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State Insurance Agency Asks Court to Quash IRS Summons

FEB. 8, 2021

United States v. Delaware Dept. of Insurance

DATED FEB. 8, 2021
DOCUMENT ATTRIBUTES

United States v. Delaware Dept. of Insurance

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

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF DELAWARE

BRIEF IN SUPPORT OF MOTION OF THE RESPONDENT, THE DELAWARE DEPARTMENT OF INSURANCE, TO QUASH THE PETITION TO ENFORCE

SUMMONS OR IN THE ALTERNATIVE, FOR PROTECTIVE ORDER

STATE OF DELAWARE
DELAWARE DEPARTMENT OF JUSTICE

OF COUNSEL:

James J. Black, III (pro hac pending)
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

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


TABLE OF CONTENTS

Table of Citations

I. Nature and Stage of the Proceedings

A. Introduction

B. Procedural Posture

II. Summary of Argument

III. Statement of Facts

A. Captive Insurance

B. The Summons and the Department's Response

IV. Argument

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

1. The McCarran-Ferguson Act

2. The Elements of the Reverse Pre-emption Standard

a. Section 6920 Was Enacted to Regulate the Business of Insurance

b. The Tax Code Does Not Specifically Relate To The Business Of Insurance

c. The Federal Statute Invalidates, Impairs, Or Supersedes Section 6920

3. The IRS' Position Uses the Wrong Standard, and Relies on a Case Which Misapplied that Standard

a. The IRS Relies Upon an Incorrect Standard

b. The City of Sterling Heights Case Is Not Persuasive Authority

i. The City of Sterling Heights Decision Was Dicta

ii. The City of Sterling Heights Decision Was Incorrectly Decided

B. The Summons Should Be Quashed for Failure to Prove a Prima Facie Case on the Issue of Whether the Information Sought Is Already in the IRS' Possession

C. A Protective Order Should Be Granted

V. Conclusion

TABLE OF CITATIONS

Cases

Ashcroft v. al-Kidd, 563 U.S. 731 (2011)

Autry v. Nw. Premium Servs., Inc., 144 F.3d 1037 (7th Cir. 1998)

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. Reinsurance 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)

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

McCray v. Fid. Nat. Title Ins. Co., CIV.A. 08-775, 2010 WL 3023164 (D. Del. July 29, 2010), aff'd, 682 F.3d 229 (3d Cir. 2012)

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

Prudential Ins. Co. v. Benjamin, 328 U.S. 408 (1946)

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

Sabo v. Metropolitan Life Ins. Co., 137 F.3d 185 (3d Cir. 1998)

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

Union Labor Life Ins. Co. v. Pireno, 458 U.S. 119 (1982)

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

United States v. Garrett, 571 F.2d 1323 (5th Cir. 1978)

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

United States v. Pritchard, 438 F.2d 969, 971 (5th Cir. 1971)

United States v. South–Eastern Underwriters Assn., 322 U.S. 533 (1944)

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

Statutes

15 U.S.C. §§ 1011-10151

15 U.S.C. § 1011

15 U.S.C. § 1012(b)

26 U.S.C. § 831(b)

26 U.S.C. § 6103

26 U.S.C. § 7602

18 Del. C. ch. 69

18 Del. C. § 316

18 Del. C. § 321(g)

18 Del. C. § 5707

18 Del. C. § 6920

18 Del. C. § 7505(e)

18 Del. C. § 8409

Other Authorities

Peter B. Steffen, After Fabe: Applying the Pireno Definition of "Business of Insurance" in First-Clause McCarran-Ferguson Act Cases, 2000 U. Chi. Legal F. 447 (2000)


I. NATURE AND STAGE OF THE PROCEEDINGS

A. Introduction

On June 19, 2020, the United States of America, on behalf of the Internal Revenue Service (“IRS”), filed a Petition (“Petition”) to Enforce Summons which seeks to compel the Insurance Commissioner of Delaware, Trinidad Navarro (the “Commissioner”), to produce confidential information which the Delaware Insurance Code unambiguously prohibits him from producing except under certain circumstances.1 The Petition is grossly misleading. Rather than the discovery dispute suggested by the Petition, the IRS actually asks the Court to force Commissioner Navarro to violate the laws of the state that he serves and in the area that he regulates — insurance. The IRS proceeds despite the fact that the United States Congress, through the enactment in 1945 of the McCarran-Ferguson Act, 15 U.S.C. §§ 1011-1015, and subsequent unambiguous rulings of the United States Supreme Court, have long recognized that the regulation of insurance is of such paramount importance to the states, is under the exclusive authority of the states, and that “[n]o act of Congress shall be construed to invalidate, impair or supersede any law enacted by any State for the purpose of regulating the business of insurance . . .”. 15 U.S.C. § 1012(b). When the threshold elements of McCarran Ferguson are met2, as they are in this matter, the state law at issue has supremacy over and negates the contrary federal law. This concept, known as “McCarran-Ferguson reverse pre-emption”, is hornbook insurance law, and the misguided effort of the IRS is a textbook case of its violation.

