Are Life Settlements Securities? — Circuit Split

SEC v. Pacific West Capital Grp., Inc., 2015 U.S. Dist. LEXIS 174800 (C.D. Cal. June 16, 2015):

Proceedings: (In Chambers) Order Re: Motion for Preliminary Injunction

Having reviewed and considered all the briefing filed with respect to plaintiff's Motion for Preliminary Injunction ("Motion"), the court concludes that oral argument is not necessary to resolve the Motion. See Fed. R. Civ. P. 78; Local Rule 7-15; Willis v. Pac. Mar. Ass'n, 244 F.3d 675, 684 n. 2 (9th Cir. 2001).

BACKGROUND

On April 7, 2015, plaintiff the Securities and Exchange Commission (the "SEC") filed a Complaint alleging five federal securities violations against ten defendants: (1) §10(b) of the Securities Exchange Act of 1934 ("1934 Act") and Rule 10b-5 promulgated thereunder; (2) §17(a) of the Securities Act of 1933 ("1933 Act"); (3) §15(a) of the 1934 Act; (4) §§ 5(a) and 5(c) of the 1933 Act; and (5) § 20(a) of the 1934 Act. (See Complaint at ¶¶ 6-15 & 108-124).

On April 17, 2015, the SEC filed the Motion against three of the ten defendants in this action: Pacific West Capital Group, Inc. ("Pacific West"), Andrew B Calhoun IV ("Calhoun"), and PWCG Trust ("Trust"). Founded in 2004, Pacific West is a California corporation that "facilitates the sale of interests in life settlements." [*2]  (Declaration of Andrew B Calhoun IV ("Calhoun Decl.") at ¶ 3). Calhoun is Pacific West's President, CEO, and sole owner. (Id. at ¶ 2). The Trust is an Ohio business trust. (Complaint at ¶ 8). Pacific West is the grantor of the Trust. (Declaration of Todd Brilliant in Support of [the SEC's] Motion for Preliminary Injunction ("Brilliant Decl."), Exh. 6 at 193). Third-party Mills, Potoczak, & Company is its trustee. (Id.).

I. LIFE SETTLEMENTS.

As described in a brochure Pacific West provides its potential investors, life settlements are arrangements where insureds "sell their existing life insurance policies to investors at a more equitable settlement than the life insurance companies [are] willing to offer. . . . [I]nstead of being able to receive[, for example,] only $100,000 on a $1,000,000 policy, the insured might expect to receive $250,000 from investors. The investors would then hold the policy until the insured passed away, at which point the policy would mature and the investors would collect the face value of $1,000,000." (Brilliant Decl., Exh. 7 at 208).

The life settlement arrangements that Pacific West sells are fractionalized interests in a type of life insurance policy called "universal" [*3]  or "flexible premium adjustable" life insurance. (See Brilliant Decl., Exh. 1 at 19, Exh. 2 at 46, Exh. 3 at 54). Universal life insurance policies have both an insurance component (i.e., they pay out when the insured dies) and a savings component (i.e., they accumulate investment returns). (See id., Exh. 4 at 35-36).1

1   Citations to Exhibit 4 are to the deposition transcript page numbers.

Pacific West's life settlement arrangements are regulated by the California Securities Division of the Department of Business Oversight. (See Calhoun Decl. at ¶ 10; Brilliant Decl., Exh. 7 at 209). Pacific West has "responded to multiple subpoenas duces tecum" served by the California Securities Division. (Calhoun Decl. at ¶ 12).

******

As in Noa and Belmont Reid, the court cannot determine -- at least at this preliminary stage -- whether Pacific West investors' profits substantially were contingent upon the efforts of Pacific West, or rather, the extrinsic factor of the underlying insureds' death. That is not to say, however, that defendants' conduct does not give the court pause. As in Belmont Reid, this case could be a close one at the summary judgment stage. See 794 F.2d at 1391. The three-tiered reserve system for Pacific West's investors (at a 46% margin), coupled with Pacific West's other activities may constitute the "undeniably significant" efforts required by Glenn Turner.

Finally, the court notes that there is a circuit split as to whether life settlements constitute investment contracts under the federal securities laws. The SEC relies on SEC v. Mutual Benefits Corp., 408 F.3d 737 (11th Cir. 2005), cert. dismissed, 551 U.S. 1180 (2007), for the proposition that "investment schemes may often involve a combination of both pre-and post-purchase managerial activities, both of which should be taken into consideration in determining whether Howey's test is satisfied." (Reply at 7) (citing Mutual Benefits, 408 F.3d at 744). But in reaching that conclusion, the Eleventh Circuit focused [*23]  on the complexity of the life settlement arrangements offered by defendants MBC in Mutual Benefits, and compared that apparent complexity with the simplicity of the arrangement in Noa, which depended on market fluctuations of the price of silver. See Mutual Benefits, 408 F.3d at 744 n. 5. Based upon this comparison, the Mutual Benefits court concluded that given the complexity of MBC's life settlement arrangements, the investors in Mutual Benefits relied on MBC's pre-purchase efforts while, for investors in Noa, "public information is available to investors by which they can independently evaluate the possible success of the investment." Id. But the Noa court did not consider the "complexity" or "simplicity" of the underlying arrangement in reaching its opinion. See, generally, Noa, 638 F.2d 77. Rather, the Noa court considered whether defendants' efforts were "the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise." Id. at 79 (citing Glenn W. Turner Enter., 474 F.2d at 482).

In turn, defendants rely on SEC v. Life Partners, Inc., 87 F.3d 536, rehearing denied, 102 F.3d 587 (D.C. Cir. 1996), for the proposition that "while post-purchase managerial efforts almost always trigger the application of the securities laws, pre-purchase efforts rarely do." (Opp'n at 7) (citing Life Partners, 87 F.3d at 548). But in reaching [*24]  that decision, the D.C. Circuit, which also relied on Noa, see Life Partners, 87 F.3d at 546-547, may have created a "pre-and post-purchase" delineation that was not a substantial factor in the Ninth Circuit's Noa decision, which focused on whether the success or failure of the investment was predicated on the essential managerial efforts of defendants, or rather, on market fluctuations in the underlying silver. See Noa, 638 F.2d at 79.

Ultimately, the court does not believe that the Eleventh or D.C. Circuit opinions in Mutual Benefits and Life Partners answer the question whether the Pacific West life settlement arrangement is a security under the federal securities laws. Each opinion tacitly adds additional factors to the Howey test that may not exist. The U.S. Supreme Court in Howey did not consider the complexity of the underlying transaction. See Howey, 328 U.S. at 298-99, 66 S.Ct. at 1102-03. Nor did the Howey Court distinguish between pre-and post-purchase efforts. See Howey, 328 U.S. at 298-99, 66 S.Ct. at 1102-03.

The Ninth Circuit's decisions in Noa, Belmont Reid, and Glenn Turner govern this court's decision. At this early stage, the record is insufficient for the court to conclude that Pacific West investors' profits substantially relied upon the "undeniably significant" efforts of Pacific West. See Glenn Turner, 474 F.2d at 482; Noa, 638 F.2d at 79 & 80; Belmont Reid, 794 F.2d at 1391. Thus, [*25]  the court finds that the SEC has not established the threshold issue of whether Pacific West's life settlement arrangement constitutes a security under the federal securities laws. As a result, the SEC has not demonstrated likelihood of success on the merits on any of its claims.

This Order is not intended for publication. Nor is it intended to be included in or submitted to any online service such as Westlaw or Lexis.

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