No. 80: Life Partners Files Its First Financial Report after the Court-Ordered Death Sentence

In Nos. 75, 77, 78, and 79, I described developments after a federal judge handed down a Final Judgment Order (FJO) on December 2 in a lawsuit filed by the Securities and Exchange Commission (SEC) against Life Partners Holdings, Inc. (NASDAQ:LPHI). The FJO is essentially a death sentence for LPHI, a company in the secondary market for life insurance. The FJO imposes huge penalties on the company and its two top officers: Brian D. Pardo, chairman and chief executive officer; and R. Scott Peden, general counsel. Here I briefly discuss important recent developments, including the filing of the company's first financial report after the FJO. (SEC v. LPHI, U.S. District Court, Western District of Texas, Case No. 1:12-cv-33.)

LPHI's Lack of Disclosure

As I reported previously, LPHI did not file an 8-K report with the SEC. An 8-K is supposed to be filed within four business days after a "material" event. It is hard to envision an event more "material" to the company's shareholders and the public than the imposition of penalties amounting to more than twice the company's total assets.

In a recent filing in the case, LPHI claimed an 8-K was not necessary because the FJO "was widely reported by various business news organizations such as The Wall Street Journal, Reuters, and the Fort Worth Star-Telegram." Further, LPHI said its share price dropped sharply after the FJO in heavy trading, showing that the word had gotten out. Still further, LPHI said that its 10-Q financial report for the fiscal quarter ended November 30, 2014 was due to be filed on January 14, 2015, and that the 10-Q would disclose information about the FJO.

LPHI's 10-Q Filing

On January 14, LPHI filed the 10-Q report with the SEC and posted the report on the LPHI website. The report shows positive net income of about $1.1 million for the quarter. Most recent quarters show net losses. The primary reason for the positive figure was the company's sudden and unexpected imposition of substantial ministerial fees on investors who own fractional interests in life settlements. The fees collected were about $4.4 million. LPHI said that, without the revenue from the new fees, the company would have realized a net loss, before taxes, of about $2.7 million for the quarter. The 10-Q also revealed a continuation of virtually no new business; two life settlements were transacted in the quarter, with a total face value of $600,000.

LPHI disclosed details of the FJO and subsequent developments in three places in the 10-Q: under "Contingencies," "Legal Proceedings," and "Risk Factors." I am reproducing for interested readers the entire "Legal Proceedings" section, which discusses not only the SEC lawsuit and the FJO but also other lawsuits, including the Willingham case mentioned in No. 78.

Hearing on Motion for Receiver

As mentioned in No. 79, the SEC filed a motion on January 5 asking the court to appoint a receiver, and recommended an individual who is ready to go to work immediately. On January 7, Senior U.S. District Court Judge James R. Nowlin, who handed down the FJO, turned over many aspects of the case to U.S. Magistrate Judge Andrew W. Austin. On the same day, Magistrate Judge Austin set a hearing for January 14 on the SEC's motion for appointment of a receiver, and ordered LPHI to file its answer to the SEC's motion by January 12.

On January 12, LPHI filed a motion to postpone the hearing until January 28. Magistrate Judge Austin reset the hearing for January 21.

Also on January 12, as ordered, LPHI filed its answer to the SEC's motion for appointment of a receiver. That is the filing in which LPHI explains why it thinks an 8-K filing was not necessary. In the filing LPHI also explains why it thinks the appointment of a receiver would be inappropriate, and characterizes the SEC's motion for the appointment of a receiver as an "end run" around the appellate process. LPHI has filed a notice of appeal to the U.S. Court of Appeals for the Fifth Circuit, but little has happened there other than the appellate court's denial of an LPHI motion for an injunction against enforcement of the FJO.

General Observations

The SEC's lawsuit against LPHI is now essentially on hold until the court acts on the SEC's motion for the appointment of a receiver. With regard to LPHI's explanation for its failure to file an 8-K report after the FJO, I think the company's reasoning is preposterous. However, it is consistent with LPHI's practice of "selective disclosure," which I discussed in No. 35 posted March 10, 2014.

I am offering a complimentary 6-page PDF showing—in enlarged type—the "Legal Proceedings" section of LPHI's 10-Q report for the fiscal quarter ended November 30, 2014. Send an e-mail to jmbelth@gmail.com and ask for the excerpt from LPHI's 10-Q report filed January 14.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 79: Life Partners—A Brief Interim Report on Developments Relating to the Court-Ordered Death Sentence

Life Partners Holdings, Inc. (NASDAQ:LPHI) is in the secondary market for life insurance. In No. 78 posted January 5, I reviewed developments through December 31 relating to the Final Judgment Order (FJO) handed down on December 2 by Senior U.S. District Court Judge James R. Nowlin in a lawsuit filed by the Securities and Exchange Commission (SEC) against LPHI and its two top officers: Brian D. Pardo, chairman and chief executive officer; and R. Scott Peden, general counsel. The FJO required LPHI to pay the SEC disgorgement of $15 million and a civil penalty of $23.7 million. The sum of those items was more than twice the total assets of LPHI. The order also required Pardo and Peden to pay civil penalties of $6.2 million and $2 million, respectively. Here I briefly discuss six developments through January 7 as LPHI struggles with the court-ordered death sentence. (SEC v. LPHI, U.S. District Court, Western District of Texas, Case No. 1:12-cv-33.)