It is thus surprising, at best, that the Petition omits any reference to McCarran-Ferguson, even after being specifically informed by the Delaware Department of Insurance (“the Department”) that the Tax Code, and the enforcement mechanism that the Petition relies upon, is reverse pre-empted under McCarran-Ferguson. Nor does the IRS inform the Court that the IRS refused the Department's request to agree in writing to hold the requested information confidential, as required by the Delaware statute, so that the Commissioner can lawfully disclose the requested information. The requested agreement would satisfy the unambiguous requirements of Section 6920 and avoid the McCarran-Ferguson determination. Further, though the Petition also purports to compel testimony, the IRS has never asked the Department for testimony at any point during the three years since the Summons was issued.

The IRS's Petition demonstrates a further lack of candor to this Court by relying upon a fundamental misstatement made in the Declaration of IRS Agent Bradley Keltner (the “Declaration”) offered to support enforcement of the Summons. As a threshold matter, for the IRS to obtain enforcement of a Summons, by long standing United States Supreme Court requirement, it must establish, inter alia, that the information requested by the Summons is not already within the IRS's possession. United States v. Powell, 379 U.S. 48, 57-58 (1964). Despite the conclusory statement in paragraph 14 of the Declaration that the requested documents are not in the IRS's possession, a careful examination of the Declaration reveals that paragraph 14 cannot be true as other paragraphs recite that the IRS is in possession of certain of the documents it seeks, apparently received from Artex, the subject captive manager. The lack of candor is not trivial, it masks an independent fatal flaw in the Petition.

While reverse pre-emption under McCarran-Ferguson, and the Petition's failure to plead the Powell requirements, each mandates that the Petition be quashed, the IRS has also rebuffed alternatives that the Department has offered which harmonize the IRS' interests in seeking production of the information with the superior right and obligation of the Commissioner to not disclose that information. Accordingly, should the Court not Quash the Petition, the Court should grant a Protective Order until such time as the IRS obtains the required consent, or agrees to preserve the confidential information in accordance with the law's dictates.

B. Procedural Posture

On June 19, 2020, the IRS filed the Petition. On January 11, 2021, the Court issued the Order To Show Cause (D.I. 8). which directed the Department to submit its defense or opposition to the Petition. Contemporaneously herewith, the Department filed an opposition to the Petition which also incorporates, by reference, this Motion and Brief. This is the Department's Brief in support of the Motion to Quash or Alternatively, for a Protective Order.

II. SUMMARY OF ARGUMENT

1. The Summons should be quashed because enforcement of the Summons is improper where it seeks information that a Delaware insurance statute prohibits the Commissioner from providing; the McCarran-Ferguson act reverse-preempts and voids the Summons.

2. The Summons should be quashed for failing to set forth the required prima facie showing that the requested information requested is not already within the IRS's possession.

3. In the alternative, the Court should grant a Protective Order requiring the IRS to seek the requested information from others, obtain consents from the captives, or agree in writing to keep information provided by the Department confidential.

III. STATEMENT OF FACTS

The Department, under the authority of the Commissioner, administers and enforces Title 18 of the Delaware Code (the “Delaware Insurance Code”).It is a comprehensive statutory scheme with the core purpose of regulating Delaware insurers from cradle to grave. For example, the Delaware Insurance Code contains over eighty chapters that address all areas of Delaware insurance regulation including formation, licensing, policies, distinct lines of business, capital requirements, market practices, financial disclosure and other areas of the business of insurance. The statutes are specifically intended and designed to protect policyholders and enable the Department to effectively oversee the operation and financial stability of Delaware insurers.

A. Captive Insurance

A captive insurance company is wholly owned and controlled by its insureds. Its primary purpose is to insure the risk of its owners/insureds who benefit from the captive's underwriting profits. (Declaration of John Tinsley, III, attached hereto as Exhibit “1” (hereinafter “Tinsley Decl.”) at ¶11). Chapter 69 of the Delaware Insurance Code is an important part of the comprehensive statutory scheme and governs the formation, licensing, and regulation of captive insurers, the integration and interplay of Chapter 69 with other chapters in the Delaware Insurance Code, and the Department's ongoing regulatory oversight of captives. Under Chapter 69, a captive can be formed in a myriad of ways. This case involves micro captives which are small captives taxed under Section 831(b) of the Tax Code, which allows them to be taxed, not on underwriting income, but on investment income only in any year that its written premium is at or below the threshold (currently $2.2 million) for the applicable tax year. (Id. at ¶¶ 9-13). “Captive Managers” facilitate the creation and management of captive insurance companies in jurisdictions which have captive insurance legislation, including Delaware. (Id. at ¶ 14).

