SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 39518 / January 6, 1998 Admin. Proc. File No. 3-8527 : In the Matter of : : RITA VILLA : : OPINION OF THE COMMISSION CEASE-AND-DESIST PROCEEDING Practice and Procedure Dismissal at the Conclusion of the Proponent's Case Administrative law judge's grant of motion for "directed verdict" at conclusion of Division's case permitted under the Rules of Practice. Determination to dismiss supported by the record. Held, this proceeding is dismissed. APPEARANCES: Andrew M. White, Eric N. Landau, and Amy W. Lasley, of Christensen, White, Miller, Fink, Jacobs, Glaser & Shapiro, for Rita C. Villa Ricardo Nunez and Michael P. Moore, for the Commission's Division of Enforcement. Appeal filed: May 15, 1995 Last brief filed: November 9, 1995 I. The Division of Enforcement ("Division") alleged that Rita C. Villa caused First Capital Holdings Corp. ("FCH") to violate Sections 13(a) and 13(b)(2)(A) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 13a-1 and 12b-20 thereunder. At the close of the Division's case, Villa moved for a "directed verdict." The law judge granted Villa's motion, concluding that the Division had failed to demonstrate a prima facie case. The Division petitioned for review of the law judge's decision. We granted the petition and further directed the parties to address whether a law judge may properly determine the outcome of a Commission administrative proceeding at the conclusion of the Division's case and the propriety of the law judge's decision in this instance. <(1)> Our findings are based on an independent review of the record, except with respect to those findings not challenged on appeal. II. At the time of the events in question, FCH had two principal subsidiaries, First Capital Life Insurance Company ("FCL"), which was domiciled in California, and Fidelity Bankers Life Insurance Company ("FLI"). Villa, a certified public accountant, was both controller and chief accounting officer of FCH. She was responsible for the financial reporting by FCH and maintained the books of the holding company. Under both applicable state law and the terms of a credit agreement to which FCH was a party, FCL was required to maintain a minimum statutory capital and surplus of $100 million at each year-end. <(2)> FCL used reinsurance treaties to increase its statutory surplus through "reserve credits." <(3)> <(1)> On July 24, 1995, revised Rules of Practice governing Commission administrative proceedings became effective. Because these proceedings were docketed prior to that date, they were conducted under the former Rules of Practice. See 17 C.F.R. Part 201. <(2)> California insurance companies are subject to both Generally Accepted Accounting Principles and statutory accounting principles. Under statutory accounting principles, an insurance company must compute statutory capital and surplus, essentially its assets minus its liabilities. <(3)> When an insurance company writes an insurance policy, it must create reserves, which are used to pay claims on the policy. Under a reinsurance treaty, the insurer cedes some of the insurer's liability under a policy to the reinsurer and pays the reinsurer part of the premium. Under then-applicable California insurance requirements, the insurer could reduce its required reserves if the particular reinsurance treaty transferred the risk of payment on claims to the reinsurer. The "reserve credits" or "surplus relief" thus created raised the company's surplus and capital. If the treaty did not comply with the California Department of Insurance requirements, the resulting surplus relief would be disallowed, and the company would have to "recapture" it by reducing its statutory surplus. ======END OF PAGE 2====== At year-end 1990, absent the reserve credits claimed pursuant to its reinsurance treaties, FCL would have had insufficient statutory capital and surplus for purposes of both the credit agreement and the Florida statute. Beginning in the fall of 1990, the California Department of Insurance ("CDI") directly warned certain members of FCH's and FCL's management that it appeared that FCL's reinsurance treaties did not in fact transfer risk from FCL to the reinsurer and that CDI was considering disallowing the treaties. On March 14, 1991, FCH's management, including Villa, signed the company's annual report on Form 10-K for the year ending December 31, 1990. By this time, CDI had made clear to various members of FCH and FCL senior staff that the CDI's disallowance of the reinsurance credits was highly likely. However, FCH's Form 10-K merely stated that "[t]he California Department of Insurance has begun to discourage the use of such [reinsurance] treaties." It did not adequately indicate the risk that FCL's use of reinsurance credits would probably be disallowed. On April 30, 1991, CDI disallowed over $65 million of reserve credits pursuant to FCL's reinsurance agreements. This disallowance, together with additional examination adjustments, reduced the amount of FCL's statutory capital and surplus at year-end 1990 to $35 million from the $107 million that FCL had reported on its 1990 Form 10-K. <(4)> The amount was well below the $100 million statutory capital and surplus required under FCH's credit agreement and the Florida