HonorableWilliam A. Harrison Opinion No. WW-459

Commissioner

of Insurance State Board of Insurance Re: What constitutes an underAustin, Texas writing transactionprohibited by Article 3.39, Section 2 of the Texas Dear Sir: InsuranceCode?

In your amended opinion request you ask whether several types of transactions are prohibitedby various provisions of the InsuranceCode among which is Article 3.39, Section 2, which reads as follows:

"No such~companyshall subscribeto, or patitlcipate in, any underwritingof the purchase or sale of securities

or property or enter Into any such transaction for such purpose, or sell on account of such company jointlywith any other person, firm or corporation; nor shall any such company enter into any agreement to withhold from sale any of Its property,but the disposition

of Its property shall be at all times within the control of Its Board of Directors;

. . ." The first two of the factual transactions that you are concerned

with are summarizedfrom our correspondence as follows:
1. A contract between a life insurancecompany and a subdivision

developmentcompany provides as follows: "Whereas, It Is contemplated and agreed that the XYZ Life Insuran‘ce Company and the B Investment Company will build or cause to have built for sale a number of~.*resldences both In Odessa, Texas, **and** Irving,Texas, to be jointly owned by both corporations, and that the title to the property shall be carried in the name of the B InvestmentCompany for convenienceonly. "Now, therefore,be It resolved that the XYZ Life InsuranceCompany shall furnish all of the money through loans or provide the necessary credit-to the B InvestmentCompany for the purchase of the building sites,materials, labor and.all building constructionHon. Wllllen~ A. Harrison, page 2 (W-459)

costs; that the B InvestmentCompany will furnish all of the supervision, let all contracts for building on a basis satisfactory to the XTZ Insurance Company and will supervise the sale of said houses. When the houses are sold all the profits, after deductingthe entire cost of lots and bulldlng plus any coumlsslons paid for sale of property or any expensesof.any nature Incurred in the bullding of said houses, shall be divided as follows:
"85s to the XYZ Life InsuranceCompany. "15% to the B InvestmentCompany. “In arriving at the cost it Is understood that the interestpaid on the money borrowed shall be a part of the costs determiningthe profit."
2. A developmentcorporationunder a trust 'ogrocment deeds fee title to real estate for subdivisionto a Trustee under an escrow arrangement whereby a life Insurance company loans the Trustee large sums of money secured by a first lien upon the real estate contributed by the developmentcorporation. These funds held by the Trustee are advanced from time to time to the development corporationto build and develop the subdivision. As the subdlvlslonIs developed and sold to the public, the entireproceeds are depositedwith the Trustee. The Trustee In turn uses a percentage of these total proceeds (agreedto in the trust instrument)to pay off:the indebtedness to the life Insurancecompany. After the loan plus interestIs paid off to the Insurancecompany, the Trustee then distributes the profits between the Insurancecompany and the development corporation

accordingto a formula agreed to in the trust lnstrum&t.
An "underwriting of the purchase or sale of

. . . property"would consist of a promise by the insurance company that if propertywere not sold for a certain price It would guaranteethat the insurancecompany would buy It for that price. Or conversely,

unless property could be acquired at a certain price the Insurancecompanywould acquire the property for the guaranteed

price whatever the market price might be. (See 43 Words and Phrases,p. 124, et seq.) Thus, It is evident that neither of the two above questioned transactionsresemblesa prohibitedunderwriting transaction.
It Is our o@lnlon,however, that both of these transactions are prohibitedon other grounds. The above quoted portion of Section 2 which contains the restrictionson underwriting andHon..-

:;~U!Ilam:.A.

Darrlson,page 3 (W-459)

joint accountswas not.ln torlc AmIWtrOngCommittee the Texas law until 1909. The hlsreported on February 22, 1906, to

.. __ - . the New York State Legislatureconcerningtne wlae scale atmses by the management of I@v York Insurancecompanies. The Committee found that the large companieshad furnished their support to numerous speculative financialventures through participating In the underwrltlngs of syndicates. In this manner, purchases had been made, not for Investment,but for resale. See %amlnation of InsuranceCompanies, Volume 2, b Insurance

Department,

New York, 1953, p. 2 L the New Yorkme

, et seq. Often .companies

furnishedall the money required for the speculative venture while officers of the company and members of the finance committee

would be parties&toa joint account and share In Its profits. In order to eliminate these wide scale abuses the fifth recommendation of the Armstrong Committeewas as follows:
"The statute should also forbid all syndicate participations,

transactionsfor purchases and sales on joint account, and the making of any agreementproviding the company shall withhold from the sale at sny time, or subject to the discretionof others, any securlties which it may own or acquire." This recommendation was adopted by the Legislatureof New York on April 27, 1906, as a part of Section 100, Laws of New York, ch. 326, p. 798 (1906). This section Is almost ldentlcal word for word wlth the above quoted Texas provision originally enacted In 1909 and brought unchanged Into the Texas Insurance Code as Article 3?39, Section 2.

