Thursday, January 16, 2014

No. 22: A Devastating Setback for Life Partners

Life Partners, Inc. (Waco, TX) is an intermediary in the secondary market for life insurance policies and the operating subsidiary of Life Partners Holdings, Inc. (NASDAQ:LPHI). In January 2012, the Securities and Exchange Commission (SEC) filed a civil complaint against LPHI and others. The jury trial is set for January 27, 2014, before Senior U.S. District Judge James R. Nowlin. (SEC v. LPHI, U.S. District Court, Western District of Texas, Case No. 1:12-cv-33.)

In November 2013, an important development occurred when Judge Nowlin issued an Order denying LPHI's motion for partial summary judgment. Incorporated in the Order is a ruling that is devastating for LPHI and its officers.

Judge Nowlin's Order
On September 23, 2013, in the current SEC lawsuit against LPHI, the company filed a motion for partial summary judgment. Among other points, and in support of its argument that the court lacks jurisdiction in the case, LPHI asserted that its life settlements are not "securities" under federal securities laws. LPHI cited the infamous 1996 decision of the U.S. Court of Appeals for the D.C. Circuit in the case of SEC v. Life Partners. In that old ruling, a two-to-one decision by a three-judge panel, the D.C. Circuit held that LPHI's life settlements displayed most but not all the characteristics necessary for the life settlements to be deemed securities. The dissenting judge said the life settlements displayed all the necessary characteristics. On November 19, 2013, Judge Nowlin issued an Order denying LPHI's motion for partial summary judgment. He ruled, among other points, that LPHI's life settlements are securities. Here are excerpts:
Viatical Settlements are securities, and even if they are not, there is more than enough evidence to support Plaintiff's claim that Defendants made misleading statements to shareholders and the public that were material.
Defendants next argue that life settlements are not securities under federal securities laws. In support of this position, Defendants cite a single case from the D.C. Circuit. Although the 5th Circuit [encompassing Texas] has not yet directly addressed the question of whether viatical settlements are securities as defined by federal law, the holdings of the Court of Appeals for the D.C. Circuit are not binding upon this Court. Additionally, the thrust of persuasive authority cuts against the D.C. Circuit's 1996 opinion in SEC v. Life Partners....
While Defendants only cite to the D.C. Circuit's opinion in Life Partners, Defendants did not manage to cozen the Court into thinking that Life Partners is the only case on point. Indeed, since the D.C. Circuit handed down Life Partners, several other federal courts have subsequently examined the same question and declined to adopt the D.C. Circuit's position....
[Blogger's notes: Judge Nowlin cited the 2005 decision of the 11th Circuit in SEC v. Mutual Benefits and the 2004 decision of the Northern District of Ohio in Wuliger v. Christie. According to the 2003 edition of Merriam-Webster's Collegiate Dictionary, "cozen" means "to deceive, win over, or induce to do something by artful coaxing and wheedling or shrewd trickery."]
On November 21, 2013, LPHI filed a motion for reconsideration, again asserting that life settlements are not securities, and again citing the D.C. Circuit's 1996 decision. On December 3, 2013, when he denied the motion for reconsideration, Judge Nowlin again ruled that life settlements are securities, and again rejected the 1996 decision.

Delayed Disclosure
LPHI did not file an 8-K report to disclose Judge Nowlin's ruling. I follow LPHI's SEC filings, but did not become aware of the ruling until late December while reviewing recent documents in the current SEC lawsuit against LPHI. LPHI finally disclosed the ruling on January 14, 2014, in a discussion of the SEC lawsuit against LPHI in the "Legal Proceedings" section on page 26 of the 30-page 10-Q report for the quarter ended November 30, 2013. Here is the key sentence:
In denying defendants' motion for partial summary judgment, the court held that the life settlements facilitated by Life Partners, Inc. were securities under Federal Law, despite the fact that (i) Life Partners, Inc. is not a defendant in the case, (ii) the SEC did not allege or argue that the life settlements were securities, and (iii) the offer and sale of our stock is not at issue in the case.
LPHI should have stopped with the words "Federal Law," because the three points that follow are nonsense. First, LPHI and Life Partners are indistinguishable. Second, LPHI argued that its life settlements are not securities. Third, although it is not the major thrust of the case, possible insider trading of LPHI stock is an issue.