B. The Summons and The Department's Response

On October 30, 2017, the IRS issued a third-party administrative summons to the Department pursuant to 26 U.S.C. § 7602 (the “Summons”) for certain Department and captive insurance company records related to the IRS investigation of Artex Risk Solutions, Inc. and TSA Holdings, Inc., f/k/a Tribeca Strategic Advisors LLC (together “Artex”). Artex is a captive manager in Delaware. To date, the Department has licensed 225 captive insurance companies managed by Artex. Micro captives make up 210 of that number, with 68 being currently active.

The Summons includes four individual requests for records. The Petition seeks to enforce Request #1 which requests “all electronic mail between [the Department] and [Artex] related to the Captive Insurance Program.” (“Request #1”). See, Petition, ¶ 19. Paragraph 14 of the Petition also states that the Summons “demanded that Delaware give testimony to the IRS.” Importantly, prior to issuance of the Summons to the Department, and as far back as 2014, the IRS began an investigation of Artex (the “Artex Investigation”). Petition, ¶¶ 5 and 9. The Department understands that Artex has produced millions of pages of documents to the IRS in the Artex Investigation.

On November 28, 2017, the Department issued objections and responses to the Summons, including confidentiality objections pursuant to 18 Del. C. § 6920, which provides:

[a]ll portions of license applications reasonably designated confidential by or on behalf of an applicant captive insurance company, . . . must, unless the prior written consent (which may be given on a case-by-case basis) of the captive insurance company to which it pertains has been obtained, 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:

(1) To the insurance department of any state or of any country or jurisdiction other than the United States of America; or

(2) To a law-enforcement official or agency of this State, any other state or the United States of America so long as such official or agency agrees in writing to hold it confidential and in a manner consistent with this section [emphasis added].

The Department's initial production contained 169 pages of records and provided links to publicly available information concerning the Department's captive insurance program. Thereafter, the IRS and the Department exchanged several written communications: a January  19, 2018 letter from the IRS; a February 26, 2018 email from the Department; a February [sic] 2, 2018 letter from the IRS; a May 20, 2019 letter from the IRS; a June 28, 2019 letter from the IRS; a July 31, 2019 letter from the Department; and a September 25, 2019 letter from the IRS. (Exhibits “A”-“I” to the Declaration of Jeffrey B. Miceli, Esquire attached hereto as Exhibit “2” (hereinafter “Ex. _”)) There were also discussions between the IRS and Department concerning the letters' subject matter. All these communications focused on: demands by the IRS for additional documents; early efforts from the Department to streamline the record requests in the Summons; that the Department considered its production governed by Section 6920; and in the June 28, 2019, July 31, 2019 and September 25, 2019 letters, the parties' positions regarding the Supremacy Clause and reverse pre-emption under McCarran-Ferguson. In none of these communications did the IRS make reference to, or seek the testimony of, the Department under the Summons.

While these communications were occurring, the Department continued to produce documents. For example, on April 30, 2018, the Department submitted a further response and objections to the Summons and produced an additional 129 pages of documents. This production was followed by additional rolling document productions in 2018 and 2019 that, in the aggregate, contained over 1,500 pages of non-company specific Department documents.

The Department also attempted to forge a practical solution to balance the IRS' interest in obtaining the documents with the unambiguous and express prohibitions on disclosure pursuant to Chapter 69. On October 11, 2019, the Department sent letters to the owners of all 225 Artex managed captives requesting consent to release their files to the IRS. On February 21, 2020, a follow-up email was sent to those owners that did not respond. The Department has produced more than 20,000 pages of records while acting within the strictures of Section 6920. This includes the complete insurance company files of 19 captives for which the Department requested and received written consents from the owners.3

In addition, the Department has requested that the IRS enter into a written agreement to address the confidentiality issues in conformity to the Delaware statute, but the IRS has refused.

The IRS has also not undertaken any of the available alternative and more direct procedural mechanisms to obtain the documents, any one of which would avoid the Petition's efforts to compel the Department to violate its own statute. For example, the IRS could seek to compel Artex to release additional documents, proceed against Artex with the documents produced already in the Artex Investigation, or seek documents or consent from the captive insurance companies directly. Instead, the IRS chooses to do what it legally cannot, enforce a Summons that is voided by the precise dictates of McCarran-Ferguson.

