State Agency Objects to IRS Summons Enforcement Recommendation

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

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF DELAWARE

RESPONDENT'S OBJECTIONS TO CERTAIN FINDINGS IN REPORT & RECOMMENDATION

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
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 Respondent,
Delaware Department of Insurance

Dated: July 30, 2021

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TABLE OF CONTENTS

Table of Citations

Introduction

Objections

TABLE OF CITATIONS

Cases

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)

Gerling Glob. Reins. Corp. of Am. v. Low, 240 F.3d 739 (9th Cir. 2001)

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)

Highmark, Inc. v. UPMC Health Plan, Inc., 276 F.3d 160 (3d Cir. 2001)

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

In re Ins. Brokerage Antitrust Litig., MDL No. 1663, 2006 WL 2850607 (D.N.J. Oct. 3, 2006))

In re Ins. Brokerage Antitrust Litig., 618 F.3d 300 (3d Cir. 2010)

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)

Robertson v. People of State of Cal., 328 U.S. 440 (1946)

Sabo v. Metropolitan Life Ins. Co., 137 F.3d 85 (3d Cir. 1998)

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)

Suter v. Munich Reins. Co., 223 F.3d 150 (3d Cir. 2000)

U.S. v. Wisconsin State Circuit Court for Dane County, 767 F. Supp. 2d 980 (2011), vacated 2013 WL 3761295 (W.D. Wis. July 16, 2013)

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

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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The Delaware Department of Insurance (the “DDOI”), by and through its undersigned counsel, files these Objections to the Report and Recommendation of the Honorable Christopher J. Burke, Magistrate Judge, dated July 16, 2021 (“R&R”) as follows:

INTRODUCTION

The R&R erred in its treatment of reverse-preemption under the McCarran-Ferguson Act. It first utilized an improper “threshold test” that is neither appropriate nor required under current Supreme Court and Third Circuit caselaw.¹ Even assuming that threshold test continues to be viable, the R&R used incorrect standards in applying that test. It did so by first formulating the “conduct at issue“ without regard to undisputed facts and legal authority relating to the purpose and intent of the Delaware statute at issue, and then used an improper narrow construction found in antitrust cases, which is not applicable in this case. The antitrust analysis applies a narrow definition of the “business of insurance” instead of the broad construction mandated by the Supreme Court and Third Circuit in non-antitrust cases such as this case where the proper focus is on laws (like Section 6920) enacted “for the purpose of regulating the business of insurance.”  (emphasis added). In the R&R's improper formulation, application of the antitrust exception swallows the general McCarran-Ferguson rule that laws which were enacted “for the purpose of regulating the business of insurance” reverse-preempt general federal statutes. Because of these errors, the R&R fails to reach and apply the elements of the test for non-antitrust cases, which upon the undisputed facts and legal authority, would have resulted in the dismissal of the Petition.

OBJECTIONS

A. Objection #1 — The R&R Erred by Applying a “Threshold Test” of Whether the Conduct at Issue Constitutes the Business of Insurance for a Non-Antitrust Case

1. Portion of R&R to Which Objection is Made

The DDOI objects to the R&R at pages 19-25 of the R&R, that the “standard for determining whether the MFA warrants reverse preemption in a non-antitrust case first requires application of a threshold inquiry — one that asks whether the challenged conduct itself constitutes the 'business of insurance.'” (R&R at p. 19).

2. Basis for Objection and Legal Authority

The R&R committed an error of law by requiring a “threshold” determination: whether the challenged conduct constitutes the 'business of insurance,' in a non-antitrust case. The most recent Supreme Court and Third Circuit precedent make clear that application of this threshold test contravenes the Supreme Court's construction of the phrase “the business of insurance.”

