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SEC v. Life Partners Holdings, Inc.
Citations: 854 F.3d 765; 2017 WL 1428959Docket: 14-51353
Court: Court of Appeals for the Fifth Circuit; April 21, 2017; Federal Appellate Court
Original Court Document: View Document
The Securities and Exchange Commission (SEC) initiated an enforcement action against Life Partners Holdings, Inc. (LPHI) and its senior officers, Brian Pardo and Scott Peden, for breaching federal securities laws related to reporting and anti-fraud provisions. The SEC accused LPHI of intentionally underestimating the life expectancies of insured individuals in its SEC filings. A jury found the defendants liable for violating section 17(a) of the Securities Act of 1933 and section 13(a) of the Securities Exchange Act of 1934. While the district court upheld the jury's verdict on section 13(a), it overturned the section 17(a) verdict. The court imposed civil penalties and issued injunctions against the defendants but did not mandate Pardo to reimburse LPHI for compensation under section 304 of the Sarbanes-Oxley Act. Pardo and Peden appealed the jury's verdict and the district court's judgment, while the SEC cross-appealed against the court's ruling. LPHI engaged in viatical and life settlement transactions, deriving income from commissions on sales of life insurance policies or fractional interests in them. The life expectancy estimate was crucial in determining sale prices, as inaccurate estimates could negatively impact investors' returns. LPHI was structured such that there was no significant operational distinction between LPHI and its subsidiary, Life Partners, Inc. (LPI), which handled the relevant transactions. LPHI required purchasers to deposit funds in escrow to cover premium payments for life insurance policies during an insured's life expectancy (LE) period. If the insured survived beyond their LE, additional premium payments were necessary to prevent policy lapses. LPHI also invested in life insurance policies and, starting in 1999, sourced LEs from Dr. Donald Cassidy, who calculated LEs using the CDC mortality table and adjusted them based on medical reviews. LPHI used the upper limit of Cassidy's range for the insured's LE. In SEC filings, LPHI acknowledged risks from potentially underestimating LEs. Following an SEC investigation initiated in March 2011, LPHI began obtaining LEs from another provider, 21st Services. In 2013, the SEC charged LPHI, Pardo, and Peden with knowingly using materially underestimated LEs for life settlement policies and misrepresenting these risks in filings from 2007 to 2011, violating anti-fraud provisions of the Securities Exchange Act and the Securities Act. The SEC also claimed LPHI, aided by Pardo and Peden, violated reporting requirements, and alleged Pardo violated specific SEC regulations. The SEC sought reimbursement from Pardo under the Sarbanes-Oxley Act. At trial, an SEC expert confirmed that LPHI’s LEs were systematically underestimated. The jury found LPHI, Pardo, and Peden violated the Securities Act and LPHI violated reporting requirements, although they did not find a violation of the Securities Exchange Act's anti-fraud provision. The defendants' motion for judgment as a matter of law was partially granted and denied by the district court, leading to an appeal regarding the section 17(a) ruling, which the court ultimately denied. At the remedies stage, the district court imposed second-tier civil penalties and issued injunctions against the defendants to prevent further violations of securities laws. The court, however, did not order Pardo to reimburse LPHI under section 304 of the Sarbanes-Oxley Act (SOX) and later denied the SEC’s motion for reconsideration on this issue. Appellants Pardo and Peden challenged the court’s denial of judgment on the SEC’s section 13(a) claim, asserting errors in the imposition and assessment of penalties, as well as the injunctions. The SEC cross-appealed against the court's grant of judgment on its section 17(a) claim and its refusal to mandate reimbursements under SOX. The appellants contested a jury verdict finding LPHI in violation of section 13(a) reporting requirements, claiming insufficient evidence supported this verdict. They argued that the district court improperly denied their motion to exclude expert testimony from Rubin, an actuary with extensive experience in the life settlement industry. Rubin analyzed LPHI’s life expectancies (LEs), concluding they were materially short through various analyses, including a cohort analysis and an actual-to-expected (A/E) performance ratio, which revealed a 13% ratio—far below acceptable benchmarks. Rubin's calculations, applying standard deviations, indicated a maximum possible actual-to-expected performance ratio of 41% with high confidence. He also developed calibrated life expectancies using these findings against mortality tables, which further supported his conclusions about the inadequacy of LPHI's LEs. Calibrated life expectancy (LE) aims to adjust initial LE estimates based on historical data from an underwriter's performance, specifically actual to expected mortality ratios, leading to an A/E ratio of 100. This indicates that there is only a 1% confidence that