IV. ARGUMENT

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

Delaware, like all states, closely regulates the business of insurance including the licensing, conduct and oversight of its domiciled insurers. See generally Delaware Code, Title 18. As part of that regulation, Delaware comprehensively regulates captive insurance and captive insurance companies. 18 Del. C. § 6901, et seq. In 1945, Congress recognized the supremacy of state regulation of insurance over contrary federal law in the McCarran-Ferguson Act.

The McCarran-Ferguson Act declared “that the continued regulation and taxation by the several States of the business of insurance is in the public interest, and that silence on the part of the Congress shall not be construed to impose any barrier to the regulation or taxation of such business by the several states.” 15 U.S.C. § 1011. The Act affirmed that from then on “no Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any state for the purpose of regulating the business of insurance . . . unless such Act specifically related to the business of insurance” 15 U.S.C. § 1012(b). This doctrine is referred to as “reverse pre-emption,” where the state law negates and has supremacy over a conflicting federal law.

That result is compelled here. The Summons should be quashed, as it is reverse pre-empted by the McCarran Ferguson Act. The Summons, and its authorizing legislation4 do not “specifically relate” to the business of insurance. It thus is reverse pre-empted by the Delaware Captives Act which comprehensively regulates the business of captive insurance, and the provisions of 18 Del. C. § 6920, which is an integral part of that Act.

1. The McCarran-Ferguson Act

The McCarran–Ferguson Act was enacted in response to the decision in United States v. South–Eastern Underwriters Assn., 322 U.S. 533 (1944). Prior to that decision, it had been assumed that issuing a policy of insurance is not a transaction of commerce, subject to federal regulation. Accordingly, the States enjoyed a virtually exclusive domain over the insurance industry. U.S. Dep't of Treasury v. Fabe, 508 U.S. 491, 499 (1993). This result, naturally, was widely perceived as a threat to state power to tax and regulate the insurance industry. To allay those fears, Congress moved quickly to restore the supremacy of the States in the realm of insurance regulation, enacting the McCarran–Ferguson Act within a year of the decision in South–Eastern Underwriters. Fabe. at 499-500.

The first section of the McCarran–Ferguson Act makes its mission very clear: “Congress hereby declares that the continued regulation and taxation by the several States of the business of insurance is in the public interest, and that silence on the part of the Congress shall not be construed to impose any barrier to the regulation or taxation of such business by the several States.” 15 U.S.C. § 1011. Shortly after passage of the Act, the Court observed: “Obviously Congress' purpose was broadly to give support to the existing and future state systems for regulating and taxing the business of insurance.” Prudential Ins. Co. v. Benjamin, 328 U.S. 408, 429 (1946). Congress achieved this purpose in two ways. The first “was by removing obstructions which might be thought to flow from [Congress'] own power, whether dormant or exercised, except as otherwise expressly provided in the Act itself or in future legislation.” Id., at 429–430.The second “was by declaring expressly and affirmatively that continued state regulation and taxation of this business is in the public interest and that the business and all who engage in it 'shall be subject to' the laws of the several states in these respects.” Id., at 430, Fabe, 508 U.S. at 499-500.

The pre-emptive portion of the McCarran-Ferguson Act is contained in section 1012(b):

Federal regulation. No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically related to the business of insurance: Provided, that after June 30, 1948, the . . . Sherman Act, and the . . . Clayton Act, and the . . . Federal Trade Commission Act . . . shall be applicable to the business of insurance to the extent that such business is not regulated by State Law. [emphasis added].

This section has two “clauses.” The “first clause” provides the general rule. The “second clause” provides an exception for antitrust cases. The first clause (which is at issue in the case at hand) is to be read broadly, while the second clause (relating to antitrust) is construed narrowly.5

2. The Elements of the Reverse Pre-emption Standard

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 National, Inc., 2020 WL 5821754 * 7 (D. Del. Sept. 30, 2020) (quoting Humana).

a. Section 6920 was Enacted to Regulate the Business of Insurance

Despite being advised by the Department of the state supremacy established in the McCarran-Ferguson Act, the Petition does not acknowledge the Act, nor attempt to argue against its applicability. Accordingly, the IRS' position on this element is unclear. Nonetheless, an examination of the letters exchanged between the Department and the IRS (Exs. “A”-“I”) suggests that the IRS may contest the applicability of whether the state law was enacted for the purpose of regulating the business of insurance. (Ex. “I” at 1-3). This argument is untenable.

