The opinion of the court was delivered by: BRIEANT
[Findings and Conclusions re Fairness of Proposed Settlement]
Beginning in 1979, two insurance company subsidiaries of Baldwin-United Corporation began to issue single premium deferred annuities ("SPDAs"), described more particularly below. These subsidiaries were National Investors Life Insurance Company, an Arkansas insurance corporation (hereinafter "NILIC"), and University Life Insurance Company of America, an Indiana insurance corporation (hereinafter "ULIC"). During the next four years, nationwide sales of these SPDAs totalled more than Three Billion Dollars. Of the total premium amount, approximately 75% were sold through investment houses (hereinafter "the broker-dealers"), such as the defendants in eighteen separate actions ("the settling actions") now before the Court by joint motion for approval of stipulations of settlement and final judgments of dismissal. The remaining SPDAs were apparently sold by independent insurance agents.
On September 26, 1983, Baldwin-United Corporation came under the supervision of the Bankruptcy Court in the Southern District of Ohio pursuant to voluntary and involuntary petitions for reorganization filed on that date. it remains in reorganization pursuant to the Bankruptcy Code. The insurance company subsidiaries, NILIC and ULIC, were placed in the custody of state appointed rehabilitators pursuant to the laws of Arkansas and Indiana, respectively. The rehabilitators have approved rehabilitation plans, but no final order or judgment has yet been forthcoming in either of the state proceedings, each conducted by the Commissioner of Insurance of Arkansas and Indiana, respectively. Purchasers of SPDAs have filed more than 109 federal actions against the broker-dealers which marketed the SPDAs. A majority of the federal actions have been consolidated before this Court by transfer orders of the Judicial Panel on Multidistrict Litigation. See In re Baldwin-United Corporation Litigation, No. 581, 581 F. Supp. 739 (J.P.M.L. 1984).
As is set forth in this Court's Memorandum Decision and Order dated November 28, 1984, as amended, actions against eighteen of these defendants were certified as tentative consolidated class actions for the purpose of notifying purchasers of the terms of the proposed settlements and holding a fairness hearing. Familiarity of the reader with that decision is assumed. Notices were mailed to the 99,128 members of the plaintiff classes by December 21, 1984.
On February 25 and 26, 1985 this Court conducted a full evidentiary hearing on the motion for approval of the settlement agreements. Decision was reserved. There follows this Court's findings of fact and conclusions of law with respect to the proposed settlements.
At issue in the underlying litigation is the mixed question of law and fact as to whether the SPDAs, which are the subject of this litigation, are "securities" for the purposes of establishing liability under federal securities statutes. Without reaching that question, especially in light of the pendency of other non-settling cases which may tender the issue to this Court for resolution, the Court must set forth for present purposes some neutral description of the SPDA.
The SPDAs were instruments by which the customer paid an initial lump sum in exchange for the identical promise of NILIC or ULIC to repay the initial investment together with accumulated interest, which would accrue from date of issue, but as to which income taxes would be deferred, until such time in the future as the SPDA owner might request either a lump sum payment or a series of payments for life.
As will be seen, the SPDA was ideally suited to a purchaser contemplating future retirement, following which event he or she would be paying income taxes in a lower bracket. Additional features made the SPDAs appealing: a high first-year guaranteed rate of interest was provided although the insurance companies each reserved the right to alter the interest rate during the remainder of the term of the SPDA. The SPDAs guaranteed a minimum interest rate of 7.5% for years two through ten, and 4% thereafter. As an additional significant feature, the SPDA owner was permitted to "bail out," or withdraw the amount paid, together with accumulated interest without penalty, if during the second through the sixth contract year the interest rate was reduced by the insurance company to a rate more than 3/4 of 1% lower than the initial interest rate. Different SPDAs had different initial rates of interest, depending on market rates of interest at the date a plaintiff purchased his or her SPDA. Other than in this "bail out" situation, the issuing insurance companies imposed a penalty for early withdrawal. Plaintiffs' expert actuary estimates that the weighted average initial rate received by class members was 14.01%.
