F.3d 903, 910 (3d Cir. 1994)); see also Chambers Dev. Co.
v. Passaic County Utils. Auth., 62 F.3d 582, 584 n.5 (3d Cir. 1995) (“a judgment cannot
be entered without first placing the adversarial party on notice that the court is
considering a sua sponte summary judgment motion. The court must also provide the
party with an opportunity to present relevant evidence in opposition to that
motion.”)(citing Celotex v. Catrett, 477 U.S. 317, 326 (1986)). Though we do not decide
the issue, nothing in the record indicates that the District Court provided the Pruskys with
actual notice that it was considering entering summary judgment in favor of ReliaStar,
and it is debatable whether the Pruskys otherwise had sufficient notice to satisfy this
requirement.
8
Under Pennsylvania contract law, a party my enforce legal provisions of a contract
containing an illegal provision provided that the primary purpose of the contract or an
essential part of the agreed exchange is not affected by disregarding the illegal provision.
Spinetti v. Service Corp. Int’l, 324 F.3d 212, 219-20 (3d Cir. 2003) (quoting Restatements
(First) and (Second) of Contracts, §§ 603 and 184 respectively); see also Huber v. Huber,
323 Pa. Super. 530, 538 (1984) (holding the child support provisions under post-nuptial
agreement were enforceable although the other terms of the contract may have been
illegal); Forbes v. Forbes, 159 Pa. Super. 243, 249 (1946) (upholding validity of contract
when disregarding the illegal provision “would not defeat the primary purpose of the
contract”).
The undisputed record evidence demonstrates that the primary purpose of the
contracts at issue was to insure the lives of Paul and Susan Prusky, while simultaneously
providing the Plan with savings and investment opportunities. This goal may be
accomplished without the late trading provisions.7 Certainly the late trading provision
did not impact the life insurance aspect of the ReliaStar policies.8 Nor was the goal to use
7
Despite the Pruskys’ assertions that the late trading provisions of the contracts could
in theory be performed in a manner consistent with applicable law and regulations and
therefore are not illegal, we agree with the District Court’s conclusion that the late
trading provisions of the contracts specifically allowed the Plan to execute transfers after
the close of the NYSE, receiving the current day’s NAV instead of the next day’s NAV,
in violation of the forward pricing rule.
8
These policies were issued more than six years ago. Particularly for insureds in the
age group of Paul and Susan Prusky, life insurance may become more valuable with the
passage of time.
9
the policies as investment vehicles meaningfully impaired. Whatever value the right of
late trading may have been to the Pruskys, it is small compared to the overall investment
benefit of the policies which the Pruskys have striven hard to keep in effect. For more
than a year after ReliaStar informed the Plan that it would no longer permit late trading on
orders received after 3 p.m. CST, the Plan continued to place numerous sub-account
transfer requests before the NYSE closed, which ReliaStar honored.9
The Plan surely bargained for the late trading provisions, but such bargaining does
not per se turn the provision into one that is the “primary purpose” of the policy. Contract
negotiations often involve a series of offers and counter-offers involving issues large and
small. The fact that a bargained for benefit is ceded by the other party is no particular
indication of the importance of the benefit to either side of the deal. Indeed, the
willingness of one side to concede a benefit to another might just as well be a sign of its
unimportance. Moreover, the importance of a contract right to a particular party is not
necessarily an indication that it is the “primary purpose” of the contract. Potential parties
to a contract may invest a great deal of importance to what others might consider a minor
point.
9
Appellee argues that one cannot modify a contract without the mutual consent of
both sides, and it alleges that the Plan never really agreed to the elimination of the late
trading provisions and, indeed, resisted the change. Standard contract principles would
certainly provide that a new obligation cannot be placed on a contracting party without
that party’s consent. In this case elimination of the late trading right may have some
impact on the Plan, but puts no new burden whatever on ReliaStar.
10
IV.
ReliaStar argued three alternate grounds for upholding the grant of summary
judgment, not relied upon by the District Court, two of which were argued on this appeal:
(i) changed circumstance had rendered the performance of the market timing provisions
of the Sierk memos impracticable and impossible; and (ii) the market timing provisions,
although not illegal, were not enforceable because they violated public policy.10
ReliaStar asserts that it should be excused from performing its obligations in the
Sierk Memos because recent regulatory developments designed to deal with market
timing have made performance impracticable. Under Pennsylvania law, a party’s
obligations may be discharged by a “supervening impracticability” “where after the
contract is made, a party’s performance is made impracticable without his fault by the
occurrence of an event, the non-occurrence of which was a basic assumption on which the
contract was made, his duty to render that performance is discharged, unless the language
or the circumstances indicate to the contrary.” Luber v. Luber, 614 A.2d 771, 774 (Pa.
Super. Ct. 1992) (quoting Restatement (Second) of Contracts § 261). “The theory of
legal impossibility is objective rather than subjective; the act contemplated under the
settlement must be incapable of being performed.” Felix v. Giuseppe Kitchens & Baths,
Inc., 848 A.2d 943, 948 (Pa. Super. Ct. 2004). On the record before us ReliaStar has not
10
We are considering these issues because the Court of Appeals may affirm the grant
of summary judgment on grounds different from those relied upon by the District Court.
