In a case filed Tuesday, January 3, 2012, the US Securities and Exchange Commission charges Nasdaq-listed Life Partners Holding Inc., which is based in Texas, and three of its senior executives for their involvement in an allegedly fraudulent disclosure and accounting scheme involving life settlements. This trend-setting enforcement action, closely watched by the life settlement industry, centers on the allegation that Life Partners was systematically and materially underestimating the life expectancy (LE) estimates it used to price transactions, resulting in misleading public filings with the Commission from January 2007 through November 2011.

The SEC alleges the company and three senior executives, CEO Brian Pardo, president and general counsel Scott Peden, and chief financial officer David Martin were overvaluing assets held on the company’s books “by employing an unqualified doctor to assign baseless life expectancy estimates to underlying insurance policies.” The systemically short LE estimates were a critical factor impacting the company’s revenues and profit margins, including an understatement of millions of dollars in impairment expense. In a restatement of its financial statements in November 2011, the company also acknowledged it had materially misstated net income from fiscal year 2007 through the third quarter of fiscal year 2011 by prematurely recognizing revenues. It did this in contravention of GAAP, by improperly accelerating revenue recognition from the closing date of a life settlement transaction to the earlier date on which it obtained a non-binding agreement with the policy owner to sell a life settlement.

Allegedly, beginning in 1999, Life Partners used life expectancy estimates provided exclusively by Dr. Donald Cassidy, a Reno, Nevada-based doctor with no actuarial training or prior experience rendering life expectancy estimates. The three senior executives were charged with having had awareness that the Cassidy-rendered LE estimates were systematically and materially short. From 88 percent to 91 percent of Cassidy’s estimates in the period 2006 through 2011 were too short (that is, the estimate incorrectly predicted the policy owner would die sooner than actually occurred). As the purchase price paid by investors includes funds to cover future premium payments necessary to maintain the policy during the insured’s estimated life expectancy, the LE estimate is a critical factor in determining the purchase price of a life settlement. Defendants allegedly misrepresented this reality – the systematic and materially underestimated LEs – as simply a contingent risk in their disclosure filings.

The individual defendants failed to disclose the actual experience, in which approximately 2,900 insureds had outlived their calculated LE in 2007 and 2008, and continued to hide these facts from the company’s auditors. From at least fiscal 2009, the defendants allegedly misstated net income by failing to appropriately impair life settlements policies owned by Life Partners.
The SEC is seeking a permanent injunction against the defendants from committing or aiding and abetting further violations of the antifraud, books and records, and internal controls provisions of the federal securities laws, disgorgement from the individual defendants for alleged insider trading profits and claw backs of bonuses.

This Life Partners case, filed in US District Court for the Western District of Texas (Waco Division) is one to watch. It could establish due diligence and competency standards for life expectancy estimates, and emphasize appropriate Generally Accepted Accounting Principles for accounting for life settlements.

To read the SEC’s announcement that it had filed charges against Life Partners Holdings Inc. and three of its senior executives, please click here.

To read the SEC’s complaint filed in federal court, please click here.

For further information regarding this matters, please contact the authors, a member of Arent Fox’s White Collar, or Insurance & Reinsurance Practice Groups, or the Arent Fox attorney with whom you work.