Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-96-05090/USCOURTS-caDC-96-05090-1/pdf.json

Parties Involved:
Life Partners, Incorporated
Appellant
Brian D. Pardo
Appellant
Securities and Exchange Commission
Appellee

Document Text:

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

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Filed December 20, 1996

No. 95-5364

SECURITIES AND EXCHANGE COMMISSION,

APPELLEE

v.

LIFE PARTNERS, INCORPORATED AND

BRIAN D. PARDO,

APPELLANTS

Consolidated with

Nos. 96-5018, 96-5090

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Appeals from the United States District Court

for the District of Columbia

(No. 94cv01861)

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On Appellee's Petition for Rehearing

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Before: WALD, GINSBURG, and HENDERSON, Circuit Judges.

O R D E R

Upon consideration of appellee's petition for rehearing, filed on August 19, 1996, and of the

response thereto, it is ordered that the petition be denied.

Per Curiam

Mark J. Langer, Clerk

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A statement of Circuit Judge GINSBURG, joined by Circuit Judge HENDERSON, is attached.

A statement of Circuit Judge WALD dissenting from the denial of rehearing is also attached.

GINSBURG, Circuit Judge with whom Circuit Judge HENDERSON joins:

In its petition for rehearing the Securities and Exchange Commission betrays a profoundly, if not a

willfully, mistaken understanding of the Court's opinion. We think it appropriate expressly to reject

the Commission's mistatement of the case in two respects.

First, the Commission says that the Court declared an "artificial bright-line" rule that an

investment is not a security "if the efforts of promoters or others on which investors rely occur just

before, rather than after, the investors commit their money." Indeed, according to the Commission,

the Court holds that all pre-purchase efforts are "irrelevant." While that position may have been the

one originally advanced by Life Partners, Inc., it is not the one taken by the Court.

In order to qualify as a security, an investment must have been made in an enterprise the

profits of which are derived from the efforts of others. SEC v. W.J. Howey, 328 U.S. 293, 298-99

(1946). To the extent that we established any rule in applying the "efforts of others" test, we held

only "that [1] pre-purchase services cannot bythemselvessuffice to make the profits of an investment

arise predominantlyfromthe efforts of others, and that [2] ministerialfunctionsshould receive a good

deal less weight than entrepreneurial activities." 87 F.3d at 548. We examined both "LPI's

pre-purchase services as a finder-promoter and itslargelyministerial post-purchase services," and we

concluded that the two in combination were not enough to establish that the investors' profits flow

predominantly from the efforts of others. Id. Nothing in our application of the Howey test can

reasonably be construed to suggest that pre-purchase efforts are "irrelevant."

Absent even one entrepreneurial post-purchase serviceand the SEC could identify

nonethere simply is no on-going common enterprise involved in owning an interest in an insurance

contract from which the profit depends entirely upon the mortality of the insured. Id. Indeed, the

Commission concedesin its petition that "in other cases where pre-purchase efforts were considered,

those courts also found significant post-purchase efforts." See, e.g., Rodriquez v. Banco Central

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Corp., 990 F.2d 7, 10 (1993) (interest in undeveloped land not security without post-purchase

managerial efforts by promoter); Noa v. Key Futures, Inc., 638 F.2d 77, 79-80 (l980) (same with

respect to silver bars); McCown v. Heidler, 527 F.2d 204, 211 (1975) (interest in undeveloped land

would not have been security but for "substantial improvements pledged by" promoters).

The second matter worthy of comment is the totally unsubstantiated assertion in the

Commission's petition for rehearing that the Court has "place[d] in question the applicability of the

federal securities laws to ... certain asset-backed securities," including mortgages and securitized

interests in commercial real estate, which account for a vast amount of investment capital. Having

leveled this astonishing charge, however, the Commission does not favor us with a single example

of a formerly regulated instrument that will now escape SEC scrutiny. In fact, the Commission

admits that "many asset-backed securities may be encompassed under other definitional terms in the

securitieslaws... and some might have sufficient post-purchase efforts" to make LPI distinguishable.

In contrast to an LPI viatical settlement, a mortgage pool must be managed on a continuing

basis. Among the post-purchase services that should easily meet the "efforts of others" test as we

have interpreted it are: collecting late mortgage payments, initiating foreclosures, structuring and

monitoring work-outs, negotiating concessions in order to avoid refinancing, and arranging for a

secondary market. In the case of commercial real estate, the property must be kept in compliance

with an array of tax, safety, and environmental laws; it must be advertised, leased, re-leased,

improved, repaired, cleaned, heated, and perhaps resold. It seems fair to say, therefore, that the

Commission's concern with the effect of this decision is, at the least, overblown.

WALD, Circuit Judge, dissenting from denial of rehearing and

rehearing in banc: Judges Ginsburg and Henderson contend that the Securities and Exchange

Commission ("SEC"), in petitioning for rehearing, is mistaken when it claims that the majority

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decision in this case setsforth a bright-line rule to the effect that "an investment is not an "investment

contract'and hence not a security ifthe efforts of promoters or others on which investorsrely occur

just before, rather than after, the investors commit their money," and when it predictsthat this holding

poses a serious potential obstacle to enforcement of the federal securities laws. With due respect,

I believe that the SEC is correct in both allegations and it is my colleagues who are mistaken.

