SEC fraud case could give new life to life settlements controversy

Life Partners accused of misleading shareholders about mortality estimates; securities or not?
MAR 02, 2012
Charges filed by the Securities and Exchange Commission against a life settlements provider could encourage the commission to revisit its recommendation that life settlements be considered securities, lawyers said. The SEC late yesterday filed suit in the U.S. District Court for the Western District of Texas against Life Partners Holdings Inc., its chairman, Brian D. Pardo, general counsel R. Scott Peden and finance chief David M. Martin. The SEC accused the four of disclosure and accounting fraud for failing to notify shareholders that the firm was drastically underestimating the life expectancies it used to price life settlement transactions. Life settlements, which involve the sale of an individual's insurance policy to an investor, depend greatly on life expectancy estimates. The longer an insured person is expected to live, they more investors must continue paying in premiums on the policy. Further, life settlement specialists charge more for policies belonging to persons with shorter life expectancies. The SEC claimed that Life Partners used life expectancies estimates — allegedly provided by an unqualified doctor with no actuarial training — that were too short by at least eight years, leading to inflated revenues and misleading shareholders. The commission also claimed that the company failed to disclose that the use of underestimated life expectancy data constituted a material risk to Life Partner's revenue. Further, the SEC claimed that Mr. Pardo and Mr. Peden knew that Life Partners' revenue and profit margins depended on the low-balled life expectancy estimates and sold their stock holdings at inflated prices. Mr. Pardo sold about $11.5 million in Life Partners stock, while Mr. Peden sold about $300,000, the commission said. The regulator is seeking repayment of profits from the stock sales and of bonuses. In a statement, Mr. Pardo said the firm will vigorously defend itself against the SEC's claims. “It is very disappointing that the SEC has chosen to pursue litigation over issues that we believe have no merit and financial presentation issues we do not believe are material,” he said. InvestmentNews was not immediately able to contact Mr. Peden or Mr. Martin. A call to Life Partners was not immediately returned. Experts suspect the charges are an indication that lawmakers will revisit life settlements and where the investment products fit in securities law. In 2010, a life settlements task force created by the regulator recommended that Congress adjust the Securities Act of 1933 to include life settlements as a security. At the moment, one-on-one transactions involving nonvariable life insurance are not considered securities transactions. The sales of fractionalized interests in a life settlement, however, are securities transactions. “We're going to see that securities issue come back,” said Mark Radke, a partner at Arent Fox LLP. “[The SEC is] going to be vigorous in that area.” Lawrence J. Rybka, chief executive of Valmark Securities Inc., agreed. “The SEC is getting vigilant,” he said. “Many people say that life settlements aren't securities, and they know that the state insurance laws are weak. The securities law has tougher teeth.” Mr. Radke did note that he didn't expect any regulatory proposals until the case against Life Partners is resolved. “As long as things are being contested in court, you don't have the same degree of certainty, but if you get to a settlement or judgment, then that's the new standard,” he said. “It might very well be increased enforcement activity prior to that settlement or final judgment, but I don't think you'll have that regulatory certainty just yet.” James Maxson, an attorney at Morris Manning & Martin LLP, believes that while the SEC has already recommended that Congress expand the definition of securities to include life settlements, the agency's workload would preclude it from taking action at the moment. “I have a hard time imagining that the SEC is going to get so excited that they'll do something about it,” he said. In the meantime, the SEC's claims related to the Life Partners' life expectancy methods will likely lead to greater vigilance on the part of life settlement providers and broker-dealers who help clients sell unwanted policies. “One of the impacts is going to be immediate: How people are looking at their past experience in projecting life expectancy,” Mr. Radke said of providers and their use of life expectancy data. “If they're getting a trend that shows a deviation from what they project and the actual turnout, then they need to do something about that.”

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