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Records Must Be Released in Microcaptive Investigation, DOJ Says

FEB. 24, 2021

United States v. Delaware Dept. of Insurance

DATED FEB. 24, 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

UNITED STATES OF AMERICA'S REPLY TO RESPONDENT'S RESPONSE TO THE ORDER TO SHOW CAUSE

Date: February 24, 2021

DAVID A. HUBBERT
Acting Assistant Attorney General

DAVID C. WEISS
United States Attorney

KYLE L. BISHOP
WARD W. BENSON
Trial Attorneys, Tax Division
U.S. Department of Justice
P.O. Box 227, Ben Franklin Station
Washington, DC 20044
Tel: (202) 616-1878
Fax: (202) 514-6866
Email: Kyle.L.Bishop@usdoj.gov

The United States seeks to enforce a summons issued to the Delaware Department of Insurance (“DDOI”) requesting information about Artex and Tribeca's involvement in potentially abusive tax transactions. (See D.I. 3, Keltner Decl. at ¶ 4). The United States met the prima facie requirements for enforcement with its petition supported by the Declaration of Bradley Keltner. (D.I. 8). The burden then shifted to DDOI to demonstrate why the Court should decline to enforce the summons. DDOI contends, without support, that the exam is not being conducted for a legitimate purpose. DDOI also mistakenly contends that the IRS is already in possession of the summoned records. In addition, DDOI asks the Court to allow it to withhold responsive information from the IRS based on its anti-disclosure statute.

The Supremacy Clause requires enforcement despite a state law preventing disclosure. DDOI attempts to bootstrap its anti-disclosure statute with the McCarran-Ferguson Act to overcome the Supremacy Clause. But Delaware's state anti-disclosure statute does not reverse preempt the IRS summons authority through the McCarran-Ferguson Act because the records sought do not involve true insurance and because the state statute was not enacted for the purpose of regulating the business of insurance. In addition, Delaware's request to condition enforcement conflicts with federal law governing the protection and disclosure of return information gathered by the IRS. Finally, DDOI cannot support its argument that the IRS waived the requirement of testimony. The Court should enforce the summons.

I. Summary of Relevant Facts.

In October 2017, the IRS served a summons on DDOI seeking “[a]ll electronic mail between [DDOI] and Artex or Tribeca related to the Captive Insurance Program,” as well as testimony. (D.I. 1 at ¶¶ 14-16). It issued this summons in support of its investigation into Artex Risk Solutions, Inc. and Tribeca Strategic Advisors, LLC. (Id. at ¶ 4). That investigation seeks to determine Artex and Tribeca's role in potentially abusive tax transactions involving entities created under the label of insurance companies, some of which are registered in Delaware. (Id. at ¶ 5). The IRS has not previously obtained the records at issue from DDOI. Although it has received some communications from Artex, the summons seeks emails from time periods not included in an earlier summons issued to Artex. See United States v. Artex Risk Solutions, Inc., No. 1:14-cv-4081, 2014 WL 4493435 (N.D. Ill. Sept. 11, 2014) (enforcing summons). After attempting to resolve the case without litigation, this lawsuit followed.1

II. Legal Framework.

A. The IRS summons power.

While the federal system of taxation rests largely on taxpayers reporting information correctly to the government, “it would be naïve to ignore the reality that some persons attempt to outwit the system.” United States v. Bisceglia, 420 U.S. 141, 145 (1975). This is especially true when the transactions under review were, apparently, designed to create improper tax benefits to enrich promoters such as Artex and Tribeca. (Dkt. 1 at ¶ 7). To prevent such chicanery, Congress charged the Internal Revenue Service with the responsibility of administering and enforcing the Internal Revenue Code. 26 U.S.C. § 7601; Donaldson v. United States, 400 U.S. 517, 523 (1971). Congress gave the Secretary the authority to examine records, summons persons with relevant information, and take testimony relevant to such inquiries. 26 U.S.C. § 7602(a); see also United States v. Euge, 444 U.S. 707, 710-11 (1980); United States v. Rockwell Int'l, 897 F.2d 1255, 1261 (3d Cir. 1990). The summons power is “critical to the investigative and enforcement functions of the IRS.” Id.

Courts construe the summons authority in section 7602 broadly. See, e.g., Euge, 444 U.S. at 714-15. In enacting section 7602, Congress “endowed the IRS with expansive information-gathering authority” so as to “encourage effective tax investigations.” United States v. Arthur Young & Co., 465 U.S. 805, 815-16 (1984) (without self-assessment and self-reporting, “and the concomitant power of the Government to compel disclosure, our national tax burden would not be fairly and equitably distributed”). In furtherance of these purposes, the Supreme Court warns that aside from traditional privileges and limitations, “any other restrictions upon the IRS summons power should be avoided 'absent unambiguous directions from Congress.'” Id. at 816 (quoting Bisceglia, 420 U.S. at 150); see also Tiffany Fine Arts, Inc. v. United States, 469 U.S. 310, 318 (1985) (reading statute expansively when faced with second federal statute that could have been read to limit the scope of section 7602).

