Appendix — Nimmo v. Grainger

A-l

PRINCIPAL STATUTES AND RULES INVOLVED

Section 2(1) of the 1933 Act (15 U.S.C. 77b(1)) —

“Sec. 2. When used in this title, unless the context other-

wise requires —

(1) The term ‘security’ means any note, stock, treasury

stock, bond, debenture, evidence of indebtedness, certificate

of interest or participation in any profit-sharing agreement,

collateral-trust certificate, preorganization certificate or

subscription, transferable share, investment contract, vot-

ing-trust certificate, certificate of deposit for a security,

fractional undivided interest in oil, gas, or other mineral

rights, or, in general, any interest or instrument commonly

known as a ‘security,’ or any certificate of interest or par-

ticipation in, temporary or interim certificate for, receipt

for, guarantee of, or warrant or right to subscribe to or pur-

chase, any of the foregoing.”

Section 3 (a) (8) of the 1988 Act (15 U.S.C. 77c (a) (8)) —

“Sec. 3(a) Except as hereinafter expressly provided, the

provisions of this title shall not apply to any of the follow-

ing classes of securities:

* *

(8) Any insurance or endowment policy or annuity con-

tract or optional annuity contract, issued by a corporation

subject to the supervision of the insurance commissioner,

bank commissioner, or any agency or officer performing

like functions, of any State or Territory of the United States

or the District of Columbia;”

Section 3 (a) (10) of the 1934 Act (15 U.S.C. 78c (a) (10) ) —

“Sec. 3(a) When used in this title, unless the context

otherwise requires —

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(10) The term ‘security’ means any note, stock, treasury

stock, bond, debenture, certificate of interest or participa-

tion in any profit-sharing agreement or in any oil, gas, or

other mineral royalty or lease, any collateral-trust certifi-

cate, preorganization certificate or subscription, transfer-

able share, investment contract, voting-trust certificate,

certificate of deposit, for a security, or in general, any in-

strument commonly known as a ‘security’; or any certificate

of interest or participation in, temporary or interim certifi-

cate for, receipt for, or warrant or right to subscribe to or

purchase, any of the foregoing; but shall not include cur-

rency or any note, draft, bill of exchange, or banker's ac-

ceptance which has a maturity at the time of issuance of not

exceeding nine months, exclusive of days of grace, or any

renewal thereof the maturity of which is likewise limited.”

Section 10(b) of the 1984 Act, 15 U.S.C. 78j(b) —

“Sec. 10. It shall be unlawful for any person, directly or

indirectly, by the use of any means or instrumentality of

interstate commerce or of the mails, or of any facility of any

national securities exchange —

‘‘(b) To use or employ, in connection with the purchase

or sale of any security registered on a national securities ex-

change or any security not so registered, any manipulative

or deceptive device or contrivance in contravention of such

rules and regulations as the Commission may prescribe as

necessary or appropriate in the public interest or for the

protection of investors.”

Rule 10b-5 of the Securities and Exchange Commission —

“Reg. §240.10b-5. It shall be unlawful for any person,

directly or indirectly, by the use of any means or instru-

A-3

mentality of interstate commerce, or of the mails, or of any

facility of any national securities exchange —

(a) to employ any device, scheme, or artifice to defraud,

“(b) to make any untrue statement of a material fact or to

omit to state a material fact necessary in order to make the

statements made, in the light of the circumstances under

which they were made, not misleading, or

“(c) to engage in any act, practice, or course of business

which operates or would operate as a fraud or deceit upon

any person, in connection with the purchase or sale of any

security.” [Adopted in Release No. 34-3230, May 21, 1942,

13 F.R. 8177.]

McCarran-Ferguson Act, 15 U.S.C. 1012 —

“(a) The business of insurance, and every person en-

gaged therein, shall be subject to the laws of the several

States which relate to the regulation or taxation of such

business.

“(b) No Act of Congress shall be construed to invali-

date, 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: Pro-

vided, That after June 30, 1948, the Act of July 2, 1890, as

amended, known as the Sherman Act, ai. the Act of Octo-

ber 15, 1944, as amended, known as the Clayton Act, and

the Act of September 26, 1914, known as the Federal Trade

Commission Act, as amended, shall be applicable to the

business of insurance to the extent that such business is not

regulated by State law.”

Illinois Revised Statutes, Sec. 845 of Insurance Code —

“After the calendar year during which this code becomes

effective, no Life company authorized to do business in this

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State shall issue both participating and non-participating

policies unless at least 90 percentum of the profits on its

participating policies shall inure to the benefit of the par-

ticipating policy-holders. Any company having in force

both participating and non-participating policies shall keep

a separate accounting for each class of business and shall

make and include in the annual statement to be filed with

the Director each year, a separate statement showing the

gains, losses, and expenses properly attributable to each of

such classes and also showing the manner in which any gen-

eral outlay of expense of the company has been apportioned

to each except that this provision shall not apply to any

company in which 90 percentum or more of the business in

force is either participating or non-participating. This sec-

tion shall not apply to business done by such Life company

outside this State, nor to paid-up, or temporary insurance

or pure endowment benefits issued or granted pursuant to

the non-forfeiture provision prescribed in Clause (g) of

Sub-Section (1) ‘of Section 2241 nor to annuities or poli-

cies of re-insurance.”” As amended by Act approved June

13, 1957.

A-5

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 75-3061

D. C. Docket No. CA 69-452

CHARLES L. GRAINGER, ET AL.,

Plaintiffs-A ppellants,

versus

STATE SECURITY LIFE INSURANCE

COMPANY, ET AL..,

Defendants-A ppellees.

Appeal from the United States District Court for the

Northern District of Alabama

Before GODBOLD, McCREE* and TJOFLAT,

Circuit Judges.

JUDGMENT

This cause came on to be heard on the transcript of the

record from the United States District Court for the North-

ern District of Alabama, and was argued by counsel;

ON CONSIDERATION WHEREOF, It is now here

ordered and adjudged by this Court that the judgment of

the said District Court in this cause be, and the same is

hereby, reversed in part and vacated in part, and that this

cause be and the same is hereby remanded to the said Dis-

trict Court for further proceedings in accordance with the

opinion of this Court;

It is further ordered that defendants-appellees pay to

plaintiffs-appellants, the costs on appeal to be taxed by the

Clerk of this Court.

February 18, 1977

Issued as Mandate:

*Of the Sixth Circuit, sitting by designation.

A-6

CORRECTED

Charles S. GRAINGER et al., on behalf of themselves and

all other similarly situated Purchasers of ‘Variable In-

vestment Plan’’ Contracts Issued and Sold by Great States

Life Insurance Company, Plaintiffs-Appellants,

v.

STATE SECURITY LIFE INSURANCE

COMPANY et al.,

Defendants-Appellees.

No. 75-3061.

United States Court of Appeals, Fifth Circuit.

Feb. 18, 1977.

Appeal from the United States District Court for the

Northern District of Alabama.

Before GODBOLD, McCREE,* and TJOFLAT, Circuit

Judges.

GODBOLD, Circuit Judge:

This case involves the issue of whether contracts sold by

an insurance company are “‘securities” for purposes of the

Securities Acts of 1933 and 1934." The district court held

that as a matter of law the contracts were insurance and not

securities and therefore were not within the purview of the

Securities Acts, and entered a Rule 54(b) judgment for

defendants. Also the court denied the request of plaintiffs

to certify a class consisting of all purchasers of the contracts.

We reverse the judgment for defendants dnd vacate the re-

fusal to certify the class."

*Of the Sixth Circuit, sitting by designation.

115 U.S.C. §§ 77a-78kk.

18This is a companion case to Hilgeman v. National Insurance Company

of America, (CA5, 1977) No. 75-1724, slip opinion p. ., . F.2d ___,

decided this date.

A-7

In the early 1960's Great States Insurance Company was

marketing what it termed “Variable Investment Plan” con-

tracts (“VIP contracts’). These contracts were, at least in

form, similar to participating coupon policies.» The VIP

contracts sold to plaintiffs allegedly incory »rated as part of

their terms a section of the Illinois insurance laws which

required companies offering both participating and non-

participating policies to keep separate accounts and to allo-

cate 90% of their “profits” on their participating policies

to the benefit of their participating policyholders.

Each named plaintiff purchased one or more VIP con-

tracts. Later Great States adopted a drastically reduced

scale of dividends on its VIP contracts. Plaintiffs brought a

class action against State Security Life Insurance Company

(the successor to Great States through a statutory merger) ,

and L. M. Nimmo and Nimmo and Associates, Inc., as con-

trolling persons of Great States, alleging: (a) violations of

§ 5 of the 1933 Act by the failure to register the VIP con-

tracts; (b) violations of § 17 of the 1933 Act, and § 10 (b)

of the 1934 Act and Rule 10b-5 thereunder, 17 C.F.R.

~ 9A participating policy is aiuiain aetiie tea ee en

holders based upon company earnings, so that net cost is determined by

deducting the amount of such dividends from the gross premiums.” 1 J.

Appleman & J. Appleman, Insurance Law and Practice, § 9 (1965).

The authors of this treatise go on to describe coupon policies in the fol-

lowing terms:

“Coupon policies are usually considered to be nonparticipating in

form, but, with the legal incidents usually attached thereto, they would

seem properly to belong in the class of participating contracts. The rate

is usually the same as for the latter group. The contract has inserted in

Sn Oe ene ee

is paid. This may be sent to the company together with a remittance

for the balance of the premium. The coupons often are graduated in

amount, increasing in the same degree that ordinary dividends would

increase, and interest is figured thereon at the company’s regular rate.

“Thus, it is usually considered that if the insured fails to clip such a

coupon and instead sends the full amount of the premium to the com-

pany, he has elected to permit it to remain at interest, and no further

action on his part is usually required.”

Id. at § 10.

A-8

240.10b-5 (1976), in mailing material misrepresentations

to buyers in connection with the sale of the VIP contracts;

(c) common law fraud in connection with the sale of the

VIP contracts; (d) breach of the VIP contract; and (e) vio-

lations of the anti-fraud and proxy provisions and rules of

the 1934 Act and common law fraud, in connection with

the 1968 merger between State Security and Great States.*

[1] Defendants filed motions to dismiss, to quash service

of process and to block discovery. The court overruled the

motion of State Security to dismiss the common law fraud

and breach of contract claims against it. It also overruled all

motions of defendants concerning the claims relating to the

1968 merger. The court granted the motions of Nimmo and

Nimmo and Associates to dismiss the common law fraud and

breach of contract claims stemming from the sale of the VIP

contracts. None of these rulings have been appealed. Two

rulings which the court made are now before us. First, it

dismissed all federal Securities Act claims arising out of the

sale of the VIP contracts against all three defendants on the

ground that the contracts were not covered by the Acts be-

cause they were insurance contracts, and thus the plaintiffs

had failed to state a claim upon which relief could be

granted. The court, under Rule 54 (b), directed entry of

judgment for the defendants on these federal Securities Acts

claims. The court also denied plaintiffs’ motion to certify

a class consisting of VIP contract holders.‘

[2] Generally, conventional life insurance policies are

not securities for purposes of the federal Securities Acts.

