Monday, February 24, 2014

No. 33: Ohio National's STOLI Lawsuit

In April 2010, Ohio National Life Assurance Corporation filed a civil lawsuit in federal court against ten defendants involved in stranger-originated life insurance (STOLI). In December 2010, the company filed an amended complaint adding three defendants. In October 2012, the company filed a motion for summary judgment (MSJ). In November 2012, two defendants filed MSJs. In February 2014, the judge issued an order largely granting Ohio National's MSJ and largely denying the defendants' MSJs. I decided to discuss the case because I think it illustrates the distortions, misconceptions, gullibility, and sheer ignorance that permeate the STOLI market. (Ohio National v. Douglas Davis et al., U.S. District Court, Northern District of Illinois, Case No. 1:10-cv-2386.)

The Defendants
Attorney Douglas W. Davis (Malibu, CA) was the initial trustee of five irrevocable life insurance trusts (ILITs) that are the subject of the lawsuit. Those trusts and Douglas Davis are among the 13 defendants in the case. The ILITs were in the names of Chicago residents Charles M. Bonaparte, Sr., Shirlee Davis, Theodore R. Floyd, Mary Ann Harris, and Robert S. Harris.

Paul Morady, a southern California resident and the central figure in the case, is an intermediary and premium financier in the STOLI market. He is the owner of Camden Investment Holdings, a California corporation in suspended status. He also owned Security Pacific Premium Financing, an Illinois corporation involuntarily dissolved in 2008.

Mavash Morady, a southern California resident and wife of Paul Morady, is an insurance producer. She owns American Pacific General Agency (APG). In 2006, she obtained an Illinois agent's license and became an Ohio National agent. In April 2010, Ohio National said she materially breached her agent's contract, fined her almost $192,000 (the commissions on seven policies), and terminated her agent's contract.

Shirlee Davis, a Chicago resident, is the mother of Douglas Davis. She is the named insured in a $1 million Ohio National policy and a $750,000 Lincoln National policy. Both were issued in 2007.

Theodore R. Floyd, a Chicago resident, is the named insured in a $400,000 Ohio National policy and a $600,000 AXA Equitable policy. Both were issued in 2007.

Steven Egbert, a California resident, is successor trustee of the Bonaparte ILIT. Thomas M. Tice, a California resident, is successor trustee of the two Harris ILITs. Christiana Bank & Trust Company (Wilmington, DE) is successor trustee of the Shirlee Davis ILIT.

The Complaint
Against all the defendants, Ohio National sought a declaratory judgment, damages, and equitable relief. The company alleged fraud by Douglas Davis and Mavash Morady; violation of the Illinois Consumer Fraud and Deceptive Practices Act by Douglas Davis; breach of contract by Mavash Morady; unjust enrichment by Douglas Davis; and civil conspiracy by Douglas Davis, Mavash Morady, Paul Morady, Shirlee Davis, and Theodore Floyd.

The Depositions
I reviewed many briefs filed in the Ohio National case and the depositions of Paul Morady, Mavash Morady, and Douglas Davis. It was gratifying that, in contrast to many STOLI cases where depositions are sealed, they are publicly available in the Ohio National case.

Paul Morady comes across as knowledgeable about STOLI, grappling with the complexity of STOLI transactions, clever, evasive, unprincipled, and in it for the money. Two excerpts from his deposition are in Appendix A below.

Mavash Morady comes across as knowing nothing about life insurance in general and STOLI in particular. She signed life insurance applications supposedly as the writing agent, but the information was inserted in the applications by others. Two excerpts from her deposition are in Appendix B below.

Douglas Davis comes across as naive about life insurance in general and STOLI in particular. In Appendix C below, instead of excerpts from his deposition, I show his answers to two questions I asked him.

Judge Durkin's Order
When the Ohio National case was filed in April 2010, it was assigned to U.S. District Judge Virginia M. Kendall. In June 2012, the case was reassigned to U.S. District Judge John Z. Lee. In February 2013, the case was reassigned to U.S. District Judge Thomas M. Durkin.

On February 7, 2014, Judge Durkin issued a memorandum opinion and order. I was impressed not only by his excellent description of the case but also by his strong grasp of it. I think he "gets it."

With regard to Ohio National's MSJ, Judge Durkin declared that the five Ohio National policies were void ab initio (from the beginning) because they were procured without an insurable interest in the insureds' lives. He ruled that Paul Morady and Mavash Morady were liable for civil conspiracy, that Mavash Morady was liable for fraud for breach of her agent's contract with Ohio National, and that Ohio National could retain the premiums on four of the policies. However, he ordered Ohio National to refund to Egbert the premiums Egbert paid on the Bonaparte policy because Egbert was not complicit in the scheme perpetrated by Paul Morady, Mavash Morady, and Douglas Davis.

With regard to Egbert's MSJ, Judge Durkin ruled that the Bonaparte policy was void ab initio, but he ordered Ohio National to refund to Egbert the premiums Egbert paid on the Bonaparte policy. Douglas Davis and Mavash Morady did not file any opposition to Ohio National's MSJ.

Judge Durkin denied Paul Morady's MSJ, which was filed pro se (without the assistance of an attorney). Paul Morady argued that the policies were valid and that there was no civil conspiracy. In the order, in a comment that needs to be considered in relation to the second excerpt in Appendix A below, Judge Durkin illustrated (with citations omitted) how "lucrative" Paul Morady's "program" was:
Taking the Bonaparte policy as an example, Paul Morady paid Bonaparte $6,000. Paul Morady also paid the first premium on this policy of $16,040. Paul Morady then sold the Bonaparte policy to Egbert for $69,512, for a potential net profit of $47,472.
I am offering the 23-page order as a complimentary PDF. Send an e-mail to with a request for Judge Durkin's order.

My General Observations
Participants in the STOLI market often assert that the following are not material to a life insurance company's underwriting decision on whether to issue a proposed policy: (1) the purpose of the proposed insurance, (2) the proposed insured's intent to borrow to pay the premiums on the proposed policy, (3) the proposed insured's intent to sell the proposed policy to investors (speculators) in the secondary market, (4) the proposed insured's net worth and income, and (5) the proposed insured's existing life insurance and other life insurance currently applied for. The assertions are false because all those items are material to an underwriting decision. The source of such assertions is a mystery to me.