A similar recent incident illustrates, in LPHI's words, the significance of a ruling that life settlements are securities. On August 28, 2013, as reported in the November 2013 and December 2013 issues of The Insurance Forum, a Texas state appellate court ruled that "the viatical settlements sold by Life Partners are investment contracts, as a matter of law, under the Texas Security Act and meet the definition of 'security.'" LPHI disclosed that ruling more than two weeks later in an 8-K report filed on September 13, 2013. In that report, LPHI said it would appeal the decision, and also said:
Should the decision ever become final, it would result in a material adverse effect on our operations and require substantial changes in our business model.
I think Judge Nowlin's Order is even more significant than the state appellate court's ruling, because it opens up the possibility that LPHI and its officers could be charged with violations of federal securities laws. That is why I think Judge Nowlin's Order is devastating for LPHI and its officers.

LPHI's delayed disclosure of Judge Nowlin's Order is not only surprising but also ironic. In my blog post No. 15, I discussed a legal victory for LPHI, which the company disclosed immediately in an 8-K report. That is how I learned about it and was able to report on it quickly. LPHI apparently discloses good news immediately and delays disclosure of bad news.

Warnings about the Future
In the recent 10-Q report, LPHI sounded warnings about the significance of the SEC lawsuit against the firm and about a life settlements trust that is in default. These two items are in the "Risk Factors" section on page 27 and are followed by detailed explanations:
The SEC enforcement proceeding has profoundly affected our operations and caused substantial losses, which has adversely affected our working capital and liquidity. It is important that the proceeding is timely resolved in our favor.
We have invested in a life settlements trust, whose secured loan is in default. The resolution of the default could cause the loss of our investment and in possible claims against us.
The Dividend Situation
According to LPHI's June 2013 proxy statement, Brian D. Pardo, LPHI's chief executive officer and a defendant in the current SEC lawsuit against LPHI, beneficially owns slightly over half the outstanding shares (9.4 million out of 18.6 million). Other officers and directors together own 376,000 shares. Pardo Family Holdings Ltd. (PFH) owns all but 14,000 of Pardo's shares. The proxy statement says PFH is located in Waco, Texas. However, according to an August 2009 Form 4 (the most recent Statement of Changes in Beneficial Ownership) filed with the SEC, PFH is located in Gibraltar, a British overseas territory.

Although LPHI incurred net losses in nine of the last eleven quarters, and despite the company's precarious financial condition, the company has continued to pay dividends. Here are the details:

Net Income
05/31/11 $ –874 20
08/31/11 –323 20
11/30/11 –1,083 20
02/29/12 –843 10
05/31/12 1,037 10
08/31/12 –1,849 10
11/30/12 –754 10
02/28/13 –1,311 10
05/31/13 1,677 5
08/31/13 –1,793 5
11/30/13 –939 5

For the eleven quarters combined, Pardo received dividends of about $11.75 million (9.4 million shares multiplied by $1.25 per share). That dwarfs the compensation he received for his services. According to the June 2013 proxy statement, he received total compensation of about $571,000 for the fiscal year ended February 28, 2013, $526,000 for 2012, and $1,080,000 for 2011.

As mentioned, LPHI's 10-Q report showing financial results for the quarter ended November 30, 2013 was filed on January 14, 2014. Nonetheless, in an 8-K report filed on December 17, 2013, LPHI announced a dividend of five cents per share (about $470,000 for Pardo) for that quarter.

My Recent Articles About Life Partners
My only previous article about the SEC's current lawsuit against LPHI is in the April 2012 issue of The Insurance Forum. Other recent articles about Life Partners are in the November 2012, December 2012, November 2013, and December 2013 issues.

Availability of Judge Nowlin's Order
Given the significance of Judge Nowlin's 21-page Order, I am making it available as a complimentary PDF. Send an e-mail to and ask for Judge Nowlin's Order.