State Insurance Agency Maintains Opposition to IRS Summons

UNITED STATES OF AMERICA,
Petitioner,
v.
DELAWARE DEPARTMENT OF INSURANCE,
Respondent.

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF DELAWARE

REPLY IN SUPPORT OF MOTION OF RESPONDENT, THE DELAWARE DEPARTMENT OF INSURANCE, TO QUASH THE PETITION TO ENFORCE SUMMONS OR IN THE ALTERNATIVE, FOR PROTECTIVE ORDER

OF COUNSEL:

James J. Black, III (pro hac)
Jeffrey B. Miceli (pro hac)
Mark W. Drasnin (pro hac)
Black & Gerngross, P.C.
1617 John F. Kennedy Blvd.
Suite 1575
Philadelphia, PA 19103
Tel. (215) 636-1650
jblack@blackgern.com
jmiceli@blackgern.com
drasnin@blackgern.com

STATE OF DELAWARE
DELAWARE DEPARTMENT OF JUSTICE

Kathleen P. Makowski, Esq. (#3648)
Deputy Attorney General
1007 Orange Street, Suite 1010
Wilmington, DE 19801
(302) 674-7326
Kathleen.Makowski@Delaware.gov

and

Patricia A. Davis, Esq. (#3857)
Deputy State Solicitor
102 W. Water Street
Dover, DE 19904
(302) 257-3233
PatriciaA.Davis@Delaware.gov

Attorneys for Respondent,
Delaware Department of Insurance

Dated: March 3, 2021

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TABLE OF CONTENTS

Table of Citations

Argument

Conclusion

TABLE OF CITATIONS

Cases

Avrahami v. Commissioner, 149 T.C. 144 (Tax Ct. 2017)

Ball v. Bd. of Governors of Fed. Reserve Sys., 87 F.Supp.3d 33 (D.D.C. 2015)

City of Sterling Heights Gen. Employee's Retirement System v. Prudential Fin., Inc., No. 12-5275, 2015 WL 196368 (D.N.J. Apr. 30, 2015)

Consumers Union of U.S., Inc. v. Heimann, 589 F.2d 531 (D.C.Cir.1978)

Fagot v. Fed. Deposit Ins. Corp., 584 F.Supp. 1168 (D.P.R. 1984)

Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205 (1979)

Heritage Healthcare Servs. Inc. v. Beacon Mut. Ins. Co., 2007 WL 1234481 (R.I. Super, Apr. 17, 2007)

Humana Inc. v. Forsyth, 529 U.S. 299 (1999)

Ludwick v. Harbinger Grp., Inc., 161 F.Supp.3d 769 (W.D. Mo. 2016), aff'd, 854 F.3d 400 (8th Cir. 2017)

Mahon v. Chicago Tit. Ins. Co., 2017 WL 3331738 (D. Conn. Aug. 4, 2017)

In Re Patriot National, Inc., 2020 WL 5821754 (D. Del. Sept. 30, 2020)

Reserve Mech. Corp. v. Commissioner, Tax Ct. Mem. 2018-86, 2018 WL 3046596 (Tax Ct. 2018)

Schwartz v. Comm. Land Title Ins. Co., 384 F.Supp. 302 (1974)

Sec. & Exch. Comm'n v. Nat'l Sec., Inc., 393 U.S. 453 (1969)

South Jersey Sanitation Co., Inc. v. Applied Underwriters, 840 F.3d 138 (3d Cir. 2016)

Syzygy v. Commissioner, T.C. Memo, 2019-34, 2019 WL 1559540 (Tax Ct. 2019)

United States Dep't of Treasury v. Fabe, 508 U.S. 491 (1993)

United States v. Powell, 379 U.S. 48 (1964)

Statutes

15 U.S.C. § 1012

18 Del. C. § 316

18 Del. C. § 6920

Cal. Ins. Code § 1215.8(b)(2)

Or. Rev. Stat. Ann. § 705.138

Tenn. Code Ann. § 56-2-801

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On February 8, 2021, the Delaware Department of Insurance (the “Department”) filed the Opposition (the “Opposition”) to the Petition to Enforce Summons (the “Petition”), the Motion To Quash the Petition, Or In the Alternative, For Protective Order (the “Motion”) and related brief in support (the “Department Brief”). D.I. #15, 16 and #19. On February 24, 2021, the IRS filed an answering brief related to the Motion (the “IRS Answer”) and a reply brief related to the Petition (the “IRS Reply,” together, the “IRS Briefs”). D.I. #23 and #24. This is the Department's reply in support of the Motion.¹