I think the Ohio National case raises at least two important questions. First, when will state insurance regulators begin to pay close attention to the extent of the fraud perpetrated on insurance companies, investors (speculators), insurance consumers, and the general public by participants in the STOLI market? Second, when will the unacceptable practices of participants in the STOLI market become widely recognized as a form of criminal wrongdoing?

Appendix A: Excerpts from Deposition of Paul Morady
Paul Morady gave a full-day sworn deposition in Chicago on June 28, 2012. He was questioned by Jacqueline J. Herring of Smith, von Schleicher & Associates, a firm retained by Ohio National. Paul Morady was not represented by counsel. The excerpts below are from pages 16-20 and 156-160 of the 279-page transcript.
Q. What was the nature of the business you discussed with Mr. Davis?
A. My background is insurance premium financing and I'm an expert in it.
THE REPORTER: "And I'm" what?
THE WITNESS: An expert in premium financing. And I wanted to see if I could premium finance some of his clients' insurance business or insurance policies.
Q. And by "his clients," you mean Douglas Davis's clients?
A. Yes.
Q. Okay. And what do you mean by a client of Douglas Davis?
A. Douglas Davis, as I understood, he is an estate attorney, an estate planner, and represents clients as an attorney and acts as a trustee for them -- family trustee, an individual trustee
 -- for his clients.
Q. And so what was the business you were going to be doing with Mr. Davis?
A. I said to him, "If they own or have an insurance policy issued to them but not paid, I'm willing to lend them money or cause a loan to them so they could purchase the insurance." Further, I mentioned I have contacts. I can help them sell their interests if they wish to.
Q. Sell their interest in the policy?
A. It's a conceptual thing you're asking me; but the concept is the insured is a donor of the policy, not the owner nor the beneficiary.
Q. Did you say "donor of the policy"?
A. Yes. Donor of life it's called. They donate their life into an irrevocable insurance trust and their beneficiary is usually a family member or someone who has interest in their life, such as a friend, family, attorney, partner, business partner. These are the kinds of interested parties in somebody's life.
Q. And the concept of donating the life, where does that concept come from? I haven't heard that term before.
A. Well, my research, through the major law firms I've retained
Q. Mm-hmm.
-- was that the structure -- it's an acceptable structure in Illinois at that time which should include a donor of a life into a policy. And once the insurable interest is intact, the owner of the policy and/or the beneficial interest holder of that policy, under the Supreme Court of the United States, is allowed to borrow, sell, loan, trade as his personal asset. It's just like owning a condominium or a house that you would own. And I'm a lender. I lend money to people like you who are going to pay it back.
Q. Okay. I'm going to back up and get some more detail from you on that. One of the things you said was once the insurable interest is attached. What does that mean?
A. "Intact," that's what I said.
Q. Once the insurable interest is intact?
A. Correct.
Q. What does that mean?
A. That means once the policy is issued by an insurance carrier and the beneficiary of that insurance policy is granted an insurable interest in the donor, then that insurable interest becomes intact.
Q. What is an "insurable interest"?
A. An individual's participation with someone who is purchasing a life policy, such as a business partner, wife, son, cousins, friends. These are the types of people who have an insurable interest in somebody's life if that individual wants to make them the beneficiary or pick him up as beneficiary through the trust as it's allowed.
THE REPORTER: I didn't hear, "as it's allowed"?
THE WITNESS: Yes, as it's allowed in the trust documents.
Q. At what point does that insurable interest become intact?
A. At the time when the policy has been issued and delivered to the trust, which is the owner of the policy, but not necessarily paid. It could be not still paid, but it's issued. So once the policy is issued, the insurable interest is intact.
Q. Whether the premium has been paid or not?
A. Correct. The owner of the policy has a period of time to decide if they want to pay for it or not. That does not preclude the policy not to be assuredly [insurable?] interest intact.
+  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +  +
Q. Okay. And the e-mail above that -- still on page 71657 -- is that an e-mail that you sent on September 21, 2007, to Regan Brown, George Jarkesy, Jerry Sexton, and others?
A. Yes.
Q. Okay. And in your e-mail, No. 2 and No. 3, you're asking why the insured has to be part of the transaction. Explain that.
A. Well, the insured was not the seller of the beneficial interest in the ILIT.
Q. Okay. So you didn't want the insured to know about the transaction?
A. No. I didn't say that. I said is there a need for him. Is there a reason since this is not the seller or she's not the seller.
Q. Was there a reason why you didn't want to disclose the deal to the insured?
A. No.
Q. Okay. Why were you asking about that?
A. I just wanted to know their position, if they need or required or is a need because it's an additional step to take, a burden to take.
Q. Okay. On the first page of Exhibit Paul Morady 27, which is page 71656, the e-mail at the bottom of the page, which is from Regan Brown to you and others dated September 21, 2007, did you receive that e-mail?
A. Yes.
Q. And at the top of that page is an e-mail from you to Regan Brown and others dated September 21, 2007. Is that an e-mail that you sent?
A. Correct.
Q. Okay. And in the second paragraph of your e-mail, you state, "The insured will not be a party to my indemnification nor are they to know how much is being paid here." Is there a reason why you didn't want the insured to know how much was being paid to you?
A. Not necessarily. I just felt it is not related to them. They're not the sellers.
Q. Why did you want to keep that information from the insured?
A. Because maybe the holder of the beneficial interest did not want it disclosed to them.
Q. And why would that be if the holder of the beneficial interest was somebody that you said was a close family member or friend, somebody that would be interested
A. Sure.
-- in the insured?
A. Well, again, I'll use you as an example. Maybe you don't want your son to know all of your transactions. Maybe you do. I don't know.
Q. Okay. Did any of the holders of the beneficial interest tell you that they didn't want the insured to know what they were doing?
A. Not necessarily. I don't recall if they did or not. I'm just trying to keep my confidentiality with the people involved.
Q. So the person whose death was going to result in a payout didn't need to know how much was being paid?
A. No.
Q. I'd like to hand you Exhibit Paul Morady 26, which is Bates labeled CGP-CAS-CLA 0071644. This is an e-mail dated September 21, 2007, from you to Jerry Sexton and Julian Goldberg, correct?
A. Yes.
Q. And this is, again, you saying, "Jerry, I do not want to get the insured into my private sale transactions." Any particular reason why you considered these your private sales?
A. If Camden Investment Holdings was holding the beneficial interest in them, it is private.
Q. Okay. And Camden was selling the beneficial interest for substantially more than it had been purchased from the original holder of the beneficial interest, correct?
A. Only to the amount of repayment of the loan plus the interest and cost, but not much more.
Q. How much would that typically be, the interest and the cost?
A. It depends on the duration of the promissory note times the interest rate
Q. All right.
-- plus legal costs and so on.
Q. If it's less than a few months, what would that typically be?
A. It would be, I would say
 -- I don't know. Maybe it comes to 1 percent sometimes, one-third of the 3 percent, something like that.
Appendix B: Excerpts from Deposition of Mavash Morady
Mavash Morady gave a full-day sworn deposition in Chicago on June 27, 2012. She was questioned by Ms. Herring. Mavash Morady was not represented by counsel. However, Paul Morady sat in and occasionally interrupted. Ms. Herring reminded him that he was not Mavash Morady's attorney and was not allowed to testify. The two excerpts below are from pages 126-128 and 253-256 of the 300-page transcript.
Q. You submitted applications for life insurance to Ohio National that you knew were going to be premium financed policies, correct?
A. I can't answer that.
Q. Why not?
A. Because I wasn't in premium financing business. I was just APG brokerage.
Q. And you knew some of those Ohio National policies were premium financed?
A. I cannot answer that. I wasn't premium finance.
Q. You testified earlier that you knew some of those Ohio National policies would be premium financed. Are you changing that?
A. I'm not changing that. Some need premium finance and Ohio National also did premium finance.
Q. You knew someone
A. If we were doing wrong, Ohio National would have just let us know right at that time.
Q. You knew some of those
A. They knew as well.
Q. When you say "as well," you're saying you and Ohio National both knew premium financing?
A. As far as I know, if it did premium finance, Ohio National knew exactly what we were doing.
Q. Because you told them? How would they know?
A. I didn't tell them because I wasn't in premium finance.
Q. How would they know?
A. Through my agent. I don't know. I don't know. I don't want to talk about my agent, what they said and what they did.
Q. You knew some of these policies were premium financed. If you would answer the question
A. No.
-- I don't need to keep asking it.
A. You just keep asking the same thing over and over.
Q. Because you won't answer.
A. You're confusing me, and I don't want to be confused.
Q. Did you know that some of the Ohio National policies that you were submitting applications for would be premium financed?
A. I'm not going to answer that because I already told you everything that I know.
Q. Did you know that the applications you were submitting for Ohio National policies would be premium financed?
A. You repeat as much as you want. I don't know.
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Q. So we're back on. What is AVS [American Viatical Services] underwriting?
A. To let us know
 -- AVS?
Q. Yes.
A. I don't remember that. That was a long time ago.
Q. They determined life expectancy for a proposed insured, correct?
A. Yes.
Q. So they'll prepare a report letting you know what somebody's life expectancy is?
A. Correct.
Q. Why was APG requesting to know the life expectancy of the five proposed Chicago insureds?
A. The insurance carrier needs that life
 -- they ask for all that information and life expectancy for the insured for the policy.
Q. Ohio National asked you to go through a separate underwriting company to determine life expectancy?
A. No. We want to make sure who we're dealing with and we want to know what their life expectancy is to fill out the application.
Q. So you would obtain the life expectancy information before you filled out the application?
A. During
 -- same time to make sure, like, everything we're doing on the right track.
Q. And what information would the life expectancy give you for the applications?
A. I don't know.
Q. So we went through the applications earlier, and I didn't see that you were ever asked any questions about life expectancy.
A. No, I didn't. But I want to make sure what is the life expectancy with any life policy.
Q. And why would you want to know that?
A. Like other things you want to know to make sure, like, to get the right insured for the policy.
Q. What impact would the life expectancy have on the insurance policy you apply for?
A. Like, for example, some of the insurance carrier[s] don't accept
 -- We have to make sure what age and how healthy they are. We have to have that life expectancy to figure out if they're okay for the application or insurance carrier to accept.
Q. So was it your understanding that the life insurance companies weren't determining the life expectancy for themselves, they expected you to do it through a separate company?
A. No, no, no. We just wanted to know what's going on and what insurance carrier asking us to
 -- what kind of life expectancy insurance carrier asked for.
Q. Which insurance carriers asked
 -- Let me narrow that. Did Ohio National ever ask you to determine somebody's life expectancy while submitting an application for life insurance?
A. I don't remember.
Appendix C: Comments by Douglas Davis
On February 11, 2014, I e-mailed Douglas Davis and asked him to confirm he is the lead defendant named in the Ohio National case. He said he is, and expressed interest in any questions I might have because "I am being portrayed as a vagabond when our goal was to help those who did not have access to Life Settlements legally obtain said access." I asked him two questions: (1) When and from whom did you learn about STOLI? (2) Why do you believe that a person can "legally obtain" access to STOLI by submitting materially false information on an application to a life insurance company?

