Prusky v. Reliastar Life Ins ( 2006 )

Opinions of the United
2006 Decisions States Court of Appeals
for the Third Circuit
4-20-2006
Prusky v. Reliastar Life Ins
Precedential or Non-Precedential: Precedential
Docket No. 05-1611
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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 *
*
The Honorable Joseph E. Irenas, Senior District Judge for the
District of New Jersey, sitting by designation.
(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
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
2
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 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
1
Paul Prusky brought suit individually and as a trustee of the
Plan.
3
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
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
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
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 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.
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
5
This practice is known as “late trading.”
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
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 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
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 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,
7
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 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 merits 6 and will reverse and
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
8
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.
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
notice to satisfy this requirement.
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
9
the late trading provision did not impact the life insurance aspect
of the ReliaStar policies.8 Nor was the goal to use 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
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
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
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.
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
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
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 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
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
12
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 risk of his own inability to perform his contractual
duties”).13
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.”).
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
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 may not be excused on public
policy grounds.14
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
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 for further proceedings
consistent with this Opinion.
15