This view is supported by the legislative history of the 1933

8At least one of the plaintiffs was also a shareholder of Great States.

*The class determination is appealable under the general rule that “in-

terlocutory orders from which no appeal lies are merged into the final

judgment and open to review on appeal from that judgment.” Monarch

Asphalt Sales Co., Inc. v. Wilshire Oil Co., 511 F.2d 1078, 1077 (CA10,

1975); 7A Wright & Miller, Federal Practice & Procedure § 1802 at 270

(1972) .

A-9

Act,® by the leading commentators in the securities law

field, L. Loss, Securities Regulation, 496-501 (1961); 2 A.

Bromberg, Securities Law: Fraud § 6.5(1) n. 92 at 134

(1968) ; and by dictum in the Supreme Court’s decision in

Tcherepnin v. Knight, 389 U.S. 332, 88 S.Ct. 548, 19 L.Ed.

2d 564 (1967) .°

However, as Professor Loss has noted, the concept of in-

surance is really a continuum ranging from one year term

insurance, which is clearly pure insurance, through variable

annuities to mutual fund shares and common stocks, which

are equally clearly securities. L. Loss, Securities Regulation

2534 (1969 Supp.) . Thus, various items which have usually

been denominated “insurance” have been found to be “‘se-

curities” for purposes of the federal Securities Acts. For

example, in S.E.C. v. United Benefit Life Insurance Com-

pany, 387 U.S. 202, 87 S.Ct. 1557, 18 L.Ed.2d 673 (1967),

and S.E.C. v. Variable Annuity Life Insurance Company,

359 U.S. 65, 79 S.Ct. 618, 3 L.Ed.2d 640 (1959), the Su-

preme Court held that flexible fund or variable annuities

are securities and are therefore subject to the provisions of

the Securities Acts.”

5In the House Report on the 1933 Act it was clearly stated that “. . . in-

surance policies are not to be regarded as securities subject to the provi-

sions of the act.” HR Rep. No. 85, 73rd Cong., Ist Sess. 15 (1933).

*In Tcherepnin the Court pointed out that Congress had specifically

stated that “ ‘insurance policies are not to be regarded as securities subject

to the provisions of the act . . and the exemption from registration for

insurance policies was clearly supererogation.’” 389 U.S. at 342-43, n. 30,

88 S.Ct. at 556, 19 L.Ed.2d at 572-73, n. 30 [cites omitted].

Justice Brennan, in his concurring opinion in S.£.C. v. Variable Annuity

Life Ins. Co., 359 U.S. 65, 79 S.Ct. 618, 3 L.Ed.2d 640 (1959), made vir-

tually the same point when he said that “[ujnder the Securities Act, it

would appear that in the case of the ordinary insurance policy, the ex-

emption would be just comfirmatory of the policy's noncoverage under

the definition of security.” 359 U.S. at 74, n. 4, 79 S.Ct. at 623, $8 L.Ed.2d

at 646, n. 4 [cites omitted].

™More recently the Securities and Exchange Commission has ruled that

variable death benefit life insurance policies are also “securities.” Securi-

ties Act Release No. 33-5360 Fed.Sec.L.Rep. [1972-73 Decisions] ¢ 79,207.

A-10

[3] The court below compared the VIP contracts with

the policies involved in Variable Annuity and United Ben-

efit and found the VIP contracts different because they

provided for what the court termed a “significant” fixed

death benefit of $10,000. The comparison of policies was

proper, but the court could not stop at this point. In mak-

ing a determination of what exactly was being offered by the

Great States salesmen it was required to consider the meth-

ods used in selling the contracts.

In S.E.C. v. Joiner Leasing Corp., 320 U.S. 344, 64 S.Ct.

120, 88 L.Ed. 88 (1943) the Court held that in determining

if an instrument is an investment contract, and therefore a

security, “the terms of offer, the plan of distribution and

the economic inducements held out to the prospect’”’ were

all relevant factors to be considered. 320 U.S. at 353, 64

S.Ct. at 124, 88 L.Ed. at 94. The Court went on to say that

“fijn the enforcement of an Act such as [the 1933 Act] it

is not inappropriate that promoters’ offerings be judged as

being what they were represented to be.” Id. [emphasis

added]. Numerous lower courts have correctly interpreted

this language from Joiner as justifying a consideration of

advertising and promotional efforts in ascertaining that

items which intuitively would not seem to be securities are,

in reality, securities within the meaning of the federal Acts,

e. g., Miller v. Central Chinchilla Group, Inc., 494 F.2d

414, 417 (CA8, 1974) (chinchillas); Glen-Arden Com-

modities, Inc. v. Costantino, 493 F.2d 1027, 1034-35 (CA2,

1974) (Scotch whisky receipts); S.£.C. v. Brigadoon

Scotch Distributors, Ltd., 388 F.Supp. 1288, 1290 (S.D.

N.Y., 1975) (rare coins) ; S.£.C. v. Haffenden-Rimar, 362

F.Supp. 323, 325 (E.D.Va., 1973), aff'd 496 F.2d 1192

(CA4, 1974) (Scotch whisky). Indeed, the Supreme Court

itself in United Benefit examined the advertising used to

sell the “policies” at issue in making its determination that

A-11

the appellee was selling investment contracts and not in-

surance.®

[4] While the district court recognized the authority of

Joiner and the subsequent “‘advertising”’ cases, it attempted

to limit their scope by formulating a rule that advertising

and promotional efforts can be used to determine the char-

acter of an instrument only where that instrument is not

clear on its face. In essence, the district court read into the

Securities Acts a parol evidence rule. We think that inter-

pretation cannot be sustained. First, neither Joiner nor any

of the lower court “advertising” cases (with one possible

exception) make use of the parol evidence rule in deter-

mining whether an item is a security.? More important,

however, use of a parol evidence rule leads a court to focus

on the wrong question. The proper question before the

district court was not “what is the correct interpretation of

the VIP contracts?” but “what were defendants purporting

to sell to plaintiffs?’""* The parol evidence rule may have

some application to the former question. It is not relevant

to the latter question." Therefore, the district court must

8Speaking for a unanimous Court Justice Harlan noted that,

“United's primary advertisement for the ‘Flexible Fund’ was headed

‘New Opportunity for Financial Growth.’ United's sales aid kit included

displays emphasizing the possibility of investment return and the ex-

perience of United’s management in professional investing.”

387 U.S. at 211, n. 15, 87 S.Ct. at 1562, 18 L.Ed. at 679, n. 15.

*The district court cited Chapman v. Rudd Paint & Varnish, 409 F.2d

635 (CA9, 1969), as authority for its use of the parol evidence rule. How-

ever, the language in Chapman concerning the consideration of promo-

tional advertising is dicta, for the Ninth Circuit did in fact examine the

relevant advertising material in making a determination that a franchise

arrangement was not a security.

Cf. Goodman v. H. Hentz & Co., 265 F.Supp. 440, 444 (N.D.IIL, 1967)

where sale of nonexistent securities was held to violate Rule 10b-5.

11Even if we were to hold that the parol evidence rule applied in the

case before us, it still by its own terms would not operate to bar evidence

of the oral representations made by Great States salesmen. First, plaintiffs’

10b-5 cause of action is a fraud-based cause of action. Cf. Ernst and Ernst

v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). Tradi-

A-12

in making a determination of whether the VIP contracts

were securities take into account all the circumstances at-

tending the sale of the VIP contracts, including the provi-

sion of Illinois law allegedly incorporated into the contract.

[5] We also have substantial doubts about the signifi-

cance which the district court attributed to the death bene-

fit on the VIP contracts. The mere presence of a death

benefit of $10,000, or for that matter any given dollar

amount, cannot conclusively establish that the insurance

features of a particular contract are not simply window

dressing on what is essentially an investment contract. Con-

sideration must be given not only to the amount of the

death benefit but also to the relationship between the size

of the death benefit and the size of ‘“‘premium’’ payments.

A showing that the “premiums” were disproportionately

high (in terms of insurance industry norms) in relation to

the amount of the death benefit would be persuasive evi-

dence that the VIP contracts were not being bought and

sold for their insurance features, i. ¢., as insurance policies,

but for their future “dividends,” i. ¢., as investment con-

tracts.”

[6] The district court held that class action was not ap-

propriate on the VIP contract fraud claims because the

claims depended upon the particularized representations

made to each class member. It is true that a class action is

tionally, the parol evidence rule will not operate to exclude parol evidence

introduced to show fraud. Restatement of Contracts § 238(b), (1932).

Moreover, many of the words in the VIP contracts such as “dividend” and

“investment” possess a variety of meanings, and, generally speaking, parol

evidence is admissible for the purpose of interpreting ambiguous language

in contracts. Id. at § 233.

12Data on premium/death benefit ratios in participating life policies can

be found. For example, such data was gathered by the SEC in formulating

its now-rescinded Rule 3c-4 and incorporated therein in the form of a

minimum multiple scale. We do not express any view on the substance of

that no longer operational rule. We mention it merely to point out the

availability of relevant data.

A-13

usually inappropriate in a securities fraud case where oral

misrepresentations are involved. As we said in Simon v.

Merrill Lynch, Pierce, Fenner and Smith, 482 F.2d 880 at

882 (CA5, 1973) :

If there is any material variation in the representations

made or in the of reliance thereupon, a fraud

case may be unsuited for treatment as a class action.

See Rule 23. Advisory Committee’s Official Note, 39

F.R.D. 98, 107 (1966). Thus, courts usually hold that

an action based substantially, as here, on oral rather

than written misrepresentations cannot be maintained

as a Class action.

However, as this quote indicates, the key concept in deter-

mining the propriety of class action treatment is the exis-

tence or nonexistence of material variations in the alleged

misrepresentations. It is possible, although unlikely, that

oral misrepresentations can be uniform, ¢. g., through use

of a standardized sales pitch by all the company’s salesmen.

Plaintiffs in the present case should be given the opportu-

nity to demonstrate the existence and use of such a device.

If plaintiffs cannot do this, then the district court may quite

properly refuse to certify a class on the grounds that com-

mon questions of law or fact do not predominate.

We therefore vacate the denial of class status to VIP con-

tract holders.

REVERSED in part, VACATED in part, and RE-

MANDED for further proceedings.

A-14

Charles $. GRAINGER et al.,

Plaintiffs-Appellants,

v.

STATE SECURITY LIFE INSURANCE

COMPANY et al.,

Defendants-Appellees.

No. 75-3061.

United States Court of Appeals, Fifth Circuit.

Nov. 17, 1977.

Appeal from the United States District Court for the

Northern District of Alabama.

