Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca9-09-55513/USCOURTS-ca9-09-55513-0/pdf.json

Nature of Suit Code: 110
Nature of Suit: Insurance
Cause of Action: 

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FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

FREEMAN INVESTMENTS, L.P.;

DARREL FREEMAN IRREVOCABLE

TRUST; FREEMAN JOINT

IRREVOCABLE TRUST, individually

and on behalf of a class of others

similarly situated; DAVID KEMP,

Trustee of the Darrel L. Freeman

Irrevocable Trust, individually and

on behalf of a class of others

similarly situated; DAVID KEMP,

Trustee of the Freeman Irrevocable

Trust, individually and on behalf of a

class of others similarly situated,

Plaintiffs - Appellants,

v.

PACIFIC LIFE INSURANCE COMPANY,

Defendant - Appellee.

No. 09-55513

D.C. No.

8:08-cv-01134-

DOC-AN

OPINION

Appeal from the United States District Court

for the Central District of California

David O. Carter, District Judge, Presiding

Argued and Submitted

June 5, 2012–Pasadena, California

Filed January 2, 2013

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2 FREEMAN INVESTMENTS V. PACIFIC LIFE

 This summary constitutes no part of the opinion of the court. It has

*

been prepared by court staff for the convenience of the reader.

Before: Alex Kozinski, Chief Judge, Stephen S. Trott,

and Sidney R. Thomas, Circuit Judges.

Opinion by Chief Judge Kozinski

SUMMARY

*

Securities Litigation Uniform Standards Act of 1998

The panel affirmed in part and reversed in part the district

court’s dismissal of a class action as precluded by the

Securities Litigation Uniform Standards Act.

SLUSA precludes state law class actions that allege

misrepresentations or fraudulent omission in connection with

the purchase or sale of covered securities. In this case,

appellants purchased variable universal life insurance policies

(under which the policy holder bears risks associated with the

investment of premiums), and alleged various state law

claims against their insurer.

The panel held that the class claims for breach of contract

and breach of the duty of good faith and fair dealing were not

precluded by SLUSA, even if such claims related to the

purchase or sale of a covered security, because these contract

claims did not rest on misrepresentation or fraudulent

omission. The panel reversed the district court’s dismissal of

these two contract claims, on the condition that plaintiffs

amend their complaint to remove any reference to deliberate

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FREEMAN INVESTMENTS V. PACIFIC LIFE 3

concealment or fraudulent omission. The panel affirmed the

dismissal of the class claim for unfair competition in violation

of California law. The panel remanded with instructions that

the district court grant leave for appellants to file an amended

complaint.

COUNSEL

Lee A. Sherman, Callahan Thompson Sherman & Caudill

LLP, Tustin, California; Stephen R. Miller and John J.

Schirger, Miller Schirger LLC, Kansas City, Missouri; and

Patrick J. Stueve and Richard M. Paul III (argued), Stueve

Siegel Hanson LLP, Kansas City, Missouri, for PlaintiffsAppellants.

James C. Martin (argued), Robert D. Phillips Jr., Thomas A.

Evans and David J. Bird, Reed Smith LLP, San Francisco,

California, for Defendant-Appellee.

OPINION

KOZINSKI, Chief Judge:

The Securities Litigation Uniform Standards Act of 1998

(SLUSA) precludes state law class actions that allege

misrepresentation or fraudulent omission in connection with

the purchase or sale of covered securities. In this case we

answer the question on everyone’s lips: Does SLUSA

displace class actions alleging breach of a variable universal

life insurance contract?

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4 FREEMAN INVESTMENTS V. PACIFIC LIFE

 Pacific must shield funds in the separate account from its general 1

liabilities and expenses, and use it only to fund the variable universal

insurance contracts. See 15 U.S.C. § 80a–2(a)(37); 17 C.F.R.

§ 270.0–1(e). The separate account is registered with the Securities and

Exchange Commission as a unit investment trust under the Investment

Company Act of 1940. See Prudential Ins. Co. of Am. v. SEC, 326 F.2d

383, 388 (3d Cir. 1964).