LEs used by LPHI are accurate, with a 99% confidence that they are underestimated. Rubin determined that LPHI’s LEs for life settlements were materially and systematically short, aligning his analysis with the Actuarial Standards Board (ASB) guidelines. The appellants contest the admissibility of Rubin's expert testimony, claiming it is unreliable and irrelevant. Courts grant trial judges broad discretion in admitting expert testimony, which will only be overturned on appeal if manifestly erroneous. For expert testimony to be admissible, it must be relevant and reliable, with the reliability evaluated based on scientific methods and procedures. The Supreme Court's Daubert case outlines factors for assessing reliability, including testing, peer review, known error rates, and general acceptance in the scientific community. The appellants criticize Rubin's A/E analysis for lacking recognized methodologies and for allegedly skewing results by mixing data from viatical and life settlements. However, the absence of peer review does not inherently render expert testimony unreliable, as demonstrated in Daubert's remand, which allows for expert conclusions to be supported by objective sources, even if they are not widely accepted. Rubin’s report thoroughly details his analyses, which adhere to the Actuarial Standards Board (ASB) guidelines. The record includes a May 2013 Exposure Draft titled "Proposed Actuarial Standard of Practice: Life Settlements Mortality," later adopted with modifications as ASOP 48, which provides a framework for evaluating mortality in life settlements. Rubin’s analyses align with ASOP 48, countering the appellants’ claim that no specific guidelines exist for calculating A/E results in the life settlement sector. The ASB's standard serves as an objective benchmark for assessing Rubin’s work. Additionally, Rubin differentiates between life settlements and viaticals within his report and during testimony, focusing exclusively on life settlements in his A/E performance ratios and life expectancies. The appellants’ challenge to the reliability of Rubin’s opinion regarding LPHI’s life expectancies lacks merit. The district court did not err in admitting Rubin’s opinion, as the appellants had the opportunity to cross-examine him and present contrary evidence, which are standard methods of contesting admissible evidence. On the relevance of Rubin’s opinion, the appellants argue it is irrelevant due to its hindsight nature and failure to consider Cassidy’s methodology. However, the SEC contends Rubin’s opinion is pertinent to whether LPHI’s life expectancies were significantly understated and whether the involved parties were aware of this. The SEC distinguishes this case from Turnbow v. Life Partners, Inc., where the focus was on Cassidy’s methods rather than the accuracy of his results. The court agrees with the SEC, affirming that Rubin’s analysis is central to the case's allegations regarding LPHI's misrepresentations. Thus, the district court’s acceptance of Rubin’s opinion is upheld without any indication of abuse of discretion. The appellants contest the jury's verdict that LPHI violated section 13(a) of the Securities Exchange Act, asserting insufficient evidence to support the claim and challenging the district court's denial of judgment as a matter of law. This denial is reviewed de novo, requiring that facts overwhelmingly favor the movant to warrant reversal. Section 13(a) and associated SEC rules mandate issuers to file specific annual and quarterly reports, disclosing material information to avoid misleading investors. The SEC alleged that LPHI, along with the appellants, misrepresented or omitted critical information regarding a material risk to LPHI's business, revenue trends, and revenue recognition policies from January 2007 to November 2011. The SEC's primary assertion was that LPHI misrepresented the known fact of its life expectancies (LEs) being short as an unmaterialized risk. Section 20(e) allows the SEC to pursue actions against individuals providing substantial assistance to primary violators, requiring proof of a primary violation, knowledge of the violation, and substantial assistance. The appellants dispute the jury's findings on LPHI’s alleged violation and their own knowledge of it, claiming the SEC failed to provide competent evidence of LPHI's LEs being short and asserting that a misrepresentation requires proof of actual harm to LPHI’s business. The court finds these arguments unconvincing, citing sufficient testimony to support the jury's conclusion regarding LPHI’s LEs being materially short. Furthermore, to establish a misrepresentation, the SEC need not demonstrate that the related risk materialized; instead, materiality is based on what a reasonable investor would find significant. It is also irrelevant that LPHI's policies could remain profitable despite underestimating LEs, as this underestimation was acknowledged in SEC filings as a risk to the business. The appellants claim ignorance regarding violations of section 13(a) by LPHI, asserting they were unaware that LPHI's life expectancies (LEs) used in life settlements were short. However, evidence suggests otherwise. In August 2008, Mark Embry, the chief information officer, analyzed