Before BROWN, Chief Judge, and THORNBERRY,

COLEMAN, GOLDBERG, AINSWORTH, GODBOLD,

MORGAN, CLARK, RONEY, GEE, TJOFLAT, HILL

and FAY, Circuit Judges.

BY THE COURT:

IT IS ORDERED by the court that the order entered on

May 25, 1977, 5 Cir., 553 F.2d 1008, for a rehearing of this

case en banc is hereby vacated, and the case is remanded to

the panel.

JAMES C. HILL, Circuit Judge, dissenting.

ON PETITION FOR REHEARING

Before GODBOLD and TJOFLAT, Circuit Judges.*

PER CURIAM:

In their petition for rehearing appellees L. W. Nimmo

and Nimmo & Associates, Inc., protest that our decision

means that an endowment insurance policy containing what

they describe as “a commonly used provision” for the pol-

*Former Circuit Judge McCree, a member of the original panel, did not

participate in this decision.

A-15

icyholder’s participating in surplus can be found to be a

security by reason of methods used in its sale. This charac-

terization of our decision is not correct. We did not hold

that participating life insurance policies in general are se-

curities or even that the particular contracts in this case are

securities. What we have held is that the district court must

consider, along with the provisions of the VIP contracts

themselves, the totality of the circumstances surrounding

their sale, including any oral representations made, in deter-

mining whether defendants were selling securities.

“Endowment policies” vary in their terms and provisions,

and participation clauses differ also. In this instance, as

pointed out in our opinion the contract in issue is named

‘Variable Investment Plan” (emphasis added) . It purports

to guarantee the purchaser “90%, of divisible surplus earn-

ings.”” Attached coupons physically resemble coupons often

attached to bonds. Also, without indicating any views on

the relationship between the size of the death benefit and

the size of premium payments in the VIP contracts, we

pointed out that this relationship is a proper factor for con-

sideration by the district court (as opposed to the substan-

tiality of the death benefit, considered in isolation) in de-

termining whether the facial characteristics of the contracts

plus the circumstances of their sale caused them to be se-

curities.

The petition for rehearing is DENIED.

A-16

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 75-3061

CHARLES S. GRAINGER, ET AL.,

Plaintiffs-A ppellants,

versus

STATE SECURITY LIFE INSURANCE

COMPANY, ET AL.,

Defendants-A ppellees.

Appeal from the United States District Court for the

Northern District of Alabama

(Filed December 12, 1977)

Before BROWN, Chief Judge and THORNBERRY,

COLEMAN, GOLDBERG, AINSWORTH, GODBOLD,

MORGAN, CLARK, RONEY, GEE, TJOFLAT, HILL,

and FAY, Circuit Judges.

BY THE COURT:

IT IS ORDERED that the petition for reconsideration

of vacation of rehearing en banc filed by appellees, Leslie

W. Nimmo and Nimmo and Associates, Inc., is DENIED.

ENTERED FOR THE COURT:

/s/ Joun C. GopBoLp

UNITED STATES CIRCUIT JUDGE

A-17

In the United States District Court for the Northern

District of Alabama, Southern Division

Charles S. Grainger, et al.,

)

Plaintiffs.)

)

vs. ) Civil Action

) No. 69-452

State Security Life Insurance Com- )

pany, et al., )

Defendants. )

)

ORDER

(Filed June 20, 1972)

The above-styled cause is presently under submission on

the following motions filed in behalf of the respective par-

ties hereto: (1) motion of defendant, State Security Life

Insurance Co., to dismiss the complaint; (2) motions of

defendants, L. W. Nimmo and Nimmo & Associates, Inc.,

to quash service of process or in the alternative to dismiss

the complaint; (3) motion of defendant, State Security Life

‘nsurance Co., to require plaintiffs to post security for costs;

(4) motion of plaintiffs for an order determining that this

suit may be maintained as a class action; and (5) motion

of plaintiffs for an order requiring production of docu-

ments by defendants.

In the exercise of its discretion, the Court elects to treat

the motion to dismiss filed in behalf of each defendant as a

motion for summary judgment and to allow all parties 20

days from the date of this order within which to submit

any affidavits or other documentary evidence which they

may deem relevant to the disposition of the following issue:

A-18

whether the “Variable Investment Plan” contracts is-

sued to plaintiffs by Great States Life Insurance Co. or

its successor in interest, State Security Life Insurance

Co., constitute “securities” within the ambit of § 2 (1)

of the Securities Act of 1938, 15 U.S.C.A. § 77 (b) (1)

(1971) or § 3(10) of the Securities Exchange Act of

1934, 15 U.S.C.A. § 78(c) (10) (1971).

All motions other than defendants’ motions to dismiss will

remain under submission pending resolution of the ques-

tion raised on motion for summary judgment.

It is so ordered.

Done this 20th day of June, 1972.

SEYBOURN H. LYNNE

Chief Judge

ORDER*

(Filed June 5, 1975)

This cause has been before this Court on motions to dis-

miss, to quash, and for summary judgment. The Court has

had the benefit of extensive briefs and learned oral argu-

ments from counsel.

Company, successor to Great States by a merger and which plain-

tiffs’ claim was controlled by Mr. Nimmo. The District Court ound

that Mr. Nimmo was not in control of State Security nor was he a

icipant in any securities law violation (A-52-3); but it held

that the claim of plaintiffs based on an alleged conspiracy was not

subject to motion to dismiss. No final judgment was entered nor

appeal taken from the order on these latter counts, which are dis-

cussed in Parts I1B and VB of the following memorandum opinion.

Consequently, that of the action was not before the Fifth Cir-

cuit and would not be brought before this Court for review.)

A-19

Upon consideration of the analyses of counsel, the Court

is of the opinion that the attached memorandum prepared

by its law clerk, E. Mabry Rogers, correctly states both the

law and the facts on this complex action, and the Court

wholly adopts it as its opinion. In conformity with such

memorandum, which the Court deems to be of obviously

superior quality in its exhaustive and analytical discussion

of subtle issues advanced by ingenious counsel,

It is Ordered, Adjudged and Decreed by the Court that

(a) Plaintiffs’ claims against all defendants based upon

the theory that the “V.I.P.” contracts are “securities”

(Counts 1, 2, and 3 of the complaint) , be and the same are

hereby dismissed for failure to state a claim under the Se-

curities Exchange Act of 1934, the Securities Act of 1933,

or the Securities Act of Alabama. There is no just reason

for delay in entering a final judgment as to this claim, so

that the Clerk is hereby Ordered to enter final judgment

hereon pursuant to F.R.Civ.P. 54 (b) ;

(b) Defendant State Security's motion to dismiss the

breach of contract and common law fraud claims (Counts

4, 5, and 6 of the complaint), is overruled insofar as the

simple failure to state a claim is involved;

(c) The motions of defendants Nimmo and Nimmo and

Associates, Inc., to dismiss the common law fraud and

breach of contract claims as to the “V.I.P.” contracts are

granted for failure to state a claim as to these defendants;

(d) The motions of all defendants to dismiss the counts

alleging fraud, both of the common law and of the federal

statutory varieties as to the 1968 merger, are overruled;

(e) The motions of defendants Nimmo and Nimmo and

Associates, Inc., to quash as to the counts concerning the

1968 merger are overruled; and

(f) The motion of plaintiffs to certify a class as to the

“V.LP.” contracts is overruled, since the common questions

A-20

of law do not predominate over the questions affecting in-

dividual members only. The Court reserves a ruling on the

class allegations regarding the 1968 merger and requests

counsel to develop the issue in due course.

Done this 5th day of June, 1975.

SEYBOURN H. LYNNE

Senior Judge

MEMORANDUM

(Filed June 5, 1975)

TO: Judge Seybourn H. Lynne

FROM: E. Mabry Rogers, Law Clerk

RE: Grainger v. State Security Life Insurance Co., Civil

Action No. 69-452, Pending Motions

I. PROCEEDINGS TO DATE.

On July 15, 1969, plaintiffs instituted this action on be-

half of themselves and of the classes they purported to rep-

resent. In their complaint, they allege five basic causes of

action:*

(1) That defendant State Security Life Insurance

Company (‘State Security”) conspired with defen-

dants L. W. Nimmo (“Nimmo”) and his corporation,

Nimmo & Associates, Inc. (“Nimmo Inc.”) , to defraud

Great States Life Insurance Co. (“Great States”) and

its public, minority shareholders by a scheme and con-

spiracy whereby Nimmo agreed to sell his stock, and

e stock held by Nimmo, Inc., of Great States at a

price far in excess of its market value (or book value)

to State Security on the understanding that State Se-

'This characterization of the complaint is taken from the brief filed

herein by plaintiffs on November 4, 1969.

A-21

curity would then be caused to merge with Great

States. Thereby Great States and its es share-

holders would be obligated to assume the debt in-

curred to buy out Nimmo and Nimmo Inc. The cause

of action here is predicated upon the Securities Ex-

change Act of 1934 (“1934 Act”) and on Rule 10b-5

thereunder;

(2) Misrepresentations were made to purchasers of

“V.I.P.” contracts issued by Great States (and there-

after assumed by State Security pursuant to the merg-

er) , each of which contracts was a “security” as defined

by federal law, either on its face or because of repre-

sentations made to the buyers. This cause of action is

predicated upon § 17 (a) of the Securities Act of 1933

(“1933 Act’), § 10(b) of the 1934 Act, Rule 10b-5

thereunder, and upon the Alabama Securities Act, Tit.

53 §§ 28, 45, Code of Alabama 1940 (Recomp. 1958)

(1973 Cum. Supp.) ;

(3) The “V.I.P.” contracts were not registered with

the SEC prior to being offered to the public, as re-

quired by the 1933 Act;

(4) Assets of Great States were allegedly unlawfully

diverted to Nimmo for his private benefit, to the dam-

age of Great States stockholders and to the holders of

Great States ““V.I.P.”’ contracts, a common law cause

of action; and

(5) The defendants have breached the terms of the

“V.LP.” contracts held by plaintiffs and are due to ac-

count for same.

Service of the complaint was accomplished upon State

Security through the Superintendent of Insurance for Ala-

bama. Service upon Nimmo and upon Nimmo, Inc., was

accomplished by the United States Marshal in Springfield,

Illinois.

On September 5, 1969, State Security filed two motions,

a motion to dismiss, based upon 57 grounds, and a motion

to require plaintiffs to post security for costs.

A-22

On September 29, 1969, Nimmo moved to dismiss or,

alternatively, to quash service. Nimmo, Inc., filed a similar

motion on the same date.

On September 30, 1969, plaintiffs filed a motion seeking

production of various documents by the defendants.

On January 15, 1970, plaintiffs filed a motion for deter-

mination of both classes and for notice to the classes so de-

termined.

