[Federal Register Volume 69, Number 210 (Monday, November 1, 2004)]
[Notices]
[Pages 63413-63417]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2918]


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SECURITIES AND EXCHANGE COMMISSION

[Investment Company Act Release No. 26643; 812-12953]


PacifiCare of Arizona, Inc., et al.; Notice of Application and 
Commission Statement

October 25, 2004.
AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: (1) Notice of application for an order under sections 3(b)(2) 
and 45(a) of the Investment Company Act of 1940 (the ``Act'') and (2) a 
Commission statement that the Commission is considering clarifying the 
primary business test under sections 3(b)(1) and (2) of the Act with 
respect to health maintenance organizations and similar entities that 
provide managed health care services (collectively, ``HMOs'').

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Applicants: PacifiCare of Arizona, Inc., PacifiCare of California, 
PacifiCare of Colorado, Inc., PacifiCare of Nevada,

[[Page 63414]]

Inc., PacifiCare of Oregon, Inc., PacifiCare of Texas, Inc. and 
PacifiCare of Washington, Inc. (the ``PacifiCare HMOs'').

Summary of Application and Commission Statement: Applicants seek orders 
under section 3(b)(2) of the Act declaring them to be primarily engaged 
in a business other than that of investing, reinvesting, owning, 
holding or trading in securities.\1\ Applicants are in the business of 
offering managed care and other health insurance products. Applicants 
also seek an order under section 45(a) of the Act granting confidential 
treatment with respect to certain financial and other information. The 
Commission also is issuing a statement that it is considering 
clarifying the primary business test under sections 3(b)(1) and (2) of 
the Act with respect to HMOs (see Commission Statement infra ).
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    \1\ On September 23, 2004, a temporary order was issued pursuant 
to section 3(b)(2) of the Act exempting applicants from all the 
provisions of the Act until the Commission takes final action on the 
application or until November 22, 2004, if earlier. Investment 
Company Act Release No. 26618 (September 23, 2004). Applicants also 
received temporary orders on May 28, 2003 (Investment Company Act 
Release No. 26060), September 29, 2003 (Investment Company Act 
Release No. 26194), January 23, 2004 (Investment Company Act Release 
No. 26339), and May 21, 2004 (Investment Company Act Release No. 
26449).

Filing Dates: The application was filed on March 31, 2003, and amended 
on May 23, 2003, September 15, 2003, January 21, 2004, May 17, 2004, 
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August 18, 2004, September 9, 2004 and September 22, 2004.

Hearing or Notification of Hearing: An order granting the requested 
relief will be issued unless the Commission orders a hearing. 
Interested persons may request a hearing by writing to the Commission's 
Secretary and serving applicants with a copy of the request, personally 
or by mail. Hearing requests should be received by the Commission by 
5:30 p.m. on November 19, 2004, and should be accompanied by proof of 
service on applicants, in the form of an affidavit or, for lawyers, a 
certificate of service. Hearing requests should state the nature of the 
writer's interest, the reason for the request, and the issues 
contested. Persons who wish to be notified of a hearing may request 
notification by writing to the Commission's Secretary.

ADDRESSES: Secretary, Securities and Exchange Commission, 450 Fifth 
Street, NW., Washington, DC, 20549-0609. Applicants, c/o Barbara L. 
Borden, Esq. and Frederick T. Muto, Esq., Cooley Godward LLP, 4401 
Eastgate Mall, San Diego, CA 92121.

FOR FURTHER INFORMATION CONTACT: Marc R. Ponchione, Senior Counsel, at 
(202) 942-7927, or Janet M. Grossnickle, Branch Chief, at (202) 942-
0564 (Division of Investment Management, Office of Investment Company 
Regulation).

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application may be obtained for a fee at the 
Commission's Public Reference Branch, 450 Fifth Street, NW., 
Washington, DC, 20549-0102 (tel. 202-942-8090).