life settlement transactions from 2004, revealing that none of the thirty-seven policies had matured, and twenty-one would exceed their LEs by the end of 2008. Embry reported these findings to the appellants, who responded with a request to keep the information confidential, which could imply awareness of the issue. Despite the appellants arguing that Pardo's response indicated doubts about the data's reliability, the jury could reasonably conclude that Pardo was aware of the short LEs and sought to conceal this from the public. Further corroboration of the appellants' knowledge comes from various indirect pieces of evidence. In 2003, LPHI's audit committee expressed concerns about the low number of policies paying off and suggested an independent review of LPHI's underwriting criteria. Additionally, in May 2007, the Colorado Securities Commissioner initiated an enforcement action against LPHI, citing that viatical insureds frequently outlived their LEs. Furthermore, Nina Piper, the chief financial officer, conducted her own analysis in November 2007, revealing that only two percent of insureds died within Cassidy's LEs, despite Pardo's earlier instruction not to analyze the data. Pardo's negative reaction to Piper's findings and Peden's comment about resolving the issue by shifting from viaticals to life settlements may indicate their awareness of ongoing issues with LEs. The record also indicates that the appellants could have easily verified the accuracy of LPHI’s LEs through a proprietary system called 'LifeApps,' which contained all relevant policy information. Embry had previously utilized this system to generate reports that could have clarified the situation. An expert witness for the SEC stated that a straightforward analysis of the data in 2008 would have clearly revealed the problem with LPHI's LEs. Piper testified she offered to assess Cassidy's life expectancies (LEs), but Pardo instructed her not to, suggesting he wanted to avoid unfavorable evaluations. In November 2008, Peden learned that various companies had lengthened their LEs due to previous short calculations and emailed himself to check on Cassidy’s accuracy but failed to do so. When asked by an investment advisor about the impact of changes in another LE provider's methodology, Peden incorrectly claimed there was no effect on LPHI, indicating a conscious choice to avoid evaluating Cassidy’s LEs despite concerns about their accuracy. The jury could reasonably conclude that LPHI and the appellants were aware that LPHI's life-settlement LEs were significantly short and misrepresented this as a mere potential risk. This supported the jury's verdict that the appellants aided and abetted LPHI’s violations of section 13(a) and related rules, leading the district court to uphold the verdict. The appellants challenged the district court's imposition of second-tier civil penalties, the number of violations assigned to them, and the injunctions issued against them. Second-tier penalties can reach up to $75,000 per violation and are applicable for acts involving fraud or reckless disregard of regulatory requirements. The court imposed penalties of $6,161,843 against Pardo and $2,000,000 against Peden, classifying their behavior as at least reckless. The appellants argued that the jury did not find any fraudulent conduct necessary for second-tier penalties and claimed that only a jury could establish the facts for such penalties under the Seventh Amendment. The SEC countered that the jury's determination of liability sufficed, while penalty amounts were within the district court's discretion, supported by the Supreme Court's ruling in Tull v. United States. Ultimately, the district court acted within its rights in assessing the penalties. The district court imposed second-tier civil penalties of $6,161,843 on Pardo and $2,000,000 on Peden for their aiding and abetting of LPHI's violation of section 13(a) of the Securities Exchange Act, concluding their conduct was at least reckless. The appellants contend that the jury's verdict did not demonstrate any requisite fraud, deceit, or reckless disregard necessary for such penalties, as mandated by 15 U.S.C. 78u(d)(3)(B)(ii). They argue that only a jury can determine the facts essential for imposing second-tier violations, referencing the Seventh Amendment. However, the SEC maintains that the jury is only responsible for determining liability, while the district court has discretion over the penalty amount. The Supreme Court's decision in Tull v. United States established that Congress can empower judges to assess civil penalties after a jury determines liability. Subsequent appellate cases have echoed this principle. The appellants assert that the district court's finding of recklessness contradicts the jury's finding of no liability for section 10(b) violations. Nevertheless, the court clarified that the jury's determination of aiding and abetting required a finding of the appellants' knowledge of LPHI’s violations and their involvement in them, which inherently indicates a reckless disregard for regulatory requirements, as they were the top officers responsible for the misleading filings. The district court affirmed the imposition of second-tier civil penalties