On June 20, 1972, following disposition of the case of

Hilgeman v. Nat'l Ins. Co. of America, 444 F.2d 446 (5th

Cir. 1971) , this Court entered an order treating the defen-

dants’ motions to dismiss as motions for summary judgment,

and requesting counsel to direct their submissions to the

disposition of the following issue:

Whether the “Variable Investment Plan” contracts is-

sued to plaintiffs by Great States Life Insurance Co. or

its successor in interest, State Security Life Insurance

Co., constitute “securities” within the ambit of § 2 (1)

of the Securities Act of 1933, 15 U.S.C.A. § 77 (b) (1)

(1971) or § 3(1) of the Securities Exchange Act of

1934, 15 U.S.C.A. § 78 (c) (10) (1971).

All other motions were held in abeyance pending resolution

of the issue above.

On September 5, 1974, the Court heard additional argu-

ments directed to this issue.

On September 23, 1974, plaintiffs filed a motion for sum-

mary judgment in their behalf as to Counts 1 through 6.

These counts encompass the claims as to fraud in the sale

of the “V.I.P.” contracts as securities and as to breach of the

“V.L.P.” contract itself.

In connection with the above proceedings, the Court has

received affidavits from L. W. Nimmo (October 23, 1969) ,

A-23

Richard V. Moore, President of State Security (July 27,

1972) , Lawrence A. Wadsworth, plaintiff (July 31, 1972),

Charles S. Grainger, plaintiff (July 31, 1972), and James

Williams Parsons, plaintift (August 3, 1972). In addition,

a transcript of the testimony of Marvin Henson, Jr., a plain-

tiff in this action who died on December 31, 1971, has been

received (August 3, 1972). Moreover, depositions and doc-

umentary evidence have been received.

The Court has also had the benefit of numerous briefs

of counsel in this case, the most recent of which include

plaintiffs’ brief of September 23, 1974, directed to the issue

outlined above, and the reply brief from Nimmo and

Nimmo Inc., of November 29, 1974.

Plaintiffs contend that because the “V.I.P.” contracts

were “securities” under the relevant federal securities pro-

visions, jurisdiction and venue are good as to all defendants

here. Additionally, they argue that because Nimmo and

Nimmo Inc. were “controlling persons” of Great States at

the time of its merger into State Security, jurisdiction as to

them is also good under the 1934 Act.

The defendants, Nimmo and his company, argue that

they were not “controlling persons” at the time of the

merger, so that jurisdiction under the 1934 Act does not

lie. Moreover, Nimmo and his company argue that the

“V.1.P.” contracts were not “securities” and that jurisdic-

tion under the 1933 and 1934 Acts is therefore likewise

defeated.

These matters are more appropriately resolved on mo-

tions for summary judgment rather than upon preliminary

motions, since the intertwining of the merits with the juris-

dictional issues warrants the consideration of more evidence

than is usually appropriate to motions to dismiss.

A-24

Il. UNDERLYING FACTS.?

A. The “V.I1.P.”’ Contracts.

In September, 1962, plaintiff Grainger was approached

by two agents who are presumed to have been employed by

Great States about purchasing a V.I.P. contract. They told

him that they were selling an investment, not insurance.

He was told that Great States would pay him and other

buyers 90 per cent of the profits from the company.

Grainger purchased, then and later, two and one-quarter

“units’’® from the salesmen.

Plaintiff Wadsworth bought his contract in October 1962.

He was told

that it was an “investment,” that it would send my son

through high school and college and pay all his ex-

penses, that after he finished college it would pay him

the income, that after the first few years the policy

would take care of itself, and in case of my son’s death,

it would also pay $10,000.00 plus everything I had paid

on it up to that point.

Plaintiff Henson, who is now deceased, was approached

in September, 1962, about buying the contracts. He was

specifically told that it was not insurance but was an invest-

ment on which he could make as much as 40 per cent

interest.

Plaintiff Parsons was contacted in early 1963 about the

parchase of an “investment policy” for his three-year-old

son. He was given much the same glowing account of the

dividend rate on his policy as were the other plaintiffs.

Each plaintiff received a similar “V.1.P.’’ contract, a copy

of which is in the record now before the Court.

2These facts have been garnered from all submissions by all parties to

date. Where relevant, differences in the submissions are noted.

3Grainger’s affidavit states that “$10,000.00 is one unit,” but this appar-

ently refers to the face value of the insurance contract, not to its purchase

price.

A-25

The contracts begin

Great States Life Insurance Company of Quincy, IIli-

nois, will pay the sum insured under the conditions

hereof to he insured on the maturity date, if then liv-

ing, provided all coupons hereon have been left with

the company to accumulate at interest. Etc.

Mr. Grainger’s contract shows a face-amount of $10,000.00,

premium amount of $401.52, payable for ten years, and a

maturity date of November 13, 1987. This kind of policy is

characterized by State Security as an “Ordinary Life Cou-

pon, Participating 25 Year Endowment Option with Cou-

pon, Reduced Premium After 25 Years” policy. Its provi-

sions will be developed more fully, infra.

Two particular features of the policy deserve mention

here, however: The 90 per cent participation feature and

the coupon feature,

As a part of the policy received by each plaintiff,* there

was an excerpt from Illinois law which provided that

No Life company . . . shall issue both participating and

non-participating policies unless at least 90 percentum

of the profits on its participating policies shall inure

to the benefit of the participating policy-holders. Any

company having in force both participating and non-

participating policies shall keep a es ay accounting

for each class of business. . . . [emphasis supplied, in

part].°

According to Charles E. Miller, Manager of Great States in

Alabama during the relevant period, this excerpt was in-

cluded in the sales presentation made in connection with

4Interestingly enough, neither of the “sample” policies tendered with

affidavits submitted by the defendants contained this excerpt from the

Illinois statutes.

5Although the law applied only to Illinois corporations, it was made a

part of the contract by language to the effect that “V.I.P.” policies in any

state would be governed by the section.

A-26

the offer and sale of ‘“V.I.P.”" contracts and was attached to

every such contract sold in Alabama.

Also attached to the policies were twenty-four “Guaran-

teed Premium Reduction Coupons.” ‘These coupons guar-

anteed payment of stated amounts of cash by Great States

to the insured upon surrender of the coupon. Provisions

were also made for other, more attractive benefits, if the

coupons were retained.

Additional evidence before the Court shows that Great

States adopted, on August 28, 1962,° a dividend schedule

which apparently approximated — very roughly’ — a pay-

out of 90 per cent of the company’s profits on these policies.

On July 1, 1966, a new dividend scale was proposed, and

apparently accepted by Great States, distributing “about 50

per cent” of the profits to “V.I.P.” contract holders. Rath-

bone Ltr., July 1, 1966. The actuary explained that this

dividend change occurred because “‘[d]ividends for the

early years were estimated rather high to attract new policy

owners. Now that experience and cost for this block of

business has been developed, a long-range dividend sched-

ule is possible.” Rathbone Ltr., March 16, 1967.

In a form letter sent to “V.I.P.” policyholders who in-

quired about the dividend reduction, Great States explained

that “[t]he reduction of this year’s dividends for this policy

series was recommended by our consulting actuaries and is

6This was just prior to the purchases made by the named plaintiffs in

this action.

7The evidence indicates that the Great States actuary constructed a divi-

dend schedule which utilized “practically all the profits that might be ex-

pected from this contract . . . [leaving] little, if anything, for the stock-

holders.” Tiffany Ltr., June 19, 1962. At the August 28, 1962, meeting of

the Great States Board of Directors, Nimmo moved that dividends be set

at the rate of 10 per cent below that suggested above. This may be viewed

as a rough attempt at complying with the Illinois law cited as a part of

the “V.I.P.” contract, but it certainly does not seem to be an attempt to

determine the 90 per cent payout by means of carefully segregated account-

ing entries, as required by that law.

A-27

due to an increased mortality experience along with the

ever increasing costs of operations.” The letter went on to

report that “\uc dividend scale will increase in the years

ahead.”

In addition, the minutes of the Great States Board meet-

ing of December 21, 1962, show a report “that the Alabama

Commissioner [of Insurance] had instructed us [i.e., Great

States] to cease selling the VIP policy in that state.” No

apparent action was taken on this instruction. On August

1, 1963, the Commissioner, in a letter to Great States, re-

quested that a representative from the company meet with

the Commissioner, since policies of “a profit-sharing or in-

vestment nature” had not been approved for sale in Ala-

bama. The results of this meeting do not appear.

It is apparent, however, from testimony taken in the case

of Henson v. State Security Life Ins. Co.,* that the Com-

missioner, as late as August of 1967, had done little or

nothing to contact holders of ‘‘V.I.P.” policies regarding any

action he had taken against Great States or its successor,

State Security.

At present, State Security maintains a statutory reserve

for the payment of benefits and obligations due under the

V.LP. policies. It does not, however, maintain separate ac-

counting entries which make readily available the amount

of profits derived from the V.I.P. contracts.°

B. The Merger.

From the time of its organization as an Illinois company

in 1959, until August 31, 1968, Nimmo was formally and

8Tt« trial court directed a verdict on statute of limitations grounds. He

was 7¢ ersed in part, 288 Ala. 497, 262 So. 2d 745 (1972).

*This information is taken from plaintiffs’ brief of September 23, 1974.

For some reason, the answers to interrogatories which would show this in-

formation have apparently not been filed with the Court. See F.R.Civ.P.

5 (d).

A-28

in fact active in the management of Great States. At all

times prior to its merger into State Security, Nimmo and

his company owned the controlling interest in Great States.

On June 13, 1967, Nimmo and Nimmo Inc., of which

Nimmo was a 90 per cent shareholder, agreed to sell their

controlling interest in Great States to State Security. The

sale was of 763,049 shares of the 1,150,000 outstanding

shares of Great States at a gross price of $2,098,384.75." In

return, Nimmo and his company agreed to deliver not only

their stock, but also the written resignations of those mem-

bers of the Great States Board of Directors requested by

State Security. Moreover, Nimmo and his company prom-

ised that “[t]he Board of Directors of Great States [and an-

other company not the subject of this lawsuit] prior to the

closing of [the] Agreement shall execute an agreement of

merger with Security and will further call a meeting of the

respective shareholders of Great States [and the other com-

pany] to be held for the purpose of approving said agree-

ment of merger.”

On July 20, 1967, State Security wrote to Nimmo pro-

posing to terminate the above agreement. Nimmo agreed

to the termination.

On November 6, 1967, State Security filed a lawsuit

against Nimmo and his company charging that the July 20,

1967, letter was a sham requested by Nimmo “to avoid ap-

pearing precommitted to a merger when dealing with the

boards of directors of the companies involved.’” The com-

plaint alleged that, despite the termination letter, Nimmo

had agreed to effectuate the June 13, 1967, agreement. The

The purchase price was broken down into separate components:

$270,000.00 for the 54,000 shares held by Nimmo Inc., or $5.00 per share;

$1,828,384.75 for the 709,049 shares held by Nimmo, or approximately

$2.60 per share.