The Delaware Captive Law (which contains § 6920) is a comprehensive set of laws regulating the captive insurance business, and captive insurers. It provides, in detail, for the requisites of corporate structure, licensing, capitalization, and other aspects of captive insurance companies, as well as their ongoing regulation and operation. Important in this regulatory scheme is Section 6920, which specifically relates to the confidential treatment of materials, not only from information submitted by the owner/insureds during the application and licensing process, but also to such treatment among other state's insurance departments and state and federal agencies. (See generally Tinsley Decl. ¶¶ 9, 16-22).

The Captive Act, including § 6920, was enacted for “the purpose of regulating the business of insurance.” A statute need not directly regulate “the business of insurance,” such as by mandating certain terms of an insurance contract or setting premiums that may be charged by an insurer, to fall within the ambit of the McCarran-Ferguson Act. Fabe, 508 U.S. at 502-03. Instead, “[t]he broad category of laws enacted 'for the purpose of regulating the business of insurance' consists of laws that possess the 'end, intention, or aim' of adjusting, managing, or controlling the business of insurance.” Id. (emphasis added). The Supreme Court has long held that “[s]tatutes aimed at protecting or regulating this relationship [between insurer and insured], directly or indirectly are laws regulating the 'business of insurance'”; Sec. & Exch. Comm'n v. National Securities, Inc., 393 U.S. 453, 460 (1969) (emphasis added).

Section 6920 provides confidentiality, immunity from subpoena, and immunity from disclosure, for confidential documents relating to the license application for captive insurance, and forbids the Commissioner or Department from disclosing such documents other than to insurance departments or law enforcement or agencies of a state or the United States with an agreement in writing to hold it confidential in a manner consistent with the section.

Regulators protect the public interest and promote the solvency of insurance companies. They require information which competes with insurers' concerns to protect confidential and proprietary information. To encourage transparency, state confidentiality laws exist to ensure that certain items will be held and remain confidential when in the possession of the insurance regulator. (See Tinsley Dec. at ¶¶ 8, 17-18).

A state's regulation of “the licensing of [insurance] companies” has long been considered to be the “regulation of the business of insurance.” See Nat'l Sec., Inc., 393 U.S. at 460 (citing Robertson v. People of State of Cal., 328 U.S. 440 (1946)). See also Gerling Glob. Reinsurance 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”).

Further, Section 6920 is part of a broader confidentiality policy that likewise provides confidentiality to other areas of insurance,6 and is part of a reciprocal policy among state insurance commissioners and state and federal agencies, allowing the sharing of information, so long as it is held confidential. 18 Del. C. § 316. Maintaining confidentiality is important while sharing information because both regulators and insurance companies have an interest in ensuring confidentiality. Other states' laws, like Delaware's, uniformly require that the receiving party verify it will maintain the confidentiality of information to be provided by the state, as well as by states with federal agencies. (Tinsley Decl.at ¶¶ 18-19).

These concerns are particularly applicable in the case of captive insurers, where the insurer owners are the insureds and the applicants for licensing. Section 6920, regulating information submitted by proposed insureds, for licensing of their proposed captive, is part of the regulation of the business of insurance. As the Supreme Court, in Nat'l Securities held:

The relationship between insurer and insured, the type of policy which could be issued, its reliability, interpretation, and enforcement — these were the core of the 'business of insurance.' Undoubtedly, other activities of insurance companies relate so closely to their status as reliable insurers that they too must be placed in the same class. But whatever the exact scope of the statutory term, it is clear where the focus was — it was on the relationship between the insurance company and the policyholder. Statutes aimed at protecting or regulating this relationship, directly or indirectly are laws regulating the 'business of insurance.'”

Nat'l Securities, 393 U.S. at 460 (emphasis added). It is the relationship between the insurer and insured, as captive owner/insured and captive insurer, and specifically the confidentiality of the information relating to the application for licensing at issue. The application process and the confidentiality requirement are aimed at protecting and regulating the insurer/insured relationship — either directly or indirectly, and thus fall squarely in the business of insurance. Id.

b. The Tax Code Does Not Specifically Relate to The Business Of Insurance

Application of the Humana test to Sections 7602 and 6103 of the Tax Code reflects clearly that these sections are pre-empted by the Act. First, the Tax Code is a federal statute of general applicability and there can be no argument that either Section 7602 or 6103 “specifically relate” to the business of insurance. There are no express provisions of those sections that “specifically relate” or address in any way the “business of insurance,” nor is there any language in those sections that provide the IRS express authority to avoid pre-emption.

c. The Federal Statute Invalidates, Impairs, or Supersedes Section 6920

There can be no cogent argument that enforcement of the Summons would not “invalidate, impair, [and] supersede” the requirements of Section 6920(2). 15 U.S.C. § 1012(b). 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.”). It is clear that the Summons which requires the Department to do something which is specifically prohibited by statute, 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).