against appellants Pardo and Peden for securities violations. Pardo was found responsible for sixty-eight violations, while Peden faced eighty-five, determined by multiplying the number of false SEC filings by the number of violated statutory and regulatory provisions. The appellants challenged the district court's calculations, arguing that the jury verdict indicated only a single violation per public filing and that the court could not impose penalties for multiple violations. However, the court clarified that the appellants had no right to a jury trial at the remedies stage and could make factual findings that did not conflict with the jury's verdict, which established at least one violation. The appellants also claimed the court abused its discretion in calculating violations by asserting that the relevant statutes and rules were interdependent and could not give rise to "discrete" violations. Nonetheless, their objections during the trial were insufficient to alert the court of their broader legal claim on appeal regarding the calculation methodology. As a result, their challenges were reviewed for plain error, which requires demonstrating that an error was clear, affected substantial rights, and undermined the judicial proceedings' fairness and integrity. The court addressed the conditions under which it may exercise discretion to remedy an error, finding that the appellants did not demonstrate a plain error regarding the district court's methodology. The relevant provision of the Securities Exchange Act allows for maximum civil penalties for “each violation,” but the term "violation" is not defined in the statute. The appellants failed to provide authority supporting their claim that section 13(a) and related SEC Rules cannot establish discrete violations under 15 U.S.C. § 78u. Consequently, they did not meet the burden of proving plain error, as a question of first impression cannot constitute plain error. The SEC conceded that section 13(a) could not independently support a violation in this case and acknowledged flaws in the district court’s calculation of penalties, which improperly included violations of Rules pertaining to both Form 10-Ks and Form 10-Qs. As a result, the court vacated the district court's civil penalty assessment and remanded for recalculation of the number of violations and reassessment of penalties. Regarding injunctive relief, the district court had enjoined the appellants from future violations of section 13(a) and from aiding such violations. The appellants contested the injunctions, asserting a lack of evidentiary support and claiming they were overly broad. The court reviews permanent injunctions for abuse of discretion and established that such an injunction is warranted if there is a reasonable likelihood of future violations based on the defendant's past conduct. The district court found the appellants’ actions to be egregious, indicative of knowing or reckless violations of securities laws, and recurrent, as they caused multiple misleading reports to be filed. Additionally, there was evidence of their indifference to the deficiencies in LPHI's management, as they failed to take corrective actions even after the trial. The district court's order restricts the appellants from submitting false statements or omitting necessary information in filings with the Commission, and from assisting an issuer that fails to file accurate and complete documents timely. The appellants contend that the SEC did not provide sufficient evidence for a reasonable likelihood of future violations, citing LPHI's use of two sets of LEs since March 2011 and the SEC's unsuccessful claims. However, the court dismissed these arguments, stating that past cessation of violations does not negate the potential for future violations. The court highlighted the appellants’ lack of remorse and the recurrent nature of their violations as justifications for its findings. Regarding the injunctions, the appellants argue they are overly broad "obey-the-law" injunctions, which are generally impermissible under Federal Rule of Civil Procedure 65(d)(1). The court noted that the appellants failed to adequately challenge the specific language of the injunctions, resulting in forfeiture of their argument. The injunctions are valid as they specify compliance with section 13(a) and the prohibited conduct. Additionally, the SEC's cross-appeal addresses the district court's decision to set aside the jury's verdict concerning section 17(a) violations, where the SEC alleged the appellants misrepresented LPHI’s revenue recognition policy in public filings from January and February 2007. The jury had found violations of this section by the appellants. The district court granted the appellants' motion for judgment as a matter of law, overturning the jury's verdict regarding their alleged violation of Section 17 in early 2007. The court determined there was no evidence supporting the jury's conclusion that the appellants misled investors about LPHI's revenue recognition practices. The SEC's request for reconsideration, citing a January 2007 quarterly report as evidence, was denied. The appellate review of the judgment is de novo, meaning the same legal standards are applied as by the district