In answer to the first question, Davis said: "I was introduced to the life settlement concept by Mr. Morady who was also named in this lawsuit." In answer to the second question, he said:
I disagree with the court's interpretation that any of the defendants engaged in material omissions designed to obtain insurance policies. Ohio National claimed that the failure to set forth that some of the applicants had applied previously for insurance policies was a material omission. An individual is not prohibited from purchasing more than one insurance policy. In fact it is common among wealthy individuals to have more than one policy. Insurance policies are property and one can purchase more than one for investment purposes. Whether they had purchased policies prior to applying for insurance from Ohio National was not material to the issuance of the insurance policy. An individual's income is also not an underwriting factor that is a major determinant by an insurance company when it decides to issue a policy. Ohio National, after discovering that it had issued policies to middle class African Americans who intended to sell them, looked for any possible reason to void those policies because it knew that if the concept became popular they would have policies issued where the risk was now on them as most of those policies were not going to lapse if they were sold compared to the normal lapse rate among African Americans which is around 60%-80%. Furthermore at the time these policies were issued there were no prohibitions in Illinois regarding what insurance companies deem stranger originated life insurance policies. We feel that the court made several errors in their decision to grant parts of Ohio National's MSJ. For example, how can there be a conspiracy to sell STOLI policies when they were not illegal. We obtained an opinion from a reputable Illinois law firm that told us there was no such prohibition. How can there be fraud regarding matters that were not material to the issuance of policies? We feel that these and other issues will be resolved in our favor at the Appellate level.