In a summons enforcement action, the United States must meet its initial burden of making a prima facie case that the summons is valid. United States v. Cortese, 614 F.2d 914, 919 (3d Cir. 1980) (citing United States v. Powell, 379 U.S. 48, 57-58 (1964)). It does so by establishing that (1) the investigation is being conducted for a legitimate purpose; (2) the inquiry may be relevant to that purpose; (3) the information sought is not already in possession of the IRS; and (4) the IRS followed all administrative steps required by the Internal Revenue Code. Rockwell Int'l, 897 F.2d at 1262 (quoting Powell, 379 U.S. at 57-58). The United States made its prima facie case here.2 (D.I. 8 at ¶ 3). Accordingly, the “burden of proof has shifted to the respondent to oppose enforcement of the summons.” Id. At this juncture, the respondent must carry a “heavy burden” by showing the Court that enforcing the summons would result in an “abuse of process.” United States v. Garden State Nat'l Bank, 607 F.2d 61, 69-71 (3d Cir. 1979); G2A.COM Sp. Z.o.o. (Ltd.) v. United States, 789 Fed. App'x 296, 300 (3d Cir. 2019); see also United States v. LaSalle Nat. Bank, 437 U.S. 298, 316 (1978).

A summonsed party may challenge the summons “on any appropriate ground.” United States v. Falgione, 395 F. Supp. 2d 241, 243 (W.D. Pa. 2005) (internal citations and quotations omitted). Appropriate grounds include disproving “one of the four elements of the government's Powell showing, or otherwise demonstrates that enforcement of the summons will result in an abuse of the court's process.” Id. A summonsed party may only assert facts opposing the prima facie case by affidavit; “[l]egal conclusions or mere memoranda of law will not suffice.” Garden State Nat'l Bank, 607 at 71 (citing Thornton v. United States, 493 F.2d 164, 167 (3d Cir. 1974)). “In the absence of such a response,” any uncontested allegations “must be accepted as admitted.” Garden State Nat'l Bank, 607 F.2d at 71. DDOI does not seriously challenge the IRS's prima facie showing that the examination is being conducted for a legitimate purpose, that the summoned records are relevant to that purpose, and that all administrative steps were followed.

The only prima facie element DDOI challenges is possession. DDOI also raises a purely legal affirmative defense, contending that state law and the McCarran-Ferguson Act combine to prevent disclosure unless the IRS agrees to further non-disclosure beyond that imposed by 26 U.S.C. § 6103. Finally, DDOI alleges, without support, that the IRS waived DDOI giving testimony. Because none of these arguments place any facts in dispute, the Court may issue a ruling in this case on the papers. Garden State Nat'l Bank, 607 F.2d at 71.

B. Captive insurance companies.

Legitimate captive insurers are companies whose sole purpose is to issue insurance to their parent company (or its affiliates). When a business creates a captive insurance company to protect against certain risks, the Internal Revenue Code permits the insured business to deduct from their income the premium payments made to the captive, thereby, lowering the insured's tax liability. 26 U.S.C. § 162(a); 26 C.F.R. § 1.1162-1(a). If the captive that receives those payments elects to be taxed under 26 U.S.C. § 831(b), it can exclude those premiums from income, which reduces the captive's tax liability. These transactions may be referred to as “micro-captive insurance transactions.”

Because the tax treatment of captive insurers departs from the traditional rule that a payment deductible by one party is includible in income by the recipient, unscrupulous taxpayers may use them to avoid and evade taxes. This is sometimes done by creating the appearance of setting up a captive to issue insurance for highly unlikely events (e.g., volcano insurance for a building in Wilmington) and charging excessive premiums. By structuring transactions in this way, taxpayers manipulate income into untaxed in the hands of the captive insurer owned by the taxpayer while the insured simultaneously takes a deduction for the alleged premium payments.

In response to concerns about such abusive usage of these transactions, the IRS designated such schemes Transactions of Interest in late 2016. IRS Notice 2016-66, 2016-47 I.R.B. 745 (Nov. 21, 2016). The United States Tax Court examined such purported microcaptive insurance transactions and found that these transactions did not constitute insurance. Avrahami v. Commissioner, 149 T.C. 144, 179-180 (Tax Ct. 2017); Reserve Mech. Corp. v. Commissioner, Tax Ct. Memo. 2018-86, 2018 WL 3046596, at *16 (Tax Ct. 2018) (appeal docketed at No. 18-9011 (10th Cir.)); Syzygy v. Commissioner, T.C. Memo. 2019-34, 2019 WL 1559540, at *45 (Tax Ct. 2019) (invalidating purported Delaware micro-captive insurance company because arrangement did not distribute risk and did not meet commonly accepted definition of insurance). In at least one case, the court noted the participation of promoters in the micro-captive insurance scheme it invalidated. Avrahami, 149 T.C. at 206 (taxpayers cannot rely on “promoters” of tax avoidance schemes to avoid penalties under 26 U.S.C. § 6662).).