A-29

suit was therefore predicated upon breach of the June

agreement and upon fraud in its July recission.”

On May 10, 1968)"State Security again contracted with

Nimmo and Nimmo, Inc., to buy the 763,049 shares of

Great States owned by them. The purchase price was now

enhanced to $2,348,200.00.% Nimmo’s 709,049 shares were

assigned a value of $2,078,200.00, or about $2.93 per share.

Nimmo, Inc.'s 54,000 shares were again assigned a value of

$270,000.00, or $5.00 per share. On May 10, 1968, the

market price of Great States, according to the plaintiffs, was

approximately $1.13 per share.”

As part of this agreement, State Security agreed to hire

Nimmo as a consultant for $30,000.00. Moreover, State

Security agreed to have its action against Nimmo dismissed

with prejudice, and the agreement recited that this was a

part of the consideration paid to obtain Nimmo’s accep-

tance of the agreement.

Paragraph five of this agreement required Nimmo to de-

liver “on or before August 28, 1968,” the resignations of

such members of the Great States Board of Directors as

State Security should direct.

This sale was financed through payment by State Security

of $992,657.02, apparently from its own assets. The addi-

tional $1,357,342.98 was apparently raised by sale of, or by

outright transfer to Nimmo of, assets belonging to Great

11In his deposition, Nimmo has testified that 90 per cent of the allega-

tions in this complaint were untrue.

12There was an additional $1,200.00 paid for 266 shares of the common

stock of Lincoln Life Ins. Co. of Arizona.

18The proxy statement sent out by Great States to its shareholders, in

preparation for a September 20, 1968, meeting, reported that the high bid

for Great States stock in 1968 was $2.50, while the low bid was $1.00.

According to plaintiffs, the book value of Great States stock was $.94

per share, and the adjusted book value was $2.09 per share.

A-30

States."* How the $992,657.02 in cash was to be raised is

unclear; it is inferable that the sales agreement required

only that by August 28, 1968, State Security would deliver

to Nimmo and his company $992,657.02. A subsequent

agreement reveals that State Security, jointly with Depend-

able Life Insurance Company, an Alabama insurance com-

pany,’* executed to Nimmo a note for $873,667.98. The im-

plication is that Nimmo and his company therefore received

$118,989.04 in cash on August 28, 1968."*

Following this agreement, Great States issued a Notice of

Meeting of Stockholders and a Proxy Statement, under date

of August 8, 1968. The notice was signed by Nimmo. It

reported that the meeting was called to elect directors and

transact other business. A natural inference from this no-

tice is that this election was related to Nimmo’s promise in

the sales agreement to deliver the resignations of the then-

governing Board of Great States.

There were seven men nominated for the seven available

Board positions. Of these, at least four were employees or

directors of State Security.’ The connection of nominees,

A. Lamar Reid, Charles Butz, and Everett W. McClure,

does not appear, although Mr. Reid’s law firm in Birming-

ham, Alabama, was serving “of counsel” for State Security

as of November 6, 1967.

The proxy statement revealed Nimmo’s controlling in-

terest and his sale of that interest effective on August 28,

14Paragraph 10 of the Sales Agreement. See also the Escrow Agreement,

tendered as Plaintiffs’ Exhibit 21 to the most recent briefs on summary

judgment. See also fn. 18, infra.

154 merger of Dependable (of Mobile, Alabama) into State Security

was approved by all involved shareholders as of August 12, 1968.

16The plaintiffs’ statement that only $25,000.00 in cash was paid to

Nimmo before August 28, 1968, seems to be in error. It is perhaps derived

from the aborted agreement of June 13, 1967.

17The proxy statement revealed the connections of three of them to

State Security. It did not show that nominee Wittenberg was a Director

of State Security.

A-31

1968. It also included the sales agreement and the escrow

agreement between State Security and Nimmo.

The statement directs its readers’ attention to the sales

agreement and states that it shows that

The net cash payment for control stock of [Great

States] will be approximately $1,500,000.00, which

[ State Security] has said it would borrow pending com-

pletion of a merger with [Great States].

It is difficult to discern how the sales agreement provides

any such thing.”

The statement also announces State Security's intention

to merge with Great States upon completion of the Nimmo

sale. It then states, “[n]either L. W. Nimmo or Nimmo

and Associates, Inc., is party to the proposed merger, nor has

either party participated in the planning of such merger.”

The notice established the meeting date as August 28,

1968, but it was not held until August 30, 1968, for un-

18See text accompanying Fn 14, supra.

This statement may be explained by combining the sale contract, the

escrow agreement and the August 8 proxy statement. Under the sales

agreement Nimmo was to have Great States sell, at stated minimum

prices, the Great States office property, bonds of Putnam Dye Co., stock

of the Horace Mann Life Ins. Co., and stock of the Life Assurance Co. of

the West. If the minimum disposition prices of these assets are added to

the amount State Security was to pay the escrow agent — $992,657.02 —

the total equals the sales price of $2,350,000.00. On page 5 of the August

8 proxy statement, it is reported that Great States had disposed of the

Horace Mann stock. If the contract minimum for this stock — $507,675.00

— is added to the amount State Security was to pay the escrow agent, the

total is “approximately $1,500,000.00.”

If this is the correct explanation of the transactions involved, it seems

clear that part of the consideration paid Nimmo reflected these proper-

ties; in a sense they were transferred to him at the stated values. Since the

values stated in the sales contract were inflated (Nimmo’s Deposition, p.

127), Nimmo actually received less for his shares than is reflected in the

for

of the explanation of the above figures, plaintiffs have not

about them nor do plaintiffs indicate how such figures may

relate to their alleged causes of action.

A-32

explained reasons.’* Immediately thereafter, the new Board

met and adopted an agreement of merger between Great

States and State Security, dated August 28, 1968.

Curiously enough, this agreement was signed for Great

States by A. Lamar Reid, as President, although he was not

elected President until August 30, 1968. In fact, on the

date of the agreement, Nimmo, according to his affidavit

filed herein, was still a director of Great States.

On August 28, 1968, A. Lamar Reid, as President of

Great States,” issued a notice of a special meeting of the

shareholders of Great States to be held on September 20,

1968. This meeting was called to vote upon the merger

agreement between Great States and State Security. The

proposed merger provided for an exchange of the stock of

Great States for that of State Security at a ratio of 1.5 to 1.

Great States management recommended, on page two, that

the merger be approved; on page one, it was stated that the

present Great States management “are persons nominated

by Security... .”

This merger was approved by the shareholders, and the

merger was consummated.

Plaintiffs contend that both the August 8 and the August

28 proxy statements were misleading. They also contend

that the net result of the sale by Nimmo and the subsequent

merger was Nimmo’s receipt of an unjustified premium for

his control of Great States and the minority shareholder’s

receipt of grossly devalued stock of State Security in return

for their stock in Great States.

19So long as the meeting was held on or after August 28, 1968, State

Security would vote Nimmo’s stock, pursuant to the proxy agreement in-

cluded in Paragraph 20 of the May 10, 1968, agreement.

2°This involves the same “curiosity” as that involved in his signature on

the agreement. These acts by Mr. Reid were ratified on behalf of Great

States by the newly-elected board on September 30, 1968.

A-33

Ill. ISSUES PRESENTED.

There are a number of complex issues involved in the

foregoing statement of facts. However, despite the numer-

ous allegations tossed around by the plaintiffs, defendants

are essentially correct in narrowing their focus to the issues

involving the propriety of the service obtained in this case.

This issue is particularly relevant to Nimmo and his com-

pany since they have been called before this Court under

the long-arm provisions of the national securities acts.

As the Court’s order of June 20, 1972, indicates, the ques-

tion whether the “V.I.P.”” contracts are “securities” is ap-

propriately addressed on more evidence than is normally

available upon motions .o quash. Since the merits of the

issue are so intertwined with the jurisdictional issues, sum-

mary judgment is a more appropriate vehicle for resolution

of the question. If, for example, it is found that the “V.L.P.”

contract is not a security, then, insofar as that issue is con-

cerned, Nimmo’s and his company’s motion to quash are

due to be granted, while State Security’s motion to dismiss

for failure to state a claim would also be due to be granted.

This memorandum, however, addresses the further issue

— not raised in the June 20, 1972, order, but briefed by the

parties — of the alleged fraud in regard to the 1968 sale of

Nimmo’s stock to State Security. The latter issue must be

reached if the Court is to explore all jurisdictional bases at

this time.

With the foregoing in mind, this memorandum considers

the following issues:

(1) Does this Court have jurisdiction over Nimmo un-

der the 1933 or 1934 Acts?

(a) On its face, is the “V.I.P.” contract a “security”

under either Act?

(b) If not, did the manner of sale of these contracts

transform them into securities?

A-34

(2) Are there any other jurisdictional bases upon which

this Court may hold Nimmo accountable with regard to

these contracts?

(3) Has a cause of action been stated as to the 1968

merger of Great States into State Security?

(4) Is jurisdiction over Nimmo and his company proper

as to the counts involving the 1968 merger?

(a) Was either defendant a “controlling” person of the

entities perpetrating the alleged frauds?

(b) May the defendants be held under a conspiracy

theory?

IV. CONCLUSIONS.

It is concluded herein that the “V.I.P.” contracts are in-

surance contracts, exempt from the 1933 and 1934 Acts. It

is further concluded that plaintiffs have stated a cause of

action against all defendants as to the 1968 merger, so that

the Court has personal jurisdiction over all defendants.

V. DISCUSSION.

As stated above, the plaintiffs contend that the “V.I.P.”

contract is a security under the 1933 and 1934 Acts, while

defendants say it is merely a contract of insurance.

If plaintiffs are correct, then this Court has jurisdiction —

both personal and subject matter — over the defendants

under the jurisdictional provisions of the 1933 and 1934

Acts. Section 22 (a) of the 1933 Act, 15 U.S.C. § 77v (a)

(1970) , provides:

The district courts of the United States . . . shall have

jurisdiction .. . of all . . . actions at law brough t to en-

force any nblity or Gay rented y h(t) Ay Any

such suit or action may be

where the offer or sale took place, eae he A ne

A-35

ticipated therein, and process in such cases may be

served in any other district of which the defendant is

an inhabitant or wherever the defendant may be found.

Section 27 of the 1934 Act, 15 U.S.C. § 78aa (1970), pro-

vides:

The district courts of the United States . . . shall have

exclusive jurisdiction . . . of all . . . actions at law

brought to enforce any liability or duty created by this

chapter or the rules and regulations thereunder. . . .

Any [such] action . . . may be brought in [the district

wherein any act or transaction constituting the viola-

tion occurred] or in the district wherein the defendant

is found or is an inhabitant or transacts business, and

process in such cases may be served in any other district

of which the defendant is an inhabitant or wherever

the defendant may be found.