From this statutoryhistory, It Is clear that the quoted phrase of Article 3.39, Section 2, establishesthree distinct and separaterestrictions on all types of Investments: First, prohibiting

underwriting;second, prohibitingsales on joint accounts and, third, prohibitingthe placing of the insurancecompany's property beyond the control of Its Board of Directors. The evil sought to be remedied by the prohibitionof selling on joint accountswas transactionsof the nature of partnership or joint ventures for a speculationIn property by which others than the Insurance companywould share some control or the profit or loss of such an "Investment".

The profit sharing features of the first transaction outlined above are clearlywithin this prohibition. Both the first and second.transactlons are essentiallysales of property on joint account with another person, firm or corporation,In which the insurance companyputs up the money In a joint account to finance the developmentand resale of property. In both :lnstances

the Insurance company Is to receive not only the loan‘> * Q;”

Hon. William A. Harrison,page 4 (WW-439)

money back with Interestbut then it will also share in the profits with the developer. The profit sharing feature as a bonus Is prohibited. Such a transactionIs characteristic of.some form of joint venture rather than an ordinary loan upon first liens upon real estate. The first transactionIs further defective for the reason that title to the real estate Is In the Insurance company and thus would be forbiddenby Article 3.40.

The statute Itself nrovldes that: "A life insurance company organized

. . . may Invest In or loan upon the following securities,

and none others, viz:

. . ." (Bnphaslsours) In this connection It should be noted that these transactionsInvolve property acquired for speculative resale rather than loans or Investments

that are held for their yield In the form of Interest or dividends. The acquisitionof such property for speculative resale is not authorizedby Article 3.39 and thereforeultra vlres.

The third factual situationon which you request an opinion as to whether or not It is a prohibited transactionis statedby you as follows:

3. A "life Insurancecompany . . . issued shares of its steak to a subsidiary underwritingcorporation with an agreement that the underwritingcorporation would sell the shares of stock to the public, and that all profits over and above 30s of the realized gross profit on the sale of the stock would be contributed by the underwriterscorporationto the life Insurance company as ~urplus.~ This third transaction by which a corporationacts as an underwriterupon shares Issued to It by an insurance company is somewhatanomalous. For a small consideration the underwriting corporationonly commits itself to use Its best efforts to market the insurance company88securities. The Insurance company-isnot Itself acting as an underwriter. Certainly, however, If the Insurance companywere to participate in such an arrangementconcerning stocks other than that of Its own issue, It would be participatingin an underwriting transaction which would be clearly forbidden. However, taken in context, the statutoryunderwriting prohibitionapplies only to lnvestments by life Insurance companies. In the instant case there is no'lnvestment

by the insurance company In any sense when the insurancecompany attempts to market its own securitiesanymore than when it attempts to sell Its own policies. For this reason we do not feel that the above quoted restrictions of ArtlcXe 3.39, Section 2, apply to this transaction. We have assumed under the facts of this transactionthat the underwritingcorporation waaactlng as a disinterested underwriterIn an arms lengthHon. William A. Harrison,.page5.(WW-459)

transaction. However, if the Board should ascertain that the directors in the Insurancecompany are "pecuniarilylnterested In" the underwritingsubsidiarycorporation,then It Is the Board's duty to subject to the strictest scrutiny the underwriting contractwith the subsidiarycorporation. From the legislative

hlstory'as stressed lh the Armstrong Committee Report, It Is abundantlyclear that any self deallng'onthe partof the directors is prohibited. InsuranceCode, Article 3.67, Article 1.15 (formerly Articles 4727 and 469) were cohstrued in Attorney General OpinionO-1889 to~allow the Board to revoke or modify any certificateof,authorltyissued If a suspect transactionfalls to meet the test of fairness, fiduciary relationship, and the standardsof soundestmorality. It should be noted In this regard that the retention of a thirty (30%) percent commlsslon by the underwritingcorporation may well be a violation of The Securities Act which limits the. total expenses of marketing securitiesIncluding commission. The commlsslonretainedby the underwrltln tion may exceed the maximum of twenty (20% 7 subsidiarycorporapercent of the price at which the stock was sold to the public If the 'pr$ce" paid by the underwritingcorporationto the lnsurance~company were nominal. In summary,both the first and second transactions are sales of property on the account of the insurance company jointly with another person, firm or corporationand are clearly prohibitedby Article 3.39, Section 2, as well as other sections of the InsuranceCode. The third transaction, although it Is not a prohibitedunderwritingtransaction, may be a suspect on other grounds.

A transaction

by which an insurance company advances capital for real estate development In return for a share of the profits is prohibitedby Article 3.39, Section 2, Texas InsurancbCode. An insurancecompanymay utilize an underwriterin order to market Its own securities unless the Insurance company directorsare so "pecuniarilyinterested"Hon. Wil1iarp.A. Harrisbn;page 6 (WW-459)

lh the transactionas to violate Article 3.67’ of the InsuranceCode.

Yours very truly,
WILL WILSON Attorney General of Texas

MS:ph
APPROVED: OPiNION COMMITTEE: &xi. P. Biackbirn, Leoxiard

Passmore Wayland C. Rivers, H&ry (1.

Braswell Mao0 Stewart Assistant

Chairman

Jr.

REVIEWEDFORTHBATTORNEYGENERAL .B!t: W. V. Geppert.