C. Delaware's anti-disclosure statute.

Delaware's anti-disclosure law provides, as is relevant here, that certain documents submitted to DDOI by purported insurance companies shall generally be given “confidential treatment,” shall not be “subject to subpoena,” and may “not be made public.” 18 Del. C. § 6920. There are two exceptions to this general rule. The first allows the Delaware Commissioner of Insurance to disclose these documents to “the insurance department of any state or of any country or jurisdiction.” 18 Del. C. § 6920(1). This exception contains one express caveat: that the Delaware Commissioner may not make such a disclosure to the United States of America. Id. The second exception permits the Delaware Commissioner to disclose such information “[t]o a law-enforcement official or agency of this State, any other state or the United States of America.” 18 Del. C. § 6920(2). But it also contains a caveat: such disclosure can only occur “so long as such official or agency agrees in writing to hold [the information] confidential and in a manner consistent with” section 6920.3 Id.

D. The McCarran-Ferguson Act.

Normally, when a federal statute and a state law conflict, the state statute yields. Courts regularly apply this rule in summons enforcement actions. See, e.g., United States v. First Bank, 737 F.2d 269, 271 (2d Cir. 1984) (state statute requiring notice to co-owner of records preempted by section 7602, which imposed no such requirement). This rule applies even when state law purports to protect the privacy interests of those governed by the law. Presley v. United States, 895 F.3d 1284, 1292 (11th Cir. 2018) (Florida constitutional provision granting a privacy interest in bank records did not preclude enforcement of IRS summons, as it would “substantially impede the IRS's ability to summon bank records pursuant to the Internal Revenue Code”).

The McCarran-Ferguson Act is an exception to this general rule. The Act provides, in relevant part:

(a) State regulation

The business of insurance, and every person engaged therein, shall be subject to the laws of the several States which relate to the regulation or taxation of such business.

(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 relates to the business of insurance: . . .

15 U.S.C. § 1012.

Congress was primarily concerned with restoring “the relationship between insurance ratemaking and the antitrust laws, and with the power of the States to tax insurance companies.” S.E.C. v. Nat'l Sec., Inc., 393 U.S. 453, 458-59 (1969) (citing 91 Cong. Rec. 1087-1088). The Act sought to ensure “activities of insurance companies in dealing with their policyholders would remain subject to state regulation.” Id. at 459.

The Act make states supreme as “to laws 'regulating the business of insurance,'” not “all the activities of insurance companies.” Nat'l Sec., 393 U.S. at 459 (quoting 15 U.S.C. § 1012(b)) (emphasis original); see also Humana Inc. v. Forsyth, 525 U.S. 299, 308-09 (1999). The Supreme Court specifically acknowledged that insurance companies would continue to do “many things” subject to federal regulation; “only when they are engaged in the 'business of insurance'” does federal law yield to state law. Id. (quoting 15 U.S.C. § 1012(b)). Statutes aimed at protecting or regulating “the relationship between the insurance company and the policyholder” fit within the definition of the phrase “business of insurance.” Id. at 460. Those aimed at other relationships do not, and are “not within the scope of the McCarran-Ferguson Act.” Id.

III. Argument.

A. The summons was issued for a proper purpose.

DDOI has failed to support its vague assertion that the summons was not issued for a valid purpose. As the district court in Falgione explained, “the requirement of legitimate purpose means nothing more than that the government's summons must be issued in good faith. . . .” Falgione, 395 F. Supp. 2d at 244–45 (internal citations and quotations omitted). The “heavy burden” of negating a proper civil purpose rests with the taxpayer. Id. Illegitimate purposes include “the institutional abandonment of a civil collection purpose” or showing “that the investigation is being conducted solely to harass the taxpayer or to put pressure on him or her to settle a collateral dispute.” Id. In the absence of such evidence, “the summons carries a presumption of validity and is virtually unassailable.” Id.

DDOI makes no allegations of the kind of bad faith conduct necessary to show a summons was issued for an improper purpose. Instead, it argues that the summons was not issued for a legitimate purpose because: (1) compliance would violate Delaware's privacy laws; (2) the IRS could have taken other actions to acquire the information; and (3) the IRS already has the information it seeks in its possession. (D.I. 15, ¶ 26). Not only are these contentions wrong, as explained below, they do not constitute grounds for finding that the summons was issued for an improper purpose. As such, the Court should conclude the IRS issued the summons for a proper purpose, i.e., investigating Artex and Tribeca's roles “in transactions involving captive insurance plans and other potentially abusive transactions” (See D.I. 3, Keltner Decl. at ¶ 4).