SEC Motion for Appointment of Receiver
On January 5, the SEC filed an opposed emergency motion for appointment of a Receiver. The motion is "opposed" because, according to the SEC, "the Defendants are opposed to the relief sought by this motion." The motion consists of three requests. In this major motion, the SEC asks Judge Nowlin to appoint a Receiver for LPHI and its affiliates, and gives detailed reasoning for the motion. The SEC says "a highly qualified Receiver candidate is prepared to act immediately," and recommends the appointment of H. Thomas Moran II, chief executive officer of Asset Servicing Group (Oklahoma City, OK), "a market leader in the life settlement industry." As an alternative, the SEC asks the Court to appoint a Monitor to "oversee and approve all LPHI financial transactions" and "report observations and recommendations to the Court." As another alternative, the SEC asks the Court to appoint a Receiver under the "Texas turnover statute," and explains the statute.

Denial of Intervention Motion
On January 6, Judge Nowlin denied the intervention motion I discussed in No. 78. He says he previously refused to allow the petitioners to intervene, and nothing has changed to justify changing course.

SEC Supplement Supporting Appointment of Receiver
On January 6, the SEC filed supplemental evidence to support its motion for appointment of a Receiver. The evidence consists of three recorded teleconferences held in December following the FJO and featuring Pardo discussing with his sales staff recent developments in the case. Pardo harshly attacks Judge Nowlin and the SEC.

Referral to Magistrate Judge
On January 7, Judge Nowlin issued an order referring all nondispositive motions to U.S. Magistrate Judge Andrew W. Austin for resolution. Also, all pending and future dispositive motions were referred to Magistrate Judge Austin for report and recommendation.

LPHI Opposition to SEC Motion Regarding Stay
On January 7, LPHI filed its objection to the SEC motion concerning conditions for a stay. LPHI also responded to the SEC's objection to the alternate security proposed by LPHI.

Scheduling of a Hearing
On January 7, Magistrate Judge Austin issued an order setting a hearing for January 14 on the SEC's motion for appointment of a Receiver. Also, LPHI was ordered to file a response by January 12 to the SEC's motion for appointment of a Receiver.

General Observations
It appears that further significant developments will occur during the next week or two. I plan to continue reporting on this important and complex situation.

Meanwhile, I offer a complimentary 28-page PDF consisting of four documents: (1) 12-page SEC motion for appointment of a Receiver, without exhibits; (2) 1-page Order denying intervention motion; (3) 5-page SEC supplemental evidence about Pardo's comments; and (4) 10-page LPHI opposition to SEC motion regarding stay. Send an e-mail to jmbelth@gmail.com and ask for the SEC-LPHI January 7 package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 78: Life Partners Struggles with the Court-Ordered Death Sentence

Life Partners Holdings, Inc. (NASDAQ:LPHI), through its operating subsidiary, Life Partners, Inc. (LPI), is in the secondary market for life insurance. In No. 75 posted December 10, I discussed the final judgment order handed down on December 2 by Senior U.S. District Court Judge James R. Nowlin in a lawsuit filed by the Securities and Exchange Commission (SEC) against LPHI and its two top officers: Brian D. Pardo, chief executive officer; and R. Scott Peden, general counsel. The order required LPHI to pay the SEC, by December 16, disgorgement of $15 million and a civil penalty of $23.7 million. The sum of those two items was more than twice the total assets of LPHI. The order also required Pardo and Peden to pay civil penalties of $6.2 million and $2 million, respectively. In No. 77 posted December 17, I reviewed developments through December 16. Here I discuss developments through December 31 as LPHI struggles with the court-ordered death sentence. (SEC v. LPHI, U.S. District Court, Western District of Texas, Case No. 1:12-cv-33.)

Orr Motion to Intervene

On December 22, James Craig Orr, Jr., an attorney representing some LPI clients, filed a motion to intervene for the purpose of filing a motion to alter or amend the order. Accompanying exhibits are the motion to alter or amend the order; LPHI's 10-Q report for the fiscal quarter ended August 31, 2014; and the third amended petition filed November 24, 2014 in Willingham et al. v. LPI et al. (191st Judicial District Court, Dallas County, Texas, DC-11-10639 and MDL 13-0357).