Since liabilities and duties under both acts hinge upon

the presence of a “‘security,” it is clear that if the “V.I.P.”

contracts are not securities, then this Court does not have

subject-matter jurisdiction over this suit under the above

provisions. Moreover, service of process upon defendants

Nimmo and his company would not be proper under the

provisions.

Section 3 (a) of the 1933 Act, 15 U.S.C. § 77c (a) , makes

certain exemptions:

mage p as hereinafter expressly provided, the provi-

sions of this subchapter shall not apply to any of the

following classes of securities:

(8) Any insurance or endowment policy or annuity

contract or optional annuity contract, issued by a cor-

poration subject to the supervision of the insurance

commissioner, bank commissioner, or any agency or

officer performing like functions, of any State or Terri-

tory of the United States or the District of Colum-

bia [.] [emphasis supplied]

A-36

There is no similar exemption from the 1934 Act; more-

over, sections 12 (2) and 17 (c) of the 1933 Act, 15 U.S.C.

§§ 771(2), 77q(c) (1970), expressly provide that the ex-

emptions of section 3 do not apply to the anti-fraud provi-

sions of the 1933 Act.

Seizing upon these features of the two acts, plaintiffs con-

tend that the 1934 Act, especially Section 10(b) thereof,

15 U.S.C. § 78) (b) (1970), and the anti-fraud provisions

of the 1933 Act apply to insurance contracts. They argue

that Section 3, because of its reference to “the following

classes of securities,’ treats insurance contracts as securities.

It follows, therefore, that the above anti-fraud provisions

and the 1934 Act apply to insurance contracts because they

are ‘‘securities.”’

The plaintiff's argument is persuasive if only the lan-

guage of the two acts is considered. However, Professor

Loss provides the following explanation of the § 3 (a) (8)

exemption:

Section 3 (a) (8) of the Securities Act exempts ‘‘any in-

surance or endowment policy or annuity contract or

optional annuity contract, issued by a corporation sub-

ject to the supervision of the insurance commissioner,

bank commissioner, or any agency or officer perform-

ing like functions, of any State or Territory of the

United States or the District of Columbia.”’

This is a perfect example of how it sometimes does

not pay to be too cautious. Without this exemption,

and without any specific reference to insurance poli-

cies in ~ ne meg of “‘security,”’ and at a time when

Paul v. inia [8 Wall. 168 (U.S. 1869) ] was still

the law of | e tana, it is hardly conceivable that Con-

gress would have subjected insurance policies to fed-

eral control sub silentio, even control which was mere-

ly of the disclosure variety. As it is, § 3(a) (8) seems

on its face to create a negative implication that insur-

ance policies are securities, which may be exempt from

A-37

the registration requirements but are subject to the

antifraud provisions. Nevertheless, the Commission

has taken the position that insurance or endowment

policies or annuity contracts issued by regularly con-

stituted insurance companies were not intended to be

securities, and that in effect § 3 (a) (8) is supereroga-

tion. This undoubtedly carries out the legislative in-

tention; for the House report states that the purpose of

the exemption “makes clear what is already implied in

the act, namely, that insurance policies are not to be re-

garded as securities subject to the provisions of the

act.” 1 Loss, Securities Regulation 497 (2d ed. 1961)

(footnotes omitted) .

Professor Loss’s analysis has been cited with approval by

the Supreme Court in Tcherepnin v. Knight, 389 U.S. 332,

342 n. 30 (1967). The Court stated, moreover:

Congress specifically stated that “insurance policies are

not to be regarded as securities subject to the provi-

sions of the act,” and the exemption from registration

for insurance policies was clearly supererogation. /d.

[citations omitted ].*

Since the definition of “security” found in section 3 (a)

(10) of the 1934 Act, 15 U.S.C. § 78c (a) (10), is virtually

identical to that in section 2(1) of the 1933 Act, 15 U.S.C.

§ 77 (b) (1), it seems reasonable that Congress intended to

exclude insurance contracts from the 1934 Act as we have

seen it did with regard to the 1933 Act.™ Therefore, the

See also S.E.C. v. Variable Annuity Life Ins. Co., 359 U.S. 65, 98

(1959) (Harlan, J., dissenting).

Plaintiffs argue that S.E.C. v. National Securities, Inc., 398 U.S. 453

(1969) , supports their contention. That case, however, held that the fed-

eral securities acts applied to relationships between an insurance company

and its stockholders, while saying nothing about whether insurance poli-

cies are “securities.”

22Plaintiffs also argue that the § 3(a) (8) exemption be construed nar-

rowly to apply only to “pure ‘risk’ insurance contracts.” This argument

falls before the same legislative intent rehearsed above.

A-38

issue is whether the “V.1.P.”’ contract is an insurance policy

or some breed of security.

“Insurance” is a mercurial term, describing a myriad of

contractual relationships and constantly expanding as new

risks are created by the activities, and the changing percep-

tions of value attendant thereto, of men. Any attempt to

define the term strictly is certain to fail. Insurance often

entails an investment feature as well as an assumption of

risk feature; when the assumptive feature becomes second-

ary to the investment feature, the insurance assumes more

and more the attributes of a security. As Professor Loss has

indicated:

In the last analysis, there is no escaping the fact that

there is a continuous spectrum from a one-year term

life insurance policy, which is pure insurance, through

the various forms of straight life and endowment poli-

cies, to the annuities, both fixed and (in varying de-

grees) variable, to mutual fund shares and ultimately

common stock, which represent pure investment. 4

a Securities Regulation 2534 (1969 Supp. to 2d

The Supreme Court has twice attempted to provide

points for drawing the line between insurance contracts,

which are exempt from the federal securities acts, and se-

curities, which are not, in S.E.C. v. Variable Annuity Life

Ins. Co., 359 U.S. 65 (1959) [“WALIC”] and S.E.C. v.

United Benefit Life Ins. Co., 387 US. 202 (1967)

[“UBLIC”}.

In VALIC, the Court considered whether variable an-

nuity contracts, issued by insurance companies regulated

by the insurance commissioners of a number of states (in-

cluding Alabama), were exempt from the disclosure pro-

visions of the 1933 Act, 15 U.S.C. § 77a, and from complli-

ance with the Investment Company Act of 1940, 15 U.S.C.

§ 80a. The contracts in question included certain conven-

A-39

tional insurance features: declining term insurance for the

first five years of pay-in, disability waiver of premium, and,

most significantly, the assumption by the company of the

entire risk of longevity.* These provisions, however, were

deemed incidental to the primary form of the investment,

which called for participation by the insured on a per-unit

basis, in the entire portfolio of the company. The com-

pany’s obligation, then, was always stated in terms of the

present condition of its investment portfolio, not in terms

of dollars.

Finding no guarantee of fixed income, the Court con-

cluded that “the variable annuity places all the investment

risks on the annuitant, none on the company.” /d., at 71.

Concurring for himself and Justice Stewart, Justice Bren-

nan provided a more detailed analysis of the risks assumed

by the company during the pay-in period of the policy:

The contract uses insurance terminol through-

out and many of the common features of life insurance

and annuity policies are operative in regard to it at this

“pay-in” stage. There are “incontestability” and “sui-

cide” clauses (which mainly relate to the term insur-

ance); a “grace period” ene for the payment of

premiums; a provision for “policy loans” (the drawing

down of accumulated units in cash, subject to replace-

ment later to the extent that repayment of the amount

of money received will then permit, the transaction

bearing a resemblance to the liquidation by a common

stock investor of his holdings in anticipation of a “bear

market’) ; and provision for a “cash value” (that is,

This means that, upon reaching the maturity date, the insured’s in-

insured. Although the actual amount paid the insured would fluctua

every month with the value of the the

annuity units every month, regardless of how he lived. Thus, i

company had a “poor” longevity experience, compared to the actuarial

predictions, it stood to lose substantially.

!

A-40

for the cashing in of the accumulated units, subject to

a surrender charge in the early years). And very cer-

tainly the commitment of the company eventually to

disburse the accumulated values on a life annuity basis

once the pay-in period is over is present throughout

this period. But what the investor is participating in

during this period, despite its acknowledged “insur-

ance” features, is something quite similar to a conven-

tional open-end management investment company, un-

der a periodic investment plan. The investor's cash

(less a charge analogous to a loading charge, which is,

at least in the early years, very high, but which it

should be said, has to cover annuity premium taxes

and some quite conventional mortality risks) goes to

buy “units” in a portfolio managed by the persons in

control of the corporation. His “units” fluctuate with

the income and capital gain and loss experience of the

management of the portfolio. He may cash them in,

wholly or partially. e amount of his equity is sub-

jected to a charge, on asset value, of 1.8% per annum.

Except for the temporary term insurance and the

waiver of premium coverage, the entire nature of the

company’s obligation to its investor during this period

is not in dollars (though of course it will be converted

into them, just as a commodity transaction can be),

but solely in terms of the value of its portfolio. 359

U.S. at 84-5.

It may be seen then, that the insureds in VALIC were

buying into a fund, with the prospect of reaping the bene-

fits of profitable management of the fund. There was sim-

ply no fixed dollar risk on the insurer nor any basis for a

concommitant expectation by the insured. Under these con-

ditions, the Court held that the investment contracts were

not exempt from either the 1933 Act or the Investment

Company Act of 1940.

Eight years later, the Court addressed the question once

again in UBLIC, with Justice Harlan, a dissenter in

VALIC, writing for a unanimous Court. In UBLIC, an

A4!1

established, old-line insurance company offered an invest-

ment contract with bifurcated interests. The plan, called a

“Flexible Fund,” provided, during the pay-in period, for

the insured’s pro rata participation in a general investment

fund. At the same time, he was guaranteed a minimum

dollar amount, called the net premium guarantee. At ma-

turity, the insured could elect various conventional annuity

plans, none of which were dependent upon the value of the

pooled funds of all insureds, as was the case in VALIC.

Addressing only the first half of this scheme, the Court de-

termined that the guaranteed dollar value associated with

the pay-in period was “substantially less than that guaran-

teed by the same premiums in a conventional deferred an-

nuity plan,” 387 U.S. at 208. Thus, although there was

some slight shifting of risk from insured to insurer, the

basic framework of the pay-in period rested upon the same

kind of investment fund which the Court had faced in

VALIC. The Court thus held that the pay-in portion of the

“Flexible Fund” contracts were not exempt insurance con-

tracts and were therefore subject to the disclosure provi-

sions of the 1933 Act.

The insurance contract at issue in the present case does

not promise its holders that the amount of insurance they

are purchasing is contingent upon how well a general fund

is invested. Instead, the insureds are promised a fixed

amount of insurance each year, and fixed options at the end

of 10 years and 25 years. The insurance promised is not set

at the illusory levels held to be tantamount to no insurance

in UBLIC.

Plaintiffs also attack the following participating provi-

sion of the contracts: mn

The proportion of divisible surplus accruing upon this

policy shall be ascertained annually by the company.