B. The records sought are not already in the IRS's possession.

DDOI next asserts that, according to the declaration submitted in support of the summons, the IRS already possesses the records sought. (D.I. 19 at 19). That assertion both misrepresents the statements in the Keltner declaration and misunderstands the nature of the third Powell factor.4

While Artex produced some emails between itself and employees of DDOI, the IRS has not received emails from DDOI. The IRS is entitled to compare the emails produced by DDOI and produced by Artex. Artex may have intentionally failed to produce some of those emails, inadvertently failed to do so, or simply no longer retained them at the time it complied with the summons the IRS issued to Artex. Additionally, the temporal scope of the summons to DDOI is broader than the one to Artex. Any emails sent between Artex and DDOI after Artex's production in 2014 presumably would not be in the IRS's possession. Of course, DDOI cannot know what Artex produced and does not support its contention with specific facts in an affidavit that these emails are already in the IRS's possession.

It is precisely due to these uncertainties that courts have interpreted the third Powell factor pragmatically. It is well-established that “the IRS is entitled to obtain relevant records from third parties to compare for accuracy any records obtained from the taxpayer.” Sugarloaf, 584 F.3d at 350. This Powell factor is designed not to prevent the IRS from obtaining copies of records from different record-holders, but to prevent the IRS from requesting the same records from the same record-holder. See, e.g., United States v. Pritchard, 438 F.2d 969, 971 (5th Cir. 1971) (IRS could not the summons file held by taxpayer's attorney, which attorney acquired from account after IRS already reviewed files when by accountant); United States v. Monumental Life, 440 F.3d 729, 733-35 (6th Cir. 2006) (IRS cannot summons same records from same insurance company in audit of different taxpayer). Because such concerns are not present here, the IRS meets this Powell factor.

C. The IRS need not look to other means of acquiring the records.

DDOI next suggests the Court should not enforce the summons because the IRS could acquire these records through “easily acceptable substitute actions,” i.e., obtaining the records from other sources; obtaining consents from the entities mentioned in the summonsed records; or agreeing to keep any records received confidential. (See D.I. 15 at 10; D.I. 19 at 20). DDOI offers nothing to support its contention that the IRS's refusal to take these steps warrants denial of enforcement, and none exists. The Supreme Court has “never held, however, that the IRS must conduct its investigations in the least intrusive way possible. Instead, the standard is one of relevance.” Tiffany Fine Arts, 469 U.S. at 323.

The suggested alternatives are also not easy or acceptable. First, it is unclear what other sources would have the records sought — DDOI's retained copies of records showing communications between Artex and DDOI. Given the claims DDOI makes about the antidisclosure statute, it is unlikely another source has its records. Second, DDOI admits it has not been able to obtain consents to disclosure from a vast majority of captive insurance companies related to Artex and Tribeca, and these entities have every incentive not to grant those consents to the IRS. Third, the IRS follows a strict anti-disclosure law, and there is no basis to restrict disclosure further. Congress provided when and how “return information” can be disclosed during an investigation or in a court proceeding in 26 U.S.C. § 6103.5 Accordingly, even if the presence of “easily acceptable substitute actions” were a ground for denial of enforcement or conditional enforcement, which is not the case, no such alternatives are available here.6

D. The McCarran-Ferguson Act does not preempt enforcement because Delaware's anti-disclosure law does not regulate the “business of insurance”.

The McCarran-Ferguson Act permits state law to preempt federal law only when four criteria are met: (1) the challenged activity must constitute the business of insurance; (2) the federal law cannot relate specifically to the business of insurance; (3) the federal law cannot invalidate, impair, or supersede the state law; and (4) the state law must have been enacted for the purpose of regulating the insurance business. Sabo v. Met. Life Ins. Co., 137 F.3d 185, 190 (3d Cir. 1998); see also Highmark, Inc. v. UPMC Health Plan, Inc., 276 F.3d 160, 166 (3d Cir. 2001). Absent any of these factors, the usual rule of federal supremacy prevails. Highmark, 276 F.3d at 166.

DDOI's case fails to clear these hurdles.7 First, the challenged activity — recordkeeping by the government — does not constitute the business of insurance, and thus does not trigger the McCarran-Ferguson Act. For similar reasons the Court should conclude that Delaware did not enact its anti-disclosure statute for purposes of regulating the business of insurance. Third, section 7602 does not impair, invalidate or supersede Delaware's non-disclosure statute.