In the petition in the Willingham case, the sum of the maximum amounts claimed by 158 LPI clients named in the petition is $95.5 million. According to the Orr motion to alter or amend the order, those clients invested about $35 million.

SEC Opposition to Motion to Intervene

On December 23, the SEC filed a response in opposition to the Orr motion to intervene. The SEC says the attempt to intervene is barred by section 21(g) of the Exchange Act, which, according to the SEC, courts have broadly applied "to preclude interference by private parties in SEC law enforcement proceedings without SEC consent."

LPHI Motion to Extend Stay

On December 29, LPHI filed an opposed motion for a stay to further extend, beyond December 30, the stay of enforcement of the order. The motion is "opposed" because, according to LPHI, "the SEC believes that the judgment is sound and ripe for enforcement and that enforcement is appropriate." LPHI seeks an order further extending the stay until 14 days after the later of (1) the date on which the court rules on the LPHI motion to set security or (2) the date on which the court disposes of all LPHI post-order motions filed by December 30.

LPHI Motion to Set Security

On December 29, LPHI filed an opposed motion to set security and for alternate security to stay enforcement of the order pending appeal. The motion is "opposed" because, according to LPHI, "the SEC believes that the proposed security is insufficient to protect its interest in the judgment against LPHI."

LPHI says Travelers Casualty and Surety Company of America and Hartford Fire Insurance Company, large writers of surety bonds, declined to issue a bond in any amount without the posting of collateral in the form of an irrevocable letter of credit for the full amount of the bond. LPHI says it is unable to obtain such a letter of credit and therefore is unable to post a bond in any amount. LPHI asks the court to approve alternate security in the form of $250,000 cash and a pledge of LPHI unencumbered real estate with a current book value of $2.3 million before depreciation.

The motion describes the impact that enforcement of the order would have on LPHI, its employees, and its clients. Accompanying exhibits are sworn statements by Charles T. Frazier, Jr., an LPHI attorney; Colette Pieper, LPHI chief financial officer; Peden; Dennis Gilliam, president of Advance Trust & Escrow Life Services, an escrow agent used by LPI; and Sabrina Braus, president of Purchase Escrow Services LLC, another escrow agent used by LPI. Personal data, LPHI internal data, and LPHI financial data as of November 30, 2014 are blacked out in the motion and in the exhibits.

Baker & McKenzie LLP, a law firm that at one time represented LPI in the Willingham case, is the largest creditor of LPHI. The motion says LPHI owes the firm $1.1 million, is paying down the debt in installments, and recently cut the weekly payments in half to help with cash flow problems at LPHI. Also, the two escrow agents mentioned above together are involved with 3,500 policies and 26,000 LPI clients who hold 100,000 positions for which the clients paid $1.5 billion.

Other Motions

On December 29, LPHI, Pardo, and Peden filed hardship motions. The motions are under seal, presumably because they contain private and personal information.

On December 30, LPHI filed a motion to alter or amend the order. On the same day, LPHI filed a notice of its intent to appeal the order to the U.S. Court of Appeals for the Fifth Circuit.

On December 30, the SEC filed a motion to alter or amend the order. The SEC had previously argued that Pardo was required to reimburse LPHI, in accordance with section 304 of the Sarbanes-Oxley Act of 2002, for "certain bonus, incentive-based, and equity-based compensation" he had received, and Judge Nowlin ruled in the order that Pardo was not required to make such reimbursement to LPHI. The SEC argues, in its motion to alter or amend the order, that Judge Nowlin's ruling is incorrect, and that Pardo should be required to reimburse LPHI in the amount of $13.3 million.

On December 30, LPHI filed several motions with the Fifth Circuit. That appellate court promptly denied the motion for an injunction pending appeal, granted the motion for an expedited ruling on the motion for an injunction pending appeal, and granted the motion to file documents under seal. (SEC v. LPHI, U.S. Court of Appeals, Fifth Circuit, No. 14-51353.)

LPHI Share Prices

In No. 75, I said LPHI's closing share price declined after the order—from $1.43 on the day of the order, to $1.10 the next day, and to 78 cents on December 16. The closing price on December 31 was 67 cents.

More on Ministerial Fees

In No. 74 posted November 25, I mentioned the LPI decision to begin charging annual ministerial fees. Many clients complained, citing this sentence in the policy funding agreement between LPI and the client:

LPI's fees for all services provided in the performance of its duties shall be complete and inclusive in the policy purchase deposit and the PURCHASER will not incur costs of any type beyond the amount tendered as the policy purchase deposit.

Pardo responded by saying the fees referred to in that sentence were for "acquisition services" associated with the purchase of the policy. He said that, for 24 years, LPI did not charge fees to cover the cost of "a small army of full time programmers and IT experts," and that "we are simply no longer able to absorb this cost." The displeasure of clients is understandable, but the issue is dwarfed by the implications of the order.