Applicants' Representations

    1. Each of the PacifiCare HMOs is a wholly-owned subsidiary of 
PacifiCare Health Plan Administrators, Inc. (``PHPA''), an Indiana 
corporation formed in 1981. PHPA is a direct wholly-owned subsidiary of 
PacifiCare Health Systems, Inc. (``PacifiCare''), a Delaware 
corporation formed in 1996.\2\ PacifiCare offers managed care and other 
health insurance products through the PacifiCare HMOs and its other 
subsidiaries to employer groups and Medicare beneficiaries in the 
United States and Guam. Each of the PacifiCare HMOs operates managed 
care plans that develop health care provider networks by entering into 
contracts with hospitals, physicians and other health care 
professionals to deliver health care cost-effectively. Each of the 
PacifiCare HMOs' managed care plans generally provides or arranges for 
the provision of health care services to subscribers or enrollees, or 
pays for or reimburses part of the cost for those services, in return 
for a prepaid or periodic charge paid by or on behalf of the 
subscribers or enrollees. Applicants state that the PacifiCare HMOs 
serve approximately 3.0 million HMO members.
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    \2\ PacifiCare was the successor to a California corporation 
formed in 1983 that was reincorporated as a Delaware corporation in 
1985.
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    2. Applicants state that each of the PacifiCare HMOs maintains a 
large portfolio of marketable securities and a cash position as part of 
its management of its primary health care operations. Applicants state 
that the PacifiCare HMOs historically have contracted with hospitals 
and physicians on a prepaid, capitated fixed-fee per member per-month 
basis, regardless of the services provided to each member, but have 
recently experienced a shift to ``risk-retention contracts'' under 
which they now bear a substantial amount of the direct risk that health 
care costs of the subscribers or enrollees of their health care 
products will differ from the prepaid or periodic charges paid by or on 
behalf of such (``underwriting risk''). Under the risk-retention 
contracts model, each PacifiCare HMO maintains a larger investment 
portfolio primarily because each PacifiCare HMO assumes underwriting 
risk that its per patient member costs may exceed its per member 
premiums that it sets in advance each year. Applicants state that each 
of the PacifiCare HMOs also maintains its portfolio to satisfy state 
regulatory net worth requirements.
    3. Applicants state that the PacifiCare HMOs' profitability 
declined recently because of health care cost inflation, a lack of 
corresponding increases in Medicare reimbursement rates and because 
they did not fully anticipate the shift to risk-retention contracts in 
recent years when they made pricing and underwriting decisions for 
their products. At times during recent years, this decreased 
profitability caused a reduction in income from operations and an 
increased percentage of income attributable to the investment 
portfolios of the PacifiCare HMOs.
    4. Applicants state that each of the PacifiCare HMOs is licensed as 
a HMO or similar entity in the state in which it operates and is 
regulated by the insurance commissioner or similar official of that 
state.\3\ Applicants also state that the PacifiCare HMOs are required 
by law, regulation and governmental policy to meet minimum statutory 
net worth requirements that generally mandate a diverse portfolio and 
prohibit exclusive investment in government securities. Applicants 
further state that each PacifiCare HMO must file financial information 
and annual reports with state regulators and is subject to audits and/
or examination by state regulatory agencies on a regular basis.
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    \3\ PacifiCare of California, PacifiCare of Colorado, Inc., 
PacifiCare of Nevada, Inc., and PacifiCare of Texas, Inc. are 
licensed as HMOs. PacifiCare of Arizona, Inc. and PacifiCare of 
Washington, Inc. are licensed as health care services organizations. 
PacifiCare of Oregon, Inc. is licensed as a health care service 
plan.
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Applicants' Legal Analysis

    1. Section 3(a)(1)(A) of the Act defines the term ``investment 
company'' to include an issuer that is or holds itself out as being 
engaged primarily, or proposes to engage primarily, in the business of 
investing, reinvesting or trading in securities. Section 3(a)(1)(C) of 
the Act further defines an investment company as an issuer that is 
engaged or proposes to engage in the business of investing, 
reinvesting, owning, holding or trading in securities, and owns or 
proposes to acquire investment securities having a value in excess of 
40 percent of the value of the issuer's total