1. Record maintenance is not the business of insurance.

At its core, the business of insurance “centers around the contract of insurance.” Nat'l Sec., 393 U.S. at 460. An activity should be characterized narrowly rather than broadly for purposes of the McCarran-Ferguson Act analysis to avoid needlessly displacing other federal regulation. See, e.g., Women in City Gov't United v. City of New York, 515 F. Supp. 295, 303 (S.D.N.Y. 1981). The typical activities that exemplify the business of insurance include “[t]he relationship between insurer and insured, the type of policy which could be issued, its reliability, interpretation, and enforcement.” Nat'l Sec., 393 U.S. at 460.; see also Sabo, 137 F.3d at 191; Am. Standard Life and Acc. Ins. Co. v. U.R.L., Inc., 701 F. Supp. 529, 532 (M.D. Pa. 1988) (citing Group Life & Health Insurance Co. v. Royal Drug Co., 440 U.S. 205, (1979)).

In determining whether an activity constitutes the business of insurance, courts consider three factors: “(1) whether the practice has the effect of transferring or spreading a policyholder's risk; (2) whether the practice is an integral part of the policy relationship between the insurer and insured; and (3) whether the practice is limited to entities within the insurance industry.”8 Sabo, 137 F.3d at 191 (citing Royal Drug, 440 U.S. at 205 (further citation omitted)). Courts should consider each of these factors, and none alone is dispositive.9 City of Sterling Heights v. Prudential Fin., Inc., No. 12-5275, 2015 WL 1969368, at *6 (D.N.J. Apr. 30, 2015). Here, all three factors support the conclusion that the regulated activity — “the dissemination and maintenance of information, documents, and communications [maintained by the state]” — do not constitute the business of insurance. Sterling Heights, 2015 WL 1969368, at *6.

In Sterling Heights, the court reviewed an anti-disclosure statute with substantially the same language as the Delaware anti-disclosure law at issue here, and concluded the activity it regulated, state recordkeeping, did not constitute the business of insurance. Sterling Heights, 2015 WL 1969368, at *6. In that securities lawsuit, a non-party litigant named Verus challenged the magistrate judge's order compelling it to produce documents subpoenaed by the plaintiffs. Id. The suit claimed Prudential violated the Securities Exchange Act “by making false and misleading statements” that misrepresented its financial position by over $100 million. Id. at *1. These alleged improprieties were uncovered in part due to an unclaimed property audit of Prudential's files conducted by Verus. Id. During the audit, “Verus, the state insurance regulators, and Prudential . . . exchanged a considerable amount of information.” Id. Verus sought to quash subpoenas seeking that information on the grounds that state insurance laws Case 1:20-cv-00829-MN-CJBDocument 23Filed 02/24/21Page 15 of 22 PageID #: 323 “generally provide that examination-related materials are 'not subject to subpoena,'” and thus the McCarran-Ferguson Act preempted Rule 45, which allows litigants to subpoena documents from third parties in federal lawsuits. Id. at *6 (citing, as an example, Cal. Ins. Code § 735.5(c)).

The Court ordered Verus to produce the documents, holding that “the state confidentiality statutes in question” did not “concern the 'business of insurance.'” Id. at *6. Sterling Heights concluded that “the activity in question that the anti-disclosure statutes seek to regulate is the dissemination and maintenance of information, documents, and communications developed as a result of an insurance examination.” Id. Because those activities had “nothing at all to do with the insurer-insured relationship,” and did not affect the spread of a policyholder's risk, it did not constitute the business of insurance and thus did not fall within the scope of the McCarran-Ferguson Act.10 Id.

The state statute analyzed in Sterling Heights contains substantially the same language as the statute at issue here. Both provisions mandate that the documents in question shall be given “confidential treatment,” shall not be “subject to subpoena,” and may “not be made public” by the commissioner of insurance. 18 Del. C. § 6920; Cal Ins. Code § 735.5. And in both instances, there is an exception to the general rule that allows the state to turn the information over to the federal government only if it “agrees in writing to hold it confidential and in a manner consistent with” the relevant state statute. 18 Del. C. § 6920; Cal Ins. Code § 735.5.

DDOI's attempts to distinguish Sterling Heights fall flat. It begins by suggesting that the decision is distinguishable because that court allowed California the opportunity to intervene. (D.I. 19 at 16-17). But that portion of the ruling only allowed California to assert privilege claims it might hold that Verus did not. Sterling Heights, 2015 WL 1969368, at *7. California did not seek — and the Court did not permit it — to assert privileges based on the McCarran-Ferguson Act. See Sterling Heights, D.I. 143 at 1 (seeking to intervene for limited purpose of asserting attorney-client privilege, work-product doctrine, and deliberative process privilege). While California and other states expressed views on the McCarran-Ferguson Act in a separate amicus brief, the Court rejected those views. See Sterling Heights, D.I. 146 at 8-17.