General Observations

The LPHI 10-Q report for the fiscal quarter ended November 30, 2014, is supposed to be filed on January 15. Under the circumstances, it would be surprising if LPHI files the report on time.

LPHI has yet to disclose the order in an 8-K (material event) report that is supposed to be filed with the SEC within four business days of the event. The most recent LPHI public document, filed November 15, is the 10-Q report for the fiscal quarter ended August 31, 2014.

Nor has LPHI issued a press release about the order. The most recent press release on the LPHI website is the September 2 announcement of a quarterly dividend. That release was attached to an 8-K report filed the same day. LPHI probably will not pay any more dividends.

It will be interesting to see how Judge Nowlin disposes of the post-order motions. It also will be interesting to see how the Fifth Circuit deals with the case. I plan to report developments.

Available Documents

Meanwhile, I offer a complimentary 72-page PDF consisting of seven documents: (1) 5-page Orr motion to intervene; (2) 5-page Orr motion to alter or amend the order; (3) 4-page SEC response in opposition to Orr motion to intervene; (4) 7-page LPHI motion for further stay; (5) 30-page LPHI motion to set security, without exhibits; (6) 10-page LPHI motion to alter or amend the order; and (7) 11-page SEC motion to alter or amend the order. Send an e-mail to jmbelth@gmail.com and ask for the SEC-LPHI December 31 package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 77: Life Partners—Latest Developments Relating to the Court-Ordered Death Sentence

Life Partners Holdings, Inc. (NYSE:LPHI) is a participant in the secondary market for life insurance. In No. 75 posted December 10, I said Senior U.S. District Court Judge James R. Nowlin handed down a "final judgment order" on December 2 in a lawsuit filed by the Securities and Exchange Commission (SEC) against LPHI and its two top officers: Brian D. Pardo, chief executive officer; and R. Scott Peden, general counsel. The order requires LPHI to pay the SEC $38.7 million (more than twice LPHI's total assets!) by December 16. I called the financial dimensions of the order a death sentence for LPHI. (SEC v. LPHI, U.S. District Court, Western District of Texas, Case No. 1:12-cv-33.)

Developments on December 10
On December 10, three things happened. First, Dana Livingston, a partner in the Austin firm of Alexander Dubose Jefferson & Townsend, appeared before the court as an attorney for LPHI.

Second, the defendants filed an "opposed emergency motion to extend stay of enforcement of the judgment." The motion is "opposed" because "the SEC is not willing to agree to any extension of the automatic stay [until December 16] at this time." The motion says the defendants intend to file by December 30 their post-judgment motions, such as motions to alter or amend the judgment and a motion for a new trial.

Third, Judge Nowlin granted LPHI's motion. He stayed execution of the judgment and any proceedings to enforce the judgment for an additional 14 days, until December 30.

Later Developments
On December 12, James Craig Orr, Jr., a partner in the Dallas firm of Heygood Orr & Pearson, sent a letter to Judge Nowlin on behalf of investors in LPHI's life settlements. Orr asks the judge to consider reducing the judgment against LPHI because the amount is far more than what LPHI possesses, and because LPHI would not be able to perform the ministerial services needed to protect the investors' funds.

On December 15, the court issued a deficiency notice because Orr's filing is in the form of a letter rather than a motion. The court asks Orr to refile immediately in the form of a motion.

LPHI's Nondisclosure
At the close of business on December 16, there is no press release on the LPHI website about the December 2 order. Also, there is no 8-K (material event) report on the SEC website, although such a report is supposed to be filed within four business days after the event.

LPHI's nondisclosure is not unusual. As I reported in No. 35 posted March 10, 2014, selective disclosure—prompt disclosure of good news and delayed disclosure of bad news—is standard practice at LPHI.

LPHI's Share Prices
Despite LPHI's nondisclosure, and despite the absence of news stories since shortly after the order, word got around. LPHI's share price declined sharply after the order—from a closing price of $1.43 on the day of the order to $1.10 the next day. Closing prices were $1.06 on December 4, $1.00 on December 11, $0.94 on December 12, $0.90 on December 15, and $0.78 on December 16.

Ministerial Fees
Meanwhile, in No. 74 posted November 25, I discussed LPHI's decision to begin charging its investors fees—through its newly formed subsidiary, LPI Financial Services, Inc.—for ministerial services relating to life settlements. On November 14, one month after the due date of the first annual fee payments, LPI sent investors a "past due" notice that reads:

PAST DUE. Please Disregard if Paid. Payment is due upon receipt. Delinquent payments will be subject to interest at the maximum rate permitted under law as well as reporting to credit bureaus. Failure or refusal may result in termination of access to platform services.

