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February 2013

Freeman Invs., L.P. v. Pac. Life Ins. Co. - Contract Claims In Putative Class Action Related to the Sale of Variable Life Policy Are Not Precluded By the Securities Litigation Uniform Standards Act Where the Claims Do Not Rest on a Misrepresentation or Fraudulent Omission

(January 2, 2013) ___ F.3d ___ ; 13 C.D.O.S. 60

In Freeman Invs., L.P. v. Pac. Life Ins. Co., the U.S. Court of Appeals for the Ninth Circuit reversed the district court’s dismissal of the plaintiffs’ contract claims, holding that their claims for breach of contract and breach of the duty of good faith and fair dealing were not barred by the Securities Litigation Uniform Standards Act (SLUSA), although the claims were related to the purchase or sale of a covered security. The court’s Jan. 2 reversal was conditioned on the plaintiffs amending their complaint to eliminate references to deliberate concealment or fraudulent omission. The dismissal of the plaintiffs’ claim for unfair competition in violation of California law was affirmed.

The plaintiffs were policyholders of variable life insurance policies issued by defendant Pacific Life Insurance Co. Part of the policyholders’ premiums were in a separate account that the defendant was to use to fund the variable life insurance contracts. The value of the account changes over time and is registered with the Securities and Exchange Commission. The defendant collected a monthly “cost of insurance” by trading in units of the plaintiffs’ separate accounts.

The plaintiffs claimed that the fees charged by defendant were excessive and filed a class action in federal district court alleging breach of contract, breach of the duty of good faith and fair dealing, and unfair competition under California Business and Professions Code §17200. The plaintiffs also claimed that since the defendant concealed the monthly charges in their quarterly statements, the statute of limitations should toll such that the plaintiffs were entitled to charges collected during the entire policy period. The defendant filed a motion to dismiss on the basis that the action was precluded by the SLUSA, which bars class actions based on state law alleging misrepresentation or omission in connection with the purchase or sale of a covered security.

The district court granted the defendant’s motion to dismiss after allowing the plaintiffs to amend their complaint twice. The district court found that although the plaintiffs had removed references to concealment and deceit, the “substance” of their complaint did not change.

The plaintiffs appealed. The Ninth Circuit first analyzed whether the plaintiffs’ claims alleged a misrepresentation or omission. The court looked to the substance of the plaintiffs’ allegations and found that they alleged the defendant overcharged them for life insurance, which resulted in a decrease in value of their investments. This dispute was based on the meaning of “cost of insurance,” which the plaintiffs claimed was a term of art that should have been calculated according to industry standards. Since the plaintiffs were disputing a contract term, to prevail they needed to convince the court to adopt their interpretation of that term. Therefore, the plaintiffs did not need to show a misrepresentation or omission on the defendant’s part to prevail. As a result, the plaintiffs’ contract claims did not “rest” on a misrepresentation or fraudulent omission.

Next, the court analyzed whether the plaintiffs’ tolling argument constituted an allegation of a fraudulent omission. The court deconstructed the plaintiffs’ argument into two pieces: First, the plaintiffs claimed a breach of contract, and second, they claimed the defendant hid the breach. The court found the concealment of the breach did not convert the breach itself into a fraudulent concealment claim. Nonetheless, the court noted the plaintiffs should remove any allegations of active concealment from their complaint.

Next, the court considered the plaintiffs’ claim under California Business and Professions Code §17200, which defines “unfair competition” as “any unlawful, unfair or fraudulent business act or practice.” The court found that SLUSA barred this claim unless the conduct was not “in connection with” the purchase or sale of a covered security. The court noted that a variable life insurance policy has qualities of an insurance product and an investment security, however, plaintiffs could avoid preclusion under SLUSA if their claims target only the insurance side of the policy. The court found that the plaintiffs’ claims “coincided” with the sale of securities because when the defendant charged its monthly fee, it redeemed units of a separate investment fund. As a result, each sale “coincided” with a sale of security and decreased the investment value. The court rejected the plaintiffs’ argument that they lacked standing to bring a private securities fraud action because they were defrauded after the sale of the policy. Since the defendant’s alleged fraud “coincided” with the sale of securities, the “in connection with” requirement under SLUSA was satisfied and the claim was barred.

Lastly, the court addressed the plaintiffs’ argument that their complaint should not have been dismissed with prejudice and that they should be allowed to bring their claims individually. The court noted that since SLUSA bars only class actions, the district court should not have dismissed their claims with prejudice if the plaintiffs had viable individual claims. The court analyzed the plaintiffs’ complaint and found that they twice classified themselves as a class action and never referenced individual claims. Furthermore, the plaintiffs did not allege that their individual claims satisfied the amount in controversy required for federal diversity jurisdiction. Since the court was remanding the case for the plaintiffs to amend their complaint, the court allowed the plaintiffs leave to amend their complaint to state individual claims.

The dismissal of the plaintiffs’ contract claims was reversed on the condition that they eliminate references to deliberate concealment and fraudulent omission, whereas the dismissal of the unfair competition claim was affirmed. The court remanded the case with instructions that the district court allow the plaintiffs to amend their complaint.

Click here for the opinion.

This opinion is not final. It may be modified on rehearing or review may be granted by the U.S. Supreme Court. These events would render the opinion unavailable for use as legal authority.

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Jordan S. Altura

Life, Health & Disability