3. The IRS' Position Uses the Wrong Standard, and Relies on a Case Which Misapplied It

The IRS' position appears to adopt unpersuasive dicta contained in an unreported District of New Jersey case.7 That case not only ignored the standard in Humana, but misapplied the pre-Humana test to be used, attempting to shoehorn discussions relating to the “business of insurance” in cases related to the anti-trust exception, which is inapplicable to this matter.

a. The IRS Relies Upon an Incorrect Standard

Prior to the Supreme Court's 1993 decision in Fabe, there was considerable confusion in cases relating to decisions discussing the definition of “business of insurance” in Section 1012(b)'s second clause relating to the anti-trust exception, and the definition of “regulating the business of insurance” used in the general, first clause. See, e.g., generally, Peter B. Steffen, After Fabe: Applying the Pireno Definition of "Business of Insurance" in First-Clause McCarran-Ferguson Act Cases, 2000 U. Chi. Legal F. 447 (2000).

The Fabe Court noted that the Supreme Court had previously articulated a tripartite standard for divining what constitutes the “business of insurance,” in cases dealing with the anti-trust exception to the McCarran-Ferguson Act: “'first, whether the practice has the effect of transferring or spreading a policyholder's risk; second, whether the practice is an integral part of the policy relationship between the insurer and the insured; and third, whether the practice is limited to entities within the insurance industry.'” Fabe, 508 U.S. at 497-498 (quoting Union Labor Life Ins. Co. v. Pireno, 458 U.S. 119 (1982)).

However, the Fabe Court distinguished Pireno (and another case, Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205 (1979)):

Both Royal Drug and Pireno, moreover, involved the scope of the antitrust immunity located in the second clause of § 2(b). We deal here with the first clause, which is not so narrowly circumscribed. The language of § 2(b) is unambiguous: 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. To equate laws “enacted . . . for the purpose of regulating the business of insurance” with the “business of insurance” itself, as petitioner urges us to do, would be to read words out of the statute. This we refuse to do.

508 U.S. at 504 (emphasis added).

The Fabe Court held “[t]he broad category of laws enacted 'for the purpose of regulating the business of insurance' consists of laws that possess the 'end, intention, or aim' of adjusting, managing, or controlling the business of insurance. This category necessarily encompasses more than just the 'business of insurance.'”Fabe, 508 U.S at 505 (citations omitted). It then confirmed that this reading of the McCarran-Ferguson Act comports with its purpose, explaining that the first clause of § 1012(b) was intended to further Congress' primary objective of granting the states broad regulatory authority over the business of insurance, while the second clause accomplishes Congress' secondary goal of carving out only a narrow exemption for “the business of insurance” from the federal antitrust laws. Id.

After Fabe, a circuit split arose over the proper analytic inquiry into first clause preclusion. As the Court in Sabo v. Metropolitan Life Ins. Co., 137 F.3d 185, 189 at n. 2 (3d Cir. 1998) explained: “Some courts draw upon a four-part inquiry[8] . . . other courts have announced a more truncated three-part test that does not require a specific conclusion that the defendant's conduct constitutes the business of insurance.” (citations omitted). See also Autry v. Nw. Prem. Servs., Inc., 144 F.3d 1037, 1041 (7th Cir. 1998) (discussing split and adopting three-part test).

Ultimately, as discussed above, the Supreme Court decided Humana, which utilized the three-part test: “The McCarran–Ferguson Act thus precludes application of a federal statute in face of state law “enacted... for the purpose of regulating the business of insurance,” if the federal measure does not “specifically relat[e] to the business of insurance,” and would “invalidate, impair, or supersede” the State's law.” Humana, 529 U.S. at 308.

The IRS' position echoes the City of Sterling analysis, which not only utilized the outdated four-factor, process, but also improperly utilized the anti-trust test for determining whether the action generally constitutes “the business of insurance.”

b. The City of Sterling Heights Case Is Not Persuasive Authority

City of Sterling Heights is factually distinguishable and analytically incorrect. In City of Sterling Heights, a securities class action, third-party subpoenas were issued to non-party, Verus Financial LLC (“Verus”), which conducted an unclaimed property audit of Prudential's files as part of an insurance examination conducted by the California Department of Insurance. Verus sought adoption of a new common-law privilege based on regulator relationships, and sought to quash the subpoena based on a similar statute to Section 6920, which governed statutory examinations by the Insurance Commissioner as opposed to the application process for captive insurance. The Court ruled against Verus' arguments, however it granted the motion by the State of California Controller to intervene to preserve the regulator's ability “to prevent the disclosure of privileged and confidential documents.” Id. at *2. The Court allowed California the opportunity to object to the production of documents in Versus' possession. Id. at *7, in part because California, not Verus, was the actual holder of the privilege. Id.