I. BACKGROUND

Plaintiffs purchased variable universal life insurance

policies from defendant Pacific Life Insurance Company.

Variable universal insurance differs in important ways from

term life insurance, which protects against risk of death for a

finite period and provides no continuing benefit once that

time expires. See American Council of Life Insurers, Life

Insurance Fact Book 64 (2011). Variable universal insurance

lasts for the duration of the policyholder’s life and allows him

to share in the gains (or losses) generated by the investment

of premiums. A policyholder may borrow against the

accumulated value of his variable universal policy, or cash

out the accumulated value by surrendering the policy while

he’s alive.

Pacific guarantees its customers a minimum insurance

benefit, and policyholders also allocate a portion of their

premiums to a separate account whose value fluctuates over

time. Policyholders choose from various investment options 1

within the separate account, and Pacific investsthe assets into

corresponding portfolios of the Pacific Select Fund. The

death benefit payable to survivors varies with the

performance of the funds each customer selects. Because the

policyholder bears the risk associated with the investments,

our sister circuits have held that the variable universal policy

qualifies as a security regulated by federal law. See Herndon

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FREEMAN INVESTMENTS V. PACIFIC LIFE 5

 Plaintiffs don’t dispute that variable universal policies are covered 2

securities. We therefore have no cause to consider whether or not we

agree with our sister circuits, though our precedent suggests we would.

See Patenaude v. Equitable Life Assurance Soc’y of the United States,

290 F.3d 1020, 1022 (9th Cir. 2002) (holding a variable annuity issued by

an insurance company to be a covered security), abrogated on other

grounds by Kircher v. Putnam Funds Trust, 547 U.S. 633, 636 n.1 (2006).

v. Equitable Variable Life Ins. Co., 325 F.3d 1252, 1253

(11th Cir. 2003) (per curiam); see also Lincoln Nat’l Life Ins.

Co. v. Bezich, 610 F.3d 448, 451 (7th Cir. 2010).2

Each month, Pacific assesses a “cost of insurance” charge,

which it collects by redeeming units of the separate account.

Plaintiffs accuse Pacific of levying excessive cost of

insurance charges. They allege that “cost of insurance” is an

industry term of art and that they understood the fee would be

calculated according to industry standards. Second Am.

Class Action Compl. ¶¶ 15–17. They brought a class action

in federal district court alleging breach of contract, breach of

the duty of good faith and fair dealing and unfair competition

under California Business and Professions Code § 17200. Id.

¶¶ 33–45. They also claim that the statute of limitations

should toll because Pacific concealed the magnitude of its

charges in its quarterly statements. Id. ¶¶ 32, 43. Tolling

would permit plaintiffs to seek restitution of charges assessed

during the entire period they held the policy, some of which

seems to go back beyond the limitations period.

Pacific moved to dismiss the complaint, arguing that the

class action was precluded by SLUSA. The statute bars class

actions brought under state law, whether styled in tort,

contract or breach of fiduciary duty, that in essence claim

misrepresentation or omission in connection with certain

securities transactions. See 15 U.S.C. § 78bb(f)(1); Segal v.

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6 FREEMAN INVESTMENTS V. PACIFIC LIFE

Fifth Third Bank, N.A., 581 F.3d 305, 310 (6th Cir. 2009).

The district court granted the motion, but only after twice

giving plaintiffs leave to amend. Plaintiffs scrubbed their

complaint of many (but not all) references to systematic

concealment and deceitful conduct, but the district court

concluded that the substance remained the same: “Such

allegations of excessive charges, hidden loads and

concealment clearly amount, at the least, to an allegation that

Defendant omitted facts in connection with the purchase of

securities, if not allegations of outright misrepresentations

made by Defendant.” We review de novo. Proctor v. Vishay

Intertechnology Inc., 584 F.3d 1208, 1218 (9th Cir. 2009).