A-42

Beginning at the end of the second policy year, and on

each anniversary thereafter, such surplus as shall have

been apportioned by the company to this policy shall

be available under any of the following options, upon

written request by the person having control of this

policy: (1) applied toward payment of renewal pre-

miums; or (2) applied to purchase participating paid-

up additional insurance payable under the same terms

and conditions as this policy; or (3) left with the com-

pany to accumulate at interest at a rate of not less than

244% per annum compounded annually; or (4) paid

in cash. Outstanding dividend accumulations may be

withdrawn in cash or shall be payable at the maturity

of this policy to the person or persons entitled to its

proceeds. If no option is selected, such divisible sur-

plus will be paid in cash.

This provision is unlike the fund created in UBLIC, which,

as has been noted, created insurance as a non-guaranteed

portion of an investment fund. In the Great States con-

tract, on the other hand, the participating feature is in

addition to a bona fide insurance scheme and may be

viewed as a reduction of premium. VALIC, 359 U.S. at 90

(Brennan, J., concurring) .

Similar participating features are common in the insur-

ance industry, 43 Am. Jur. 2d, Insurance § 120, pp. 177-8

(1969) ; 44 C.J.S., Insurance § 103, pp. 639-41 (1945); 1

Appleman, Insurance Law and Practice § 9 (Rev. ed.

1965), and they reflect the investment experience of the

company, mortality savings, and savings in administrative

costs. In the Great States policy, the participating feature

is denominated as a “dividend,” not as a “security” or as an

ascertainable share of an investment fund. This feature,

then, is not separable from the indisputably insurance as-

pects of the contract, and it is not a “‘security.” Thus, it

does not remove the ‘‘V.I.P.”’ contract from the insurance

A-43

exemptions of the 1933 and 1934 Acts.* Cf. Olpin v. Ideal

National Ins. Co., 419 F.2d 1250 (10th Cir. 1969) .

Plaintiffs argue that the coupons attached to the “V.I.P.”

policy are additional evidence that the policy is a “security”

and not an insurance contract. This contention is unper-

suasive.

The coupons provide:

Subject to the provisions of [this] policy . . . and upon

the payment of 2nd annual premium in full and not

otherwise, Great States Life Insurance Company will

pay to the order of the insured under said policy [a

stated sum] or upon written request of the insured

within thirty-one days after said date will apply said

sum to the purchase of a paid-up life addition of [a

stated sum].

The sum to be paid to the insured under the sample policy

($249.30) remains the same every year, while the amount

of additional insurance which may be purchased declines

by $30.00 each year. Various inducements are offered to the

insured to refrain from cashing in his coupons, and each of

them is plainly stated in the initial page of the contract.

Such coupon policies are not widely used, but they are a

standard form of insurance. 1 Appleman, supra, § 10. In

effect the coupons are a guaranteed dividend, or rebate of

premium. They are not premised upon a share in an in-

vestment pool and in no way represent a “security.”

Their presence on an insurance policy, of course, may

lend themselves to abuse, since the coupons might be com-

pared to those on a bond, for example. The Insurance

This conclusion is reinforced by Judge McFadden’s similar conclusion

in Hilgeman v. National Insurance Co. of America, 1970 CCH Fed. Sec.

L.Rep. ¢ 92,647 (N.D. Ala., April 22, 1970), rev'd 444 F.2d 446 (5th Cir.

1971). However, because of the confusing aspects and the ambiguous lan-

guage of the Fifth Circuit in that case, no reliance is explicitly placed

upon it.

A-44

Commissioner of Alabama apparently objected to the poli-

cies on this basis, as have other state commissioners. 1 Ap-

pleman, id. However, this fact does not change the exempt

status of these insurance policies; rather it confirms the

Congressional choice, embodied in the insurance exemp-

tion, to leave the regulation of insurance and its sale to the

states. Cf. VALIC, 359 U.S. at 75 (Brennan, J., concur-

ring) .

The plaintiffs argue furthermore that these policies are

transformed into “securities’’ because of the inclusion in

each policy of a statutory provision drawn from Illinois law.

The provision, as it appeared in the policy, is included in

the statement of facts of this memorandum. While it is cer-

tain that this provision, like the coupons, may lend itself

to abuse in the hands of unscrupulous salesmen, it does not

change the character of the contract from one of insurance

to an investment contract which is not exempt from the

1933 and 1934 Acts. The excerpt provides that at least 90

percent of the profits derived from participating policies

shall inure to the benefit of the participants. To facilitate

enforcement of this provision, a company issuing both par-

ticipating and non-participating policies is enjoined to keep

a separate accounting of the profits derived from the differ-

ent types of policies. It is undisputed that Great States (and

State Security) failed to keep this separate accounting. It is

further undisputed that Great States lowered its dividends

to its participating policy-holders in 1967. None of these

facts changes the character of the risk assumed by the in-

surance company nor the kind of contract which the in-

sured bought. The “V.I.P.” contract is still insurance.

Plaintiffs also present a welter of information regarding

the sales pitch given each plaintiff regarding the “V.I.P.”’

contracts. The plaintiffs argue that these facts should be

considered in determining whether the “V.I.P.” contracts

A-45

were securities. They rely upon the Supreme Court's lan-

guage in its seminal decision of S.E.C. v. Joiner Corp., 320

U.S. 344, 351 (1943) :

In the Securities Act the term “security” was defined

to include by name or description many documents in

which there is common trading or speculation or in-

vestment. Some, such as notes, bonds, and stocks, are

pretty much standardized and the name alone carries

well-settled meaning. Others are of more variable

character and were necessarily designated by more de-

scriptive terms, such as “transferable share,” “‘invest-

ment contract,” and “‘in general any interest or instru-

ment commonly known as a security.”” We cannot read

out of the statute these general descriptive designations

merely because more specific ones have been used to

reach some kinds of documents. Instruments may be

included within any of these definitions, as a matter

of law, if on their face they answer to the name or de-

scription. Hoy ever, the reach of the Act does not stop

with the obvious and commonplace. Novel, uncom-

uon, or irregular devices, whatever they appear to be,

are also reached if it be proved as matter of fact that

they were widely offered or dealt in under terms or

courses of dealing which established their character in

commerce as “investment contracts,” or as “any in-

terest or instrument commonly known as a ‘security.’ ”

The proof here seems clear that these defendants’ offers

brought their instruments within these terms.

The Court concluded its opinion by noting that in order to

prove a document a “security,” it might be necessary, as was

done in Joiner to “go outside the instrument itself... .”

Id., at 355.

Joiner, however, involved the sale by defendant of lease-

holds in small parcels of land in Texas to purchasers scat-

tered around the nation. The evidence aside from the

leases themselves indicated that woven into the sale of the

leasehold was an assurance that the seller would under-

A-46

take to drill a well which might enhance the value of all

the nearby leaseholds. Thus, the additional evidence there

indicated that the buyers were purchasing not a leasehold

but an agreement to drill a well. The proof showed that

the buyers were investing in the efforts of another with an

expectation of profit from the other’s efforts.

On the other hand, none of the evidence brought forth

by plaintiffs here remotely suggests such a relationship. At

most, plaintiffs indicate that the salesmen treated the

“V.LP.” insurance contract as if it were a “security.”™

These facts would tend to show common law fraud in the

sale of the insurance contract, but they would not transform

the nature of the contract itself. The insurance nature of

this contract is plain and substantial on the face of the docu-

ment, and the plaintiff has failed to show how the evidence

outside the document would change its essential nature.

See Chapman v. Rudd Paint & Varnish Co., 409 F.2d 635,

640-1 and n. 5 (9th Cir. 1969) ; cf. S.E.C. v. W. J. Howey

Co., 328 U.S. 293 (1946) .*

At this point, it is clear that there is no personal juris-

diction over Nimmo or his company on this claim under

the securities act long-arm statutes. Service as to them

should therefore be quashed as to all counts relying upon

the “V.I.P.” contracts. The Court should, in light of the

second part of this memorandum, also dismiss as to this

count for failure to state a cause of action against these two

defendants.

*5Plaintiffs underscore the use of the word “investment” in the contract

and in the sales pitch. Although this term is subject to muci abuse, it

seems indisputable that insurance is usually a form of “investment.” See

VALIC, supra, 359 U.S. at 75 (Brennan, J., concurring). Use of this term

hardly warrants a finding that the contract here in issue was a “security.”

26The same conclusion must be reached as to a cause of action under

the Alabama Securities Act, Tit. 53 §§ 28, 45, Code of Alabama 1940

(Recomp. 1958) (1973 Cum. Supp.), since that act likewise does not en-

compass causes of action based upon bona fide insurance contracts.

A-47

The situation is different as to State Security. It was

served through the Superintendent of Insurance of Ala-

bama. Personal jurisdiction is therefore established. Sub-

ject matter jurisdiction is predicated not only upon the

Securities Acts, but also upon diversity of citizenship.

Therefore, the quashing of service as to the Nimmo group

does not require similar treatment of State Security, assum-

ing there are causes of action alleged aside from those deal-

ing with breaches of the securities acts.

Plaintiffs have alleged causes of action sounding in com-

mon law fraud and breach of contract. As to the former,

the affidavits filed by the plaintiffs indicate that there are

material and substantial factual contentions upon which a

cause of action in fraud may be grounded. The admission

of all defendants that the profits from the participating

policies were never kept separate indicates a substantial

breach of contract claim and may entitle plaintiffs to an

accounting from State Security.”

Note, however, that neither Nimmo nor Nimmo Inc., as

officers or shareholders of Great States, are personally liable

for the fraud or breach of contract claims. Neither is al-

leged to have participated in the sales pitches given to the

individual plaintiff-buyers. And the corporate structure

shields them from the alleged breach of contract. There-

fore, these claims, likewise, must be dismissed as to them

for failure to state a cause of action.

This disposition, however, likewise precludes a class ac-

tion as to either of these claims. The fraud claims each de-

pend upon the particularized representations made to each

plaintiff. The contract claim depends upon whether the

27This is a conclusion only as to whether a cause of action has been

stated. It is not intended to preclude the defendant's taising defenses,

such as statute of limitations, by way of answer or motion for summary

judgment. Nor is this intended to establish that State Security must an-

swer for torts allegedly committed by Great States or its agents.

A-48

excerpt from Illinois law was included in each plaintiff's

insurance contract; since there is evidence in Mr. Nimmo’s

deposition that it was not the company’s practice to include

the excerpt in the policies, it would be inappropriate to as-

sume that every class member received it as a part of his

contract.

Under these circumstances, a class action may not be

maintained as to the two claims on the “V.I.P.” contract.