Maschio v. Prestige Motors, 37 F.3d 908, 910 n.1 (3d Cir. 1994).
11
met this standard.
ReliaStar in fact allowed the Plan to execute frequent transfers via electronic
means, which clearly indicates that the contract could be performed. ReliaStar honored
such transfers (as long as they were executed before the close of the NYSE) until late
2003. Moreover, while regulators have focused more attention on dealing with the
perceived adverse effects of market timing in recent years 11 no regulation prevented
ReliaStar from executing frequent transfers submitted by electronic means. The
regulatory focus on market timing 12 may have imposed difficulties on ReliaStar in
conducting these transactions, but increased burden on a party does not render
performance impracticable. See Luber, 614 A.2d at 774 (“a party generally assumes the
11
See, e.g., Disclosure Regarding Market Timing and Selective Disclosure of Portfolio
Holdings, 68 Fed. Reg. 70,402 (Dec. 17, 2003).
12
We also question whether increased regulatory attention to market timing can be
considered changed circumstances at all. The practice of market timing was well known
at the time the Sierk Memos were drafted, as were the funds’ distaste for such practices.
See Windsor Secur., Inc. v. Hartford Life Ins. Co., 986 F.2d 655, 666 (3d Cir. 1993)
(“market timing caused increased trading and transaction costs, disruption of planned
investment strategies, forced and unplanned portfolio turnover, lost opportunity costs, and
subjected a fund’s asset base to large asset swings that diminished a fund’s ability to
provide a maximized return to all contract owners. . . .These concerns were shared by
others in the mutual fund industry and noted by the Securities and Exchange Commission.
See Offers of Exchange Involving Registered Open-End Investment Companies and Unit
Investment Trusts, Investment Company Act Rel. No. IC-16504, 53 Fed. Reg. 30,299,
30,301, 30,307 (1988). During [1989 and 1990], other mutual funds such as Fidelity
Investments and Vanguard Group began imposing ‘anti-timer’ restrictions to mitigate the
perceived negative effects of unrestricted timing activity.”).
12
risk of his own inability to perform his contractual duties”).13
Similarly, we also conclude that the market timing provisions do not violate public
policy. ReliaStar readily admits that market timing is not illegal and that investors are
expressly permitted to engage in market timing under applicable regulations. Yet
ReliaStar asserts that they are excused from performing because market timing is a
“disruptive,” “suspect and disfavored activity.” This is not the law. “Public policy is to
be ascertained by reference to the laws and legal precedents and not from general
considerations of supposed public interest. As the term ‘public policy’ is vague, there
must be found definite indications in the law of the sovereignty to justify the invalidation
of a contract as contrary to that policy.” Prudential Prop. & Cas. Ins. Co. v. Colbert, 813
A.2d 747, 750 (Pa. 2002). We find no basis in the laws or legal precedents to conclude
that market timing is contrary to public policy. Thus we hold ReliaStar’s nonperformance
13
The question of ReliaStar’s contractual obligation should a particular fund lawfully
refuse to honor a purchase or sale initiated by Plan on the ground that it involved market
timing is not before this Court. While the Pioneer Mid Cap Fund apparently did raise the
issue of market timing with ReliaStar, nothing in the record suggests any fund has ever
refused to execute an order from ReliaStar initiated by the Pruskys. We note that
effective May 23, 2005, the Securities and Exchange Commission adopted 17 C.F.R.
§ 270.22c-2(a). This provision may bar the redemption of fund shares within seven days
of issue unless a redemption fee is paid. This same regulation may also require a
financial intermediary, like ReliaStar, to agree not to execute purchases or exchanges of
fund shares for shareholders who have been identified by the fund as violators of a fund’s
policies on market timing. § 270.22c-2(a)(2). The impact of this new regulation and other
recent developments on the rights and duties of the parties may be considered by the
District Court on remand.
13
may not be excused on public policy grounds.14
V.
Based on the foregoing we will reverse the District Court’s sua sponte grant of
summary judgment to ReliaStar and remand the case to that Court to for further
proceedings consistent with this Opinion.
14
ReliaStar also argued before the District Court (but not on appeal) that the Pruskys
are precluded from recovering pursuant to the doctrine of unclean hands because the
Pruskys accepted brokers’ commissions on the contracts at issue in violation of
Pennsylvania law in effect at the time. “No insured person . . . shall, directly or
indirectly, receive or accept, or agree to receive or accept, . . . all or any part of any . . .
broker’s commission [on insurance].” 40 P.S. (Purdon’s) § 276 (Repealed by 2002, Dec.
6, P.L. 1183, No. 147, § 1). The Pruskys replied that any such acceptance was legal
because Steven Prusky accepted commissions in his capacity as a broker at a time when
he was neither a trustee of the Plan nor an insured. Even assuming, arguendo, that Steven
Prusky did accept illegal commissions, unclean hands do not bar relief because the
misconduct does not have an “immediate and necessary relation” to the market timing
provisions. New Valley Corp. v. Corporate Prop. Assocs. 2 & 3 (In re New Valley Corp.),
181 F.3d 517 (3d Cir. 1999).
14