II. DISCUSSION

SLUSA is part of a series of reforms targeted at costly

securities litigation. Congress first passed the Private

Securities Litigation Reform Act of 1995 (PSLRA) to deter

the filing of so-called strike suits—frivolous securities class

actions that put defendants to the unappealing choice of

settling claims, however meritless, or risking extravagant

discovery and trial costs. See H.R. Conf. Rep. 104–369

(1995); Michael A. Perino, Fraud and Federalism:

Preempting Private State Securities Fraud Causes of Action,

50 Stan. L. Rev. 273, 290–91 (1998). The statute imposed a

number of procedural hurdles on federal securities class

actions, including a heightened pleading requirement. See

15 U.S.C. § 78u–4(b); Proctor, 584 F.3d at 1217. But

inventive lawyers found detours around these obstacles. By

bringing state law class actions in state courts, they avoided

the procedural steeplechase erected by the PSLRA. See

Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit,

547 U.S. 71, 81–82 (2006).

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FREEMAN INVESTMENTS V. PACIFIC LIFE 7

 A covered class action is one in which “damages are sought on behalf 3

of more than 50 persons or prospective class members.” 15 U.S.C.

§ 78bb(f)(5)(B). A covered security is one issued by an investment

company registered under the Investment Company Act of 1940. Id.

§ 77r(b)(2).

Equal to the challenge, Congress persisted by adopting

SLUSA, which seeks to prevent state class actions alleging

fraud “from being used to frustrate the objectives” of the

PSLRA. See H.R. Conf. Rep. 105–803 (1998). SLUSA bars

private plaintiffs from bringing (1) a covered class action (2)

based on state law claims (3) alleging that defendant made a

misrepresentation or omission or employed any manipulative

or deceptive device (4) in connection with the purchase or

sale of (5) a covered security. See 15 U.S.C. § 78bb(f)(1).

Plaintiffs and Pacific agree that this case involves (1) a

covered class action, (2) state law claims and (5) a covered

security. They hotly dispute the two remaining elements:

3

Do the state law claims, no matter how labeled, in substance

allege (3) misrepresentation or omission (4) in connection

with the purchase or sale of securities?

A. Misrepresentation or omission

In arguing that plaintiffs “allege numerous

misrepresentations and omissions in furtherance of an

inherently deceptive scheme,” Pacific quotes extensively

from the initial complaint, which accuses the company of

“systematic concealment” and “deceitful conduct” designed

“to generate undeserved revenues.” As our sister circuits

have recognized, the statute operates wherever deceptive

statements or conduct form the gravamen or essence of the

claim. See Rowinski v. Salomon Smith Barney Inc., 398 F.3d

294, 299–300 (3rd Cir. 2005). Because we look to the

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8 FREEMAN INVESTMENTS V. PACIFIC LIFE

 In California, interpretation of contract terms is a question of law for 4

the court “unless the interpretation turns upon the credibility of extrinsic

evidence,” such as expert testimony. Parsons v. Bristol Dev. Co.,

402 P.2d 839, 842 (Cal. 1965) (Traynor, C.J.), cited in United Commercial

Ins. Serv., Inc. v. Paymaster Corp., 962 F.2d 853, 856 (9th Cir. 1992).

substance of the allegations, plaintiffs cannot avoid

preclusion “through artful pleading that removes the covered

words . . . but leaves in the covered concepts.” Segal,

581 F.3d at 311. Were it otherwise, “SLUSA enforcement

would reduce to a formalistic search through the pages of the

complaint for magic words—‘untrue statement,’ ‘material

omission,’ ‘manipulative or deceptive device’—and nothing

more.” Id. at 310.

Stripped to its essence, plaintiffs’ latest complaint alleges

that Pacific charged them too much for life insurance and, as

a result, reduced the value of their investments. Specifically,

they claim that “cost of insurance” is a term of art that refers

to “the portion of premiums from each policyholder set aside

to pay claims.” Second Am. Class Action Compl. ¶ 15

(internal quotation marks and emphasis omitted). They allege

that they expected Pacific to calculate the cost of insurance

charge “based on industry accepted actuarial determinations,”

but the companydeviated from industry norms and debited an

amount “in excess of true mortality charges.” Id. ¶¶ 16–17.

