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SEC v. LIFE PTNRS.

August 30, 1995

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
LIFE PARTNERS, INC. and BRIAN D. PARDO, Defendants.



The opinion of the court was delivered by: ROYCE C. LAMBERTH

 This matter comes before the Court on plaintiff Securities and Exchange Commission's (hereafter "the Commission" or "SEC") motion for a preliminary injunction and other provisional relief. The Commission's complaint alleges violations of the securities and broker/dealer registration requirements and the antifraud statutes. The Commission's motion was fully briefed and orally argued to the Honorable John H. Pratt, but was reassigned to the undersigned upon Judge Pratt's death. I have carefully considered the transcript of the oral argument, the briefs of counsel, and the record herein. I conclude, as a preliminary matter, that defendants sold unregistered securities and were not registered as brokers or dealers, and grant a preliminary injunction to the Commission. I also conclude that the Commission also makes a strong prima facie showing that defendants made untrue or misleading statements. Preliminary relief is therefore granted to the Commission on this issue as well.

 I. Background

 At issue is an unusual investment medium that rests within the grey area of securities law. Defendants Life Partners, Inc. ("LPI") and its president, Brian Pardo, "facilitate" the sale of life insurance policies from AIDS victims to investors at a discount. The investors then recover the face value of the policy after the policy holder's death. Meanwhile, the terminally ill sellers secure much needed income in the final years of life when employment is unlikely and medical bills are often staggering. This process is known as "viatical settlements" after the ecclesiastical term "viaticum" (the communion given to a dying person). *fn1" The Court must decide whether defendants simply act as agents for the investors or whether defendants are repackaging policies as investment contracts and promissory notes in violation of securities laws. *fn2"

 LPI is the largest viatical settlement organizer in the country, accounting for approximately one half of the total settlement volume in 1994. For acceptance into the standard LPI program, an insured *fn3" must meet the following criteria: (1) be diagnosed with "Full Blown AIDS"; (2) have a life expectancy of twenty-four months or less *fn4" as determined by LPI's "independent reviewing physician"; and (3) be certified as mentally competent. LPI also represents that a policy qualifies for purchase only if it is issued by an insurance company rated "A-" or higher by a national insurance rating service. In addition, the policy allegedly must be in good standing and be noncontestable, transferable or eligible for irrevocable transfer of beneficiary.

 LPI and Pardo attend to all aspects of finding and evaluating the policies. Typically, the policies are assigned to LPI, not to investors. After the insured's death, the benefits are also paid directly to LPI which then pays the investors. Investors have no direct contractual rights against the insurance companies that issue the policies. Whether they receive a return on their investments or even recover their principal depends upon LPI's ability to honor its contractual obligations to them. *fn5" The Commission is also concerned that ninety percent of LPI is owned by offshore corporations whose owners the SEC has been unable to identify.

 The Commission alleges that defendants are violating sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 ("Securities Act") [ 15 U.S.C. §§ 77e(a), 77e(c), 77q(a)], and sections 10(b), 15(a), and 15(c) of the Securities Exchange Act of 1934 ("Exchange Act") [ 15 U.S.C. §§ 78j(b), 78o(a), 78o(c)]. The SEC does not contend that all viatical settlements are securities, but limits its focus to three LPI offerings. The first is the standard policy of an insured with a life expectancy of twenty-four months or less. The second involves the standard policy structured as an Individual Retirement Account ("IRA") investment. *fn6" The third offering permits investors to select the policies of viators expected to live longer than two years. Because the return on this longer term investment is more speculative, LPI promises to facilitate the resale of these investments to other LPI investors. In the Commission's view, LPI is illegally creating a secondary market in these longer term policies. In addition, the Commission claims that LPI's solicitation and promotional materials contain materially false and misleading statements and omissions. Defendants vigorously deny these allegations.

 II. Analysis

 The Commission is entitled to seek provisional relief on a "proper showing" of violative conduct. 15 U.S.C. §§ 77t(b), 78u(d)(1). Unlike a private litigant, the SEC is not required to show irreparable injury or a balance of equities in its favor. Instead, it must make out a "strong prima facie case of previous violations" and show that there is "a reasonable likelihood that the wrong will be repeated." S.E.C. v. Int'l Loan Network, 770 F. Supp. 678, 688 (D.D.C. 1991).

