In Summons Dispute IRS Entitled to Confidential Emails Between Insurance Companies and State Regulator

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In US v Delaware Department of Insurance a federal district court ordered the Delaware Department of Insurance (DDOI) to turn over emails associated with micro-captive promoters.  In tax cases it is somewhat unusual that the federal government finds itself in court with state attorneys as adversaries. The case flags tension between the vast information-gathering powers of the IRS versus state and non tax specific federal law designed to provide state law with exclusive responsibility for regulating insurance companies. In this post I will briefly describe the case and highlight how federal law preempts Delaware confidentiality provisions.

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IRS had previously investigated Artex Risk Solutions, Inc. (“Artex”) and Tribeca Strategic Advisors, LLC (“Tribeca”) (which is owned by Artex) in transactions involving micro-captive insurance plans. As part of its investigation into possibly abusive micro-captive insurance transactions, IRS served an administrative summons on DDOI asking for a wide range of information relating to Artex and Tribeca. DDOI turned over thousands of pages of documents but refused to turn over client specific information.

As justification for its refusal, DDOI relied on Section 6920 of the Delaware Insurance Code, which provides for confidential treatment of materials and information that captive insurers submit to the state tax commissioner, either directly or through DDOI, as part of the application and licensing process.

In response to the IRS’s seeking client specific information, DDOI contacted the parties and asked for consent to comply with the IRS summons. A handful agreed but most did not. DDOI then sought to enforce the summons and DDOI filed a petition to quash, relying on Section 6920 of the Delaware Insurance Code.

As a general matter, when there is a conflict between a federal statute and a state statute, the state statute yields under the doctrine of preemption. The McCarran-Ferguson Act (“MFA”) creates an exception to this general rule.  The MFA generally provides that states are entitled to regulate the business of insurance and that “no Act of Congress shall be construed to invalidate, 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.”

MFA thus sets out a reverse preemption principle. State law cedes to federal law but not when the state law pertains to the state’s role in regulating the business of insurance. The opinion discusses the policy underlying the MFA:

“Congress was mainly concerned with the relationship between insurance ratemaking and the antitrust laws, and with the power of the States to tax insurance companies.” S.E.C. v. Nat’l Sec., Inc. , 393 U.S. 453, 458-59 (1969) (citing 91 Cong. Rec. 1087-1088). The MFA attempted “to assure that the activities of insurance companies in dealing with their policyholders would remain subject to state regulation.” Nat’l Sec., 393 U.S. at 459.

While the language in the MFA is broad, the opinion notes that It did not “purport to make the States supreme in regulating all the activities of insurance companies; its language refers not to the persons or companies who are subject to state regulation, but to laws ‘regulating the business of insurance.’ Insurance companies may do many things which are subject to paramount federal regulation; only when they are engaged in the ‘business of insurance’ does the [MFA] apply.” 

The opinion gets into some detailed discussion about how cases have applied the MFA and its reach but essentially the magistrate and ultimately the district court held that the MFA “simply does not apply – i.e., the MFA only allows for reverse preemption when the conduct at issue is the “business of insurance,” which was found missing here. “

DDOI asserted that the conduct “is more properly characterized as “receiving, maintaining and restricting dissemination of application and licensing information of captive insurers,” which it argues is fundamental to insurance regulation.”

The magistrate and district court judge disagreed, framing the state’s conduct as akin to maintaining records rather than actual regulation:

Here, the Court finds no error in the Report’s conclusion that the challenged conduct itself is fairly characterized as “record maintenance” and, more specifically, the dissemination and maintenance of information, documents, and communications maintained by the state. In the Court’s view, this is a fair characterization because it flows directly from the language of Section 6920, which is what DDOI argues protects it from complying with the Summons. Section 6920 protects from disclosure broad swathes of information, not merely application and licensing information of captive insurers (as DDOI suggests). See, e.g. , 18 Del. C. § 6920 (“ … all examination reports, preliminary examination reports, working papers, recorded information, other documents, and any copies of any of the foregoing, produced or obtained by or submitted or disclosed to the Commissioner that are related to an examination pursuant to this chapter … ”). Given the broad scope of documents and information covered by Section 6920, the Report committed no error in characterizing the conduct at issue.

I am giving somewhat short shrift to the MFA arguments that DDOI made, including a disagreement on the standard relating to how to define the business of insurance, but they will be of interest more to a small group of practitioners. Not only does the case highlight the IRS appetite to challenge captive insurance arrangements, but it also resonates n light of the recent Pandora Papers scandal. The Pandora Papers release reveals how at times states’ trust laws are designed to shield information from taxing authorities and other creditors. Many state laws, such as in the DDOI case, present formidable but not insurmountable barriers to engaged and inquisitive IRS employees. Tax havens are not only located outside the US. We will likely see government efforts to obtain information that is potentially subject to state laws that are meant to make it difficult, though not impossible, to attract the eyes of the federal government.

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

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