Wednesday, May 13, 2015

Life Settlement Agreements Meet Howey Securities Test in Texas

By Jay Fishman, J.D.

The Texas Supreme Court affirmed the Texas Court of Appeals’ decision in two consolidated cases filed against a seller of life settlement agreements, finding that the agreements met the 1946 U.S. v. Howey “investment contract” definition to deem them “securities” under the Texas Securities Act (TSA). The court applied the decision retroactively to the company’s previous cases, and remanded the consolidated case to the trial court for the relief defendants to present their arguments (Life Partners, Inc. v. Arnold, May 8, 2015, Boyd, J.).

Facts. Life Partners, Inc. bought an insured person’s life insurance policy (life settlement) and then sold the life settlement interests to purchasers. Life Partners’ pamphlet asserted that “the returns on life settlements, unlike stocks, mutual funds and other investments are unaffected by market fluctuations, business cycles, the economy or global unrest.”

The plaintiffs, in the first case, filed a class action seeking rescission and damages for claims that Life Partners and certain others violated the TSA by selling unregistered securities and materially misrepresenting to purchasers that the life settlements were not, in fact, securities. In the second case, the State of Texas sought an injunction and other relief for allegations Life Partners committed fraud when selling securities. The district courts in both cases ruled in favor of Life Partners, holding that it did not promote or market “securities” and could, therefore, not be liable under the TSA. The appellate court in each district, however, reversed on finding that the life settlements were indeed “securities” under the TSA.

Life Partners’ contention. Life Partners acknowledged that the life settlement agreements fell in line with Howey by being transactions through which purchasers paid money to participate in a common enterprise with the expectation of receiving profits. Life Partners contended, however, that the failure or success of the enterprise, and thus the purchaser’s realization of the expected profits, did not depend on the entrepreneurial or managerial efforts of Life Partners or others. Life Partners also contended that its post-transaction efforts were merely ministerial rather than entrepreneurial or managerial.

Broad definition of securities under TSA. The Texas Supreme Court reviewed the entire history of Howey’s interpretation by U.S. and Texas courts to declare that: (1) The TSA’s definition of “securities” must be construed broadly to protect investors as well as focus on a transaction’s economic realities (regardless of any labels or termination the parties might have used); (2) an “investment contract” under the TSA means a contract through which a person pays money to participate in a common venture with the expectation of receiving a profit, under circumstances where the failure or success of the enterprise, and thus the person’s realization of the expected profits, is at least predominantly due to the entrepreneurial or managerial, rather than merely ministerial or clerical, efforts of others; and (3) the entrepreneurial or managerial efforts, whether those of the purchasers or of others, include those made before as well as after the transaction.

Life Partners’ pre- and post-transaction efforts. The court disagreed with the argument that the enterprise’s success or failure, together with the purchaser’s expected profits does not depend on Life Partners’ efforts. The court determined that Life Partners’ pre-transaction efforts as the facilitator and administrator of the life settlements through its power of attorney drove the enterprise’s success and the purchaser’s profit. The court proclaimed that Life Partners’ identifying insureds, negotiating policy discounts, evaluating policy terms and conditions, evaluating an insured’s health, buying the insured’s policy and then finding purchasers to buy an interest in it until all interests are sold, are entrepreneurial or managerial activities. And these activities, said the court, are significant because they require Life Partners to accurately evaluate the insured’s life expectancy and to set the correct purchase price (discount) to yield a profit based on the insured’s life expectancy.

The court similarly found that Life Partners’ post-transaction activities were significantly entrepreneurial or managerial rather than non-ministerial activities because Life Partners, not the purchasers, had all the control over monitoring the insureds and their health status. The purchasers, moreover, had to rely on Life Partners to obtain the death certificate, complete the required insurance forms, and give them their pro-rata benefit share after an insured dies.

The cases are Nos. 14-0122 and 14-0226.

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