ARGUMENT

A. The Summons Is Reverse-Preempted Pursuant to the McCarran Ferguson Act

1. The IRS Presents No Cognizable Exception to the Congressional Mandate

In a non-antitrust case, the McCarran Ferguson Act unambiguously precludes the application of a federal statute where: (1) the state law was enacted for the purpose of regulating the business of insurance; (2) the federal law does not “specifically relat[e] to the business of insurance;” and (3) the federal law would “invalidate, impair, or supersede” the State's law. Humana Inc. v. Forsyth, 529 U.S. 299, 308 (1999); see also South Jersey Sanitation Co., Inc. v. Applied Underwriters, 840 F.3d 138, 142 n. 7 (3d Cir. 2016) (same); In Re Patriot National, Inc., 2020 WL 5821754 * 7 (D. Del. Sept. 30, 2020) (quoting Humana). This test leads to only one conclusion: 18 Del. C. § 6920 preempts the Tax Code relating to the IRS summons.

Faced with this inevitability, the IRS Briefs present unfounded insinuations, circular reasoning, and the improper application of legal standards in an effort to distract from the central issue — that Section 6920 unambiguously regulates the business of insurance and directly prohibits the Insurance Commissioner from providing the requested documents. The IRS Summons, by its terms, does not relate to the business of insurance but, if enforced here, would supersede the state insurance statute. Therefore, Section 6920 reverse-preempts the IRS Summons.

As discussed below, the IRS arguments variously: (1) suggest that McCarran-Ferguson does not apply to illegal conduct; (2) wrongly rely on tax court cases which examined and ruled upon specific federal tax deductions, and did not make determinations concerning the validity of the subject insurance companies; (3) first acknowledge, and then ignore, the important distinctions in McCarran-Ferguson analysis between the narrow treatment of “the business of insurance” in antitrust cases, as opposed to the broad interpretation of the phrase “regulating the business of insurance” at issue here; (4) posit that because Delaware has other statutes with confidentiality provisions, Section 6920's confidentiality is not specific to the insurance industry; (5) argue on the one hand that captives, in general, do not deserve McCarran-Ferguson protection while, on the other, argue that only Section 6920, and not the whole captive law, is the focus; (6) ignore that in captive insurance, the owners are the insureds and thus the application process directly deals with the insured-insurer relations; (7) misconstrue the necessity of the reciprocal information-sharing arrangements among insurance departments; and (8) argue that the Tax Code's confidentiality provision does not impair Section 6920 while later maintaining that the opposite is true and that that the dictates of both cannot be reconciled.

a. McCarran-Ferguson Applies Regardless of Whether Illegality Is Alleged

The IRS first suggests that McCarran-Ferguson should not apply to the regulation of insurance companies conducting illegal operations asserting without support that only “[l]egitimate captive insurers are companies whose sole purpose is to issue insurance to their parent company (or its affiliates).” IRS Reply at 5 (emphasis added). The IRS cites three Tax Court cases, and asserts they examined captive insurance transactions and “found that these transactions did not constitute insurance.” Id. at 4-5. Indeed, the parenthetical the IRS inserted for Syzygy v. Commissioner, T.C. Memo, 2019-34, 2019 WL 1559540 (Tax Ct. 2019) asserts “invalidating purported Delaware micro-captive insurance company because arrangement did not distribute risk and did not meet commonly accepted definition of insurance.” Id. at 6. Syzygy without question did not “invalidate” a “purported” micro-captive insurance company. Indeed, the Court recognized that “[the micro-captive] was organized as an insurance company and regulated in the State of Delaware.” Id. at *39. The Tax Court, relying on tax precedents, held that “the arrangement is not insurance for federal income tax purposes. . . .” (Id. at 45). The suggestion that the company was invalidated is simply untrue. The other cases cited by the IRS likewise restrict their determination of whether the transaction involved insurance “for federal tax purposes.” See, Avrahami v. Commissioner, 149 T.C. 144, 181 (Tax Ct. 2017); Reserve Mech. Corp. v. Commissioner, Tax Ct. Mem. 2018-86, 2018 WL 3046596, * 33 (Tax Ct. 2018).