As mentioned above, most of these SPDAs were marketed and sold through various broker-dealers who were supplied with marketing literature and instructions by NILIC and ULIC. NILIC and ULIC appointed state licensed insurance agent employees of the broker-dealers to sell the SPDAs, and then paid a single commission to the broker-dealer upon a sale. In the typical situation, the SPDA purchaser would draw a check payable to the issuing insurance company in the total amount of the initial premium; no commissions or administrative fees were deducted from customer payments. The broker-dealers customarily received a single commission of 4% of the initial premium, paid to it by the insurance companies. In turn, the broker-dealers generally shared this commission, one-half to the registered representative whose efforts brought about the sale.
Although Baldwin-United, a diversified financial holding company developed from a piano business, was a relative newcomer to the insurance field it achieved a high volume of SPDA sales in a relatively short period of time. In part this high volume was achieved because this was the first time that annuities had been sold in large quantities by member firms, which generally have access to a pool of funds not readily available to the insurance industry. Also the instruments filled in a perceived need on the part of customers seeking to defer taxes and assure a high rate of return by acquiring an instrument regarded as safe because issued by a state licensed insurance company, theoretically at least, under the regulation and supervision of the insurance commissioners of Arkansas and Indiana, as well as 47 other states, excluding only New York, which had approved these companies, and authorized them to do business therein. The high sales volume may also be attributable to the aggressive sales tactics of the issuing companies and the broker-dealers, who allegedly recommended the SPDAs as very safe, high-yield investments, suitable for sale to customers planning their retirement income. For example, one brochure distributed by a defendant described the SPAs as "a tax shelter that's as safe as a savings account." As noted above, these opinions derived at least in part from the status of NILIC and ULIC as statutory reserve life insurance companies presumably subject to close regulation by state insurance officials. In each state where one or both of these companies sold SPDAs, local regulatory and licensing officials engaged n examination of the financial condition of NILIC and/or ULIC as a prerequisite to such sales. A.M. Best & Co., the leading insurance company rating agency, rated both insurance companies "A" or "Excellent" for 1980, 1981 and 1982.
Neither Baldwin-United, nor NILIC or ULIC are parties to the large majority of these actions.
It appears from allegations and statements of counsel for plaintiffs and defendants that the parent corporation, Baldwin-United, engaged in a series of corporate acquisitions of doubtful value. In so doing, it jeopardized its own solvency, and it had "upstreamed" 20% of the reserves of the insurance subsidiaries by investing the funds of NILIC and ULIC in Baldwin-United paper, or paper of other affiliates or subsidiaries. Apparently Baldwin-United's 1981 purchase of MGIC Investment Corporation, reportedly financed with the insurance companies" reserves, was the principal cause of the parent's having to borrow more than it could repay. Apparently also while collecting millions of dollars in proceeds of annuities, NILIC and ULIC deviated from the traditional practices associated with the investment of reserves for future payouts in annuities by investing in equities, rather than in fixed income obligations. Thereby it placed at greater risk the reserves protecting the amounts to be paid in the future to SPDA purchasers. Plaintiffs also assert that Baldwin-United engaged in an improvident "tax arbitrage" strategy which sought to utilize the tax losses of the insurance companies to effect the anticipated profits of other subsidiaries which were not engaged in the SPDA business.
Central to the majority of plaintiffs' claims in the eighteen settling actions is the assertion that broker-dealers knew or should have known that because of these improvident financial manipulations within Baldwin-United, NILIC and ULIC, the SPDAs were a high-risk investment, not the "guaranteed safe" investment allegedly promised to most SPDA purchasers.