Plaintiffs thus raise a dispute about the meaning of a key

contract term, and the success of their claim will turn on

whether they can convince the court or jury that theirs is the

accepted meaning in the industry. See Restatement (Second) 4

of Contracts § 202(3)(b); Cal. Civ. Code § 1645. This is just

like the “what is chicken?” case with which every first-year

law student is familiar. See Frigaliment Importing Co. v.

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FREEMAN INVESTMENTS V. PACIFIC LIFE 9

B.N.S. Int’l Sales Corp., 190 F. Supp. 116, 117, 119

(S.D.N.Y. 1960) (Friendly, J.).

To succeed on this claim, plaintiffs need not show that

Pacific misrepresented the cost of insurance or omitted

critical details. They need only persuade the court that theirs

is the better reading of the contract term. See Yount v. Acuff

Rose–Opryland, 103 F.3d 830, 836 (9th Cir. 1996). “[W]hile

a contract dispute commonlyinvolves a ‘disputed truth’ about

the proper interpretation of the terms of a contract, that does

not mean one party omitted a material fact by failing to

anticipate, discover and disabuse the other of its contrary

interpretation of a term in the contract.” Webster v. N.Y. Life

Ins. and Annuity Corp., 386 F. Supp. 2d 438, 441 (S.D.N.Y.

2005). Just as plaintiffs cannot avoid SLUSA through crafty

pleading, defendants may not recast contract claims as fraud

claims by arguing that they “really” involve deception or

misrepresentation. Id.; see also Walling v. Beverly Enters.,

476 F.2d 393, 397 (9th Cir. 1973) (“Not every breach of a

stock sale agreement adds up to a violation of the securities

law.”).

Nor do plaintiffs make a stealth allegation of fraudulent

omission with their tolling argument. Plaintiffs seek

restitution for cost of insurance charges made during the

entire period they held their insurance policies, even that part

foreclosed by the statute of limitations. To reach those older

charges, they argue that the statute should toll because Pacific

“knowingly and actively concealed” the excessive charges

and kept its customers “ignorant of information essential to

the pursuit of these claims.” Second Am. Class Action

Compl. ¶ 32. The complaint makes two distinct allegations,

that Pacific (1) breached the contract and then (2) hid the

breach. The latter doesn’t corrupt the former, turning it into

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10 FREEMAN INVESTMENTS V. PACIFIC LIFE

a claim of fraudulent omission. The breach and tolling

arguments are perfectly consistent: If the parties disagreed

about the meaning of “cost of insurance,” as plaintiffs allege,

Pacific may well have believed there was no breach to

disclose.

All the same, plaintiffs would be wise to rid their

complaint of the allegations of active concealment. In

California, the statute of limitations period does not

commence until plaintiffs have a reasonable way of detecting

the breach. See El Pollo Loco, Inc. v. Hashim, 316 F.3d

1032, 1039 (9th Cir. 2003). This “discovery rule” applies

even if the defendant didn’t engage in fraud or concealment.

See Gryczman v. 4550 Pico Partners, Ltd., 131 Cal. Rptr. 2d

680, 682 (Cal. Ct. App. 2003). On remand, the district court

shall give plaintiffs leave to amend their complaint for a third

time to eliminate references to hidden loads, knowing

concealment and wrongful conduct. These concepts are

irrelevant to both the breach and the tolling claims, so there’s

no reason to risk tainting any eventual verdict by including

references to fraud or misrepresentation.

In sum, the breach of contract claim survives SLUSA, as

does the class claim for breach of the duty of good faith and

fair dealing, itself a species of contract claim. But California

Business & Professions Code § 17200, on which plaintiffs

base a separate claim, defines unfair competition as “any

unlawful, unfair or fraudulent business act or practice.” This

claim doesn’t survive SLUSA unless the charged conduct

didn’t occur “in connection with” the purchase or sale of a

covered security.