Thursday, February 20, 2014

No. 32: More Comments from Readers about Universal Health Care

My blog post No. 12 is entitled "The Expanded and Improved Medicare For All Act of 2013" and also mentions the Patient Protection and Affordable Care Act of 2010 (PPACA). My blog post No. 18 shows comments by a reader who opposes universal health care, a reader who supports it, and a prominent Republican who supports it. In response to No. 18, I received comments from two other readers. One of them is Reginald L. Jensen, CLU, ChFC (Eugene, Oregon). He said:
Single payer, universal health care, and socialized medicine are three names for the same thing. The movement is based on the idea that health care is a "right." It is also a movement with an eye on controlling a lot of money. One advocate of single payer is Lewin Group, an Optum company, which in turn is owned by UnitedHealth Group, one of the largest health insurers in the U.S.
No one has a "right" to the time, work product, knowledge, or services of another. One must do whatever necessary to receive the professional help of another. We can give a waiver to those who simply do not have the capacity to help themselves, but that would not be an advance from provider to recipient. There is an answer.
Dr. Kenneth Cooper's Clinic in Dallas conducted a study covering 20 years and over 7,000 participants to see whether moderate daily exercise would reduce health care costs. The result was that costs can be reduced by up to 50% for those who engage in 30 minutes of daily exercise five days a week. A 30-minute walk would do it. We could set up a health care plan where those who exercise would have medical costs covered 100%, but those who do not would have medical costs covered only up to the same average dollar amount incurred by exercisers, with the non-exercisers paying the balance. Those not capable of exercising could be included in the exerciser group.
The other reader is G. James Blatt, Jr., CLU (Pittsford, New York). He said:
Universal health care is an absolute right for all our citizens. The primary obstacle is the obscene compensation of health insurance executives. They neither save lives nor improve health outcomes, but simply pay bills. We are further hampered by the archaic notion that health care should be provided through employers. Now, with an expanding population of individuals who cannot find employment, emergency departments are providing more expensive health care than ever. At least the PPACA takes a swing at changing that situation.
Health care in the U.S. is manipulated by a cabal of self-interest: AMA-controlled access to medical education; overpaid health insurance executives; a revolving-door relationship between insurance regulators and insurance companies; the compensation awarded by mutual health insurance company directors to themselves and their executives; a broken tort system; a conflict-of-interest relationship with the best politicians money can buy; and a willing media that reports negative outcomes supposedly connected to universal health care in other countries.
The only solution that would bring sanity to this picture is a single payer system. We do not even need a mandate. Just give everyone access to Medicare. That would be a nuclear bomb for the fat cats mentioned above.

Saturday, February 15, 2014

No. 31: Phoenix Life's Legal Expenses

Over the past few years, I have written several articles about the extensive litigation involving the cost-of-insurance increases imposed by the operating subsidiaries of The Phoenix Companies, Inc. (NYSE:PNX) on the owners of universal life policies of the type used in stranger-originated life insurance (STOLI) transactions, as well as about Phoenix's many lawsuits seeking rescission of STOLI policies. Recently I began to wonder about how much the company pays to outside legal firms.

A source of such information is Schedule J in the New York Supplement to the statutory annual statement blank promulgated by the National Association of Insurance Commissioners (NAIC). The schedule is described as follows:
Showing all legal expenses paid during the year, other than the salaries of officers or employees. List individually all items of $500 or more.
For many years, Schedule J was in the NAIC's uniform annual statement blank, but it is one of several schedules the NAIC eliminated from the blank in recent years. Another schedule removed from the blank was Schedule K, which disclosed lobbying expenses.

Still another schedule removed from the NAIC blank, and from which for many years I obtained executive compensation data for my annual tabulations, was Schedule G. It was removed from the blank in 1986. NAIC officials with whom I discussed the matter at the time acknowledged the extensive public interest in the data, but said the data did not serve any useful regulatory purpose. (See "More Secrecy from the NAIC" in the January 1987 issue of The Insurance Forum.)

The New York State Department of Financial Services still believes that such information should be available to the public. For that reason, many of the schedules remain part of the New York Supplement.

Phoenix Life
The 2013 Schedule J will be available after March 1, 2014, when the 2013 statements are filed. Meanwhile, I obtained the 2012 Schedule J for Phoenix Life Insurance Company. The payments shown in the schedule totaled $20.3 million, of which $16.5 million, or 81 percent, went to five prominent law firms:

Edison McDowell & Hetherington
DeBevoise & Plimpton
Day Pitney
Dorsey & Whitney

There is no Schedule J for PHL Variable Insurance Company, an affiliate of Phoenix Life, because PHL is not licensed in New York. Since PHL is domiciled in Connecticut, I asked the Connecticut Insurance Department whether it has any breakdown of legal expenses incurred by PHL along the lines of the old Schedule J. A spokesperson said the department did not have such information. Based on other information in PHL's 2012 annual statement, I think it is likely the amounts paid by PHL to outside law firms are smaller than the amounts paid by Phoenix Life.


