© 2015 The Texas Lawbook.
By Janet Elliott
AUSTIN (Jan. 23) – Companies such as Life Partners that sell investments in the secondary life insurance market should be required to provide more information to potential investors, lawyers for the state of Texas and a group of investors told the Texas Supreme Court last week.
Information on how accurately companies calculate policyholders’ life expectancy would be available if the court determines that life settlements are subject to securities regulation, the attorneys said. A lawyer for the industry said investors have sufficient protection under existing laws if a life settlement product is marketed fraudulently.
The Jan. 15 arguments were delivered in two cases consolidated for oral argument. Both cases involve Life Partners Inc., a Waco company that buys life insurance policies from elderly and terminally ill policyholders and markets fractional interests in the policies as investments.
One case involves a group of investors who sued Life Partners in 2011 for allegedly engaging in a scheme to sell unregistered securities in violation of Texas law. The second case stems from a claim by the State Securities Board alleging the company was perpetrating securities fraud by using longer life expectancies when purchasing the policies and shorter life expectancies when marketing them to investors.
Life Partners on Jan. 21 filed for bankruptcy protection in Fort Worth while it appeals a $46 million federal court judgment against the company and two executive officers accused by the Securities and Exchange Commission of filing misleading financial statements.
At the Texas Supreme Court, the issue is one of first impression and is expected to resolve a split in the lower appeals courts on the issue of whether life settlements should be regulated as securities.
The Howey Test
Many of the court’s questions focused on the timing of Life Partners’ activities and how those activities could affect the value of the policies. Justices also wanted to know whether the company’s activities after the policies are sold to investors is purely ministerial or more managerial.
The issue of what the company does to chose and value a life settlement could go to the question of whether life settlements should be considered investment contracts under the “Howey test,” a 1946 U.S. Supreme Court case. The four elements of the Howey test are (1) the investment of money through (2) a common enterprise that (3) provides an expectation of profits that (4) is derived solely through the efforts of others.
Justice Jeff Boyd noted that the activities of Life Partners in determining which policies to buy would seem to meet the Howey test.
Douglas Alexander, who represents the company, said Life Partners does exercise substantial effort in looking at a policyholder’s life expectancy and deciding whether to buy the policy. But he said those activities occur before the policies are sold to investors. Post-sale, he said, the company does nothing to increase the value of the policies and serves merely as a caretaker to pay premiums and monitor the health of the insured.
“That is not enough. That is not an enterprise,” Alexander said.
Robert T. Cain, Jr., who represents investors Michael and Janet Arnold, said the main issue in determining whether a policy will be a good investment is the initial life expectancy determination. But the Lufkin attorney said Life Partners also must make decisions about continuing to pay premiums if an insured lives longer than expected.
Assistant Texas Solicitor General Kristofer Monson said Life Partners should be regulated to improve transparency on issues such as its record of accurately estimating life expectancy.
“That’s definitely going to help people make better decisions about whether to invest in these vehicles,” Monson said.
The purpose of Howey’s “efforts of others” test is to protect investors who have neither information nor control and Life Partners’ investors meet that test, Monson said.
Insurance Code Provisions
Chief Justice Nathan Hecht asked Cain about provisions in the Texas Insurance Code that regulate transactions between policyholders and companies that buy the policies. “If that part is now so thoroughly regulated by the state, why should it be subject to securities regulations?” Hecht asked.
“That statute is addressed to protect the insured,” said Cain. “It does not address issues in our case of how profits are calculated and how life expectancy is calculated.”
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