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FREEMAN INVESTMENTS V. PACIFIC LIFE 11

B. In connection with the purchase or sale of a

covered security

Misrepresentation occurs “in connection with” the

purchase or sale of a covered security if “the fraud and the

stock sale coincide or are more than tangentially related.”

Madden v. Cowen & Co., 576 F.3d 957, 966 (9th Cir. 2009)

(internal quotation marks omitted). While this language is

capacious, it doesn’t reach all transactions in which securities

play a role, however incidental. See SEC v. Zandford,

535 U.S. 813, 820 (2002). “The fraud in question must relate

to the nature of the securities, the risks associated with their

purchase or sale, or some other factor with similar connection

to the securities themselves. While the fraud in question need

not relate to the investment value ofthe securities themselves,

it must have more than some tangential relation to the

securities transaction.” Falkowski v. Imation Corp., 309 F.3d

1123, 1130–31 (9th Cir. 2002) (internal quotation marks and

brackets omitted), abrogated on other grounds by Kircher v.

Putnam Funds Trust, 547 U.S. 633, 636 n.1 (2006). 

A variable universal life insurance policy is a “hybrid”

creature that has “characteristics of both insurance products

and investment securities.” Patenaude v. Equitable Life

Assurance Soc’y of the United States, 290 F.3d 1020, 1027

(9th Cir. 2002) (internal quotation marks omitted) (addressing

variable annuities), abrogated on other grounds by Kircher,

547 U.S. at 636 n.1. In some cases, plaintiffs may raise

claims that survive SLUSA because they target only the

insurance features of the policy. Cf. Ring v. AXA Financial,

Inc., 483 F.3d 95, 99–101 (2d Cir. 2007). But not here.

Pacific collects the cost of insurance charge by redeeming

units of the separate account, which itself holds investments

in the Pacific Select Fund. According to the policy’s

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12 FREEMAN INVESTMENTS V. PACIFIC LIFE

prospectus, “Unless you tell us otherwise, we deduct the

monthly charge from the investment options that make up

your policy’s accumulated value, in proportion to the

accumulated value you have in each option.” Each inflated

charge not only “coincides” with the sale ofsecurities; it also

depletes the value of the investment. A fund subject to higher

fees and charges will, over time, have a lower value than a

fund subject to more modest charges. Cf. Behlen v. Merrill

Lynch, 311 F.3d 1087, 1094 (11th Cir. 2002). To the extent

plaintiffs allege that Pacific engaged in fraud or

misrepresentation that drained their investments, SLUSA

stands in the way.

Plaintiffs in fact allege that the “wrongfully diverted

funds . . . reduced Policy values” and thereby worked to their

“financial detriment.” Second Am. Class Action Compl.

¶¶ 21–22. Essentially, they claim that Pacific harmed them

by fraudulently debiting funds that would otherwise have

been invested in securities. The Supreme Court instructs us

to construe SLUSA’s “in connection with” language broadly,

“not technically and restrictively.” Zandford, 535 U.S. at 819

(internal quotation marks omitted). We conclude that the

conduct charged in the complaint satisfies this standard.

Plaintiffs argue that the “in connection with” requirement

is satisfied only if they “bought or sold a security in reliance

on misrepresentations as to its value.” Appellants’ Br. 18

(emphasis omitted) (quoting Araujo v. John Hancock Life Ins.

Co., 206 F. Supp. 2d 377, 383 (E.D.N.Y. 2002)). They claim

that on the day they purchased the variable universal policy,

they “initially received the policy as represented” and were

defrauded only later when Pacific started deducting excessive

fees. Id. Most likely they derive this argument from Blue

Chip Stamps, where the Supreme Court held that only

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FREEMAN INVESTMENTS V. PACIFIC LIFE 13

purchasers and sellers of securities have standing to bring a

private securities fraud action. See Blue Chip Stamps v.

Manor Drug Stores, 421 U.S. 723, 731–32, 749 (1975). But

the Court has also said that SLUSA may bar state law class

actions even if plaintiffs can’t satisfy that standing

requirement, and thus wouldn’t have a federal securities

claim. See Dabit, 547 U.S. at 88–89.

