© 2014 The Texas Lawbook.
By Janet Elliott – AUSTIN (Jan. 12)– The issue of whether life settlements should be regulated as securities will be considered by the Supreme Court of Texas Thursday in a pair of high-profile cases being watched by regulators nationwide.
The court will hear arguments in two cases involving Life Partners Inc., a Waco company that pioneered the secondary market for life insurance in 1991. The company buys life insurance policies from the elderly or terminally ill and markets the policies to investors.
Securities regulators are closely watching the case. They say that investors need protection from widespread abuses in the life settlement industry.
With conflicting opinions in state appeals courts about the nature of life settlements, the Texas Supreme Court’s ruling could take on added importance, according to North American Securities Administrators Inc., a nonprofit association of state and provincial securities regulators in the United States, Canada and Mexico.
“Allowing [Life Partners] to evade the securities laws in Texas would weaken investor protection nationwide, as a holding adverse to the investors here poses the threat of being used as persuasive authority by courts in other jurisdictions,” the association said in an amicus brief filed last month.
Life Partners has a legal team that includes former Texas Supreme Court Chief Justice Wallace Jefferson and former Justice Harriet O’Neill. The company argues that since the Tenth Court of Appeals in Waco ruled in its favor 10 years ago, the Texas Legislature has declined to specify that life settlements should be regulated under the Texas Securities Act.
Cases Consolidated for Oral Argument
One of the cases began in 2011 when Michael and Janet Arnold sued Life Partners for allegedly engaging in a scheme to sell unregistered securities in violation of Texas law.
After a Dallas County district judge dismissed the case, the Arnolds won a favorable ruling in 2013 from the Fifth Court of Appeals. The Dallas appeals court held that the life settlements sold by Life Partners are investment contracts that meet the definition of securities.
Writing for the Dallas appeals court, Justice Michael O’Neill said the Waco appeals court was wrong in 2004 in the way it applied the “Howey test,” a reference to a 1946 U.S. Supreme Court case that established a four-prong test to determine whether a financial instrument is an investment contract.
The elements of the Howey test are: investment of money, common enterprise, expectation of profit and derived solely through the efforts of others. The main dispute in the Life Partners case is whether profits were derived from the entrepreneurial or managerial efforts of others.
Life Partners, in court filings, says that it evaluated policyholders’ life expectancies and negotiated a purchase price. Once investors purchased their financial interests, Life Partners says it did nothing to increase the policies’ value.
“But to constitute an ‘investment contract’ under the securities laws, the seller must offer or agree to commit significant managerial or entrepreneurial efforts toward adding to that value,” the company says. “And that is the element wholly missing here.”
If the Texas Supreme Court rules that its products are securities, Life Partners asks the court to apply that decision to prospective cases only, saying that it had relied on the Waco appeals court ruling.
In a brief filed for the Arnolds and other investors by Robert T. Cain, Jr. of Lufkin’s Alderman & Cain, the investors say that Life Partners controls every aspect of the life settlement transaction and any profits or losses are due to the company’s efforts.
“LPI’s life settlements are a prime example of the kind of investment scheme that securities laws were designed to regulate: LPI leads investors to invest their money in fractionalized interests in life insurance policies with an expectation of earning a profit solely through LPI’s efforts in selecting, assessing, and managing those policies,” the brief states.
AG’s Case
The second case stems from a claim by the Texas State Securities Board that alleges Life Partners was perpetrating securities fraud by using longer life expectancies when purchasing the policies and shorter life expectancies when marketing and selling the investments. A shorter life expectancy makes a policy more valuable because it has a higher present value.
A brief filed by the Texas attorney general says that Life Partners’ expertise in choosing and valuing the life settlements constitutes the essential entrepreneurial effort on which the profitability of the investment depends and that Life Partners also exercises control over premium payments after it purchases the policies.
A district judge in Travis County dismissed the state’s claims and the Third Court of Appeals reversed last year, relying on the Dallas appeals court ruling in the Arnolds’ case.
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