court. Judgments as a matter of law are permissible when facts overwhelmingly favor the movant, making it unreasonable for jurors to reach a different conclusion, and require substantial evidence to support jury findings. The SEC contends that the January 2007 report, which included references to LPHI's annual report and significant accounting policies, demonstrated misleading information similar to that in filings tied to another verdict under section 13(a). The appellants argue the January report should be viewed differently due to its timing and implications for their knowledge at that time. Under Section 17(a), liability requires severe recklessness for subsection (1) but only negligence for subsections (2) and (3). Liability under sections 17(a)(2) and 17(a)(3) does not necessitate proof of scienter, allowing the jury to find the appellants liable for violations. Substantial evidence supports the jury’s verdict, indicating that prior to 2007, the appellants were aware of issues regarding viatical life expectancies (LEs). LPHI had means to assess LEs accurately, yet an offer to evaluate them was ignored by Pardo. Rubin noted that by 2007, it was evident that LPHI faced problems with its life-settlement LEs. This evidence suggests that the appellants negligently misrepresented risks in their January 2007 quarterly report, which included data from prior annual reports. The jury's reference to section 17(a)(1) was acknowledged as a clerical error. The appellants did not present other grounds to overturn the jury’s verdict, leading to a reversal of the district court's judgment as a matter of law regarding section 17(a) and a remand for appropriate remedies. In 2011, LPHI restated its financial statements for 2009 and 2010 due to non-compliance with generally accepted accounting principles (GAAP). The restatement indicated that LPHI's Board, Audit Committee, and management concluded a need for restatement to accurately reflect investments in policies, which had been improperly accounted for. LPHI’s adjustments also pertained to impairment expenses related to owned policies. The restatement outlined the need for accurate financial reporting under SEC regulations, stating that non-compliant financial statements are presumed misleading. By February 2011, LPHI managed over 1,300 policies valued at over $32 million. The methodology for calculating impairment on these investments was improved by incorporating more actuarial data, which generally resulted in increased life expectancies for the held policies. The restatement also noted a disagreement between LPHI and its auditor, Ernst. Young, the auditor, confirmed LPHI’s revenue recognition policy, leading to a restatement of financial statements based on Ernst & Young's updated guidance. Under Section 304(a) of the Sarbanes-Oxley Act (SOX), if an issuer must restate accounts due to material noncompliance from misconduct, the CEO is required to reimburse the issuer for specified compensation and profits. The SEC sought a court order for Pardo to reimburse LPHI $13,340,371, arguing that the restatement arose from material noncompliance due to misconduct involving the use of understated life expectancies (LEs) in asset impairment calculations. LPHI had shifted to using actuarial LEs from a second provider starting in 2011. The district court, however, declined to mandate reimbursement, stating that the evidence did not sufficiently demonstrate that LPHI’s noncompliance stemmed from misconduct instead of good faith reliance on its auditor. The SEC’s motion for reconsideration was denied, prompting an appeal that challenges the district court's finding regarding the causation of noncompliance. Causation is assessed for clear error, and the SEC contends that LPHI's use of materially short LEs led to Generally Accepted Accounting Principles (GAAP) violations, impacting the accuracy of financial statements and investment valuations. The SEC asserts that these LEs affected both the purchase price and the necessary premiums for policy maintenance, ultimately influencing impairment assessments. The elements required under section 304(a) were not disputed in this case. The improved methodology for calculating loss estimates (LEs) significantly increased LPHI's impairment charges, resulting in substantial adjustments in 2009 and 2010. The SEC contends that LPHI's deliberate use of materially short LEs led to noncompliance with financial reporting standards, necessitating a restatement of its financial statements. Despite LPHI's argument that the restatement was solely due to its auditor Ernst & Young's revised revenue recognition policies, the SEC maintains that LPHI's prior use of short LEs also mandated the restatement due to GAAP violations. The court agrees with the SEC, asserting that the requirement for a restatement stems from LPHI's misconduct, not merely good-faith reliance on its auditor. The district court's assertion that the restatements were unrelated to LPHI's use of short LEs is deemed erroneous. Consequently, the court reverses the district court's judgment, affirming some aspects while vacating others, and remands the case for reassessment of civil penalties and SOX reimbursements, as well as remedies for section 17(a) violations.