Securities & Exchange Commission v. Life Partners Holdings, Inc.

Citations: 71 F. Supp. 3d 615; 2014 U.S. Dist. LEXIS 176540Docket: Civil Action No. 1-12-CV-33-JRN

Court: District Court, W.D. Texas; December 1, 2014; Federal District Court

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Defendants’ Motion for Entry of Judgment and Plaintiffs’ Motion for Judgment as a Matter of Law were considered by the court, which noted that the jury found Defendants guilty of fraud under Section 17(a)(1) of the Securities Act of 1933, as well as violations of Section 13(a) of the Securities Exchange Act of 1934 through false filings. Although the court set aside the fraud verdict, it upheld the jury's other findings. The Commission seeks sanctions, including permanent injunctions against future violations, disgorgement of ill-gotten gains, civil penalties, and reimbursement by Pardo to LPHI under the Sarbanes-Oxley Act. The Commission argues for permanent injunctive relief based on the egregious nature of Defendants' conduct, scienter, and the likelihood of future violations. The court evaluates requests for injunctions by considering factors such as the severity of the conduct, the defendant’s awareness of wrongdoing, and the potential for future violations. Defendants contend that their actions were not egregious, referencing the SEC's failure to secure a verdict on core allegations against LPHI. However, the court emphasizes that the jury's findings of violations related to critical disclosure obligations are serious, as transparency is fundamental to securities law.

Defendants had knowledge that Life Partners may have failed to comply with legal obligations but resisted making necessary changes. Evidence shows that when Ernst and Young, LPHI’s auditors, raised concerns about LPHI’s non-compliance with GAAP, CEO Brian Pardo threatened legal action against the auditors instead of investigating the issues. This conduct is particularly egregious given Pardo's prior misconduct, including a 1991 settlement with the SEC that involved a permanent injunction against violating the Exchange Act, and a 2007 settlement with Colorado securities regulators for using materially short life expectancies. Despite this history, Life Partners showed a lackadaisical approach to legal compliance. Pardo's oversight was crucial, yet evidence suggests that compliance was virtually absent within the organization. Testimony from Tad Ballantyne, a director and head of the risk and compliance committee, revealed his ignorance of significant media coverage questioning Life Partners' practices, as he did not regularly read relevant publications. Ballantyne also failed to recognize critical audit-related requirements imposed by Ernst and Young. As the controlling shareholder and CEO, Pardo had the authority to select competent directors, yet he chose individuals like Ballantyne, whose lack of awareness raises concerns about the board's integrity and commitment to shareholder protection.

Ballantyne's continued position on the Board, despite his inadequate testimony during the trial, illustrates a lack of accountability among LPHI’s leadership, including Pardo and Peden, for the company’s legal failures. The Court observes no changes at LPHI post-trial, suggesting Pardo’s unwillingness to implement reforms. The Court, aligning with the SEC, deems injunctive relief necessary, permanently enjoining LPHI, Pardo, and Peden from future violations of specific provisions of the Exchange Act. Furthermore, the Court orders LPHI to disgorge $27 million in illicit gains, emphasizing the SEC's broad discretion in disgorgement matters. The amount does not require precise calculation but must reasonably approximate profits linked to the violations. Once the SEC presents a reasonable estimate of ill-gotten gains, the burden shifts to the defendants to disprove the approximation. The principle holds that uncertainties in determining amounts fall on the wrongdoer, and doubts are resolved against them. Disgorgement is applicable to all securities law violations, not limited to fraudulent actions.

The SEC requests the Court to order Defendants to disgorge $500 million, citing expert testimony from Larry Rubin, who indicated that Life Partners’ retail investors would have paid significantly less if accurate life estimates had been provided. However, the Court finds Rubin's testimony insufficient to support this estimate, despite acknowledging that Life Partners unlawfully benefited from misleading investors. The difficulty in accurately determining LPHI’s ill-gotten gains is highlighted, with the SEC's approach deemed overly simplistic. 

The Court recognizes that while Life Partners’ incomplete disclosures harmed retail investors, shareholders also benefited during the period when the inaccuracies were hidden. Consequently, ordering a $500 million disgorgement solely to shareholders is viewed as unjust. Instead, the Court determines that a $15 million disgorgement would be appropriate to deter future violations without overcompensating investors who were not directly deprived of funds.

Additionally, the SEC seeks a civil penalty for the Defendants, advocating for a third-tier penalty ranging from $67,930,000 to $1.5 billion. The Exchange Act outlines three tiers of penalties, with the first tier for individuals imposing sanctions that do not exceed specified amounts per violation or the individual's gross gain from the wrongdoing.