In Humana Inc. v. Forsyth, 529 U.S. 299 (1999), the Supreme Court explained the standard for applying the McCarran-Ferguson Act in a non-antitrust case, holding that the Act precludes 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. Id. at 308. This Court applies the Humana formulation. In Re Patriot Nat., Inc., 2020 WL 5821754 * 7. (D. Del. Sept. 30, 2020) (quoting Humana). This is also the most recent formulation by the Third Circuit. S. Jersey Sanit. Co., Inc. v. Applied Underwriters Captive Risk Assur. Co., Inc., 840 F.3d 138, 142 (3d Cir. 2016) (quoting Suter v. Munich Reins. Co., 223 F.3d 150, 160 (3d Cir. 2000)).²

Before applying the above test, the R&R required a threshold showing that the challenged conduct constituted the “business of insurance,” citing Sabo v. Metropolitan Life Ins. Co., 137 F.3d 85 (3d Cir. 1998), which predated Humana. The R&R also noted that Highmark, Inc. v. UPMC Health Plan, Inc., 276 F.3d 160 (3d Cir. 2001), which post-dated Humana, adopted the Sabo formulation, including the “threshold” question. (R&R at 22-23).

The phrase “the business of insurance,” appears in both the First Clause and the Second Clause of Section 2(b) of the McCarran-Ferguson Act. However, they are not treated the same. The Supreme Court has made it clear that laws enacted for the purpose of regulating the business of insurance (First Clause) are more broad and not coterminous with the business of insurance itself (Second Clause).The First Clause, unlike the Second Clause, consists of those broad categories of laws that possess the “end, intention, or aim” of adjusting, managing, or controlling the business of insurance, See e.g., U.S. Dept. of Treasury v. Fabe, 508 U.S. 491, 504-505 (1993). 

Imposing a threshold requirement (“business of insurance”) which is more restrictive than a later requirement (“for the purpose of regulating the business of insurance”) is contrary to the letter and spirit of Fabe. In In re Ins. Brokerage Antitrust Litig., 618 F.3d 300 (3d Cir. 2010) the Third Circuit extensively reviewed the history of the McCarran-Ferguson Act, and the difference between a First and Second Clause claim under Section (2). Id. at 351-361.³ The Third Circuit explained:

This first clause . . . impos[es] what is, in effect, a clear-statement rule, a rule that state laws enacted 'for the purpose of regulating the business of insurance' do not yield to conflicting federal statutes unless a federal statute specifically requires otherwise. Both clauses incorporate the phrase “business of insurance,” but as the Supreme Court has emphasized, the respective protections afforded to state law under the two clauses are of different scopes. The first clause commits laws 'enacted . . . for the purpose of regulating the business of insurance' to the States, while the second clause exempts only 'the business of insurance' itself from the antitrust laws. Because “[t]he broad category of laws enacted 'for the purpose of regulating the business of insurance' . . . necessarily encompasses more than just the business of insurance,” judicial determinations made when applying one clause may not be dispositive when applying the other.

Id. at 360 (citations and quotes omitted).

The Court illustrated that this distinction results in different treatment under Clause One versus Clause Two in a claim relating to advertising:

In light of Fabe, we interpret this to mean that although any state law that regulates “the selling and advertising of insurance” will qualify as a “law enacted by [a] State for the purpose of regulating the business of insurance” under clause one of the McCarran-Ferguson Act, “the selling and advertising of insurance” is not the “business of insurance” under clause two unless it has some effect on “reliability” or underwriting issues.

618 F.3d at 360-61.

As a more narrow test cannot form the “threshold” inquiry for an indisputably broader analysis, the R&R erred in applying the threshold requirement.

B. Objection #2 — Challenged Conduct Does Not Constitute the “Business of Insurance”

1. Portion of R&R to Which Objection is Made

The DDOI objects to the R&R at pages 25-34 of the R&R, that the Government's Petition Should be Granted because the “challenged conduct at issue” does not constitute the “business of insurance.” (R&R at p. 26). In making this determination, the R&R committed several legal errors, in particular mis-defining the “conduct at issue” and then using the improper standard for determining that the “conduct at issue” was not the “business of insurance.” ⁴

2. Basis for Objection and Legal Authority

The R&R committed an error of law in characterizing the “challenged conduct at issue” and in determining that the challenged conduct at issue does not constitute the “business of insurance,” incorrectly applying the “threshold element” of 15 U.S.C. § 1012(a). 

a. Improper Designation of “Challenged Conduct at Issue”

The first error was improperly designating the “challenged conduct at issue” as “'[r]ecord maintenance' or 'the dissemination and maintenance of information, documents, and communications [maintained by the state].” (R&R at p. 25).⁵ This mischaracterization not only ignored unrebutted testimony and legal authority, but also contradicted earlier findings of fact. 