The class plaintiffs have filed nearly identical consolidated complaints against each of the eighteen broker-dealer defendants in the settling actions and against defendant Planco, Inc., a Pennsylvania corporation alleged to have become an aider and abetter by having provided consulting services to NILIC and ULIC and having distributed promotional literature on the SPDAs. The complaints assert a variety of federal claims for relief as well as pendent state common law and statutory claims. The federal claims, for the most part, center on the allegation that the SPDAs are securities subject to the registration requirements of the Securities Act of 1933, and subject to the disclosure obligations of both the 1933 Act and the Securities Exchange Act of 1934, including Rule 10b-5 promulgated thereunder. Liability is predicated upon 15 U.S.C. §§ 773, 771(1) and 771(2), 17 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b-5. There is also a federal claim under the Racketeer Influenced Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1960, et seq., against all broker-dealer defendants but one.
Plaintiffs contend that defendants failed to file a registration statement, that they used writings in the nature of a prospectus which included untrue statements and omitted material facts, that they made false and misleading statements, and used deceptive practices, all in connection with the sale or offer for sale of the SPDAs, and did so using interstate means.
Plaintiffs' contention that the SPDAs are securities is an allegation concerning a mixed issue of fact and law, which this Court finds non-frivolous, and therefore sufficient to vest subject matter jurisdiction in this Court, and indeed, exclusive subject matter jurisdiction to the extent that the claims are founded on the 1934 Act. See Bell v. Hood, 327 U.S. 678, 90 L. Ed. 939, 66 S. Ct. 773 (1946); 15 U.S.C. § 78aa. Essentially, plaintiffs assert that the SPDAs were sold by firms which are engaged primarily in the securities industry, and that there were conversion and bail-out options said to be more characteristic of securities than insurance. Plaintiffs argue that there was no substantial mortality risk as a practical matter. Defendants in turn insist that the SPDAs are not securities and were not sold as such, and that plaintiffs would not at trial be able to establish liability either under the federal securities acts, or comparable state laws which regulate the sale of securities. Assuming arguendo that an SPDA is a security, plaintiffs hope to prove at trial that defendants each knew or should have known of the financial deterioration within the Baldwin-United empire and its subsidiaries, and nevertheless continued to present the SPDAs to customers as risk free.
In addition to federal claims, the eighteen complaints plead pendent state claims including common law fraudy, common law negligence and breach of fiduciary duty, breach of contract, and violations of state licensing and regulatory statutes including so-called consumer protection statutes of the various states. The degree or extent of proof required under the different statutory and common law bases for liability is a disputed issue, discussed below in this Court's evaluation of the merits of the proposed settlements.
On July 13, 1983, both NILIC and ULIC, together with four affiliated companies which had reinsured the SPDAs n part, were placed in rehabilitation by official action of the insurance commissioners of Arkansas and Indiana. The respective state courts issued interim orders of rehabilitation and appointed the two insurance commissioners as Rehabilitators, instructed to assume control of the assets and business of the six insurance companies. Among the causes necessitating rehabilitation was the fact that the insurance companies held securities of Baldwin-United and its affiliates which were of uncertain value doe to Baldwin-United's financial difficulties. On September 26, 1983, as noted earlier, Baldwin-United and its non-insurance affiliates came under the protection of the Bankruptcy Court.
Following state court hearings in January, 1984, and extensive cooperative efforts among the court-appointed Rehabilitators and various insurance officials of other states, a Rehabilitation Plan ("the Plan") was developed for submission to the Arkansas and Indiana courts. These courts approved the Plan and it became effective on May 1, 1984. Under its terms SPDA purchasers will receive 100% of their principal and 100% of all credited interest up to the date of rehabilitation. SPDA owners generally are credited with their guaranteed first-year rate of interest, even if the SPDA was still in its first contract year on the date rehabilitation began. Then, beginning on the later of date of rehabilitation (July 13, 1983), or expiration of the first year, and until May 1, 1984, SPDA owners are to receive a 9.5% per annum interest rate. After May 1, 1984 and until the completion of the Rehabilitation Plan on November 1, 1987, they are to receive an "assured rate" of 5.5%. The significance and extent of this "assurance" is discussed below.
