Monday, March 10, 2014

No. 35: Life Partners Holdings and Selective Disclosure

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 post No. 22 entitled "A Devastating Setback for Life Partners," I mentioned LPHI's practice of disclosing good news immediately and delaying disclosure of bad news. I decided on this follow-up after LPHI failed to disclose promptly a recent Texas appellate court decision that may have a material adverse effect on the company.

Regulation FD
Regulation FD (Fair Disclosure) promulgated by the Securities and Exchange Commission (SEC) has been in effect since October 23, 2000. The SEC said the regulation addressed the issue of "selective disclosure of material information by issuers," which "bears a close resemblance ... to ordinary 'tipping' and insider trading." The SEC also intended to address "the potential for corporate management to treat material information as a commodity to be used to gain or maintain favor with particular analysts or investors."

8-K Reports
Among the documents public companies file with the SEC and thereby make publicly available are 10-K annual reports, 10-Q quarterly reports, and 8-K reports. I call an 8-K a "material event report," and the SEC calls it a "current report on Form 8-K." The SEC says the 8-K "provides investors with current information to enable them to make informed decisions."

Numerous categories of information are disclosed in an 8-K. Here are three examples: Item 1.01 is "entry into a material definitive agreement," Item 2.02 is "results of operations and financial condition," and Item 5.07 is "submission of matters to a vote of security holders."

The 8-K category on which I focus here is Item 8.01, which is "other events." The SEC says: "This is the place where companies may report anything that they believe is important but is not specifically required elsewhere in the 8-K."

LPHI's Recent 8-K Reports
Consider LPHI's ten most recent 8-K reports. The following seven of them contain an Item 8.01 disclosure, with the date of the event and the date LPHI filed the 8-K shown in parentheses:
  1. The denial of class certification in a consolidated class action lawsuit against LPHI (7/9/13; 7/10/13)
  2. LPHI's announcement of the declaration of a quarterly dividend to shareholders (9/6/13; 9/12/13)
  3. A Texas state appellate court reversal of a lower court decision that had been favorable to LPHI (8/28/13; 9/16/13)
  4. The plaintiffs' withdrawal of the class action lawsuit referred to in (1) above (12/2/13; 12/4/13)
  5. LPHI's announcement of the declaration of a quarterly dividend to shareholders (12/17/13; 12/17/13)
  6. LPHI's announcement of a verdict following the jury trial in the SEC's lawsuit against LPHI (2/3/14; 2/4/14)
  7. LPHI's announcement of the declaration of a quarterly dividend to shareholders (3/4/14; 3/5/14).
Events 1, 2, 4, 5, and 7 above were good news for LPHI and the 8-K reports were filed within four business days after the event. Under SEC rules, an 8-K generally is supposed to be filed within four business days.

Event 3 was bad news for LPHI. A three-judge panel of a Texas state appellate court ruled unanimously that LPHI's life settlements are securities under Texas law. The court handed down the decision on Wednesday, August 28, 2013. LPHI filed the 8-K on Monday, September 16, the 12th business day after the event. In the 8-K, LPHI said it strongly disagreed with the decision and will appeal. In recognition of the materiality of the decision, LPHI 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.
Event 6 related to a federal jury verdict in the recent case of SEC v. LPHI. As I discussed in post No. 29, LPHI and its top two officers were found guilty of some and not guilty of other civil securities violations. The verdict was clearly a material event. LPHI promptly filed an 8-K, but the two-sentence text of the 8-K did not describe the verdict. Instead, the text said LPHI had issued a press release, had attached the press release to the 8-K as an exhibit, and had posted the press release on LPHI's website. However, LPHI cleverly and falsely titled the press release "Life Partners Prevails in SEC Lawsuit." In the press release, LPHI featured the "not guilty" elements of the verdict in the first few paragraphs, and briefly mentioned the "guilty" elements later in the press release. Also, LPHI prominently displayed the title of the press release at the top of the home page of the company's website with a link to the press release.

Another Adverse Court Decision
On Thursday, February 6, 2014, as I discussed in post No. 30, a three-judge panel of another Texas appellate court unanimously reversed a state district court judgment that had been favorable to LPHI. This was another ruling that LPHI's life settlements are securities under Texas law. An LPHI attorney told a reporter for The Wall Street Journal and me that LPHI plans to petition the Texas Supreme Court to review the decision.

As of the close of business on Friday, March 7, the 20th business day after February 6, LPHI had not filed an 8-K disclosing the decision. I believe that LPHI decided not to file an 8-K about the decision, and instead to mention it deep in LPHI's next major report, in the "Legal Proceedings" section of the report. LPHI's next major report will be the 10-K for the fiscal year ended February 28, 2014. LPHI filed its 10-K last year on May 29, 2013.

General Observations
In my opinion, LPHI's practice of disclosing good news immediately and delaying disclosure of bad news is precisely the type of selective disclosure about which the SEC has expressed concern. Whether LPHI will be called to account for its practice of selective disclosure remains to be seen.