In the “Factual Background,” the R&R found that “Section 6920 of the Delaware Insurance Code (“Section 6920”) relates to the confidential treatment of materials and information that captive insurers submit to the state [insurance] commissioner, either directly or through DDOI, as part of the application and licensing process.”(R&R at p. 2) (citing Declaration of John W. Tinsley, III (hereinafter “Tinsley Dec.”), D.I. 17 at ¶ 20).The R&R does not address the uncontradicted purpose of the confidentiality provisions of this statute, which is to promote transparency between the insurer and its regulator and provide a framework for the free flow of information in the licensing process. (Tinsley Dec., D.I. 17 at ¶ 19).

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.” 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)).⁶

Additionally, information received from other states is integral to the licensing and regulation of insurers in general. (Tinsley Dec., D.I. 17 at ¶¶ 18, 21, 23). The information-sharing agreements with other insurance commissioners require the confidentiality provisions in Section 6920. Id. see also, 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. These provisions make clear that other states Insurance Commissioners will only share information with Delaware (and vice versa) if the requirements of Section 6920 are in place. As such, Section 6920 is necessary to not only receive full information from insurers relating to licensing, but also to receive information from other state insurance departments. Section 6920 specifically prohibits the Insurance Commissioner from providing such documents absent the required confidentiality assurances from the recipient.

Accordingly, the actual “conduct at issue” here is receiving, maintaining and restricting the dissemination of application and licensing information of captive insurers — a fundamental tenant of the regulation of insurance.

b. The R&R Utilized the Wrong Standard in Determining Whether the Conduct at Issue Constituted the “Business of Insurance”

The R&R's error in ignoring the above facts when formulating the definition of the “challenged conduct” resulted in additional error when the R&R determined whether that conduct constituted the “business of insurance.” The R&R focuses unduly on the relationship between insurer and insured,⁷ and suggests that the relationship between an insurer and its regulator cannot be the “business of insurance.” (R&R at p. 30). This conclusion is contrary to caselaw. The Supreme Court explained that “other activities of insurance companies relate so closely to their status as reliable insurers that they too must be placed in the same class [as activities relating to the relationship between the insurer and insured].” Sec. & Exch. Comm'n v. Nat'l Sec., Inc., 393 U.S. 453, 460 (1969). Nat'l Securities specifically listed “the licensing of companies” as within the scope of the McCarren-Ferguson Act. Id. (citing Robertson v. People of State of Cal., 328 U.S. 440 (1946)). See also Gerling Glob. Reins. Corp. of Am. v. Low, 240 F.3d 739, 746 n. 3 (9th Cir. 2001) (“Seeking information from insurers . . . to be used in the licensing process, is a form of regulating the business of insurance”).

Although the R&R recognized that the licensing of insurance companies constitutes the business of insurance (R&R at pp 30-31), it erred in applying the threshold question of whether the conduct was the “business of insurance” in light of the considerations set forth in Section A(2)(a), above (i.e. the undisputed testimony and caselaw that the purpose of laws like Section 6920 is to promote full and transparent information sharing by insurers in the licensing process; that information received from other state insurance departments are integral to the licensing and regulation of insurers, and that the protections of Section 6920 are required in order for other states' insurance departments to provide such information; and that the statute specifically precludes the Insurance Commissioner from doing what the IRS is seeking to require). In doing so, the R&R expressly used the “narrow” construction utilized in antitrust cases rather than the broad construction required when construing non-antitrust cases. Id. at 30-31. The R&R expressly stated that “to view the gravamen of Section 6920 as being about the 'licensing'⁸ is to take an “unduly broad view of the statute's texts.” Id. at 30-31 citing Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205, 216-17 (1979). Royal Drug, however, was an antitrust case and was construing the “narrow exemption” from the antitrust laws. Fabe, 508 U.S. at 505. Non-antitrust cases are to be given the broad interpretation the R&R did not apply.