Available Documents
I am offering a complimentary 13-page PDF showing LPHI's seven-page motion for a stay, LPHI's one-page proposed order, the judge's one-page order granting a stay until December 30, Orr's three-page December 12 letter to the judge, and the court's one-page December 15 deficiency notice. In No. 75, I offered a complimentary 21-page PDF showing Judge Nowlin's December 2 final order; this PDF is still available. Send an e-mail to jmbelth@gmail.com and ask for the LPHI motion for stay, or the final order in the SEC lawsuit against LPHI, or both.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 76: Daniel Stallings and an Update on the Case of Mrs. X

The March 2012 and January 2013 issues of The Insurance Forum contain articles about Daniel H. W. Stallings (Muncie, IN), who replaced life insurance policies and annuities owned by Mrs. X. Here I discuss some matters not mentioned in the Forum articles.

Background

The replacements occurred in the fall of 2010. At the time, Mrs. X was aged 81, was living in her home in Muncie, was the widow of a longtime member of the Ball State University faculty, was wearing an Exelon patch as medication for marked cognitive impairment, was a member of the Ball State Federal Credit Union, and had met Stallings through his position as "Our Expert" at the credit union. Stallings at the time was a registered representative of New England Securities, Inc. (a unit of MetLife, Inc.) through Financial Partners Group (Indianapolis).

Mrs. X owned two life insurance policies issued many years earlier on a standard basis by The Northwestern Mutual Life Insurance Company. One was a paid-up policy that was paying significant dividends. The other was a premium-paying policy on which the dividend each year was substantially larger than the annual premium. Stallings replaced the two policies with a policy issued by Massachusetts Mutual Life Insurance Company on a Table D substandard basis, with the rating apparently caused by Mrs. X's cognitive impairment. Mrs. X signed a "Letter of Instruction" (often called a "CYA letter") to Massachusetts Mutual in which she said she understood the effect of replacing the Northwestern Mutual policies and expressed her desire to proceed with the application to Massachusetts Mutual for the replacement policy. Later she had no recollection of the letter.

Mrs. X also owned several fixed annuities and variable annuities. They were issued many years earlier by The Teachers Insurance and Annuity Association of America, College Retirement Equities Fund, and Northwestern Mutual. Stallings replaced the annuities with two variable annuities issued by Metropolitan Life Insurance Company.

In the first Forum article about the case, I expressed the opinion that the replacements were not justified, and expressed hope that the companies would restore Mrs. X to her original financial position. In the second Forum article, I reported that Northwestern Mutual and Massachusetts Mutual had restored her to her original financial position with regard to the life insurance. I do not know what happened with regard to the annuities.

FINRA Involvement

In October 2011, Mrs. X's family filed a written complaint, which New England Securities reported to the Financial Industry Regulatory Authority (FINRA). The complaint related only to the annuity aspect of the case. According to FINRA's BrokerCheck reports on Stallings and Bryan Todd Baker (Indianapolis), here is the allegation:

Customer alleged that the representative's recommendation to transfer funds from contracts with no surrender charges into two new variable annuities with surrender charges, in September 2010, was not appropriate. No specific compensatory damages were alleged.

The complaint was settled in August 2012. The settlement amount was $3,000. Stallings (aka Dana Harris Wiltsey Stallings, CRD #4942231) paid $750, and Baker (CRD #4410211) paid $750. The reports do not say who paid the other $1,500; it may have been New England Securities.

Stallings was associated with New England Securities from July 2006 to August 2012. Since then he has been associated with American Portfolios Advisors, Inc. (Holbrook, NY).

The Credit Union

I wrote to Randy Glassburn, president and chief executive officer of the Ball State Federal Credit Union, and inquired about the situation. I enclosed the two Forum articles and mentioned the FINRA BrokerCheck reports on Stallings and Baker. In response, Glassburn said:

We had a relationship with Financial Partners Group, and over the course of time they had become much more sales focused, and much less service focused. Not the service base we wanted. In the process of waiting for our contractual obligations to expire with them, Daniel Stallings exited his relationship with them. And after we terminated our relationship with them, we brought Daniel back as an independent representative of American Portfolios. FINRA found no fault in your Mrs. X situation, and my members love working with Daniel. He takes a genuine member focused approach to each member he works with, and we are totally satisfied with that relationship.

The Indiana Department

In my first article about the case, I said Mrs. X's family filed a complaint with the Indiana Department of Insurance. Two consumer consultants in the Department dismissed the complaint in separate but identical letters.

Recently I wrote to the Department asking whether it had taken any disciplinary action in the case. In response, Doug Webber, chief of staff in the Department, said that no disciplinary action was taken, and that the Department was instrumental in getting the parties together to arrange for reinstatement of the original life insurance policies. He also said the Department concluded that the matter should be closed.