DDOI's argument that the portion of the decision regarding the McCarran-Ferguson Act amounts to dicta fares no better. (D.I. 19 at 17). Dicta are “statements of law in the opinion which could not logically be a major premise of the selected facts of the decision.” See State Auto Prop. & Cas. Ins. Co. v. Pro Design, P.C., 566 F.3d 86, 92 (3d Cir. 2009) (internal quotation marks, alteration, and citation omitted). In Sterling Heights, a major premise in the decision's analysis is that the McCarran-Ferguson Act does not serve to allow anti-disclosure statutes to preempt federal provisions requiring disclosure. Sterling Heights, 2015 WL 1969368, at *7. Had the Court not reached this conclusion, it could not have ultimately answered the question of whether to grant the motion to compel the documents or quash the subpoena. Id. at 3. Because the analysis was necessary to the Court's conclusion, it is not dicta.

DDOI also contends the Sterling Heights court simply reached the wrong result. DDOI argues Sterling Heights incorrectly utilized the four-factor test from Highmark, and instead should have ignored the first factor (i.e., whether the challenged activity constitutes the business of insurance). (D.I. 19 at 14-16 (citing Humana, 525 U.S. at 308). But nothing in Humana demands that the McCarran-Ferguson Act apply when the challenged activity does not constitute the business of insurance. And a mere two years after the Supreme Court issued its decision in Humana, the Third Circuit reiterated that the test continues to include four factors.11 Highmark, 276 F.3d at 166 (using four-factor test).

Lastly, DDOI's argument that Sterling Heights failed to follow Sabo's admonition that the test concerning whether a challenged activity constitutes the business of insurance represents “merely a starting point” for a McCarran-Ferguson Act analysis in the non-antitrust context. (See D.I. 19 at 18 (quoting Sabo, 137 F.3d at 191 n. 3)). While it is not clear Sterling Heights made such an error, even if it had, that would not change the result. As Sterling Heights makes clear, this Court does not face a close call here. Sterling Heights, 2015 WL 1969368, at *6 (anti-disclosure statute has “nothing at all to do with the insurer-insured relationship, nor does it have the effect of spreading a policyholder's risk”).

2. Delaware did not enact section 6920 for the purpose of regulating the business of insurance.

Delaware did not enact section 6920 with the “end, intention, or aim of adjusting, managing, or controlling the business of insurance.” U.S. Dep't of Treasury v. Fabe, 508 U.S. 491, 505 (1993). The focus in this inquiry is to determine whether the state statute is “aimed at protecting or regulating” the “relationship between the insurance company and the policyholder.” Nat'l Sec., 393 U.S. at 460; see also Royal Drug, 440 U.S. at 215-216.

Statutes enacted for the purpose of regulating the business of insurance include those related to the “actual performance of an insurance contract.” Fabe, 508 U.S. at 505. State statutes focused on “the fixing of rates,” the “selling and advertising of policies, and the licensing of companies and their agents” also fall within the McCarran-Ferguson Act. Nat'l Sec., 393 U.S. at 460 (internal citations omitted). And the McCarran-Ferguson Act also applies to state laws that prohibit the sale of insurance without approval from the state's Department of Insurance. Am. Deposit Corp. v. Schacht, 84 F.3d 834, 838 (7th Cir. 1996). In contrast, the business of insurance does not extend to “separate contractual arrangements between [an insurance company] and pharmacies engaged in the sale and distribution of goods and services other than insurance.” Royal Drug, 440 U.S. at 216. The “statutory language [of the McCarran-Ferguson Act], [ ] exempts the “business of insurance” and not the “business of insurance companies.” Royal Drug, 440 U.S. at 217.

The Delaware statute at issue here falls outside the business of insurance. As noted above, the anti-disclosure statute does not alter or otherwise impact the relationship between the insurer and insured. Rather, it provides “direction to the state regulatory entity as to how and when documents and communications related to an insurance examination may or may not be disseminated.” Sterling Heights, 2015 WL 1969368, at *6. The focus is on the relationship between Delaware and the insurance company, and perhaps Delaware and a third party seeking these documents (e.g., the United States in this case). But nowhere is the relationship between the insurer and insured implicated by Delaware's anti-disclosure law.12

DDOI's protestations to the contrary are unavailing. First, it seeks to define the law at issue in this case not as section 6920 (the anti-disclosure statute), but Delaware Captive Law (while undefined, this appears to encompass at least 18 Del. C. §§ 6901-6983). But courts apply the McCarran-Ferguson Act to discrete statutes, not comprehensive statutory schemes. See, e.g., Fabe, 508 U.S. at 493 (analyzing Ohio Rev. Code. § 3903.42 (1989)); Nat'l Sec., 393 U.S. at 462 (analyzing Ariz. Rev. Stat. § 20-731(B) (1969)). While it may be true that Delaware Captive Law provides “for the requisites of corporate structure, licensing, [and] capitalization,” the IRS summons in this case has no impact on those matters.13 (D.I. 19 at 10).

