The opinion of the court was delivered by: LAMBERTH
This matter is before the court on the plaintiff's motion to hold the defendants in contempt and to compel discovery. Plaintiff, the Securities and Exchange Commission ("SEC"), alleges that the defendants, Life Partners, Inc. ("LPI") and Brian D. Pardo, continue to engage in the practice of selling unregistered securities in violation of the registration and antifraud provisions of the federal securities laws. By continuing to sell the unregistered securities, the SEC alleges, the defendants have violated this court's August 30, 1995,
order and its September 18, 1995, order that required the defendants to, inter alia, bring their operations into compliance with the applicable federal securities laws. In response to the allegations, the defendants claim to have brought their operations into compliance, or, in the alternative, that they have made a good faith effort to do so. Upon consideration of the parties' most recent submissions, the court shall deny the SEC's motion to hold defendants in contempt. Although the court does not find the defendants' behavior to be contemptible at this time, the court does find that defendants have not brought their operations into compliance with the applicable securities laws. Accordingly, the court shall enjoin the defendants, pending a final judgment on the merits, from offering and selling unregistered securities in the form of investment contracts representing fractional interests in the death benefits under insurance policies written on the lives of persons with terminal illnesses.
As fully discussed in this court's August 30, 1995, opinion, defendant LPI and its president, defendant Brian D. Pardo, facilitate the sale of life insurance policies from AIDS victims to investors at a discount. These so-called "viatical settlements" provide AIDS victims with much needed income in the final years of their lives while allowing investors to collect the face amount of the policy at the insured's death. As the facilitator, LPI takes an active role in finding and evaluating policies, determining the life expectancy of the insured, as well as locating investors. Prior to this court's August opinion, the insured assigned the policy to LPI, not to individual investors. At the insured's death, the benefits were paid to LPI who then dispersed the funds to investors. Under this scheme, investors had no direct contractual rights against the insurance companies that issued the policies.
The SEC contends that LPI's sale of fractional interests in an insurance contract amounts to a sale of an investment contract subject to the federal securities laws. Following an extensive investigation of LPI, the SEC brought this action seeking a preliminary injunction that would prohibit LPI from selling any further viatical settlements until it properly registered under the securities laws. The SEC also claimed that LPI's solicitation and promotional materials contain materially false and misleading statements and omissions.
In its August 30, 1995, opinion, this court concluded that LPI's basic policy is an investment contract that is subject to federal securities laws. Accordingly, the court entered a preliminary injunction that ordered LPI to "forthwith" bring their operations into compliance with the applicable securities laws. Further, the court ordered LPI to transfer the ownership of all the life insurance policies to a neutral third party, rather than retaining the assignments of the policies. Significantly, after considering the valuable service provided to AIDS victims by LPI, the court decided against enjoining LPI from selling the investment contracts pending their compliance with securities laws. Instead, the court ordered that the SEC file a report within thirty days detailing LPI's compliance with the securities laws and the court's order. Inherent in this order was the court's understanding that the SEC and LPI would work together to both preserve the valuable service provided by LPI as well as provide the protection for investors that the SEC desired.
Dissatisfied with the defendants' progress toward complying with the court's August order, the SEC moved for supplemental preliminary relief eight days following the entry of that order. In the meantime, defendants filed their notice of appeal and asked this court for a partial stay of these proceedings pending that appeal. On September 18, 1995, the court signed the parties' stipulation that resolved the issue of transferring ownership of the policies from LPI. In that stipulation, LPI agreed to transfer ownership of the policies to the investors themselves, rather than a third party.
With respect to defendants' motion for a partial stay pending appeal, on September 29, 1995, the court issued an order denying this request. The court also amended its August order in so far as it required the SEC to file a report on the defendants' compliance efforts. The court instructed the defendants to file a compliance report with the court within twenty days. After the SEC would have a chance to respond, the court would then decide if the SEC was entitled to further injunctive relief.
Pursuant to the court's September 29 order, LPI filed its report of compliance with the court on October 19, 1995. In this report, Pardo and LPI described the changes that had already been made in its operations as well as the changes LPI was in the process of making. At the outset, the report indicated that the lack of cooperation on the part of the SEC hindered LPI's efforts to develop a compliance strategy.
LPI's compliance strategy was twofold: (1) divest themselves of ownership of the policies purchased by investors, and (2) take steps to ensure that investors understand LPI's self-proclaimed "limited role," and that investors understand that they are in a position to exercise control over the policy.
To this end, LPI no longer takes record ownership of the policies, instead placing the policies in the names of the various investors. However, at the time of filing their compliance report, LPI had not yet completed the process of divesting itself of record ownership of policies sold prior to this court's August 30 opinion. With respect to ensuring that investors are aware of the control that they can exercise over the policies, LPI drafted a disclosure statement that it would provide to all new investors regarding the investor's rights. In that draft, LPI describes the post-sale services that it makes available to investors, for example, monitoring the insured and submitting claims for benefits, as only "a convenience and accommodation to the purchasers." In other words, investors can, if they so choose, exercise more control and have access to more information.
In response to LPI's report of compliance efforts, the SEC filed this current motion to hold the defendants in contempt. The SEC requests that the court enjoin LPI from selling any further settlements until LPI registers the settlements and sells them as securities. The SEC further asks that the court impose a fine for each day that LPI continues to violate the court's orders. Finally, the SEC moves to compel LPI and Pardo to produce discovery.
A. LPI's Compliance With Securities Laws.
The threshold issue for the court is whether the defendants, through the changes in their operations detailed to the court, have brought their operations into compliance with federal securities laws.
1. Definition of a Security Under Howey.
Defendants first argue that because of changes made in their operations since the court's orders, their viatical settlements no longer meet the definition of a security under SEC v. W.J. Howey Co., 328 U.S. 293, 90 L. Ed. 1244, 66 S. Ct. 1100 (1946) [hereinafter Howey]. The Supreme Court in Howey ...