Wednesday, December 17, 2014

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 and ask for the LPHI motion for stay, or the final order in the SEC lawsuit against LPHI, or both.


Monday, December 15, 2014

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.

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 and ask for the articles about the case of Mrs. X.


Wednesday, December 10, 2014

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.)

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 and ask for the Final Judgment Order in the SEC lawsuit against LPHI.