The City of Sterling Heights determination is not applicable here. In the first instance, it is dicta, and the granting of California's Motion to Intervene suggests it well may have determined the matter differently when brought by the correct party. In addition, the case was determined incorrectly, using the wrong standard, and is thus not persuasive.

i. The City of Sterling Heights Decision Was Dicta

The City of Sterling Heights decision was merely dicta. By its terms, the decision did not apply to the arguments to be made by California (the entity in the same position as the Respondent here). While the IRS, in Ex. “I” asserted that the “Court ruled against California and Verus,” that is blatantly incorrect as to the claims of California. In fact, the Court ruled in favor of allowing California to intervene to raise the issues of privilege and confidentiality. Id. at * 2, 7-8. This is a clear recognition that the matter may have been determined differently if the Government entity actually referred to in the statute resists the subpoena.9

ii. The City of Sterling Heights Decision Was Incorrectly Decided

As discussed above, the City of Sterling Heights decision did not utilize the Humana formulation, but instead purported to utilize the four-prong factor of Sabo. In addition to utilizing an outdated standard, the City of Sterling Heights Court did not even apply that standard correctly. In making an initial determination that the statute “did not concern the business of insurance,” the Court utilized the factors from the anti-trust exceptions10 to determine whether conduct was “the business of insurance.” 2015 WL 1969368 at *6. The City of Sterling Heights Court merely considered these three factors, and ignored the admonition in Sabo that three enumerated standards are “merely a starting point” in a non-antitrust case, and “because laws 'enacted . . . for the purpose of regulating the business of insurance” necessarily encompass more than just the insurance business, the analysis here is broader.'” Sabo, 137 F.3d at 191 n.3. The City of Sterling Heights Court held that because the activity had nothing to do with the insurer-insured relationship, nor does it have the effect of spreading a policyholder's risk, the conduct did not constitute the business of insurance. 2015 WL 1969368 at *6. This was error. Further, the Court held the “anti-disclosure statutes” were not designed for the purpose of regulating the business of insurance, holding they were not made with the goal “of adjusting, managing or controlling the business of insurance.” Id. (quoting Fabe, 508 U.S. at 505). Instead, the Court argued they “merely control the flow of information during an insurance examination.” Id. The Court, in essence, merely performed the same incorrect analysis twice. In doing so, it ignored the mandates of both Fabe (a statute need not directly regulate “the business of insurance,” such as by mandating certain terms of an insurance contract or setting premiums that may be charged by an insurer, to fall within the ambit of the McCarran-Ferguson Act) 508 U.S. at 502-03 and Nat'l Securities (“Statutes aimed at protecting or regulating this relationship [between insurer and insured], directly or indirectly are laws regulating the 'business of insurance'”) 393 U.S. at 460 (emphasis added). As such, City of Sterling offers no support to the IRS' position.

B. The Summons Should Be Quashed Because the Petition Failed to Set Forth a Prima Facie Case

To obtain enforcement of a summons, the IRS must make a four-part prima facie showing that: (1) "the investigation will be conducted pursuant to a legitimate purpose;" (2) "the inquiry may be relevant to the purpose;" (3) "the information sought is not already within the Commissioner's possession;" and (4) "the administrative steps required by the Code have been followed." Powell, 379 U.S. 57-58.

On the face of the Petition the IRS has failed to make a prima facie showing of the first and third factors, that the investigation was conducted pursuant to a legitimate purpose, and that the information sought is not already in the IRS' possession. The IRS could avoid implicating McCarran-Ferguson by obtaining the requested information from other parties or complying with the statute's requirement. Thus, their efforts to compel the Commissioner to violate Delaware law make the Petition unnecessary and do not evince a legitimate purpose. Further, although the Petition makes a conclusory allegation at paragraph 21 (“Aside from those documents [already produced by the Department], the documents described in Request 1 of the summons are not already in the possession of the IRS. . . .”) (See also Declaration at ¶ 14), that statement is false.