[[Page 63415]]

assets (exclusive of government securities and cash items) on an 
unconsolidated basis. Under section 3(a)(2) of the Act, investment 
securities include all securities except U.S. Government securities, 
securities issued by employees' securities companies, and securities 
issued by majority-owned subsidiaries of the owner which (a) are not 
investment companies, and (b) are not relying on the exclusions from 
the definitions of investment company in section 3(c)(1) or 3(c)(7) of 
the Act.
    2. Applicants state that none of the PacifiCare HMOs has ever held 
itself out as an investment company and that none of the PacifiCare 
HMOs believes that it is an investment company as defined in section 
3(a)(1)(A) of the Act. Applicants state that more than 40 percent of 
the total unconsolidated assets of each of PacifiCare of Arizona, Inc., 
PacifiCare of Colorado, Inc., PacifiCare of Oregon, Inc., PacifiCare of 
Nevada, Inc., PacifiCare of Texas, Inc., and PacifiCare of Washington, 
Inc. consist of investment securities as defined in section 3(a)(2). 
Accordingly, each of these PacifiCare HMOs may be deemed an investment 
company within the meaning of section 3(a)(1)(C) of the Act.\4\
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    \4\ Applicants state that PacifiCare of California does not 
currently meet the definition of an investment company under section 
3(a)(1)(C). Applicants further state that PacifiCare of California 
also needs to maintain a substantial investment portfolio. 
Applicants assert that if any adverse development results in any 
asset impairments, goodwill impairments or other reduction in 
PacifiCare of California's total assets, its investment securities 
as a percentage of its total assets could exceed 40 percent. 
Applicants also state that the operating results of PacifiCare of 
California during the past four fiscal quarters have fluctuated 
widely. Applicants believe that it is more cost-effective for 
PacifiCare of California to seek an order in conjunction with the 
other PacifiCare HMOs.
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    3. Rule 3a-1 provides an exemption from the definition of 
investment company if no more than 45 percent of a company's total 
assets consist of, and not more than 45 percent of its net income over 
the last four quarters is derived from, securities other than 
Government securities and securities of majority-owned subsidiaries and 
companies primarily controlled by it. Applicants state that none of the 
PacifiCare HMOs currently are able to rely on rule 3a-1 because 
investment securities comprise a large percentage of their total 
assets. In recent years, some of the PacifiCare HMOs also would not 
have been able to rely on rule 3a-1 because of operating losses.
    4. Section 3(b)(2) of the Act provides that, notwithstanding 
section 3(a)(1)(C), the Commission may issue an order declaring an 
issuer to be primarily engaged in a business other than that of 
investing, reinvesting, owning, holding or trading in securities 
directly, through majority-owned subsidiaries, or controlled companies 
conducting similar types of businesses. Applicants request orders under 
section 3(b)(2) of the Act declaring that each of the PacifiCare HMOs 
is primarily engaged in a business other than that of investing, 
reinvesting, owning, holding or trading in securities, and therefore is 
not an investment company as defined in the Act. Applicants submit that 
each of the PacifiCare HMOs meets the requirements of section 3(b)(2) 
because it is primarily engaged in the health care service business, 
and not in the business of investing, reinvesting, owning, holding or 
trading in securities, and its business operations are analogous to 
those of insurance companies.
    5. In determining whether an issuer is ``primarily engaged'' in a 
non-investment company business under section 3(b)(2), the Commission 
considers the following factors: (a) the company's historical 
development, (b) its public representations of policy, (c) the 
activities of its officers and directors, (d) the nature of its present 
assets (the ``Asset Factor''), and (e) the sources of its present 
income (the ``Income Factor'').\5\
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    \5\ Tonopah Mining Company of Nevada, 26 SEC 426, 427 (1947) 
(``Tonopah'').
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a. Historical Development

    Applicants state that each PacifiCare HMO was formed for the 
purpose of providing health care services and that each has provided 
such services since inception. Applicants also state that each of the 
PacifiCare HMOs has engaged in the pursuit of providing health care 
services to the exclusion of other activities and that each intends to 
continue to engage in the business of providing health care services.