statutory requirements. <(5)> <(4)> FCH consented, without admitting or denying, to the entry to a permanent injunction, enjoining the company from further violations of Sections 10(b), 13(a), and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 13a-1, 13a-13, and 12b-20 thereunder. SEC v. First Capital Holdings Corp., Civil Action No. 94-8469HLH(Kx) (C.D. Cal. March 17, 1995). See Litigation Rel. No. 14444 (March 17, 1995), 58 SEC Docket 3002. In addition, the Commission accepted offers of settlement from Philip A. Fitzpatrick, the former executive vice president and chief financial officer of FCH, and Gerry R. Ginsberg, the former chief operating officer of FCH, in which both respondents agreed to cease and desist from committing or causing any violations of Sections 10(b), 13(a), and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 13a-1, and 12b-20 thereunder. Securities Exchange Act Rel. No. 34865 (October 20, 1994), 57 SEC Docket 2448. <(5)> On May 10, 1991, the CDI ordered FCL to "cease and desist" doing business in California, and, on May 14, 1991, placed FCL in conservation. On May 13, 1991, creditors filed an involuntary bankruptcy petition with respect to FCH. ======END OF PAGE 3====== As noted, Villa's attorney made a motion for a "directed verdict" at the conclusion of the Division's case. Because the law judge determined this proceeding on Villa's motion, he made no findings of fact. Instead, he stated that he would view the facts in the light most favorable to the Division, and assumed certain facts arguendo for the purposes of making his decision. The law judge assumed that, by the time FCH's Form 10-K was signed on March 14, 1991, FCH and certain members of its management were on notice, from a memorandum prepared by a CDI senior actuary and provided to FCL on November 7, 1990 (the "CDI Memorandum") and a letter dated February 19, 1991 from Norris Clark, chief of CDI's Financial Division, to FCH's chief operating officer (the "Clark Letter"), that the CDI had very substantial problems with FCH's reinsurance treaties and that the reserve credits generated by those treaties might be disallowed. The law judge also assumed that the Form 10-K contained a material misrepresentation concerning the degree of the CDI's concern with respect to the reserve credits and the "substantial possibility" that CDI would disallow FCL's reserve credits. The law judge concluded, however, that the Division had failed to make a prima facie showing that Villa had responsibility for FCH's material omission. The law judge found nothing in the record that indicated that Villa had notice of the CDI's questions concerning the reserve credits. In the law judge's view, the strongest evidence against Villa was her delivery of the Clark Letter from the facsimile machine to Gerry Ginsberg, FCH's chief operating officer; her presence during a portion of the telephone conference between Philip Fitzpatrick, FCH's chief financial officer, and Ed Mekeel, FCL's chief financial officer, in which the CDI Memorandum was mentioned; "and perhaps other conversations too . . . getting bits and pieces of things which went beyond her personal knowledge." He also concluded that Villa, as a corporate officer, was not necessarily responsible for obtaining knowledge in support of each assertion in FCH's Form 10-K. III. The Division challenges, among other things, the procedures used by the law judge in disposing of this proceeding. The Division asserts that, while Rule 11(e) of the Commission's former Rules of Practice permitted the law judge to rule on a dispositive motion at the conclusion of the Division's case, such a ruling should be deferred until the close of all the evidence in order to avoid piecemeal appeals and to promote administrative economy. The Division further notes that the law judge did not write an initial decision in this case. <(6)> The Division also <(6)> The law judge entered a "Notice Regarding Initial Decision," which stated that, for the purposes of Rule 17 of the former Rules of Practice, the initial decision was contained in the transcript of the hearing (continued...) ======END OF PAGE 4====== contends that the law judge erred when he failed to give the parties the opportunity to file proposed findings and conclusions and supporting briefs as provided for in former Rules 16(d) and (e). We conclude that former Rule of Practice 11(e) permitted a law judge to grant a dispositive motion dismissing a Commission proceeding at the close of the Division's case. The former rule did not provide a standard for evaluating such motions, <(7)> and we are unaware of any prior case in which a law judge granted a motion to dismiss at the conclusion of the Division's case. A law judge's ability to dismiss a proceeding when he or she concludes that the Division has failed to establish a prima facie case, however, appears to have been permissible under this rule. Former Rule 11(e) further did not require the law judge to obtain written briefs or proposed findings and conclusions of law. While that rule provided that dispositive motions should generally be made in writing and accompanied by a written brief of points and authorities, it nonetheless authorized the law judge to "prescribe[] or permit[] a different