 A. Whether viatical settlements are exempt from securities laws.

 The initial question before the Court is whether a viatical settlement is an insurance policy exempt from securities laws. § 3(a)(8) of the Securities Act, 15 U.S.C. § 77c(a)(8). This exemption is based on the long tradition of vesting regulation of the "business of insurance" in the states. See McCarran-Ferguson Act, 15 U.S.C. § 1012(b). It is not dispositive what form the assets underlying the investment are in as substance and not form is the guide. SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351, 88 L. Ed. 88, 64 S. Ct. 120 (1943). The hallmark of "insurance" is the spreading and underwriting of a policyholder's risk. SEC v. Variable Annuity Life Insurance Co., ("VALIC "), 359 U.S. 65, 73, 3 L. Ed. 2d 640, 79 S. Ct. 618 (1959). By contrast, in a securities "investment" the basic risk is borne by the purchaser of the investment not by the issuer. Associates in Adolescent Psychiatry, S.C. v. Home Life Ins. Co., 941 F.2d 561, 566-68 (7th Cir. 1991), cert. denied, 502 U.S. 1099, 112 S. Ct. 1182, 117 L. Ed. 2d 426 (1993). Securities, unlike insurance policies, do not transfer or spread risk.

 The Court has no difficulty concluding that viatical settlements do not qualify under the section 3(a) exemption. Viatical settlements do not transfer or distribute risk. The investor (buyer) does not assume any risk from the seller. The buyer does undertake an investment risk that the seller will live longer than expected, thereby reducing the buyer's return on investment. Such a risk, however, is inherent in any investment and does not serve the central purpose of insurance: to transfer risk from the insured to the insurer. This has already been done by the insurance company which issued the policy. It is equally clear that LPI and Pardo are not in the "business of insurance" so as to be covered by the McCarran-Ferguson Act. "The relationship between the insurer and insured, the type of policy which could be issued, its reliability, interpretation, and enforcement-- these were the core of the 'business of insurance'." SEC v. National Securities, Inc., 393 U.S. 453, 460, 21 L. Ed. 2d 668, 89 S. Ct. 564 (1969). LPI does not issue insurance policies or underwrite risk or undertake the normal activities of an insurance company.

 Defendants are also concerned about the effects of securities disclosure rules on the privacy of viators by requiring terminally ill sellers to comply with the securities disclosure requirements. This is a false concern. The disclosure obligations fall only on those selling or offering securities, not on those selling assets which are then repackaged by others as securities. The Commission readily agrees that a straight viatical settlement is not a security. *fn7" It is the methods employed by defendants which are challenged.

 B. LPI's standard viatical settlement as a security.

 The Court must decide whether the products offered by defendants qualify as investment contracts under section 2(1) of the Securities Act. An investment contract is a

 
contract, transaction or scheme whereby a person invests his money [1] in a common enterprise and [2] is led to expect profits [3] solely from the efforts of the promoter or a third party.

 SEC v. W.J. Howey Co., 328 U.S. 293, 298-99, 90 L. Ed. 1244, 66 S. Ct. 1100 (1946). Under recent refinements, the requirement that the profits be secured "solely" from the efforts of others has been diluted to include profits secured "predominantly" from the efforts of others. SEC v. Int'l Loan Network, Inc., 297 U.S. App. D.C. 22, 968 F.2d 1304, 1308 (D.C. Cir. 1992); SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 (9th Cir.), cert. denied, 414 U.S. 821, 38 L. Ed. 2d 53, 94 S. Ct. 117 (1973). The substance of an investment contract is a security-like interest in a "common enterprise" that is expected to generate profits through the efforts of others. Tcherepnin v. Knight, 389 U.S. 332, 336, 19 L. Ed. 2d 564, 88 S. Ct. 548 (1967); Rodriguez v. Banco Central Corp., 990 F.2d 7, 10 (1st Cir. 1993). The parties to the instant case do not contest that the buyers of viatical settlements are investing money. Therefore, the Court will concentrate on the three prongs of the Howey test.

 1. Common Enterprise.

 Courts have identified three types of commonality in a quest to bring meaning and uniformity to this prong of the Howey test. The first is "horizontal commonality" which demands that the fortunes of two or more investors be joined in a pooling of interests. Wals v. Fox Hills Development Corp., 24 F.3d 1016, 1018 (7th Cir. 1994). The fortunes of investors are tied by pooling of assets, usually combined with a pro-rata distribution of profits. Id.; Revak v. SEC Realty Corp., 18 F.3d 81, 87 (2d Cir. 1994). The second type of commonality is "broad vertical" which considers whether the fortunes of investors are tied to the efforts of the promoter. SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 479 (5th Cir. 1974). The final type of commonality is "strict vertical" which centers on whether fortunes of investors are tied to the fortunes of the promoter. Brodt v. Bache & ...


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