The NAIFA Chapter

The East Central Indiana (Muncie) Chapter of the National Association of Insurance and Financial Advisers (NAIFA) recently ran a newspaper advertisement showing the full text of the NAIFA Code of Ethics and photographs of the officers, directors, and several other members of the chapter. Stallings was identified as president of the chapter, and Katy M. Sargent-Combs was identified as president-elect.

NAIFA has published a booklet entitled "Keep It Legal," which among other matters describes the procedure for filing complaints against NAIFA members. The booklet says that complaints are handled at the chapter level, and describes in detail the procedures (including the hearing process) to be used in the investigation of a complaint. The possible results are dismissal of the complaint, a letter of reprimand, suspension of membership until a specified date, and revocation of membership. A complaint may be filed by "any person," but there is no mention of whether such a person who is outside NAIFA is notified of the result.

I sent a complaint by regular mail to Sargent-Combs. I expressed the belief that Stallings had engaged in conduct unbecoming a member of NAIFA and in violation of its Code of Ethics. I enclosed the two Forum articles and asked her to acknowledge receipt of the complaint.

Two weeks later, having received no acknowledgement, I sent a follow-up by regular mail again requesting acknowledgement. A week later, having received no acknowledgement, I sent an e-mail follow-up. Within minutes came this reply: "I have received both your letters and your e-mail and we as a board have no comment." I sent another e-mail asking: "Will you have a comment for me at some future date?" I received no further reply. I may never learn the result of the investigation, or even whether an investigation was conducted.

American Portfolios

Recently I wrote to Lon T. Dolber, president of American Portfolios. I enclosed the two Forum articles and mentioned the FINRA BrokerCheck reports on Stallings and Baker. I asked whether American Portfolios was aware of the case of Mrs. X when Stallings joined the firm. In response, Frank A. Tauches, Jr., executive vice president and general counsel, said:

Mr. Stallings disclosed the matter regarding "Mrs. X" prior to joining American Portfolios. Our Compliance Department, which reports to me, reviewed the matter. This matter was resolved as reported in FINRA's Broker Check during the same month that Mr. Stallings joined American Portfolios. Mr. Stallings remains a well-respected member of our firm who has had no customer complaints nor any regulatory issues since he joined us. I trust that this satisfies your inquiry.

General Observations

When I learned about the case of Mrs. X, I believed that the replacements were not justified, and that the life insurance aspect of the case was one of the most egregious replacements I had ever seen. In my first article about the case, I expressed the belief that commissions motivated the replacements, and that the transactions therefore involved churning. I think it is unconscionable that no significant punishment was imposed in the case.

I am offering a complimentary five-page PDF containing the two Forum articles. Send an e-mail to jmbelth@gmail.com and ask for the articles about the case of Mrs. X.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 75: Life Partners Faces a Court-Ordered Death Sentence

On December 2, 2014, Senior U.S. District Judge James R. Nowlin handed down a Final Judgment Order in a lawsuit filed by the Securities and Exchange Commission (SEC) against Life Partners Holdings, Inc. (NASDAQ:LPHI); Brian D. Pardo, chief executive officer of LPHI; and R. Scott Peden, general counsel of LPHI. The financial dimensions of the order are a death sentence for the company. (SEC v. LPHI, U.S. District Court, Western District of Texas, Case No. 1:12-cv-33.)

Background

On January 3, 2012, the SEC filed a civil complaint in federal court alleging that LPHI and its top officers had violated securities laws and regulations. On February 3, 2014, after a four-day trial, the jury voted in favor of the SEC on some and in favor of LPHI on some of the alleged violations of securities laws and regulations. LPHI declared victory because the jury voted in favor of LPHI on what the company considered the most serious charges. I wrote about the case in the April 2012 issue of The Insurance Forum and on my blog in Nos. 22, 29, 35, and 37.

The Permanent Injunction

Judge Nowlin ruled that the conduct of the defendants warranted the entry of a permanent injunction. He said their conduct was egregious, they understood they were not complying with their obligations, their violations were recurrent rather than isolated, they refused to recognize their obligations, and there was a likelihood of future violations in the absence of an injunction. The judge permanently enjoined the defendants from future violations of securities laws and regulations.

The Disgorgement

Judge Nowlin ordered LPHI to disgorge its ill-gotten gains by paying $15 million to the SEC. He expressed the belief that the figure is sufficiently large (more than half LPHI's current market capitalization) to deter future wrongdoers, and that the figure does not overstate the amount of LPHI's ill-gotten gains.

I think the judge calculated the current market capitalization by multiplying the number of outstanding shares (18,647,468 according to the proxy statement filed July 2, 2014) by the closing price per share on December 1 ($1.43), the day before he filed the order. That calculation produces a figure of $26.7 million, and the $15 million of disgorgement is 56 percent of the market capitalization. However, the share price declined sharply the next day on heavy volume in the wake of the order, closing at $1.10, and closing on December 8 at $1.00. Using the latter figure means the $15 million was 80 percent of the reduced market capitalization. Furthermore, I believe that even the $1.00 price is inflated by the fact that LPHI has continued to pay dividends to shareholders (Pardo beneficially owns 50.3 percent of the shares) despite continuing and significant operating losses.