The McCarran-Ferguson Act has been held to apply to numerous situations where the conduct at issue was declared illegal. See, e.g. Ludwick v. Harbinger Grp., Inc., 161 F.Supp.3d 769, 772 (W.D. Mo. 2016), aff'd, 854 F.3d 400 (8th Cir. 2017) (RICO violations). Cf. Schwartz v. Comm. Land Title Ins. Co., 384 F. Supp. 302, 304 (1974) (laxness on part of Insurance Department of Pennsylvania, if any, in allowing title insurance companies to collect extra revenues in form of a so-called seller charge did not constitute nonregulation within provision of McCarran-Ferguson Act exempting business of insurance from federal antitrust laws to extent business is regulated under state law where there was no evidence that regulatory scheme was a mere sham or pretense).

The IRS's suspicions that the companies at issue are improperly taking a tax deduction that Congress allowed and would not, for federal income tax purposes, be considered insurers is not only premature, its irrelevant. At the end of the day, the IRS fails to present any support that McCarran-Ferguson does not apply to the regulation of a company which the IRS suspects may be committing wrongdoing. Indeed, captive insurance companies do not cease being subject to regulation by the Department if they are engaged in wrongdoing. In fact, regulation by the State is even more warranted in that situation. The IRS cannot wish away the unambiguous will of an act of Congress by the false logic that because some captive transactions have been ruled improper for tax purposes, captive insurance companies themselves cease to be insurance companies whenever the IRS suspects possible tax avoidance, and in those circumstances reverse preemption does not apply. If accepted, this backward logic would negate a decades-old allocation of governmental power, refined in its application by Supreme Court and appellate precedent, through a mere conclusory incantation.

b. The IRS Recognizes the Distinction Between Clause 1 and Clause 2 of Section 1012(b) But Ignores It

As discussed at length in the Department's Brief at 9, 14-15, Section 1012(b) of the McCarran-Ferguson Act contains two distinct clauses, the “first clause” is read broadly and provides the general rule while the “second clause” provides an exception for antitrust cases and is construed narrowly. United States Dep't of Treasury v. Fabe, 508 U.S. 491, 505 (1993). The IRS recognized this distinction in footnote 8 of the IRS Reply, simply ignores it, and utilizes and relies upon the narrow test used in antitrust cases in its arguments here, and even then, misapplies this test. IRS Reply at p. 12, n 8.

The IRS asserts that Section 6920 does not satisfy one of the three non-exclusive factors used in antitrust cases for determining whether an activity is the “business of insurance” — whether a practice is limited to entities within the insurance industry — by arguing that other Delaware statutes also grant confidentiality. IRS Reply at p. 14, n.10. This argument applies to numerous activities which even the IRS agrees are the “business” of insurance, e.g. “the fixing of rates” the “selling and advertising of policies, and the licensing of companies and their agents.” IRS Reply at p. 17.² All states, including Delaware, regulate licensing, selling and advertising, and rates for business other than insurance. This factor actually relates to whether the specific statute is limited to entities within the insurance industry. An examination of Section 6920 shows that is in fact the case. The IRS's lack of confidence in its own argument may be shown by the bare statement at the end of the footnote: “[e]ven if this Court were to find this factor favors Delaware, this one fact should not outweigh the others.” Id. at p. 14, n.10.

The IRS uses another footnote to submit that the Tax Court cases discussed above “examined transactions similar to the transactions at issue here using similar criteria and concluded that the indicia of insurance were missing.” IRS Reply at p.13, n.9. This assertion has nothing to do with Section 6920. It is, at best, a cursory, unsupported attack on the entire Delaware Captive Law and is at odds with the IRS's later argument that “courts apply the McCarran-Ferguson Act to discrete statutes, not comprehensive statutory schemes.” IRS Reply at p. 18.

These examples illustrate the strained contortions of the IRS's position which relies on make-shift arguments rather than squarely addressing the real issue: that Section 6920 squarely fits McCarran-Ferguson reverse-preemption: (1) the state law was enacted for the purpose of regulating the business of insurance; (2) the federal law does not specifically relate to the business of insurance; and (3) the federal law would invalidate, impair, or supersede the State's law.

2. Section 6920 Regulates the “Business of Insurance.”

The IRS's alternative argument is based on a hard-lined and incorrect insistence that City of Sterling Heights Gen. Employee's Retirement System v. Prudential Fin., Inc.,No.12-5275, 2015 WL 196368 (D.N.J. Apr. 30, 2015) is both on-point and correctly decided, and a complete misunderstanding of the purpose of state insurance reciprocal sharing agreements.