Wednesday, February 12, 2014

No. 30: Another Court 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). On February 3, 2014, as discussed in my blog post No. 29, a federal jury found LPHI and its two top officers guilty of some and not guilty of other civil securities violations. On February 6, in a separate case, a Texas appellate court reversed a state district court judgment and ruled that the life settlements offered by Life Partners are securities subject to regulation under the Texas Securities Act. The latest ruling, another setback for Life Partners, follows similar recent rulings by another Texas appellate court and a federal district court.

The State Lawsuit
On August 16, 2012, the Texas attorney general, on behalf of the state and at the request of the Texas securities commissioner, filed a lawsuit in a state district court against the Life Partners companies, their two top officers, and five "relief" (nominal) defendants. The state alleged, among other things, that the defendants orchestrated a fraudulent enterprise and manufactured the value of life settlements through artificially short life expectancies. The state requested, among other things, a temporary injunction and the appointment of a receiver.

On October 3, 2012, Judge Stephen Yelenosky ruled that the state had "failed to establish that the transactions at issue are securities under Texas law." He denied the state's requests. (State of Texas v. LPHI, District Court of Travis County, Texas, No. D-1-GV-12-001128.)

The State Appeal
The state appealed the denial. The appeal was heard by a panel consisting of Justices David Puryear, Jeff L. Rose, and Melissa Goodwin.

On February 6, 2014, the panel issued an opinion written by Justice Puryear unanimously reversing the district court judgment and ruling that "the life settlements offered by Life Partners are investment contracts and, therefore, qualify as securities subject to regulation under the [Texas] Securities Act." The panel sent the case back to the district court "for further proceedings consistent with this opinion." (State of Texas v. LPHI, Texas Court of Appeals, Third District at Austin, No. 03-13-00195-CV.)

Two Other Recent Court Rulings
On August 28, 2013, as discussed in the December 2013 issue of The Insurance Forum, a three-justice Texas appellate court panel unanimously reversed a district court decision. The panel ruled that "the viatical settlements sold by Life Partners are investment contracts, as a matter of law, under the Texas Securit[ies] Act and meet the definition of 'security.'" (Arnold v. Life Partners, Texas Court of Appeals, Fifth District at Dallas, No. 05-12-92-CV.)

On November 19, 2013, as discussed in my blog post No. 22, Senior U.S. District Judge James R. Nowlin issued an order denying LPHI's motion for partial summary judgment in the civil lawsuit the Securities and Exchange Commission (SEC) had filed against LPHI. Judge Nowlin ruled, among other points, that LPHI's life settlements are securities. (SEC v. LPHI, U.S. District Court, Western District of Texas, No. 1:12-cv-33.)

The Alexander Statement
Douglas W. Alexander is one of the attorneys who represented LPHI in the Texas appellate court case decided last week. According to the website of the Texas firm of Alexander DuBose Jefferson & Townsend LLP, Mr. Alexander "is widely regarded as one of the premier advocates specializing in practice before the Supreme Court of Texas."

An article by Mark Maremont in the February 6 online edition of The Wall Street Journal referred to a statement by Mr. Alexander. In response to my request, Mr. Alexander sent me this statement:
We are disappointed by the court of appeals' decision and we intend to timely pursue appellate review to the Texas Supreme Court. Two appellate courts have ruled that LPI's life settlements are not securities, and we continue to believe that those are the better reasoned decisions. [LPI is Life Partners, Inc.]
I asked Mr. Alexander what appellate decisions he had in mind. He said one was the 1996 ruling by the federal District of Columbia Circuit in SEC v. Life Partners. I first wrote about that ruling—a 2 to 1 decision where the dissenter wrote a lengthy opinion—in the March 1999 issue of The Insurance Forum. I also wrote about it in my blog post No. 22, where I mentioned Judge Nowlin's recent rejection of it.

The other decision to which Mr. Alexander referred was a 2004 ruling that he said "follows the D.C. Circuit's [1996] decision but also cites some Texas authorities." I checked on the 2004 ruling and found it was a 2 to 1 ruling in which the dissenter said: "I would find that the viatical settlement contracts and notes are securities under the Searsy-Howey four-pronged test and the Reves test." (Griffitts v. Life Partners, Texas Court of Appeals, Tenth District at Waco, No. 10-01-00271-CV).

I appreciate Mr. Alexander's prompt responses to my requests. Over the years, LPHI's officers and attorneys have ignored or brushed off my requests for information.

General Observations
The appellate ruling last week is the third recent ruling that LPHI's life settlements are securities. LPHI has said in public filings with the SEC that, if such a view should ever be finalized, "it would result in a material adverse effect on our operations and require substantial changes in our business model."

By the close of business on Monday, February 10, LPHI had not filed an 8-K (material event) report with the SEC about the February 6 ruling. On February 10, LPHI's shares closed at $2.45, down from Friday's $2.61 close on higher than average volume.

Because of the importance of the latest ruling, I am making it available as a four-page complimentary PDF. Send an e-mail to and ask for the February 6 opinion relating to Life Partners.


Monday, February 10, 2014

No. 29: A Federal Jury Finds Life Partners Holdings, Pardo, and Peden Guilty of Some and Not Guilty of Other Civil Securities Violations

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). On January 3, 2012, the Securities and Exchange Commission (SEC) filed a civil complaint in federal court alleging violations of federal securities laws. The defendants were LPHI and three top officers: Brian D. Pardo, chairman and chief executive officer; R. Scott Peden, general counsel; and David M. Martin, chief financial officer. On February 8, 2013, the SEC filed an amended complaint against the same defendants. On January 8, 2014, the SEC permanently dismissed the charges against Martin. On February 3, 2014, the jury found the remaining three defendants guilty of some and not guilty of other civil violations of federal securities laws and regulations.

Location of the Case
Initially the case was filed in the Waco Division of the Western District of Texas and assigned to U.S. District Judge Walter S. Smith, Jr., the only district judge in Waco. On January 11, 2012, Judge Smith recused himself because Pardo "has been a close personal friend of the undersigned for several years," and transferred the case to Senior U.S. District Judge James R. Nowlin in the Austin Division. (SEC v. LPHI, U.S. District Court, Western District of Texas, Case No. 1:12-cv-33.)