DDOI also argues that, because the information it seeks to withhold under its anti-disclosure statute was compiled during its process of licensing and examining insurers, the purpose of section 6920 is focused on licensing insurers. (D.I. 19 at 11-12 (citing Gerling Glob. Reinsurance Corp. of Am. v. Low, 240 F.3d 739, 746 n. 3 (9th Cir. 2001))). This overstates Gerling, which holds only that federal law does not override state statutes aimed at requiring insurers to submit certain information in order to obtain a license, and says nothing about laws related to disclosure of information to a federal agency engaged in a legitimate investigation. Gerling, 240 F.3d at 746 n. 3; Sterling Heights, 2015 WL 1969368, at *6.

The state's arguments regarding the importance of confidentiality only underscore that section 6920 does not target the relationship between the insurer and insured. DDOI notes that confidentiality is important for “both regulators and insurance companies,” (D.I. 19 at 12), but as noted above, the relevant inquiry is whether the statute impacts insurers relationships with the insured, not with government agencies. Nat'l Sec., 393 U.S. at 460. Similarly, if the purpose of the statute is to ensure “a reciprocal policy among state insurance commissioners,” that focuses on the relationship between Delaware and other states. (D.I. 19 at 12). The McCarran-Ferguson Act does not seek to save such statutes. Royal Drug, 440 U.S. at 216-217.

Courts agree, and regularly conclude that federal statutes allowing federal agencies to conduct investigations do not fall afoul of the McCarran-Ferguson Act. See S.E.C. v. Republic Nat'l Life, 378 F. Supp. 430, 436 (S.D.N.Y. 1974) (McCarran-Ferguson Act “is to be narrowly construed in the face of valid federal regulatory interests,” and “accommodation of federal and state regulatory interests is to be sought”); F.T.C. v. Dixie Fin. Co., Inc., 695 F.2d 926, 931 (5th Cir. 1983) (allowing FTC to obtain documents from investigation into insurance companies when investigation centered on role in consumer credit transactions); F.T.C. v. Mfrs. Hanover Consumer Servs., Inc., 567 F. Supp. 992, 996 (E.D. Pa. 1983) (warning that courts should “guard against possibility” of allowing expansion of McCarran-Ferguson to bar federal investigations of insurance companies just because “the practice sought to be investigated is characterized as the business of insurance because insurance is somehow involved”); S.E.C. v. Brigadoon Scotch Distrib. Co., 480 F.2d 1047, 1052-53 (“Commission must be free without undue interference or delay to conduct an investigation”).

3. Section 7602 does not invalidate, impair, or supersede Delaware's anti-disclosure statute.

Section 7602 does not impair, invalidate or supersede Delaware's non-disclosure statute, which allows disclosure “[t]o a law-enforcement official of * * * the United States of America,” 18 Del. C. § 6920(2), “so long as such official or agency agrees in writing to hold [the information] confidential and in a manner consistent with” section 6920. Congress enacted a comprehensive statute to ensure confidentiality of tax return information in 26 U.S.C. § 6103. The information sought by the summons would fall within the definition of “return information” in § 6103(b)(2) and would be subject to the non-disclosure provisions Congress imposed. As such, these provisions can be read harmoniously.

E. The IRS has not waived its right to demand testimony.

Finally, DDOI suggests that the IRS has waived its right to demand the testimony sought in the summons. (D.I. 19 at 2). It offers no legal support for this contention. Presumably it is based on an equitable laches theory, but that defense is not available against the United States. See United States v. Tuerk, 317 F. App'x 251, 253 (3d Cir. 2009) (citing, inter alia, United States v. St. John's General Hosp., 875 F.2d 1064, 1071 (3d Cir.1989) (“It is well established that the United States is not subject to the defense of laches in enforcing its rights.”). The Court should reject this argument.

IV. Conclusion.

For all the foregoing reasons, the Court should enforce the IRS summons.

Date: February 24, 2021

KYLE L. BISHOP
Trial Attorney, Tax Division
U.S. Department of Justice
P.O. Box 227, Ben Franklin Station
Washington, DC 20044
Tel: (202) 616-1878
Email: Kyle.L.Bishop@usdoj.gov

FOOTNOTES

1In response to the petition, this Court entered an order to show cause. (D.I. 9). Delaware replied by a motion to quash the petition (or in the alternative, enter a protective order). (D.I. 16). It also filed a response to the petition. (D.I. 15). Lastly, it filed a brief in support of the motion to quash, but that it also largely incorporated into its response to the petition. (D.I. 19; see also D.I. 15 at ¶ 1 (incorporating substantially all of D.I. 19 into D.I. 15 by reference). This brief responds to the opposition to the petition to enforce the summons, (D.I. 15), as well as the arguments incorporated into that opposition. (See D.I. 15 at ¶ 1 (incorporating D.I. 19 at 7-18)). The United States will oppose the motions (D.I. 16) in a separate filing.