procedure." Former Rule 11(e) also did not require (or even refer) to proposed findings and conclusions in former Rules of Practice 16(d) and (e). Thus, it appears that permitting Villa to make an oral motion for a directed verdict was permissible under the plain language of former Rule 11(e). <(6)>(...continued) dated May 4, 1995. The Division suggests that practice under former Rule 11(e) should be guided by Federal Rule of Civil Procedure 52(c), which requires a trier of fact to weigh the evidence, resolve any conflicts in the evidence, and determine where the balance of the evidence lies before entering a judgment on partial findings. <(7)> Only one Commission case has attempted to enunciate such a standard, and that case relied on an analogy that has been superseded. In The Stuart-James Co., Inc., Initial Decision No. 16 (March 22, 1991), 48 SEC Docket 955, the law judge looked to case law under former Federal Rule of Civil Procedure 41(b), which, at that time, governed dismissals in bench trials at the close of the plaintiff's case. The law judge concluded that Former Rule 41(b) disfavored such dismissals. 48 SEC Docket at 958-60. Former Federal Rule of Civil Procedure 41(b) was repealed in 1991, and Federal Rule of Civil Procedure 52(c) was amended to provide an opportunity for an early dismissal. Rule 52(c) provides that a district court in a bench trial may make a judgment on partial findings at the close of the plaintiff's case. ======END OF PAGE 5====== Similarly, the law judge's oral opinion appears to comply with former Rule 16(a). The only case construing this rule held that an initial decision could be narrative in form and "need not specifically show [the law judge's] ruling on each proposed finding and conclusion as long as such rulings are in some way indicated." <(8)> The law judge's statement here appears to meet this relaxed standard. While the law judge's ruling comprises only five pages of transcript, he made the determination that Villa did not have actual knowledge of the proposed disallowance of the reinsurance credits. He also explicitly rejected the legal theories advanced by the Division and explained his reasoning. This statement suffices to set forth the grounds of his decision for the benefit of the parties and to permit effective review. We wish to make clear, however, that, absent extraordinary circumstances, we do not favor the abbreviated procedure used here. We agree with the Division that such motions can result in piecemeal disposition of a proceeding. Were we to determine that a proceeding had been improperly dismissed, it would require that we remand the proceeding for retrial. <(9)> If the hearing officer believes that final disposition of a proceeding is appropriate, the parties should be permitted to brief the issues and present their views concerning the record. If it is determined that such disposition should be granted, the hearing officer should promptly prepare a written order stating his or her reasons for this conclusion. In this regard, we note that, under revised Rule of Practice 250, the hearing officer may grant a motion for summary disposition "if there is no genuine issue with regard to any material fact and the party making the motion is entitled to a summary disposition as a matter of law." That rule further contemplates that a motion for summary disposition will be accompanied by a supporting memorandum and, if appropriate, declarations, affidavits, or attachments. We expect that the procedure described in revised Rule 250 will guide any summary disposition of the remaining cases that are pending under our former Rules of Practice. <(8)> Augion-Unipolar Corporation, 44 S.E.C. 613, 619 (1971). <(9)> Remand could be particularly difficult in a situation where, as here, the law judge who presides at the original hearing and has the opportunity to observe and judge the credibility of witnesses is no longer with the Commission, requiring a complete retrial of the matter. ======END OF PAGE 6====== We have reviewed the record before us. We conclude in this instance that the Division has not established by a preponderance of the evidence that Villa engaged in the violations alleged here. We have therefore determined to dismiss this proceeding. <(10)> An appropriate order will issue. <(11)> By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, CAREY, and UNGER). Jonathan G. Katz Secretary <(10)> Villa filed a request for oral argument pursuant to former Rule 21(a). We recognize that, under that Rule, argument shall be set except in "exceptional circumstances". However, because the issues here have been thoroughly briefed, and given the resolution of the matter, we believe there is no prejudice to Villa and her request is hereby denied. <(11)> All of the contentions advanced by the parties have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed herein. ======END OF PAGE 7====== UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 39518 / January 6, 1998 Admin. Proc. File No. 3-8527 : In the Matter of : : RITA VILLA : : ORDER DISMISSING PROCEEDING On the basis of the Commission's opinion issued this day, it is ORDERED that this administrative proceeding against Rita C. Villa be, and it hereby is, dismissed. By the Commission. Jonathan G. Katz Secretary