A Strong Offense
A Stronger Defense
Alaska (and potentially Pennsylvania) law may be or so says the United States Court of Appeals for the Third Circuit. In Michael S. Rulle Family Dynasty Trust v. AGL Life Assurance Company, the federal appellate court – applying Alaska and some Pennsylvania law – summarily dismissed a trust’s suit against a life insurance company for losses sustained through investments in four funds operated by Bernie Madoff. In fact, the court went so far as to decide that each of the Michael S. Rulle Family Dynasty Trust’s eight claims against AGL Life Assurance Company failed to state a claim upon which relief could be granted, meaning they couldn’t even get to get into the good stuff through discovery. Here’s the background:
The Rulle Trust purchased a flexible premium variable life insurance contract issued by AGL. Michael S. Rulle was the named insured on the policy and the court was quick to note that Rulle “is an experienced investment banker,” which may explain some of the ruling and differentiate it from cases involving unsophisticated investors. The policy offered the Rulle Trust the opportunity to invest its premiums in either a money market account or a potentially more lucrative “fund of funds” established by AGL (the “Tremont Fund”) but which was managed by Tremont Partners, LLC. Per the usual, a document explained these options and (along with the policy itself) contained the standard investment risk boilerplate including the statement that “[t]he policy owner bears the entire investment risk for all amounts invested in the policy, including the risk of loss of principal. There is no guaranteed minimum account value.”
The President and CEO of AGL solicited the Rulle Trust to invest in the Tremont Fund and allegedly represented that no more than 7% of the Trust’s investments would be placed in the hands of any single investment manager. Pretty standard diversification stuff. So, the Rulle Trust invested all of the premiums in the Tremont Fund, which were distributed into various hedge funds, including four funds operated by Bernie Madoff. You know the rest of the story. When Madoff’s Ponzi scheme was exposed, it was discovered that 23% (as opposed to 7%) of the Rulle Trust’s premiums have been invested with Madoff and had lost all their value.
The Rulle Trust sued AGL for (1) breach of contract, (2) breach of fiduciary duty, (3) breach of the common law duty of good faith and fair dealing, (4) federal securities fraud, (5) fraud under the Alaska and Pennsylvania Securities Acts, (6) professional negligence, negligence, and gross negligence, (7) negligent misrepresentation, and (8) unjust enrichment. The court tossed all of the claims without letting the parties get into discovery.
Breach of Contract – The boilerplate “risk of loss” language in the policy placed the entire risk of investing on the Rulle Trust. The Rulle Trust might have worked around the contract language but here’s where it made a common mistake. The Rulle Trust apparently chose to affirm the contract (and its clear risk of loss language) and seek damages for an alleged breach rather than rescind the contract and seek restitution. Where a party claims there is a material misrepresentation that induced it to enter a contract, the contract can be rescinded and restitution awarded. Moreover, if a party elects to rescind a contract, boilerplate language in the contract, such as the risk of loss language, would be inapplicable. The Rulle Trust never attempted to rescind the contract and, therefore, it was stuck with the plain risk of loss language included in the boilerplate.
Covenant of Good Faith and Fair Dealing – This entire claim was dependent on the breach of contract claim and, therefore, necessarily failed when the breach of contract claim failed.
Securities Fraud – Securities fraud claims require scienter – a mental state where the defendant intends to deceive, manipulate or defraud. None of the Rulle Trust’s allegations explained how or why AGL – which didn’t control the investments – should have known that 23% of the premiums would ultimately be invested with Madoff by the Tremont Fund, which was a separate entity that did have control over the investments.
Fiduciary Duty/Negligence – In order for AGL to owe the Rulle Trust a duty, it would have had to maintain control over the premiums. The Rulle Trust was informed that its premiums would be managed by Tremont, who would be entirely responsible for investment decisions.
AGL did not owe the Trust a duty simply by virtue of its position as an insurance provider or simply because it provided investment advice. If the dispute had been over insurance, then that would be a different situation. Instead, with respect to investments, AGL did not enter into or adopt the role of a broker-dealer, investment manager, or investment advisor. Here Rulle’s background became particularly important insofar as the court noted that Rulle would have understood the relationships between all the players.
Unjust Enrichment – Although the Rulle Trust alleged that the management fees AGL received were “improper,” the Trust failed to allege anything improper about how AGL got those fees (as the court noted the allegations that AGL insured the Trust’s risk or owed the Trust a duty with respect to the investments were without merit).
This case is probably unique because the Trust sued the middleman. There are some undertones in the opinion that suggest that the Trust’s case may have been able to proceed if AGL had control over the investment decisions. Instead, all of the alleged bad stuff (the concentrations, etc.) was the result of the acts of a third party. Certainly, the appellate courts are going to have plenty of opportunities to clarify these issues as the Madoff and other Ponzi scheme cases wind their way through the courts.