Trial and Verdict
On January 27, 2014, the four-day trial began. The SEC's witnesses were Akita Adkins, Kurt Carr (vice president of Life Partners and son-in-law of Pardo), Mark Embry (chief operations officer of Life Partners), Peden, Pardo, Nina Piper, Dr. Donald Cassidy (Reno physician and former provider of life expectancy estimates to Life Partners), Larry Rubin, and James Sundelius. The defendants' witnesses were LaDonna Johnson, Peden, Tim Harper, Harold E. Rafuse (member of LPHI board), and Tad M. Ballantyne (member of LPHI board).

On January 30, Judge Nowlin charged the jury with detailed instructions concerning the alleged violations of the Securities Exchange Act of 1934 and the Securities Act of 1933. The jury then deliberated for two days. On February 3, the jury made its findings by responding to 12 questions on the verdict form:

  1. Section 10(b) and Rule 10b-5 (securities fraud): LPHI, Pardo, and Peden not guilty. 
  2. Aiding and Abetting Violations of Section 10(b) and Rule 10b-5: Not answered because of not guilty finding on (1).
  3. Section 10(b) and Rule 10b-5 (insider trading): Pardo and Peden not guilty.
  4. Section 17(a) (securities fraud): LPHI, Pardo, and Peden guilty.
  5. Section 13(a) and Rules 12b-20, 13a-1, and 13a-13 (public filing violations): LPHI guilty.
  6. Aiding and Abetting Violations of Section 13(a) and Rules 12b-20, 13a-1, and 13a-13: Pardo and Peden guilty.
  7. Sections 13(b)(2)(A) and 13(b)(2)(B) (falsification of books and records): LPHI not guilty.
  8. Aiding and Abetting Violations of 13(b)(2)(A) and 13(b)(2)(B): Not answered because of not guilty finding on (7).
  9. Section 13(b)(5) and Rule 13b2-1 (falsification of books and records): Pardo and Peden not guilty.
  10. Rule 13b2-1 (falsification of books and records): Pardo and Peden not guilty.
  11. Rule 13b2-2 (misleading auditors): Pardo and Peden not guilty.
  12. Rule 13a-14 (false certifications): Pardo guilty. 

SEC Statement
On February 4, Andrew Ceresney, director of the SEC's division of enforcement, issued a statement on the verdict. He said:
We're very pleased the jury found Life Partners and its executives liable for knowingly or recklessly defrauding shareholders and filing false SEC filings. We're also pleased the jury found Pardo, Life Partners' CEO, responsible for falsely certifying that the company's public filings were accurate when they were not.
LPHI 8-K and Press Release
On February 4, LPHI filed an 8-K (material event) report with the SEC. The two-sentence text said nothing about the results of the trial. Instead, the 8-K merely referred to LPHI's press release, which was attached as an exhibit.

The press release was entitled "Life Partners Prevails in SEC Lawsuit." The body of the press release consisted of five paragraphs. The lead paragraph said "a federal jury has found that Life Partners did not commit fraud and its officers did not engage in insider trading." The fourth paragraph said the "jury did find for the SEC regarding its claim that Life Partners had misstated its revenue recognition policy." The fifth paragraph quoted Pardo as saying:
We are extremely pleased that the jury has exonerated our company, our business practices and the life settlement asset class itself. As we demonstrated to the jury, life settlements as transacted through Life Partners provide a valuable service to senior Americans who want to sell their unwanted life insurance policies and are a tremendous alternative asset class for accredited investors seeking to avoid the volatility of the stock market. We provide a win-win transaction for everyone involved and, when put to the test, the jury could see the SEC's allegations were not true.
Article in The Wall Street Journal
On February 5, The Wall Street Journal carried a 15-paragraph, 536-word article entitled "Mixed Verdict in Case Against Life Partners," by Mark Maremont. The lead paragraph said:
Both sides declared victory after jurors delivered a mixed verdict on a civil lawsuit brought by the Securities and Exchange Commission against Life Partners Holdings Inc., a Texas seller of life insurance investments.
The article quoted Thomas A. Gorman, a securities attorney at Dorsey & Whitney LLP in Washington, who was not involved in the case, as saying: "When you look at the crux of this case, the SEC took another loss." It also quoted Jay Ethington, an attorney for Pardo, as saying that the jurors "in effect endorsed the business model of Life Partners," and that the verdicts against his client were for "inadvertent technical violations." The article also quoted Mr. Ceresney of the SEC as saying: "We're proud of our record of success at trial and will continue to bring aggressive cases to protect investors and hold wrongdoers accountable."

An earlier online version of the article quoted Elizabeth Yingling, an attorney for LPHI, as saying: "It was a definite win for our client." It also quoted S. Cass Weiland, an attorney for Peden, as saying the verdict was a "resounding win for the company and the individuals." It also quoted a government attorney as saying that "we won on most of the claims," and that the civil fraud revenue recognition claim on which the jury found in the SEC's favor was a "lead claim" in the case.

Stock Prices
The prices of LPHI shares reflect many problems faced by the firm in recent years. From $16.63 per share on January 4, 2010, the price declined to $3.43 by June 30, 2011. The plunge was caused by a combination of critical articles in The Wall Street Journal, class action lawsuits against the company, resignation of the company's independent auditor, decertification of an earlier financial report by the company's previous independent auditor, lengthy delays in filing the company's financial reports with the SEC, the possibility of the delisting of the company's shares by NASDAQ, an investigation by the Texas securities commissioner, and the threat of civil action by the SEC. The price recovered somewhat when the company hired a new independent auditor, filed its overdue financial reports, and avoided the delisting of its shares by NASDAQ.

Just before the SEC filed its complaint in January 2012, the price of LPHI shares was $6.37. In the first week after the complaint, the price declined to $4.00 and continued to drift downward. The closing price on December 31, 2013, was $1.78. Recently the price rose slowly to $2.56 on February 3, 2014. The next day, when the jury verdict was announced, the price rose to $2.98 in the heaviest trading of the year. By February 7, the price was back down to $2.61.