During the first year of the rehabilitation proceedings, SPDAs lost their liquidity, since the NILIC and ULIC assets were frozen. Accordingly the "bail out" window was closed, as was the right to withdraw even with a penalty. However, beginning in June 1984, SPDA holders have been able to elect from six options under the Plan, thereby obtaining access to their funds; an SPDA holder can, for example, take a non-recourse loan for up to 75% of the May 1, 1984 accumulated value of his SPDA or withdraw 10% of the value of his SPDA each year. As may be seen, in addition to this limited deprivation of the right to obtain liquid funds, the effect of the Rehabilitation Plan is to reduce earnings on the SPDAs to rates below the generally prevailing market rates, which the owner presumably would have earned had he "bailed out" and reinvested his funds in the event of a decrease in rates paid by NILIC and ULIC. Also, after May 1, 1984, the rate of interest fixed by the Plan (5.5%) is 2% less than the guaranteed minimum rate of 7.5% per annum provided on the face of the SPDAs.
The various claims for relief in the class complaints leave room for argument concerning the possible extent or amount of damages recoverable from the broker-dealers. Assuming that the Rehabilitation Plan succeeds, a point discussed below, the absolutely essential loss of the class members henceforth, and after May 1, 1984, will be the 2% difference between the 7.5% minimum contract rate of interest, which the SPDAs carried, and the 5.5% "assured" rate under the Rehabilitation Plan. The Court believes that plaintiffs' liaison counsel has thoroughly examined all damage theories, and is probably correct in estimating class damages at a figure representing the difference between the value of amounts to be received under the Rehabilitation Plan and the value plaintiffs would have obtained by investing in identical SPDAs issued by a company which did not require a Rehabilitation Plan.
Under a realistic "benefit of the bargain" damages analysis, a SPDA owner might attempt to prove that he lost interest he was due to earn at a rate greater than the 7.5% guaranteed minimum rate and less than the high first-year rate (actuarily estimated at an average of approximately 14%). This latter theory is difficult, however, because no one knows how many SPDA holders would have bailed out in the event of a decrease in the interest rate paid by NILIC and ULIC, not connected with Rehabilitation. We do know that the SPDA owner had a disincentive to bail out, since probably he would have incurred tax liability unless he reinvested in another tax deferred annuity, and probably he would have confronted stiffer withdrawal penalties in a new SPDA. Therefore it is likely that the most a SPDA owner would have earned under his "bargain" was whatever interest rate prevailed in the market for comparable investment instruments during the relevant period. A major SPDA writer was crediting a 10.25% rate on new SPDAs during the second half of 1983, the period in which most of Baldwin-United's policy renewal windows were concentrated. As demonstrated by the Tables attached to Exhibit B to the Affidavit of David J. Bershad, sworn to February 25, 1985, average market rates have fluctuated between 13.47% and 10.75% for the period from January 1983 to date.
The Court cannot accept the argument by the Maine Attorney General that the amount of damages sustained by the class should be measured by the bail-out rate applicable to the particular SPDA. It is unrealistic to expect that Baldwin-United would have continued to establish future rates for outstanding SPDAs at a rate higher than market rates on similar investments or even that the SPDA holder who desired a tax deferred retirement income would have bailed out immediately and been able to reinvest at a higher than market rate. Under Maine's theory, the broker-dealers would be liable for the highest first-year rate less 3/4 of 1% -- the bail out level -- for the entire period following Rehabilitation. This cannot be a reasonable prediction of what plaintiffs could recover if they proceeded to trial and established liability against the broker-dealers under a statute or common law precedent permitting benefit of bargain damages.
