A panel of the Fifth Circuit Court of Appeals reversed a district court’s order that set aside a jury verdict that found a life settlement provider liable for securities fraud relating to statements about life expectancy estimates. The panel also rejected the lower court’s finding that a clawback of compensation was not supported by the evidence. It agreed with the district court that civil penalties and injunctions should be imposed for violations of the reporting provisions of the securities laws; however, it ordered the lower court to recalculate the penalties assessed based on the number of violations (SEC v. Life Partners Holdings, Inc., April 21, 2017, Dennis, J.).
Lawsuit. The SEC charged Life Partners Holdings, Inc. (LPHI) and two of its senior officers, Brian Pardo and Scott Peden, alleging that the defendants had systematically underestimated life expectancies in order to inflate the company’s revenues in violation of the reporting and antifraud provisions of the federal securities laws. A jury found the defendants liable for the antifraud violations under Securities Act Section 17(a) and the reporting violations under Exchange Act Section 13(a). The district court sustained the jury verdict as to the reporting violations but set aside the verdict as to the antifraud violations. In addition, the district court imposed injunctions and civil penalties on the defendants, but declined to order Pardo to reimburse the company under Sarbanes-Oxley’s clawback provision. The LPHI parties and the SEC appealed the portions of the court’s order that went against them.
Exclusion of testimony. The LPHI defendants objected to the testimony of the SEC’s expert witness, an actuary specializing in the life settlement industry, claiming it was unreliable and irrelevant. The appellate panel agreed with the district court judge, finding that the expert’s opinion was sufficiently reliable and that the defendants had ample opportunity to cross examine the SEC’s expert witness at trial and to introduce contrary evidence.
Reporting requirements. The panel also sided with the district court in finding that the defendants were liable for the statements in LPHI’s reports filed with the SEC that misrepresented the fact that its life expectancy estimates (LEs) were short as an unmaterialized contingent risk. Despite the defendants’ arguments that the SEC had not established that they knew that the LEs were short, the panel’s opinion pointed out both direct and indirect evidence to the contrary, including an analysis by the company’s chief information officer shared with Pardo, as well as information supplied to Pardo and Peden by the audit committee, by the Colorado Securities Commissioner, and by the CFO regarding the understated LEs.
District court sanctions. The appellate next discussed the defendants’ appeal against the imposition of second-tier civil penalties, injunctions, and the number of violations for which they were held responsible. The panel agreed with the district court that second-tier penalties are merited, finding that the defendants were reckless in violating the reporting provisions. However, noting that the SEC itself conceded that the number of violations upon which the actual amount imposed was calculated was flawed, the panel ordered that the case be remanded on this issue to reassess the amount of the civil penalties imposed on the defendants. The panel affirmed, however, the lower court’s order enjoining the defendants from future violations of Section 13(a).
Fraud allegations. The district court had set aside the jury’s finding on Section 17(a) fraud liability because "not a single piece of evidence" supported the jury’s conclusion that the defendants had violated Section 17 "in January and February of 2007 by misleading investors about LPHI’s revenue recognition practices." On appeal, the SEC argued, and the appellate panel agreed, that a January 2007 quarterly report incorporated into LPHI’s annual report included the same kind of misleading information that formed the basis of the jury’s Section 13(a) verdict. The panel pointed out that liability under Section 17(a)(2) and Section 17(a)(3) does not require proof of scienter. The allegations regarding the reporting violation charges, for which the defendants were found liable, proved to be "more than a scintilla of evidence" that the defendants negligently misrepresented the risk of its underestimated LEs in its quarterly report from January 2007, which had been incorporated the prior annual report, according to the panel.
Clawback. Section 304(a) of the Sarbanes-Oxley Act allows for the "clawing back" of compensation paid to a CEO in the event of an accounting restatement. The district court denied the SEC’s request to order former CEO Pardo to reimburse LPHI, concluding that the allegation that the company’s noncompliance with financial reporting requirements was caused by misconduct was not established by the evidence.
The appellate panel disagreed. LPHI’s restatements were not required solely because of its good faith reliance on the company’s auditor; rather, LPHI knew that the use of materially understated LEs rendered its financial statements noncompliant. The panel accordingly reversed the lower court’s judgment and remanded the matter to determine the appropriate amount of reimbursement.
The case is No. 14-51353.
Attorneys: Benjamin M. Vetter for the SEC. Charles Alfred Mackenzie (Law Office of C. Alfred Mackenzie) for Brian Pardo and Scott Peden.
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