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.