Under a rescission damages analysis, it also is difficult to predict the possible recovery available to class members. Plaintiff's liaison counsel has analyzed this issue and has provided the COurt with graphs illustrating the proceeds which would go to a SPDA holder whose policy was rescinded and who received pre-judgment interest at the statutory rate effective in various states. It is noteworthy that the figures presently before the Court demonstrate that a rescission theory of damages would probably provide a lower total recovery, for most class members, than would the combination of the Rehabilitation Plan and this proposed settlement.
In summary, then, plaintiffs may or may not be able to prove some measure of damages based on a claim that they were due interest at a rate higher than the face guaranty of 7.5%. Undoubtedly any proof they may advance will be opposed by the broker-dealers who would argue, among other things, (1) that retention of the SPDAs precludes a damage remedy for violations of the 1933 Act, Wigand v. Flo-Tek, Inc., 609 F.2d 1028, 1035 (2d Cir. 1979); (2) that a rescissionary measure of damages yields a negative sum; (3) that the "bargain" contracted for was no more than 7.5% interest for years two through ten; and (4) that if any damages exist, they were not caused by the broker-dealers.
Without making any finding as to the damages issue, and whether plaintiffs could succeed even presenting a prima facie case against the settling defendants, the Court is persuaded to consider the limited loss of liquidity suffered by class members, together with the 2% gap between the assured rate and the SPDA guaranteed rate, as a minimum or floor in determining the face value of the class members claims against the settling broker-dealers, assuming plaintiffs prevail.
IV. The Proposed Settlements
Against the possible damages which could be recovered, the settling defendants have agreed to an overall plan which will terminate all the actions and release all the claims of th participating class members. All of the SPDAs marketed by the settling defendants are treated equally, without regard to the date on which sold, or whether sold by NILIC or ULIC. Furthermore, it is of no significance in the settlement which of the settling defendant served as the agent in connection with the sale. The approximate dollar contribution of each of the various broker-dealer defendants is as follows:
Advest, Inc. $ 528,801.00
A.G. Edwards & Sons, INc. 11,935,000.00
Bateman Eichler, Hill Richards,
Blunt Ellis & Loewi, Inc. 4,374,984.00
Boenning & Scattergood, Inc. 37,539.00
Drexel Burnham Lambert
E.F. Hutton Group, Inc. 33,982,765.00
Herzfeld & Stern 55,321.00
Janney Montgomery Scott Inc. 1,375,000.00
Kidder, Peabody & Co., Inc. 7,116,433.00
Merrill Lynch & Co., Inc. 44,203,500.00
Moseley Hallgarten Estabrook
& Weeden, Inc. 1,347,500.00
Oppenheimer & Co., Inc. 685,245.00
Parker/Hunter, Inc. 29,909.00
Smith Barney Harris Upham,
Thomson McKinnon Securities,
Tucker Anthony & R.L. Day,
In addition to these contributions by the settling broker-dealers, Planco, Inc., an insurance consulting firm named as a defendant in all eighteen settling actions, has agreed to contribute an aggregate of $232,940.00 in cash and to assign $871,200.00 of its claims in the Rehabilitation proceedings, claims for unpaid commissions or compensation owed to Planco by certain of the companies undergoing Rehabilitation. The settlement fund is now bearing interest and has been as of February 1, 1985.