The R&R initially acknowledged the distinction between “broad” and “narrow” interpretations,⁹ and repeated Sabo's formulation of the threshold question as whether “the alleged conduct at issue broadly constitutes the 'business of insurance,'” and is thus subject to state regulation under [S]ection [ ]2(a).” (R&R at 21 quoting Sabo, 137 F.3d at 190)(emphasis added). But instead of applying this command, the R&R then expressly used a narrow formulation, repeating the inappropriate antitrust Royal Drug caution not to analyze in too broad a manner. (R&R at pp 30-31).

The R&R then erred in relying on City of Sterling Heights Gen. Employee's Ret. Sys. v. Prudential Fin., Inc., 2015 WL 196368 (D.N.J. Apr. 30, 2015) which contained the same legal errors. The City of Sterling Heights Court utilized the three antitrust factors in determining the “business of insurance” as did the R&R (R&R at 26-28; City of Sterling Heights. at *6). However, the Highmark Court cautioned it is 'difficult, if not impossible” to apply the three antitrust factors to first clause, non-antitrust cases. Highmark, Inc., 276 F.3d at 167 n. 1.¹⁰

The R&R compounds errors in City of Sterling Heights, and in effect establishes an entirely new test and standards borrowed from a combination of conflicting sections of the McCarron-Ferguson Act and cases which variously construed those differing sections. This blending has the effect of negating the intent and plain meaning of the Act, and disregards guidance of the Supreme Court. As a result, the analysis vitiates the longstanding distinction between the “business of insurance” and “for the purpose of regulating the business of insurance” found separately in antitrust and non-antitrust cases, nullifying the central purpose of the McCarran-Ferguson Act.

C. Objection #3 — The R&R Should Have Recommended Dismissal of the IRS' Petition on the Grounds that the McCarran-Ferguson Act Reverse-Preempted the IRS Summons

1. Portion of R&R to Which Objection is Made

The DDOI objects to the R&R's determination that “having determined that the challenged conduct at issue does not constitute the 'business of insurance,' the Court declines to apply the MFA to Section 6920.” (R&R p. 34).

2. Basis for Objection and Legal Authority

The R&R committed an error of law in not addressing the parties' arguments relating to the three factors¹¹ from the first clause of Section 2(b) of the McCarran-Ferguson Act. (R&R at p. 34 n.22). The R&R should have determined that the undisputed facts and the clear law showed that the three factors mandated a decision that the McCarran-Ferguson Act reverse-preempted the IRS' Summons, and thus dismissed the IRS' Petition.

The first factor is established by the facts and law set forth in Objections 1 and 2, above. The second factor, that the IRS statutes relating to a Summons do not specifically relate to the business of insurance was not contested by the IRS. (D.I. 23 at pp. 11) (listing factors and addressing all but whether federal law relates to the business of insurance). The Summons would also “invalidate, impair, [and] supersede” the requirements of Section 6920. See, Humana, 525 U.S. at 301 (“When 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”). The Summons requires the Insurance Commissioner to do something he is specifically prohibited from doing by statute, which directly conflicts with and would “invalidate, impair [and] supersede” the broad confidentiality requirements of Section 6920(2) and “provide a substitute rule.” C.f. U.S. v. Wisconsin State Circuit Court for Dane County, 767 F. Supp. 2d 980, 984 (2011), vacated on other grounds, 2013 WL 3761295 (W.D. Wis. July 16, 2013) (enforcement of an IRS injunction would “invalidate, impair and supersede” state insurance insolvency laws). The IRS has refused to treat the material as required by Section 6920. (R&R at p. 15 n. 9).

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
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 Respondent,
Delaware Department of Insurance

July 30, 2021