General Observations
The trial transcript will become freely available to the public on April 30, 2014. I hope to review it and try to improve my understanding of what happened at the trial.

It remains to be seen what motions will now be submitted by the parties, and what appeals will be filed. Meanwhile, it seems that LPHI has won the public relations battle through the widespread circulation of its cleverly and falsely titled press release.


Thursday, February 6, 2014

No. 28: Phoenix's Denial of a Suspicious Death Claim

PHL Variable Insurance Company and Phoenix Life Insurance Company are operating units of Phoenix Companies, Inc. (NYSE:PNX). In 2005, PHL issued a $1 million policy (No. 40048215) on the life of Ebrahim Alrwazek, who resided in Oakdale, Minnesota. The beneficiary is his spouse, Mounia Zerrhouni. The annual premium payable on November 26, 2011 was not paid. The insured reportedly died on October 12, 2011, in a terrorist car bombing in Baghdad, Iraq.

The Claim Denial
On November 7, 2011, a person who identified himself as Mohsen Noor, the insured's attorney, informed the company by telephone from Morocco that the insured was dead. The company sent claim forms to the beneficiary, who also was in Morocco, and sent follow-up letters in December 2011 and February 2012. On March 1, 2012, the attorney told the company by telephone that the beneficiary was working on the forms. The same day, the beneficiary told the company by e-mail that she had not received the forms. On March 12, 2012, the company sent the forms again by e-mail.

By April 27, 2012, the company had received no documents. On that date, Neal Regels, the company's claims director, wrote to the beneficiary. He denied the claim because of the lack of adequate proof of the insured's death. He also said that, if the insured died while the insurance was in force, the company would pay the death benefit.

On June 25 and August 1, 2012, the company received documents purportedly showing that the insured died on October 12, 2011. However, there was conflicting information about the date of death. Also, the company's investigator provided additional conflicting information.

On January 30, 2013, Regels wrote a two-page letter to the beneficiary. He listed the documents the company had received and described the conflicting information. He again denied the claim because of the lack of adequate proof of the insured's death.

On June 28, 2013, an attorney in New York representing the beneficiary wrote to Regels requesting a complete copy of the policy, including the application and the history of premium payments. The attorney did not receive a reply at that time.

The Lawsuits
On July 7, 2013, the beneficiary filed a lawsuit against Phoenix Life in a New York State trial court. She alleged breach of contract and fraud against a consumer. (Zerrhouni v. Phoenix Life, Supreme Court of New York, New York County, Index No. 652434/2013.)

On September 9, Phoenix Life filed a motion to dismiss the lawsuit on the grounds that PHL, not Phoenix Life, issued the policy. The motion included an affidavit from Regels that "PHL does not maintain in its records a copy of the actual Policy issued," and "a specimen of the Policy form" was attached to the affidavit. Also attached were incorporation papers showing that PHL and Phoenix Life are separate companies, and that the beneficiary therefore had sued the wrong company.

On September 16, the beneficiary filed a second state court lawsuit. This time PHL was the defendant. (Zerrhouni v. PHL, Supreme Court of New York, New York County, Index No. 653204/2013.)

On November 29, despite the fact that the wrong company had been sued, the judge in the first state court lawsuit denied Phoenix Life's motion to dismiss the complaint. The judge said in part:
Here, the four corners of the Complaint state a cause of action as against Defendant for breach of the subject Policy and consumer fraud under General Business Law, §349, and the documentary submissions submitted by Defendant do not flatly contradict the legal conclusions and factual allegations of the Complaint.
On October 9, PHL removed the second state court lawsuit to federal court on two grounds. First, the matter in controversy exceeds $75,000. Second, there is diversity of citizenship between the plaintiff and PHL; the plaintiff resides in Morocco, and PHL thinks she is not lawfully admitted for permanent residency in the U.S. (Zerrhouni v. PHL, U.S. District Court, Southern District of New York, Case No. 1:13-cv-7154.)

On November 22, in the federal court lawsuit, the parties filed a joint status report and discovery plan. The parties do not agree on the beneficiary's request that the court appoint appropriate experts to exhume the body and perform testing to determine whether the body is that of the insured. PHL says the request is premature because it is not clear at this stage of the litigation whether testing is needed. The joint discovery plan provides that the parties will complete discovery by July 2014.

On December 9, in the first state court lawsuit, Phoenix Life filed a motion for a stay. In support of the motion, Phoenix Life mentioned the second state court lawsuit, which PHL already had removed to federal court. Phoenix Life also said:
PHL's denial of the death claim is reasonable. As Zerrhouni is fully aware, PHL believes the insured is not dead and that it is the victim of a scam. PHL has evidence that this is a scam, it has presented some of that evidence to Zerrhouni, and it is developing additional evidence.
The January 30, 2013 letter from Regels to the beneficiary contains what may be the "some of that evidence" PHL presented to the beneficiary. It remains to be seen whether the public will ever see PHL's "additional evidence" that the insured is alive and that PHL is being scammed.

General Observations
The beneficiary's attorney requested a complete copy of the policy, including the application and the history of premium payments. PHL eventually provided only a specimen of the policy, saying the company did not maintain in its records a copy of the actual policy issued. It is hard to believe that the company does not maintain in its records at least the application for the policy and the record of premium payments.

I have long regarded the disappearance of an insured, combined with the problems involved in proving that an insured is in fact deceased, as a troublesome aspect of the life insurance business. For that reason, I think the suspicious death claim discussed here bears close watching.

Meanwhile, because the two-page letter of January 30, 2013 from Regels to the beneficiary contains considerable detail on the company's claims process, I am making it available as a complimentary PDF. Send an e-mail to and ask for the Regels letter.


Monday, February 3, 2014

No. 27: An Important Lawsuit Against Coventry First

Coventry First LLC (Fort Washington, PA) is an intermediary in the secondary market for life insurance. In 2010, Leonard T. Griswold (Erdenheim, PA) filed a class action lawsuit against Coventry. I think the case, which remains pending, is important.