Instead, the Petition and the Declaration make clear that the IRS has at least some of the documents it is seeking. Paragraph 15 of the Declaration asserts: “A comparison of the documents produced by the DDOI thus far to the documents produced by Artex in the summons enforcement action against Artex indicates that there are documents responsive to Request 1 of the summons in the possession of the DDOI that the DDOI has not produced.” Paragraph 15 of the Declaration states that because the IRS has documents in its possession that were already produced by another party that the IRS expected would also be in the possession of the Department, the absence of those documents in the Department's production shows that the Department has documents that the IRS does not already have in its possession. It is thus obvious from Paragraph 15 that documents that are the subject of the Petition are already in the possession of the IRS. As such, the summons should be quashed. See, e.g. United States v. Pritchard, 438 F.2d 969, 971 (5th Cir. 1971). The case of United States v. Garrett, 571 F.2d 1323,1328-29 (5th Cir. 1978) also supports quashing the subpoena. The Court distinguished a facially sufficient affidavit from the affidavit in Pritchard, where the requirement was omitted. Here, in light of the contradictions on the face of the declaration, the circumstances are the same as Pritchard, in that no effective prima facie case has been made.

C. A Protective Order Should Be Granted

Alternatively, this Court may grant a Protective Order. Section 6920 is unambiguous and mandatory. It states that such information and documents “be given confidential treatment, are not subject to subpoena, [and] may not be made public by the Commissioner, and may not be provided or disclosed to any other person at any time.” 18 Del. C. § 6920. It does, however, provide methods whereby federal agencies like the IRS may receive the information it seeks: (1) either if the captive insurance company gives consent; or (2) “[s]o long as such official or agency agrees in writing to hold it confidential and in a manner consistent with this section.” Id.

As the IRS has refused to take easily acceptable substitute actions which would allow it to gather the requested information without implicating the McCarran-Ferguson Act, the Court should grant a Protective Order until such time as the IRS complies with the dictates of Delaware Law by obtaining consents or agreeing in writing to keep the requested information confidential. C.f. Ashcroft v. al-Kidd, 563 U.S. 731, 735 (2011) (“Courts should think carefully before expending “scarce judicial resources” to resolve difficult and novel questions of constitutional or statutory interpretation that will “have no effect on the outcome of the case.”)

V. CONCLUSION

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

 

STATE OF DELAWARE
DELAWARE DEPARTMENT OF JUSTICE

OF COUNSEL:

James J. Black, III (pro hac pending)
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

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

FOOTNOTES

1The information requested involves licensing information concerning Delaware captive insurers. Under Section 6920 of the Delaware Insurance Code, codified at Title 18 of the Delaware Code, this information is confidential and disclosure by the Commissioner is expressly prohibited except where the insurer consents or such information is disclosed to another insurance department or to a state or federal law enforcement official or agency long as such official or agency agrees in writing to hold it confidential and in a manner consistent with Section 6920.

2The McCarran–Ferguson 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. Humana Inc. v. Forsyth, 529 U.S. 299, 308 (1999).

3Prior to the Petition, the Department produced sixteen company specific files. The Department subsequently produced three more company specific files after receiving company-owner consents. These files totaled over 18,000 pages.

4IRC §§ 7602 and 6103.

5See, e.g. Fabe, 508 U.S at 505 (“first clause of § 2(b) was intended to further Congress' primary objective of granting the States broad regulatory authority over the business of insurance. The second clause accomplishes Congress' secondary goal, which was to carve out only a narrow exemption for “the business of insurance” from the federal antitrust laws”); McCray v. Fid. Nat. Title Ins. Co., CIV.A. 08-775, 2010 WL 3023164, at *3 (D. Del. July 29, 2010), aff'd, 682 F.3d 229 (3d Cir. 2012) (anti-trust preclusion construed narrowly). See also Sec. A(3)(a), below.

6See 18 Del. C. §§ 321(g) (examinations); 5707 (holding company registration), 7505(e) (viatical examinations); 8409 (solvency assessments).

7City of Sterling Heights Gen. Employee's Retirement System v. Prudential Fin., Inc., No. 12-5275, 2015 WL 196368 (D.N.J. Apr. 30, 2015), discussed in Section A(3)(b), below.

8The Sabo Court adopted such a four-part inquiry, which added a requirement that “whether the challenged conduct broadly constitutes the 'business of insurance'” to the standard test of (1) whether the federal statute specifically relates to insurance; (2) whether the state statute was enacted for the purpose of regulating the business of insurance; and (3) whether application of the Federal statute would invalidate, impair or supersede state law. Sabo, 137 F.3d at 190-92.

9The case was settled without resolution of California's Objection. (See docket).

10“[F]irst, whether the practice has the effect of transferring or spreading a policyholder's risk; second, whether the practice is an integral part of the policy relationship between the insurer and the insured; and third, whether the practice is limited to entities within the industry.” (quoting Pireno, 458 U.S. at 129).

END FOOTNOTES

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