The Civil Penalties

The judge ordered LPHI to pay a civil penalty of $23.7 million to the SEC. That figure is twice LPHI's total shareholders' equity of $11.8 million as of August 31, 2014. Indeed, the civil penalty exceeds LPHI's total assets of $19.8 million, and the $38.7 million sum of the disgorgement and the civil penalty is almost twice the total assets!

The judge also ordered Peden and Pardo to pay civil penalties of $2 million and $6.2 million, respectively. Thus the sum of the disgorgement and all the civil penalties is $46.9 million.

Other Aspects of the Order

As the case progressed, LPHI repeatedly argued that, because its life settlements are not securities, the firm is not engaged in the securities business. LPHI in recent years has lost a number of legal battles over that question, including in the current case.

After the trial, the defendants argued that no punishment should be imposed. The SEC argued not only for a permanent injunction, but also for penalties that the judge described as "ranging from a low of $67,930,000 to a high of $1.5 billion."

In the order, Judge Nowlin focused on Pardo. Here is how the judge described Pardo's role:

Brian Pardo owns a controlling stake in LPHI and serves as its CEO. He and he alone possesses the power to make strategic decisions, and it was he who guided the company down the path it took despite numerous warning signs that doing so might entail violating the law. Likewise, Pardo has a history of violating securities laws that dates back to 1991. He is a repeat offender who shows no signs that he has learned his lesson. The evidence suggests that Pardo behaved recklessly.... Accordingly, the Court assesses civil penalties against him based on his rendering knowing and substantial assistance in LPHI's filing of seventeen separate, false reports, and his knowingly false certifications thereof, as discrete violations of five separate provisions of the Exchange Act...for a total of 85 individual violations....

Judge Nowlin said Pardo, as chief executive officer and controlling shareholder, had the power to strengthen LPHI's "oversight and compliance regime." The judge also said that "oversight and compliance at Life Partners were non-existent," even after the company's ouster from Colorado in the wake of charges by Colorado's securities regulators.

Judge Nowlin singled out the sworn trial testimony of Tad M. Ballantyne (Racine, WI), a director of LPHI since 2001. In what the judge called "remarkable" testimony, Ballantyne said that he had never read, seen, or even heard of a 2,100-word December 21, 2010 article in The Wall Street Journal about LPHI's practices, and that he does not regularly read the Journal. The judge said the testimony revealed Ballantyne to be "either profoundly dishonest or amazingly uninformed about the company whose shareholders he has a fiduciary responsibility to protect." The judge described as "telling" the fact that Ballantyne remains on the board even after the embarrassing and uninformed testimony.

General Observations

Most media stories about Judge Nowlin's order said LPHI had not replied to requests for comment. However, according to The Wall Street Journal, Pardo said that "all the defendants plan to appeal." Presumably that means they will head for the U.S. Court of Appeals for the Fifth Circuit, and if they lose there, they would petition the U.S. Supreme Court to review the matter. Thus final resolution of the case may be at least one or two years away.

Judge Nowlin said the disgorgement and the civil penalty against LPHI were to be paid within 14 days of the order, and the civil penalties against Peden and Pardo were to be paid within 30 days of the order. However, the defendants may try to obtain a stay pending appeal.

Meanwhile, it remains to be seen what LPHI will say in an 8-K (material event) report, which is supposed to be filed within four business days after the event. I think that means December 8 in this case. At 4:00 p.m. EST on December 9, I found no 8-K on the SEC website, no press release on the LPHI website, and nothing on the district court docket after the Final Judgement Order. Something has to happen by December 16, because that is the date by which Judge Nowlin ordered LPHI to pay $38.7 million to the SEC. Also, on January 15, 2015, LPHI is supposed to file its 10-Q report for the fiscal quarter ended November 30, 2014. I plan to report further developments.

Saying LPHI faces "bankruptcy" is too gentle a description, because the word often implies at least the possibility of a reorganization. Rather, I think the order is a death sentence for the company. The Journal story quotes an attorney for Pardo as saying: "Has the government tried to burn down the village in order to save it? Apparently, yes." It is hard to disagree with the attorney's comment, but it also appears that Pardo's actions brought on the overwhelming financial dimensions of the order.

I am offering a complimentary PDF containing Judge Nowlin's 21-page order. Send an e-mail to jmbelth@gmail.com and ask for the Final Judgment Order in the SEC lawsuit against LPHI.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 74: Life Partners—A New Fund-Raising Scheme that Borders on Extortion

I wrote extensively in The Insurance Forum about Life Partners, Inc. (Waco, TX), an intermediary in the secondary market for life insurance and a subsidiary of Life Partners Holdings, Inc. (NASDAQ:LPHI). I also wrote about LPHI in Nos. 15, 22, 29, 30, 35, 36, 37, and 63. Here I discuss LPHI's new fund-raising scheme that apparently grew out of a desperate need for revenue and that I think borders on extortion.