In Dabit, the defendant circulated misleading research

that distorted stock prices and lulled plaintiffs into holding

overvalued investments theywould have been wise to unload.

Id. at 75. The Court held the “in connection with”

requirement satisfied even though the plaintiffs engaged in no

active trading. “Under our precedents,” the Court said, “it is

enough that the fraud alleged ‘coincide’ with a securities

transaction—whether by the plaintiff or someone else.” Id.

at 85; see also Carpenter v. United States, 484 U.S. 19, 24

(1987) (plurality).

Every time Pacific collected the allegedly inflated cost of

insurance charge, it sold securities to generate the funds.

Because the insurer’s alleged fraud “coincided” with the sale

of securities, it doesn’t matter that the policyholders didn’t

themselves redeem the securities. The “in connection with”

requirement is satisfied.

C. Individual claims

Plaintiffs argue that the district court erred in dismissing

their complaint with prejudice because, even if SLUSA

prevents them from proceeding as a class, they should be free

to pursue their claims as individuals. As they correctly note,

SLUSA isn’t a complete bar to state law claims that sound in

fraud. The statute only “denies plaintiffs the right to use the

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14 FREEMAN INVESTMENTS V. PACIFIC LIFE

class-action device to vindicate” those claims. Dabit,

547 U.S. at 87. If plaintiffs presented viable individual

claims, the district court should have dismissed them without

prejudice so that plaintiffs might bring them in state court.

See Segal, 581 F.3d at 312.

But Pacific tells us that plaintiffs never asserted

individual claims, and instead brought their complaint solely

as a class action. The complaint is ambiguous on that score.

In the very first line, plaintiffs declare that they’re proceeding

“individually and on behalf of all others similarly situated.”

The Eighth Circuit recently held that similar language,

coupled with factual allegations specific to the named

plaintiffs, “distinctly makes out individual claims” separate

from the class claims. McCrary v. Stifel, Nicolaus & Co.,

687 F.3d 1052, 1057–58 (8th Cir. 2012). But in our case

plaintiffs twice identify their case as a class action without

referencing any individual claims. Second Am. Class Action

Compl. ¶¶ 1, 6. They also fail to allege that their individual

claims, standing alone, would satisfy the amount in

controversy requirement for federal diversity jurisdiction,

asserting only that they meet the $5 million threshold for

class actions. Id. ¶ 6.

We need not decide whether plaintiffs pleaded individual

claims; we’ll assume they did not. But if that’s the case, we

see no merit to the insurer’s argument that plaintiffs forfeited

those claims by failing to seek leave to amend their complaint

and plead such claims while the motion to dismiss was

pending. Because we’re remanding for plaintiffs to amend

their complaint on other grounds, there’s no reason they can’t

also amend to pursue their claims as individuals, if they so

choose. See Smith v. Pacific Props. and Dev. Corp., 358 F.3d

1097, 1101 (9th Cir. 2004) (noting that leave to amend should

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FREEMAN INVESTMENTS V. PACIFIC LIFE 15

be freely given, except in cases of bad faith, undue delay or

prejudice to the opposing party).

III. CONCLUSION

The class claims for breach of contract and breach of the

duty of good faith and fair dealing are not precluded by

SLUSA, even if such claims relate to the purchase or sale of

a covered security. Plaintiffs allege that their insurer

promised one thing and delivered another. That’s a

straightforward contract claim that doesn’t rest on

misrepresentation or fraudulent omission. We therefore

reverse the district court’s dismissal of the two contract

claims, on the condition that plaintiffs amend their complaint

to remove any reference to deliberate concealment or

fraudulent omission. We affirm the dismissal of the class

claim for unfair competition in violation of California law.

We remand with instructions that the district court grant

leave for plaintiffs to file an amended complaint consistent

with our opinion.

AFFIRMED IN PART, REVERSED IN PART AND

REMANDED.

NO COSTS.

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