A second-tier penalty for securities violations necessitates that the misconduct involves fraud, deceit, manipulation, or a reckless disregard for regulatory requirements. The Exchange Act stipulates third-tier penalties for individuals, capped at $130,000 per violation prior to March 3, 2009, and $150,000 thereafter, or the amount of the violator's gross pecuniary gain. To impose third-tier penalties, the defendant's actions must also involve substantial losses or the risk thereof to others. Civil penalties serve to punish violators and deter future misconduct, with the actual penalty amount being at the court's discretion. In determining penalties, courts consider factors such as the severity of the misconduct, the defendant's intent, the impact on others, the frequency of violations, admissions of wrongdoing, and potential financial hardship. 

In this case, the Defendants engaged in significant violations of securities laws, exhibiting at least reckless behavior, while ignoring multiple warning signs about Life Partners' compliance. Their actions risked substantial losses to investors due to a lack of critical information. While the Court noted the Defendants' lack of remorse and failure to change the leadership responsible for the violations, it found no evidence of financial incapacity to pay second-tier penalties. 

Regarding Defendant Peden, the Court evaluated civil penalties based on his significant involvement in submitting false reports, resulting in 68 individual violations across four provisions of the Exchange Act. Although the evidence supported a second-tier penalty of $4,740,000, the Court deemed this excessively high given Peden's lesser role and history compared to co-defendant Pardo. Consequently, the Court reduced Peden's penalty to $2,000,000 to ensure equity.

Mr. Brian Pardo, the CEO and controlling stakeholder of LPHI, is held responsible for making strategic decisions that led the company to violate securities laws, despite being warned of potential legal issues. Pardo has a history of securities law violations dating back to 1991, indicating a pattern of reckless behavior. The Court has determined that he knowingly assisted in the submission of seventeen false reports, resulting in 85 violations across five provisions of the Exchange Act. Consequently, Pardo is ordered to pay a second tier penalty of $6,161,843, which includes $5,922,000 as the low maximum second tier penalty plus $239,843 for personal expenses he charged to the company.

LPHI is also subject to penalties under the Exchange Act for its violations, with the Court imposing a second tier low maximum penalty of $23,700,000 for its 68 individual violations across four provisions. The penalties for companies are higher than those for individuals, with specific amounts set for first, second, and third-tier violations.

Additionally, Pardo was charged with failing to reimburse LPHI for certain bonuses and compensation under Section 304 of the Sarbanes-Oxley Act (SOX). SOX provides a mechanism for the Commission to enforce reimbursement of such compensation from the CEO if the company experiences financial restatements due to misconduct. The jury found Pardo in violation of the related certification requirements under Rule 13a-14 of the Exchange Act, which mandates that senior executives certify the accuracy of financial reports.

SOX 304 mandates that CEOs and CFOs reimburse their company for bonuses and other compensation received within 12 months following the first public filing of a financial document that meets reporting requirements. To enforce this reimbursement, the SEC must prove three elements: (1) LPHI's need for an accounting restatement due to material non-compliance with financial reporting, (2) that this non-compliance was due to misconduct at LPHI, and (3) that Pardo received relevant compensation during the specified period. Although LPHI did restate its financials and Pardo received incentive compensation, the SEC failed to provide evidence connecting the restatement to misconduct by LPHI. The absence of evidence suggesting that LPHI acted in bad faith towards its auditor, Ernst and Young, or that the auditor conspired with LPHI undermines the SEC's position. Consequently, Pardo is not obligated to reimburse under SOX 304. 

The Court orders that LPHI and its associates are permanently restrained from violating Section 13(a) of the Exchange Act and associated regulations by submitting false statements or omitting material information. Additionally, Defendants Pardo and Peden, along with their associates, are enjoined from aiding violations of the same section by providing substantial assistance to issuers who fail to file accurate information. Pardo and his associates are also permanently restrained from including false certifications in any required reports filed with the Commission.

Life Partners is ordered to disgorge $15,000,000 and to pay a civil penalty of $23,700,000, both to be paid to the Securities and Exchange Commission (SEC) within 14 days of the Final Judgment. Defendant Peden is required to pay a civil penalty of $2,000,000 within 30 days, while Defendant Pardo must pay $6,161,843 within the same timeframe. All relief not explicitly granted is denied, and the case is closed. The Court did not dismiss the jury's Section 17 verdict due to insufficient evidence of securities fraud, but rather because the SEC's allegations were limited to a specific period, during which the evidence did not support a fraud finding. However, the record indicated that the Defendants knowingly or recklessly violated securities laws. A Wall Street Journal article from December 21, 2010, highlighted that a significant percentage of life expectancies predicted by Life Partners were inaccurate, with many insured individuals living well beyond their projected life spans. Following the article's publication, Pardo issued an open letter to investors denying the allegations. Pardo retains a 51% stake in Life Partners, a share deemed significant enough to deter future misconduct. Additionally, tiered penalties apply to Life Partners for nine false reports filed between January 2007 and January 2009, as well as for eight false reports filed between May 2009 and January 2011, under relevant regulations.