b. Public Representations of Policy

    Applicants state that PacifiCare's periodic reports describing the 
business of the PacifiCare HMOs focus on improving net income from 
health care services operations and have never emphasized the 
possibility of significant appreciation from investment securities as a 
material factor in PacifiCare's or the PacifiCare HMOs' future growth. 
Applicants also state that the PacifiCare HMOs have never held 
themselves out as investment companies within the meaning of the Act 
and are unaware of any public representations that would indicate that 
any of the PacifiCare HMOs are in any business other than the health 
care services business. Applicants assert that press releases issued by 
PacifiCare and the PacifiCare HMOs concern events regarding the 
PacifiCare HMOs' operations and the development of new products and 
services and that public statements by PacifiCare and the PacifiCare 
HMOs emphasize PacifiCare's mission to create long-term stockholder 
value as a leading health and consumer services company.

c. Activities of Officers and Directors

    Applicants state that members of the boards of directors and the 
officers of each of the PacifiCare HMOs generally have extensive 
experience in the management and oversight of health care services 
provider organizations and focus almost exclusively on the management 
of their respective managed care plans and the further development of 
their respective health care provider networks. Applicants also state 
that other than adopting an investment policy and receiving periodic 
reports, the PacifiCare HMOs' officers and directors have minimal 
involvement with their respective PacifiCare HMO's investment 
securities and typically spend substantially all of their time on 
operating activities. Applicants further state that only the CFO and/or 
treasurer or assistant treasurer of each of the PacifiCare HMOs spends 
any time on cash and securities management. Applicants represent that 
management of PacifiCare's investments involves the equivalent of nine 
full-time employees, or 0.1% of a total of approximately 8,000 
PacifiCare employees. Applicants state that the other employees of the 
PacifiCare HMOs are involved in activities in connection with the day-
to-day operations and support of a health care services provider 
organization, including provider and hospital contract management, 
claims processing, medical bills review, member enrollment, accounting, 
customer services, data entry and other activities.

d. Nature of Assets

    Applicants state that each of the PacifiCare HMO's operations as a 
health services company do not require substantial investments in 
property, plant, equipment or other tangible assets. Further, each of 
the PacifiCare HMOs maintains a large investment securities position 
because of statutory net worth or regulatory capital requirements, the 
need to manage the risk that the health care costs it underwrites will 
exceed premiums, and working capital requirements. Excluding PacifiCare 
of California, more than 40 percent of each of the PacifiCare HMO's 
unconsolidated assets consist of investment securities and, in some

[[Page 63416]]

cases, investment securities constitute a large majority of total 
unconsolidated assets. Each PacifiCare HMO has adopted an investment 
policy that is designed to result in (1) each PacifiCare HMO holding 
predominantly high quality instruments; (2) capital preservation; (3) 
maintenance of sufficient liquidity to meet operating cash 
requirements; (4) outperforming certain benchmarks; (5) centralizing 
fiduciary control of all investment securities; and (6) adhering to 
state and federal regulations. None of the PacifiCare HMOs invests or 
trades in securities for short-term speculative purposes.

e. Sources of Income

    Applicants state that each of the PacifiCare HMO's income from 
operations fluctuated widely during the past several years due to the 
greater than expected increase in risk-retention contracts and 
unanticipated health care cost increases. Applicants state that less 
than 45% of each PacifiCare HMO's total income for the last four fiscal 
quarters combined was derived from investment securities. For the four 
fiscal quarters ending on December 2002, however, most of the 
PacifiCare HMOs recorded a net operating loss. Applicants state that 
net investment income will continue to comprise a significant portion 
of the PacifiCare HMOs' income as they adapt to the changing health 
services market and because they use their investment securities to 
manage the risks they underwrite. Applicants believe that their sources 
of revenue are more representative of their activities as operating 
companies than their sources of income. Applicants assert that each of 
the PacifiCare HMO's income from investments constitutes only a small 
portion of each PacifiCare HMO's gross revenue. Applicants state that 
for each PacifiCare HMO, revenues from health care operations represent 
approximately 99 percent of each PacifiCare HMO's gross revenue, while 
revenues from investments constitute the remaining one percent. Each of 
the PacifiCare HMOs expects that in the future the percentage of its 
total revenue derived from health care operations will continue to be 
substantial and the percentage of its revenue from investments will 
continue to be minimal.
    6. Section 3(c)(3) of the Act excludes insurance companies from the 
definition of investment company. Applicants believe, however, that 
none of the PacifiCare HMOs would be considered an insurance company 
within the meaning of the Act because none of the PacifiCare HMOs is 
organized as a traditional indemnity insurance company and the 
PacifiCare HMOs primarily offer HMO products that are not regulated as 
insurance products under state insurance laws. Applicants submit that 
managed care companies, which developed after enactment of the Act and 
far more recently than insurance companies, are subject to similar 
regulatory schemes. Applicants believe that each of the PacifiCare 
HMO's operations and use of investment portfolio are substantially 
analogous to those of insurance companies. Applicants state that, 
similar to insurance companies, the PacifiCare HMOs manage the 
underwriting risk of excess health care costs in part through returns 
in their investment portfolios, are regulated under state law, and are 
required to maintain statutory net worth and comply with state 
investment regulations.
    7. The PacifiCare HMOs thus assert that they qualify for an order 
under section 3(b)(2) of the Act.

