87 F.3d 536 (D.C. Cir. 1996), 95-5364, S.E.C. v. Life Partners, Inc.

Docket Nº:95-5364, 96-5018 and 96-5090.
Citation:87 F.3d 536
Party Name:SECURITIES AND EXCHANGE COMMISSION, Appellee, v. LIFE PARTNERS, INCORPORATED and Brian D. Pardo, Appellants.
Case Date:July 05, 1996
Court:United States Courts of Appeals, Court of Appeals for the District of Columbia Circuit
 
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Page 536

87 F.3d 536 (D.C. Cir. 1996)

SECURITIES AND EXCHANGE COMMISSION, Appellee,

v.

LIFE PARTNERS, INCORPORATED and Brian D. Pardo, Appellants.

Nos. 95-5364, 96-5018 and 96-5090.

United States Court of Appeals, District of Columbia Circuit

July 5, 1996

Page 537

[Copyrighted Material Omitted]

Argued April 4, 1996.

Thomas W. Kirby, Washington, DC, argued the cause for appellants, with whom Ida W. Draim was on the briefs.

Eric Summergrad, Assistant General Counsel, Securities & Exchange Commission, Washington, DC, argued the cause for appellee, with whom Richard H. Walker, General Counsel, Paul Gonson, Solicitor, and Ross A. Albert, Special Counsel, Washington, DC, were on the brief. Jacob H. Stillman, Associate General Counsel, Washington, DC, entered an appearance.

Before: WALD, GINSBURG and HENDERSON, Circuit Judges.

Opinion for the Court filed by Circuit Judge GINSBURG.

Dissenting Opinion filed by Circuit Judge WALD.

GINSBURG, Circuit Judge:

A viatical settlement is an investment contract pursuant to which an investor acquires an interest in the life insurance policy of a terminally ill person--typically an AIDS victim--at a discount of 20 to 40 percent, depending upon the insured's life expectancy. When the insured dies, the investor receives the benefit of the insurance. The investor's profit is the difference between the discounted purchase price paid to the insured and the death benefit collected from the insurer, less transaction costs, premiums paid, and other administrative expenses.

Life Partners, Inc., under the direction of its former president and current chairman

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[318 U.S.App.D.C. 304] Brian Pardo, arranges these transactions and performs certain post-transaction administrative services. The SEC contends that the fractional interests marketed by LPI are securities, and that LPI violated the Securities Act of 1933 and the Securities Exchange Act of 1934 by selling them without first complying with the registration and other requirements of those Acts. The district court agreed and preliminarily enjoined LPI from making further sales.

LPI argues that (1) viatical settlements are exempt from the securities laws because they are insurance contracts within the meaning of the McCarran-Ferguson Act, 15 U.S.C. § 1012(b), and § 3(a)(8) of the 1933 Act, 15 U.S.C. § 77c(a)(8), and (2) the fractional interests sold by LPI are not in any event securities within the meaning of the 1933 and 1934 Acts. LPI asserts alternatively that it could modify its program so as to come within a safe harbor exemption for private offerings under SEC Rule 506, 17 C.F.R. § 230.506.

We agree with the district court that viatical settlements are not exempt from the securities laws as insurance contracts. Contrary to the district court, however, we conclude that LPI's contracts are not securities subject to the federal securities laws because the profits from their purchase do not derive predominantly from the efforts of a party or parties other than the investors; therefore, we do not reach LPI's alternative argument that it might be able to alter its operation in such a way as to be entitled to a private offering exemption.

I. Background

LPI appeals four orders of the district court. First, in August 1995 the court held that LPI violated §§ 5(a) and (c) of the Securities Act, 15 U.S.C. § 77e(a) and (c), and § 15(a) of the Securities Exchange Act, 15 U.S.C. § 78o(a), by selling unregistered securities. The court ordered LPI to bring its operations into compliance with the Acts "forthwith," but did not enjoin the company from continuing to sell viatical contracts. In the same order the court found that the SEC made out a prima facie case that LPI had materially misstated and omitted certain facts in selling securities, in violation of the anti-fraud provisions of § 10(b) of the 1934 Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and preliminarily enjoined LPI from committing securities fraud.

Second, the following month the court denied LPI's motion for a partial stay of the August order pending appeal. The district judge directed LPI to file within 20 days a report detailing the steps the company had undertaken to comply with the securities laws.