Griswold's Policy
In January 2006, United of Omaha Life Insurance Company issued a flexible premium adjustable life policy to Griswold, who was aged 74 at the time. The applicant and owner of the policy was Griswold's irrevocable life insurance trust, which had been established in Georgia. The trustee was Wells Fargo Bank NA (Atlanta, GA). The beneficiary of the policy was Griswold's wife Jean. The death benefit of the policy was $8.4 million, and the annual premium was $737,000. The company issued the policy in the non-tobacco category, but in the 175 percent substandard class because of Griswold's cardiac condition. One agent was Kevin J. McGarrey (Exton, PA). The other agent was Mark T. Berlenbach (Sicklerville, NJ), against whom the Pennsylvania insurance department issued a related consent order in July 2010.

In March 2008, Coventry offered to buy the policy for $1,675,000, consisting of $1,530,000 for Griswold and a commission of $145,000 for McGarrey. Griswold did not learn of McGarrey's $145,000 commission until March 2010, when a Pennsylvania insurance department investigator informed him of it.

Griswold's Lawsuit
In October 2010, Griswold filed a class action lawsuit against Coventry in state court in Pennsylvania. Relying heavily on the findings of investigations of Coventry in 2006 by the New York Attorney General and the Florida Office of Insurance Regulation, Griswold alleged there was a bid-rigging scheme that resulted in his receiving substantially less than the fair market value of the policy. (I wrote about the New York and Florida investigations of Coventry in the January/February 2007, December 2007, and December 2009 issues of The Insurance Forum.)

The defendants in Griswold's lawsuit were Coventry, three affiliates of Coventry, and Reid S. Buerger, executive vice president of Coventry. Griswold alleged six counts: fraudulent viatical settlement acts and common law fraud, common law fraud, fraudulent concealment, aiding and abetting breach of fiduciary duty, conversion, and unjust enrichment. Griswold sought class certification, compensatory damages, punitive damages, disgorgement of profits, and injunctive relief. (Griswold v. Coventry, Court of Common Pleas, Montgomery County, Pennsylvania, Case No. 2010-29237-0.)

In November 2010, Coventry removed the case to federal court for three reasons: diversity, because at least one member of the class was a citizen of a state different from any defendant; the class consisted of more than 100 members; and the amount in controversy exceeded $5 million. The case was assigned to U.S. District Judge C. Darnell Jones II. (Griswold v. Coventry, U.S. District Court, Eastern District of Pennsylvania, Case No. 2:10-cv-5964.)

On December 6, 2010, in federal court, Griswold filed an amended complaint alleging the six counts in the original state court complaint and adding two others: conspiracy in restraint of trade, and RICO (Racketeer Influenced Corrupt Organizations Act). He sought the same five forms of relief sought in the original complaint.

Coventry's Motion to Dismiss
On December 23, 2010, Coventry filed a motion to dismiss the complaint or compel arbitration. Coventry argued the plaintiffs lacked standing, the arbitration clause in the purchase agreement required the plaintiffs to arbitrate claims on an individual basis rather than a class basis, the plaintiffs failed to state a RICO claim, and the plaintiffs failed to state an antitrust claim.

On June 26, 2011, Judge Jones conducted a hearing. He considered Coventry's motion to dismiss the complaint or compel arbitration, the opposition to the motion, the answer to the opposition, and the oral arguments at the hearing.

Denial of Coventry's Motion to Dismiss
On February 27, 2013, Judge Jones denied Coventry's motion to dismiss the complaint or compel arbitration. He ruled the plaintiffs have standing, denied the request to compel arbitration because the plaintiffs were not signatories to the agreement containing the arbitration clause, ruled the plaintiffs pled sufficient facts to establish a pattern of racketeering activity and more particularized information will be borne out through discovery, and ruled the plaintiffs pled sufficiently to confer standing with respect to the antitrust claims. 

Coventry's Appeal
Coventry appealed to the Third Circuit the denial of its motion to dismiss the complaint or compel arbitration. The appellate panel consists of Judges Thomas L. Ambro, Thomas M. Hardiman, and Joseph A. Greenaway Jr.

On January 14, 2014, after extensive briefing, the panel heard oral arguments. The parties discussed three matters at the hearing: the question of standing, because the trust that owned the policy before it was sold into the secondary market no longer exists; the question of whether arbitration can be applied in the case of a party that was not a signatory to the agreement providing for arbitration of disputes; and the question of individual versus class arbitration. A decision by the panel probably is months away. (Griswold v. Coventry, U.S. Court of Appeals, Third Circuit, Case No. 13-1879.)

Coventry's Producer Agreement
Recently, while reviewing Griswold's lawsuit, I saw a document I had not seen previously. It is a six-page producer agreement that Coventry uses. Section 2.3, entitled "Duties," requires the producer to "identify and submit to Coventry all Policies produced by Producer, in respect of which a Life Settlement is being sought by Seller." Section 2.4, entitled "Right of Counteroffer," reads:
If Producer receives a bona fide offer (a "Competing Offer") from any person or entity, other than Coventry, to consummate a Life Settlement with respect to any Policy submitted by Producer to Coventry pursuant to Section 2.3 above, Producer shall promptly, but in no event more than one business day after the receipt of such Competing Offer, notify Coventry in writing of all of the material terms, including price, of such Competing Offer and shall provide Coventry with such verification of the Competing Offer as Coventry shall reasonably require, and Coventry shall have a right to make a counteroffer to contract for a Life Settlement in respect of such Policy on terms that with respect to purchase price of the policy are more favorable to the seller than those set forth in the Competing Offer. If Coventry desires to exercise this right to make a counteroffer, it shall deliver written notice to such effect to Producer within three business days of Coventry's receipt of written notice of the Competing Offer and such verification of the Competing Offer as Coventry shall reasonably require.
According to public documents filed after the New York and Florida investigations, Coventry at that time used a "Right of Final Offer" clause in its producer agreement. I have not seen the wording of the "Right of Final Offer" clause. It is my understanding that the clause was changed to a "Right of Counteroffer" clause as a compromise with the regulators. I am making the current form of the producer agreement available as a complimentary PDF. Send an e-mail to and ask for Coventry's producer agreement.