The settlement fund totals approximately 140 Million Dollars. The settling parties calculated contributions to the fund by charging each of the eighteen brokers at the rate of 5.5% of the aggregate accumulated value as of May 1, 1984 of all SPDAs sold through that broker. Thus a broker which produced a higher dollar value of SPDAs will pay more than another broker which sold less; but each class member obtains the same proportionate recovery based on the May 1, 1984 accumulated value of his or her SPDA, a value already determined for each class member by the court-appointed Rehabilitators. It is estimated by plaintiffs' liaison counsel that this settlement fund, which represents a cash payment wholly apart from what the class will recover under the Rehabilitation Plan, equals approximately 27% of a plaintiff's damages, that is, 27% of the shortfall in interest during the Rehabilitation period. As discussed above, plaintiffs' counsel estimates that the "assured rate" (5.5%) is nearly six percent less than the probable open market rate of return that would be available but for the Rehabilitation proceeding. Of his six percent loss, the settlement fund is to yield an additional return near 1.8% per annum, reducing the shortfall in yearly earnings from 6% to 4.2%. The ultimate value of the settlement fund depends upon how the settlement fund is invested and the overall performance of the financial marketplace. however, if plaintiffs' damages are measured at the SPDA face guaranty of a 7.5% minimum rate of interest, then the broker-dealer contribution of 1.8% together with the 5.5% assured rate makes up 7.3% which comes close to a 100% recovery for SPDA holders.
Upon approval of the Court, the 140 Million Dollars in settlement proceeds will be utilized in one of two ways. It could be directed to fund in part an overall or "Global Enhancement Plan" by which an unrelated insurance company would assume the obligations for payments pursuant to the Rehabilitation Plan. In the alternative, the settlement proceeds and all interest accrued thereon would be distributed in lump sum cash payments to class members in proportion to their accumulated values as of the May 1, 1984 date. Attorneys fees and expenses will be deducted before the settlement proceeds are distributed to class members or contributed to a Global Enhancement Plan.
In evaluating the potential recovery available to the plaintiff classes, the Court must also consider the role of state insurance "guaranty" associations, six of which have intervened as party plaintiffs and objected to the proposed settlements. Approximately 33 states have these guaranty associations, or the equivalent, which function in a manner similar to the Federal Deposit Insurance Company. Funded by levies generally raised from insurance companies on total premiums written, these associations, membership in which is usually compulsory, make up the difference in value between that which is received in the rehabilitation of an insolvent or failing insurance company, and the amount due the insured for the value of the insurance policies or annuities prior to rehabilitation. In 33 of the states where NILIC and ULIC did business, the class members are protected by the additional sums to be due from the guaranty associations. However, the statutory liability of the guaranty associations does not inhere until a "final" plan of rehabilitation has been adopted with respect to NILIC and ULIC; only thus could the value of what is received be compared with the value of the insurance purchased, in order to compute the amounts of damage or loss due from the guaranty association. The Commissioners in their Rehabilitations Plans have not made a final order, and the nature of their Plan is such that no final amount could yet be determined. Such a determination may take years in light of the upstreamed "investments" of the insurance companies in Baldwin-United affiliates, the true value of which may depend on the outcome of the Baldwin-United bankruptcy.
Under the terms of the stipulations, conclusion of this settlement may tend to release the guaranty associations from liability to those who accept settlement, and it is arguably true that even in those cases which might go to trial and prevail on the merits, the net recovery of a plaintiff from a broker-dealer must be credited to amounts which may come due from the guaranty association. As far as the Court can tell, some of the state associations mean to disclaim liability, or at least to postpone a determination of their liability until 1987 when the Rehabilitation Plan is concluded. Other states;' funds have notified SPDA holders in their states that the guaranty fund will insure a full recovery. (See Defendant's Ex. C-3 and G-46).
The applicable standards by which a class action settlement is judged have been set forth clearly in the case law of this Circuit. A settlement proposal must be "fair, adequate and reasonable," Weinberger v. Kendrick, 698 F.2d 61, 73 (2d Cir. 1982), cert. denied, 464 U.S. 818, 104 S. Ct. 77, 78 L. Ed. 2d 89 (1983), upon a comparison of "the terms of the compromise with the likely rewards of litigation." Id. at 73 (quoting Protective Committee for Independent Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414, 424-25, 20 L. Ed. 2d 1, 88 S. Ct. 1157 (1968). The role of the court is to reach an objective, educated estimate of the complexity and probable success of full litigation, together with all other factors relevant to a fair evaluation of the wisdom of the proposed ...