F.R.Civ.P. 23 (b) (1) (A) is not satisfied because, as to the

two remaining claims, there are no “standards of conduct”

sought to be imposed upon the defendant. R. 23 (b) (1) (B)

is likewise unsatisfied because adjudications of the indi-

vidual claims will not be dispositive of the interests of other

members not parties to this suit, since the individual claims

each depend upon facts peculiar to that individual. For the

same reason, R. 23 (b) (3) is not satisfied since the questions

of fact peculiar to each plaintiff outweigh any common

questions involved.

It likewise is inappropriate to grant plaintiffs’ motion for

summary judgment as to Counts One through Six, filed

September 23, 1974, even as to breach of the provision re-

garding the separate accounts. While plaintiffs have pre-

sented strong evidence as to this breach, defendant State

Security has not been heard from on this issue as of this

time.

B. Remaining for resolution are the issues surrounding

the merger of Great States into State Security:in 1968. For

the purposes of this memorandum, the issues treated will

be those necessary to dispose of Nimmo’s and his company’s

motions to quash or dismiss. These matters are not treated

as motions for summary judgment on the merits. Consider-

ation of affidavits and other evidence upon motions to

quash does not thereby transform the motions into sum-

AA49

mary judgment adjudications. See 5 Wright and Miller,

Federal Practice and Procedure § 1351, at 565 (1969).

Naturally, we look first to determine whether a cause of

action has been stated as to any defendant. In assessing this

issue, the complaint is weighed heavily in plaintiffs’ favor.

Conley v. Gibson, 355 U.S. 41 (1957). Moreover, to ac-

complish the broad anti-fraud objectives of the securities

acts, the statutes upon which plaintiffs rest their case must

be construed “flexibly, not technically and restrictively.”

Superintendent of Insurance v. Bankers Life & Casualty

Co., 404 U.S. 6, 12 (1971); see Herpich v. Wallace, 430

F.2d 792, 802 (5th Cir. 1970) .

Under these principles, whether plaintiffs have stated a

cause of action is nevertheless problematical. In essence, it

is alleged that Nimmo and his company contrived to sell

their stock in Great States to State Security at a premium,

with a resultant dilution of the value of Great States’ stock

in the hands of minority shareholders, including plaintiff

Grainger. This was accomplished, as seen in the statement

of facts, through the sale of stock to State Security and the

subsequent merger of Great States into State Security. Un-

der the wide umbrella of this transaction, plaintiffs also

charge violations of the proxy rules.

Plaintiffs sue on their own behalf and on behalf of Great

States. Therefore, they have two analytical bases upon

which to premise compliance with the doctrine of Birn-

baum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.) , cert.

denied, 343 U.S. 956 (1952) , to the effect that standing to

seek redress for violations of Rule 10b-5 requires a “pur-

chase” or a “sale.”

In their latest brief, plaintiffs assert that the facts alleged

show that Great States’ assets were used to purchase Great

States’ stock. This telescopes the allegations, for the actual

facts show that Nimmo sold to State Security. State Security

A-50

borrowed funds from a third party to make the purchase.

Then Great States was merged into State Security. The

only sense in which Great States purchased its securities

from Nimmo is that, subsequent to the merger, Great States’

assets were subject to the loan obtained to buy Nimmo’s

stock. However, there is no allegation that the loan was

obtained on the strength of the proposed merger, nor is

there an allegation that the Great States’ assets were sub-

jected to the terms of the loan. Nevertheless, the facts al-

leged are sufficient to establish a kind of “purchase” by

Great States sufficient to warrant a derivative action on its

behalf. Herpich v. Wallace, 430 F.2d 792, 807-10 (5th Cir.

1970) ; cf. Dasho v. Susquehanna Corp., 380 F.2d 262, 267

(7th Cir. 1967), cert. denied sub non, Bard v. Dasho, 389

U.S. 977 (1967) [“Dasho I]. The proof as to the cause of

action must be directed to whether the scheme complained

of was carried on to defraud Great States and whether Great

States has been proximately injured thereby. Herpich,

supra, at 810.

As to the individual plaintiffs, the Graingers, their stand-

ing must rest upon their exchange of Great States’ stock for

State Security’s stock. In S.E.C. v. National Securities, Inc.,

393 U.S. 453, 467 (1969) , the Supreme Court held that an

exchange of stock in a merger context was a “purchase.”

The Court made it clear, however, that its holding was de-

terminative only as to a suit by the S.E.C., and it explicitly

declined to address the question for purposes of a private

action like the present one. Nevertheless, the extension is

a natural one, for by exchanging their shares in Great States

for shares in State Security, the plaintiffs have converted

their investment from one company to another, precisely

the type of situation sought to be covered by the 1934 Act.

Moreover, the exchange was the final step in the alleged

fraud. Thus, it seems clear that plaintiffs are “purchasers”

A-51

within the meaning of the 1934 Act. 15 U.S.C. § 78c (13) ;

see Whitaker, The Birnbaum Doctrine: An Assessment, 23

Ala. L. Rev. 543, 555 n. 57 (1971).

Once the “purchase” requirement is met, the facts state

a cause of action for violation of Rule 10b-5. Herpich v.

Wallace, supra; Dasho I, supra.™ It is well to point out that

plaintiffs’ allegations of fraud in the overall transaction

merit full development upon motions for summary judg-

ment. Herpich and Dasho I are both distinguishable. Both

cases involved a similar scheme, but in both the defrauded

corporation was the final purchaser of its own over-valued

stock; the merger brought into the complaining corporation

both the loan and the stock. In this case the merger brought

in nothing but assets which might be charged with the loan

which was already held by the surviving corporation. How-

ever, this distinction does not vitiate the plaintiffs’ claim

since they assert that the net effect was to pay Nimmo and

his company a premium,” at the expense of his fellow Great

States shareholders. This allegation raises fraud regardless

of how the sale and merger were structured, so long as ma-

terial facts were withheld from the plaintiffs. While there

may be no fiduciary duty on the part of a majority stock-

holder to report every offer he gets to his fellow share-

holders, there is a duty of disclosure where those sharehold-

ers may be charged with the burden of the premium price

paid. Dasho v. Susquehanna Corp., 461 F.2d 11, 26 (7th

Cir.), cert. denied, 408 U.S. 925 (1972) (“Dasho II").

The failure to make such a report may constitute a portion

of a larger scheme to defraud the shareholders, regardless

28]t needs emphasis that this memorandum addresses only the allega-

tions and whether they state a cause of action. No attempt has been made

to deal with the statute of limitations or any other issues.

**Whether a premium was in fact paid is unclear from the evidence

now before the Court, especially in light of Nimmo

assets he was required to buy from Great States, in order to consummate

the sale, were over-valued in the contract of sale. See fn 18, supra.

E

e

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of the right of a majority shareholder to receive a premium

for his shares. Cf. Dasho II, supra, at 33.

This disposition requires the Court to reach Nimmo’s

motion to quash.” He is correct in arguing that his sale of

the Great States stock precludes this Court’s assertion of

personal jurisdiction over him solely on the basis of the

August 28, 1968, proxy statement. Gould v. Tricon, 272

F. Supp. 385 (S.D. N.Y. 1967). That he was still techni-

cally a member of the board of Great States on August 28,

1968 (since his replacement was not formally chosen until

August 30, 1968) , does not change the result, since his prior

sale of his stock precluded his having any direct hand in the

preparation of that proxy statement. Thus, the allegedly

false and misleading statements made therein — on which

plaintiffs rely heavily — will not support personal jurisdic-

tion over Nimmo.

Nor may this Court hold Nimmo as a “controlling per-

son” under 15 U.S.C. § 770. Plaintiffs argue strenuously

that his receipt of $30,000.00 from State Security as a con-

sultant in the year following the merger and his retention

of the power to approve every check issued by Great States

in excess of $1,000.00 make him liable for the fraudulent

acts of State Security following the sale. To find control,

the securities laws require:

. . . [t]he possession, direct or indirect, of the power

to direct or cause the direction of thy management and

policies of a person, whether through the ownership of

voting securities, by contract, or otherwise. Rule 405,

- 1933 Act; Rule 12b-2, 1934 Act.

Neither of the above contractual terms gave Nimmo control

over Great States for purposes of the August 28, 1968, proxy

statement, particularly in light of the undisputed evidence

For the desirability of the Court's treating documents outside the

pleadings, see text at pp. 26-7, supra.

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that he asked, but was never allowed, to exercise his check

approval authority. See Ayers v. Wilfinbarger, 491 F.2d 8

(5th Cir. 1974) ; United States v. Sherwood, 175 F. Supp.

480-3 (S.D. N.Y. 1959) .

However, Nimmo and his corporation may be required

to answer to this Court under plaintiffs’ conspiracy count.

As it is now before this Court," plaintiffs argue that the

August 8, 1968, proxy statement was misleading in that it

did not adequately disclose the premium which Nimmo

and his company received for sale of control, and that it did

not adequately disclose the fact that the ensuing merger

would have the effect of charging the Great States minority

shareholders with the premium price. While the August

8, 1968, statement does disclose, at page 3, the basic facts

from which the above conclusions could be drawn, a ques-

tion for further development is presented as to whether this

disclosure was adequate.

Given this substantial link between the May 10 sales

agreement and the September 20 merger, it cannot be said

that there is no evidence of a conspiracy here, by which

Nimmo agreed to sell his stock in Great States to State Se-

curity, with z subsequent merger so that the majority share-

holders of Great States would be charged, at least in part,

with the burden of paying for the control premium. That

Nimmo and his company may have been a part of this con-

spiracy is sufficiently raised by plaintiffs’ documentary evi-

dence regarding the aborted sale and the subsequent law-

suit. Certainly the two defendants may be charged with

knowledge of the scheme even if they did not originate it,

31Plaintiffs’ complaint makes no mention of the August 8, 1968, proxy

statement in its substantive allegations; there is a veiled reference to it in

the “venue” portion of the complaint. Beginning with their brief of De-

cember 30, 1969, however, this proxy statement has assumed added im-

portance until, in their latest brief, plaintiffs aver that the August 8, 1968,

proxy statement is materially misleading and in furtherance of the con-

spiracy. The conspiracy itself is clearly alleged in the complaint.

ae

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especially in light of the benefits they derived from it.

Herpich v. Wallace, 430 F.2d 818, 819 (5th Cir. 1970) .”

Jurisdiction over Nimmo then may be had under the

conspiracy count. Wyndham Assoc. v. Bintliff, 398 F.2d

614, 620 (2d Cir. 1968). Commission of any act in further-

ance of the conspiracy here likewise makes venue appro-

priate in the Northern District of Alabama. Int’! Controls

Corp. v. Vesco, 490 F.2d 1334, 1347 (2d Cir. 1974).

This conclusion makes it unnecessary to reach other con-

tentions raised by the parties.

%2Defendants stress the dismissal of the suits against three defendants,

situated similarly to Nimmo, in Dasho II, supra, at 33. This dismissal must

be viewed in light of the plaintiffs’ abandonment there of their conspiracy

counts. Jd., at 16.