The Continuing Losses

On October 15, 2014, LPHI timely filed its 10-Q report with the Securities and Exchange Commission for the fiscal quarter ended August 31, 2014, which is the second quarter of LPHI's fiscal year ending February 28, 2015. LPHI reported a net loss of a whopping $7.2 million for the quarter, compared to a net loss of $1.8 million in the corresponding quarter a year earlier. Quarterly losses over the preceding 13 quarters have consistently been under $2 million, with positive net income in only two of those quarters.

On page 11 of the 26-page 10-Q, LPHI gave a detailed discussion of its continuing legal struggle with a German bank that loaned LPHI money in exchange for an interest in some life settlements. The uncertainties associated with the litigation prompted LPHI to record an impairment to the investment value of its interest in those settlements. On page 17 of the 10-Q, LPHI mentioned the impairment in its brief explanation for the large loss in the second fiscal quarter. LPHI said:

The net loss for the Second Quarter of this year was primarily due to the recording of an impairment reserve against the value of the investment in life settlements trust of $6,648,478. Without this reserve, we would have realized a net loss, before taxes, of $838,857 for the Second Quarter of this year.

On top of the continuing losses, LPHI reported an average of slightly fewer than ten new life settlements per quarter during the 14 most recent fiscal quarters. During the most recent five quarters, LPHI reported an average of slightly fewer than four new life settlements per quarter.

Despite the continuing losses and the lack of new life settlements, LPHI has continued paying shareholder dividends. Slightly more than half the dividends go to Brian Pardo, LPHI's chief executive, who beneficially owns slightly more than half the outstanding shares. Prior to 2012, the quarterly dividends were 20 cents per share. LPHI reduced the dividend to 10 cents per share in the next five quarters, and to 5 cents per share since then. At one spot on page 21 of the 10-Q, LPHI said: "We may have to decrease our stock dividends and may make further cuts." At another spot on the same page, LPHI said: "We may reduce or eliminate the dividends for the remainder of fiscal 2015 and for 2016 to conserve working capital until we can realize improved operating results."

The New Fund-Raising Venture

On page 21 of the 10-Q, near the end of a lengthy paragraph explaining how "the operating losses we experienced in fiscal 2014 have eroded the strength of our financial condition," LPHI disclosed a new fund-raising venture. Here is the relevant sentence:

Beginning in the Third Quarter of this year we will bill our life settlement investors for policy monitoring costs in order to recover the expenses of tracking policy premium payments and maturity payouts through the life settlement process.

The First Pardo Letter

On October 14, Pardo sent a one-page letter to clients informing them of the fund-raising venture. Pardo said the company provided important ministerial functions to 23,500 clients without charge for 24 years, but the company can no longer provide those functions without charge. He said a new subsidiary, LPI Financial Services, Inc., will provide those functions "at a very reasonable cost to you."

Pardo said the "cost will be a base charge of $240 per year for each account plus an incremental monthly charge per active life settlement position" of $1.25 for one position, $1.75 for each of two positions, $2 for each of three positions, $2.25 for each of four positions, and $2.50 for each of five positions or more. He said the cost "will be billed in arrears starting with this notice." The word "arrears" means the charge will be for services performed during the past year rather than for services to be performed during the coming year.

An invoice was enclosed with the letter. For example, a client with three positions was asked to remit $312: the base charge of $240 plus a monthly charge of $72 ($2 times 3 positions times 12 months).

The Second Pardo Letter

On October 27, Pardo sent a three-page follow-up letter prompted by what probably was a large number of complaints. He apologized for not providing more details. He said the initial fee charged by Life Partners when the policies "closed" was a fee "for acquisition services." He explained in greater detail than in the first letter the "monumental administrative and technically intense task which requires a small army of full time programmers and IT experts to maintain and manage."

An Unanswered Question

The Pardo letters do not explain what would happen if a client ignores the bill. For example, clients have fractional interests, and it is not clear what would happen if some with interests in a policy pay the bill and some with interests in the same policy do not pay the bill. I asked Life Partners to address the question, but received no reply.

General Observations

The agreements that clients entered into with Life Partners did not provide for ministerial fees. Nonetheless, I think many clients will pay the bills to avoid the possibility of losing everything they invested. I think billing for ministerial fees borders on extortion.

I am offering a five-page complimentary PDF consisting of the one-page first letter, the one-page invoice, and the three-page second letter, with redactions to conceal client identity. Send an e-mail to jmbelth@gmail.com with a request for the Life Partners package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com