The IRS does not even attempt to address the point made at pages 12-13 of the Department's Brief that because in captive insurance, the owners are the insureds, Section 6920 does relate to the protection and regulation of the relationship between insureds (the owner) and the insurers (the captive) “directly or indirectly,” and thus is a law regulating the business of insurance. Further, Courts have examined the purpose of anti-disclosure statutes in insurance codes around the country, and have specifically found that:

[t]he statute is designed to assure companies such as [defendant] that they will not suffer harm from disclosure by entities over which they have no control, so that they will be encouraged to cooperate with DBR during an examination.

See, e.g. Mahon v. Chicago Tit. Ins. Co., 2017 WL 3331738 (D. Ct Aug. 4. 2017); quoting Heritage Healthcare Servs. Inc. v. Beacon Mut. Ins. Co., 2007 WL 1234481 (R.I. Super, Apr. 17, 2007).³

The Sterling Heights court disagreed that this justification would “serve some broader public interest” in denying a new federal privilege, but did not address it in the argument on McCarran-Ferguson, as to whether the section dealt with the “business of insurance.”⁴ The IRS does not dispute that Delaware's captive licensing application process deals with the “business of insurance.” Given the findings that such provisions are designed to encourage cooperation and provide a more fulsome record for determination, Sterling Heights' dismissal of the efficacy of such a provision to support a new federal privilege does not detract from the fact that Section 6920 was enacted specifically for the purpose of regulating the “business of insurance.”

The IRS also dismisses the Department's argument as to the importance of reciprocal information-sharing arrangements with a single sentence: “[s]imilarly, if the purpose of the statue is to ensure 'a reciprocal policy among state insurance commissioners,' that focuses on the relationship between Delaware and other states.” (IRS Reply at 18-19; citing Group Life & Health Insurance Co. v. Royal Drug Co., 440 U.S. 205, 216-17 (1979)). Royal Drug held that agreements between Blue Cross and pharmacies relating to pricing of drugs was not the business of insurance for antitrust purposes. The IRS likens the relationship between state insurance commissioners to that of an insurance company and a pharmacy. Its argument here completely misses the point. The IRS does not dispute that the licensing (and examination) of insurance companies constitutes regulation of the “business of insurance.” Information received from other states is integral to the licensing and regulation of insurers in general. The information-sharing agreements with other insurance commissioners require the confidentiality provisions in Section 6920. See, e.g., 18 Del. C. § 316; Cal. Ins. Code § 1215.8(b)(2); Or. Rev. Stat. Ann. § 705.138; Tenn. Code Ann. § 56-2-801. Sections 316 and 6920 specifically allow information-sharing for purposes of insurance regulation with and from other insurance regulators. To say that it has nothing to do with the “business of insurance” is incorrect on its face.

3. Section 6920 Would Be Superseded by Sections 7602 and 6103 of the Tax Code

The IRS makes a final unsupported argument that Section 6920 can be harmonized with the Tax Code because Section 6302 imposes confidentiality on the IRS. IRS Reply at p. 19-20. The IRS's position is belied by its adamant refusal to enter into the specific agreement required by Section 6920 to allow release of information to federal agencies like the IRS. The IRS, in its response to the Motion, attempts to justify its refusal because it would “allow the [Department] to dictate to the United States whether it can use the information obtained in this summons enforcement proceeding in an examination or case involving Artex or Tribeca.” IRS Answer at p. 5. The Supreme Court has determined that it is only “[w]hen federal law does not directly conflict with state regulation, and when application of the federal law would not frustrate any declared state policy or interfere with a State's administrative regime, the McCarran–Ferguson Act does not preclude its application.” Humana, 525 U.S. at 310. The IRS's dismissal of a protective order is an acknowledgement of the direct conflict. Further, as discussed above, the IRS's position directly conflicts with the state policy relating to confidentiality, both as a means for getting the information from insured's and insurers (as captives) as well as from other commissioners.