This case arose out of an attempt by the SEC to require Life Partners, Inc. ("LPI") to register

its offerings under the federalsecuritieslaws. LPI sells fractional interests in the life insurance policy

of terminally ill people to investors, and markets the policies through a network of commissioned

licensees. SEC v. Life Partners, Inc., 87 F.3d 536, 537-39 (D.C. Cir. 1996). The majority held that

LPI contracts are not securities because they do not meet the Howey test for what constitutes an

investment contract. Under the Howey test, "an investment contract is a security subject to the Act

if investors purchase with (1) an expectation of profits arising from (2) a common enterprise that (3)

depends upon the efforts of others." Id. at 542; SEC v. W.J. Howey Co., 328 U.S. 293, 298-99

(1946). As the SEC notes, the court unanimously agreed that the first two prongs of the Howey test

were met here. In particular, the majority noted that "horizontal commonalitydefined by the

pooling of investment funds, shared profits, and shared lossesis ordinarily sufficient to satisfy the

common enterprise requirement" and specifically held that "pooling isin practice an essential element

of the LPI program." Life Partners, Inc., 87 F.3d at 544.

The court did not hold that theLPI contracts were not investment contracts because there was

no common enterprise, but rather because the entrepreneurial efforts of LPI occurred before

purchase, so that any expectation of profits did not arise from such efforts and Howey's third prong

was not satisfied. The court held that "pre-purchase services cannot by themselves suffice to make

the profits of an investment arise predominatelyfromthe efforts of others, and ... ministerialfunctions

should receive a good deal less weight than entrepreneurial activities." Id. at 548. The court then

proceeded to emphasize that "[t]he SEC ... has identified no post-purchase service provided by LPI

... that could fairly be characterized as entrepreneurial," id., a point that my colleagues underscore

again here in their denial of rehearing by remarking on the absence of "even one entrepreneurial

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post-purchase service." Statement concurring in denial of rehearing at 1. It seems clear, therefore,

that in concluding that LPI's contracts are not securities the court did in fact adopt a bright-line rule

to the effect that in order for an investment contract to count as a security the promoter must provide

at least one entrepreneurialservice after purchase. Moreover, although my colleagues now admit that

pre-purchase activities are important in the overall determination of whether the Howey test is met

(presumably after some post-purchase activity has been identified), the majority's original opinion,

with its comment that "we doubt that pre-purchase activities should ever count for much," Life

Partners, Inc., 87 F.3d at 548 and its conclusion that the "undeniably essential" activities performed

byLPI do not create a security because they occur prior to purchase, id. at 547-48, leavesthe distinct

impression that pre-purchase activities are largely irrelevant and never, by themselves, sufficient to

support finding that a security exists.

As I stated in dissent, I continue to believe that the court's bright-line rule distinguishing

between pre-investment and post-investment efforts is at odds with the Supreme Court's frequent

remonstrance that courts should apply the securities laws flexibly to achieve the goal of investor

protection. See, e.g., Pinter v. Dahl, 486 U.S. 622, 653 (1988); Tcherepnin v. Knight, 389 U.S.

332, 336 (1967). The new rule cannot but pose difficulties for enforcement of the securities laws.

Investorsin viaticalsettlements depend on viaticalsettlement brokersto provide accurate and honest

assessments of an insured's health as well as of the likelihood ofmedical developments occurring that

might extend the insured's life expectancy. See David W. Dunlap, Recalculating Death-Benefit

Math: AIDS Progress Alters an Industry, N.Y.TIMES, July 30, 1996, at D1. Moreover, the viatical

settlement industry has grown tremendously in recent years, and is in the process right now of

expanding from AIDS to other terminal illnesses. A further spur to the industry's growth is the

recently enacted Kennedy-Kassebaumbill, whichmade the income fromsale ofinsurance policies not

taxable. See Arthur Allen, The Invisible Hand: Greed, Ethics and the New Value of Dying, WASH.

POST, Nov. 17, 1996, Magazine, at 12; Dunlap, supra, at D1, D4. The panel's decision prevents the

SEC from protecting investors in these viatical settlements from dishonest and unscrupulous

profiteers. And while it is true, as my colleagues point out, that interests in mortgage pools or

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commercial real estate (familiar examples of asset-backed investments) would likely qualify as

securities even under their test, because ofthe post-purchase entrepreneurial and managerial activities

required to make these investmentssucceed, it is not difficult to conjure up instances where their rigid

"before-or-after" measuring stick would result in exempting the sale of other risky asset-backed

interests from the scope of the securities laws. One example is a promoter selling interests in a

package of long-term bonds, where the realization of profitsturns on the promoter'sskill in selecting

what bonds to purchase; another is a dealer organizing a complex set of derivative transactions for

a group of investors, where realization of profits depends predominantly on the dealer's expertise in

balancing positionsin different markets. In any event, the SEC's understandable reluctance to identify

arrangementsthat it will acknowledge in advance asfalling outside ofthe securitieslawsif the court's

bright-line rule stays does not mean that its basic concerns are "overblown." As the Supreme Court

has remarked, the importance of retaining flexibility in the definition of a security is so that our

securitieslaws are "capable of adaptation to meet the countless and variable schemes devised bythose

who seek the use of the money of others on the promise of profits." Howey, 328 U.S. at 299.

Experience shows that the novelty and ingenuity of exploitative investment schemes can rarely be

contemplated ahead of time.

Because the panel's decision is inconsistent with Supreme Court precedent and holds the

potential for obstructing enforcement of the nation's securities laws, I believe the panel's opinion

merits review by the full court and should be reversed. I therefore dissent from the court's decision

to deny rehearing or rehearing in banc.

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