Third, in January 1996 the district court, holding that LPI had not adequately complied with its prior directives, preliminarily enjoined LPI from offering or selling unregistered fractional interests in viatical settlements. With the court's approval, the parties stipulated that the injunction would be stayed with respect to transactions then in process, and that LPI would not seek any broader stay pending our resolution of this matter.

Finally, in March 1996 the district court granted an Emergency Motion for Supplemental Provisional Relief that the SEC filed in reaction to an affidavit in which Pardo asserted that LPI had complied with the court's prior rulings and advised the court that LPI planned to resume the sale of viatical settlements. LPI interpreted a statement in the court's opinion of January 1996, to the effect that "pre-purchase activities cannot alone" subject LPI to the Securities Acts, to mean that by discontinuing its performance of post-purchase services, the company could resume its sales without violating the injunction. The district court, however, concluded that LPI's "technical changes have done little to alter the substance of the services provided to investors," and preliminarily enjoined LPI from selling fractional interests in viatical settlements "by any ... means whatsoever," pending this court's decision on appeal.

At the same time that it was issuing these three preliminary injunctions against LPI, the district court acknowledged that the company provides "valuable funds [to] AIDS patients in their final illness" and that after "an

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[318 U.S.App.D.C. 305] apparently exhaustive two-year investigation" the SEC could produce no evidence or even allegations "that any investor, terminally ill patient, or insurance company has been defrauded, misled, or is in any way dissatisfied with an LPI viatical settlement." The Commission, however, points out that the securities laws, and in particular the disclosure requirements of the 1933 and 1934 Acts, are intended to prevent abuses before they arise. Still, that neither policyholders nor investors have complained of any abuse may help to explain why the viatical settlements industry is not more regulated. A number of states have enacted laws protecting the insureds but, according to the SEC, no state has undertaken specifically to protect investors in viatical settlements. (In all states investors are still protected by the common law of fraud, of course.)

Although some promoters of viatical settlements do register them as securities under the federal securities laws, LPI observes that registration means higher costs for investors and correspondingly lower prices for terminally ill policyholders, and objects that any significant administrative delay--even if the Commission were, for example, to permit the offeror to use one master registration and to make only a supplemental filing pertaining to each policy in which it proposes to sell fractional interests--might be fatal in this time-sensitive context. The Commission concedes that some policy-by-policy disclosure of risk factors would be required but ventures that the burden would not be prohibitive. The Commission also notes that some firms have sought and obtained an exemption from the federal securities laws for their viatical contracts; presumably a firm might also buy insurance policies for its own account or act as an agent, matching a single investor with a terminally ill insured, without running afoul of the securities laws.

That is not how LPI does business, however. LPI sells fractional interests in insurance policies to retail investors, who may pay as little as $650 and buy as little as 3% of the benefits of a policy. In order to reach its customers, LPI uses some 500 commissioned "licensees," mostly independent financial planners. For its efforts, LPI's net compensation is roughly 10% of the purchase price after payment of referral and other fees. Pardo claims that LPI is by far the largest of about 60 firms serving the rapidly growing market for viatical settlements; in 1994 the company accounted for more than half of the industry's estimated annual revenues of $300 million. The company is 95% beneficially owned by Pardo through a trust, and 5% owned by Dr. Jack Kelly, who performs medical evaluations of policyholders on LPI's behalf.

LPI was also the first company to develop a plan by which an investor could participate in a viatical settlement through an Individual Retirement Account. In order to circumvent the Internal Revenue Code prohibition upon IRAs investing in life insurance contracts, LPI structures the purchase through a separate trust established for that purpose. The IRA lends money to the trust, for which it receives a non-recourse note; the trust then uses the loan proceeds to purchase an interest in a life insurance policy, the death benefits of which collateralize the note. When the insured dies and the benefits are paid, the proceeds go to pay off the note held by the IRA.

Both LPI's program for individual investors and its IRA program have gone through three iterations during the course of this litigation. In each, LPI performed or performs a number of pre-purchase functions: Specifically, even before assembling the investors, LPI evaluates the insured's medical condition, reviews his insurance policy, negotiates the purchase price, and prepares the legal documents. The difference among the three versions is that LPI performs ever fewer (and ultimately no) post-purchase functions.

In Version I, the program that was the subject of the district court's August 1995 order, LPI or Pardo could appear,...

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