Section 45(a) of the Act

    1. Section 45(a) provides that information contained in any 
application filed with the Commission under the Act shall be made 
available to the public, unless the Commission finds that public 
disclosure is neither necessary nor appropriate in the public interest 
or for the protection of investors. Each of the PacifiCare HMOs 
requests an order under section 45(a) of the Act granting confidential 
treatment to information submitted in Appendix 7 to the application 
containing financial and other information about the PacifiCare HMOs, 
PacifiCare and PHPA.
    2. The PacifiCare HMOs submit that the information disclosed in the 
application is sufficient to fully apprise any interested member of the 
public of the basis for the requested relief. Applicants state that 
from the presentation in the Application, the public can see the 
general nature of certain of the PacifiCare HMO's assets.
    3. Applicants believe that public disclosure of certain financial 
and other information about the PacifiCare HMOs, PacifiCare and PHPA 
would cause the PacifiCare HMOs and PacifiCare competitive harm. 
Applicants state that they do not normally disclose specific financial 
information about the PacifiCare HMOs, the precise make-up of their 
consolidated investment portfolios and their internal investment 
policies. Applicants also state that their competitors would benefit 
from access to such information and neither PacifiCare nor the 
PacifiCare HMOs has access to similar information about its 
competitors. Applicants further state that disclosure of certain 
financial information regarding the PacifiCare HMOs may confuse 
investors because the limited publicly available financial information 
concerning the PacifiCare HMOs is prepared for the purpose of complying 
with state regulations and in some cases is not calculated in 
accordance with GAAP, and therefore it may be different than the 
financial information set forth in the application. For these reasons, 
applicants believe that public disclosure of the information in 
Appendix 7 is neither necessary nor appropriate in the public interest 
or for the protection of investors.
    4. The Freedom of Information Act generally provides that all 
information provided to or generated by the government should be made 
available to the general public, with certain exceptions set forth in 
the statute. One of those exceptions is for ``trade secrets and 
commercial or financial information obtained from a person and 
privileged or confidential.'' Each of the PacifiCare HMOs believes that 
the information with respect to which applicants request confidential 
treatment falls within the exception described, and is thus eligible 
for protection under the Freedom of Information Act.\6\
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    \6\ Applicants understand that any relief granted pursuant to 
section 45(a) will not be dispositive in connection with any request 
the Commission might receive pursuant to the Freedom of Information 
Act.
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Commission Statement

    It does not appear that the circumstances that have led the 
PacifiCare HMOs to seek orders pursuant to section 3(b)(2) of the Act 
are unique. The Commission thus is considering clarifying the primary 
business test under sections 3(b)(1) and 3(b)(2) of the Act with 
respect to HMOs in the context of the order that would be issued to the 
PacifiCare HMOs.\7\ In place of the Asset Factor, the Commission is 
focusing on an HMO's bearing a substantial amount of underwriting risk, 
using its investment securities consistent with its business, and being 
licensed and supervised by a state. In connection with the Income 
Factor, the Commission is focusing on clarifying that an HMO may 
consider the sources of its present revenue so long as it derives 
substantially all of its total revenues from the health care 
operations.
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    \7\ See, e.g., ICOS Corp., Investment Company Act Release No. 
19334 (Mar. 16, 1993).


[[Page 63417]]


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    By the Commission.
Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E4-2918 Filed 10-29-04; 8:45 am]
BILLING CODE 8010-01-P