B. The IRS Has Failed to Show a Prima Facie Case

On their face, the Petition and Affidavit do not establish a prima facie case. Department Brief at p. 19-20. The IRS responds that its statement that “the documents described in Request 1 of the summons are not already in the possession of the IRS” did not really mean what it said, but instead means that the records received from Artex “are not the [Department's] records.” IRS Reply at p. 9, n.4. Given the nature of the documents being requested from the Department: “all electronic mail between [the Department] and [Artex] related to the Captive Insurance Program,” this argument is pure semantics. The requirement is that “the information sought is not already within the Commissioner's possession,” United States v. Powell, 379 U.S. 48, 57-58 (1964) (emphasis added). Emails between the Department and Artex contain identical information.

The IRS's real argument on this point is nowhere contained in either the Petition or Affidavit. It now appears to be that the asserted purpose is for the IRS to review documents in the hands of one entity to test the production of documents in the hands of another entity (and that the IRS does not have documents post the 2014 period of investigation). IRS Reply at p. 9-10. However, these allegations — that the IRS had some documents, but needed to check them against Artex' documents, and needed later documents, are conspicuously missing from the Petition and affidavit. Rather than amending the Petition and Affidavit, the IRS makes this argument solely in its reply, confirming the lack of a prima facie case — generally made by an affidavit of an agent. IRS Reply at p. 4, n.2. As the IRS itself grants, where there is no issue of fact on whether a prima facie case has been made out, judgment should be granted on the papers.⁵ IRS Reply at p. 5.

C. Issues Solely Related to Motion to Quash and for Protective Order

a. Timeliness of Motion to Quash

The IRS argues that the time for filing a motion to quash has passed. However, The Order to Show Cause allows for defenses to be presented up to 14 days prior to the date set for the show cause hearing. D.I #8, ¶5). In addition, as acknowledged by the IRS, the Department makes the same arguments in its Opposition. IRS Answer at pg. 2, n.2.

b. A Protective Order is Appropriate

As discussed above, the IRS argues that Section 6920 is not superseded (and therefore the McCarran-Ferguson Act does not apply) because of the confidentiality provisions of Section 6103 of the Tax Code. The IRS then contradicts this position by asserting that the Department cannot “dictate to the United States whether it can use the information obtained in this summons enforcement proceeding in an examination or case involving Artex or Tribeca.” IRS Reply at pg. 5. The agreement sought by the Department is not that the IRS pledge to hold all information confidential unless the Department approves its use. Id. at p. 5, n.5. Instead,like every other state and federal agency to which the Department provides such information, that the IRS agree to hold it under the same confidentiality provisions as the Department does (i.e. that the documents be given confidential treatment, are not subject to subpoena, may not be made public by the Commissioner, and may not be provided or disclosed to any other person at any time except to certain entities who agree to hold it confidential and in the same manner). 18 Del. C. § 6920.

The stated goals of the IRS could be accomplished without involving the Department or this Court — i.e. The IRS can and should seek the post 2014 data from Artex and compare the documents it receives from the Department with what was given to it by Artex. Any documents which Artex did not have could be sought from the individual captives or others.

As discussed above, the purpose of statutes such as Section 6920 is to foster open communications and cooperation between the insurer captive, the insured/owner and its regulator. Abrogation of Section 6920 threatens to jeopardize the sharing of information by other insurance departments. To avoid such undue burden, and in order to avoid having to determine the thorny issue of statutory preemption, a protective order is appropriate to issue.

CONCLUSION

For the foregoing reasons, the Delaware Department of Insurance respectfully requests that this Honorable Court deny further enforcement of the Summons, deny enforcement of the Petition to Enforce Summons and grant its Motion to Quash, or in the Alternative for a Protective Order.

OF COUNSEL:

James J. Black, III (pro hac)
Jeffrey B. Miceli (pro hac pending)
Mark W. Drasnin (pro hac pending)
Black & Gerngross, P.C.
1617 John F. Kennedy Blvd.
Suite 1575
Philadelphia, PA 19103
Tel. (215) 636-1650
jblack@blackgern.com
jmiceli@blackgern.com
mdrasnin@blackgern.com

STATE OF DELAWARE
DELAWARE DEPARTMENT OF JUSTICE

Kathleen P. Makowski, Esq. (#3648)
Deputy Attorney General
1007 Orange Street, Suite 1010
Wilmington, DE 19801
(302) 674-7326
Kathleen.Makowski@Delaware.gov

and

Patricia A. Davis, Esq. (#3857)
Deputy State Solicitor
102 W. Water Street
Dover, DE 19904
(302) 257-3233
PatriciaA.Davis@Delaware.gov

Attorneys for the Respondent,
Delaware Department of Insurance

March 3, 2021