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From Securities Regulation Daily, December 3, 2014

Life-settlement firm to pay millions for fraudulent disclosure and accounting scheme

By Amy Leisinger, J.D.

The Western District of Texas has imposed sanctions in an SEC action against Life Partners Holdings, Inc. and certain of its executives for their involvement in a fraudulent disclosure and accounting scheme involving life settlements and related insider trading transactions. In the action, a jury found that the defendants committed fraud in materially underestimating the life expectancy estimates it used to price transactions and disclosure and accounting violations in overvaluing the company’s assets to create the appearance of regular earnings. The court permanently enjoined the executives from future violations and ordered Life Partners’ President and CEO Brian D. Pardo and General Counsel R. Scott Peden to pay civil penalties of over $6.1 million and $2 million, respectively. The court also ordered Life Partners to pay disgorgement in the amount of $15 million and a civil monetary penalty of over $23 million (SEC v. Life Partners Holdings, Inc., December 2, 2014, Nowlin, J.)

In a 2012 press release, then-SEC Enforcement Director Robert Khuzami said: “Life Partners duped its shareholders by employing an unqualified medical doctor to assign baseless life expectancy estimates to the underlying insurance policies. This deception misled shareholders into thinking that the company's revenue model was sustainable when in fact it was illusory.”

In a statement applauding the court’s determination of sanctions against the defendants, Enforcement Director Andrew Ceresney said: “In ordering this significant monetary relief, the [c]ourt recognized the egregious nature of their misconduct.”

Background. Life Partners is a publicly traded company engaged in brokering life-settlement transactions in which life insurance policy owners sell their policies to investors for lump-sums that take into account the insureds’ life expectancies. A purchaser of a policy assumes responsibility for paying premiums on it until maturity (the death of the insured), and Life Partners captures as revenue the difference between the purchase and sale prices. In a life-settlement transaction, if the insured outlives the life-expectancy estimate included in the transaction, an investor must continue to pay the premiums after the escrowed funds included in the sale price are depleted; otherwise, the policy would lapse, and the entire investment would be lost. Beginning in 1999, Life Partners used life-expectancy estimates provided by

Dr. Donald Cassidy, who had no actuarial training or prior experience in developing these estimates. According to the SEC, the doctor deviated from standard practices in the life-settlement industry in making his calculations, and his methodology resulted in short life-expectancy estimates.

In its complaint, the SEC alleged Pardo and Peden, together with Life Partners’ CFO David Martin, failed to conduct due diligence on Cassidy’s qualification to act as a life-expectancy underwriter and failed to disclose (and, in some cases, concealed) that the company was “systematically and materially” underestimating the life expectancy estimates it used to price transactions to inflate its revenues and that this practice constituted a material risk to the company’s profit margins. Further, according to the Commission, Life Partners and the executives overvalued Life Partners’ assets held on the company’s books to create the appearance of a steady earnings stream and materially misstated net income from 2007 through 2011 by prematurely and improperly recognizing revenues and understating impairment expenses associated with the life-expectancy estimates. The SEC also charged that Pardo and Peden profited from the fraud by trading on inside information in Life Partners stock while in possession of this material, nonpublic information.

A jury found that, by this conduct, Life Partners and the individual defendants violated the antifraud provisions of the federal securities laws and various reporting, books and records, and internal controls provisions under the Exchange Act.

Sanctions. The court found that the individual defendants’ conduct warranted permanent injunctions against future violations, given the egregiousness of the offenses and the ongoing risk that they would continue to violate the securities laws. “[T]he evidence suggests that [d]efendants resisted any change of course,” the court noted. Settling on an order of $15 million in disgorgement, the court limited the SEC’s disgorgement request, finding that a disgorgement figure must be “sufficiently large to deter future violators but not so large that the [c]ourt overcompensates investors.”  

As to civil penalties, the court noted that the defendants committed serious, reckless violations of the federal securities laws, ignored numerous red flags, and created a risk of substantial losses in for its investors. As such, the court ordered Life Partners to pay a civil penalty of $23.7 million and ordered Peden to pay a penalty of $2 million. Given Pardo’s controlling stake in Life Partners and his power to make its strategic decisions, the court imposed a move severe civil penalty of $6,161,843. The court  declined the SEC’s request to require reimbursement to the company of stock sales profits and bonuses received under Sarbanes-Oxley Act Sec.304.

The case is No. 1-12-CV-33-JRN.

Companies: Life Partners Holdings, Inc.

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