2“The requisite showing is generally made by affidavit of the agent who issued the summons and who is seeking enforcement.” Garden State Nat. Bank, 607 F.2d at 68 (citing United States v. McCarthy, 514 F.2d 368, 372 (3d Cir. 1975)). Accord Sugarloaf Funding, LLC v. U.S. Dep't Of The Treasury, 584 F.3d 340, 345 (1st Cir. 2009) (“An affidavit of the investigating agent that the Powell requirements are satisfied is sufficient to make the prima facie case.”).

3The IRS is bound by its own comprehensive anti-disclosure statute, 26 U.S.C. § 6103.

4The United States vigorously denies any suggestion in DDOI's papers that the United States demonstrated a lack of candor towards the Court. As explained in this section, the statement that the United States lacks possession of DDOI's records is accurate. The United States does not possess DDOI's records at issue here. While the IRS received records from persons other than DDOI, such as Artex, those are not DDOI's records. The United States' papers were clear on that point.

5The information DDOI provides would be return information as it is collected by the IRS during an exam of Artex's and Tribeca's liabilities. See 26 U.S.C. § 6103(b)((2).

6The United States addresses DDOI's suggestion of conditional enforcement by way of protective order in its Opposition to DDOI's Motion to Quash also filed today.

7Section 7602 is a means of obtaining information to allow the IRS to examine compliance with Internal Revenue Code provisions dealing with taxation of insurancecompanies, such as § 831(b) concerning micro-captive insurance companies, the promotion of which is under examination here.

8Sabo acknowledged that this inquiry originally came from the Supreme Court's analysis of the antitrust subsection of the McCarran-Ferguson Act, which provides that federal antitrust law shall apply to “the business of insurance.” Sabo, 137 F.3d at 191. Here, as in Sabo, the court must analyze the first clause of section 1012(b), which focuses on non-antitrust laws enacted “for the purpose of regulating the business of insurance.” 15 U.S.C. § 1012(b). Accordingly, more activities of insurance companies will be covered by the first subsection, as it is not limited to just the “business of insurance.” Thus, “the analysis here is broader” than one would find in a case analyzing the antitrust provision. Sabo at 191 n. 3 (quoting 15 U.S.C. § 1012(b)).

9The Tax Court examined transactions similar to the transactions at issue here using similar criteria and concluded that the indicia of insurance were missing. Avrahami, 149 T.C. at 179-180; Reserve Mech. Corp., 2018 WL 3046596, at *16; Syzygy, 2019 WL 1559540, at *45 (Tax Ct. 2019).

10The Court did not address the third factor, i.e., whether the practice is limited to entities within the insurance industry.” Sabo, 137 F.3d at 191. Nevertheless, it is clear that Delaware's practice of refusing to disclose documents it maintains is not limited to the insurance community. See, e.g., 24 Del. C. § 1768 (records related to medical board proceedings to be held confidentially and not subject to subpoena); 11 Del. C. § 9503 (records related to victim-offender alternative case resolution to remain confidential); 29 Del. C. § 7996 (names of individuals participating in sterile needle and syringe exchange program to remain confidential); 5 Del. C. § 2416 (diagnosis or treatment of congenital disability to remain confidential); 31 Del. C. § 3912 (records and information held by Delaware related to adult protective services to be kept confidential). Even if this Court were to find this factor favors Delaware, this one factor should not outweigh the others.

11DDOI notes this Court recently issued an opinion that only set forth three of the four factors. In re Patriot Nat'l, 623 B.R. 696, 709 (D. Del. 2020). But the district court opinion did not cite Highmark, giving that opinion limited persuasive authority on this point.

12DDOI offers conclusions about the legislative history of its statute through a declarant, but any conclusions as to the legislative history beyond the statements of the legislature made by the declarant are his own conclusions, and certainly not facts. See, e.g., Kaplan v. Chertoff, 481 F. Supp. 2d 370, 386 n. 15 (E.D. Pa. 2007) (court refusing to allow individuals “to opine on legislature's intent” as to the meaning of a statute).

13Further, because section 7602 does not impact Delaware's laws on matters related to corporate structures, licensing, and capitalization, reverse preemption does not apply because section 7602 would not “invalidate, impair, or supersede” those laws. 15 U.S.C. § 1012(b).

END FOOTNOTES

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