On July 22, 2010, the Securities and Exchange Commission's (the "SEC's") Life Settlements Task Force (the "Task Force") issued its Staff Report to the SEC. The most significant recommendation in the Staff Report was that the SEC should consider recommending to Congress that the definition of a "security" under the federal securities laws, including the Securities Act of 1933, as amended (the "Securities Act"), and the Investment Company Act of 1940, as amended (the "Investment Company Act"), be revised specifically to include life settlements.
Because the SEC already possesses the tools to characterize life settlements as securities, it is unnecessary for Congress to amend the securities laws. Furthermore, were Congress to make this amendment per the Task Force recommendation, the most probable consequence is that consumers seeking to sell their policies for more than cash value would have few, if any, options to do so.
The life settlements industry already is regulated in 43 of the 50 states, and life settlements are defined as a security under state law in 48 of the 50 states. While aspects of life settlements regulation remain patchwork in nature, nearly 90% of Americans live in a jurisdiction regulating the sale of life insurance into the secondary market. Mandating an additional layer of federal regulatory scrutiny is unlikely to offer investors any significant extra protection but will pose a real risk that regulatory compliance costs (licensure as broker-dealers, FINRA membership, potential Securities Act and Investment Company Act registrations) for industry participants will increase to the point that many of them will be unable to continue as a viable business, thereby depriving consumers of this important option for realizing the true value of their otherwise illiquid asset.
The principal concern with the Task Force's recommendation to amend federal securities laws is that it is unnecessary – the SEC already has the authority, where appropriate, to characterize life settlement investments as securities. Investments not explicitly defined as securities in the Securities Act or the Investment Company Act are frequently found to be within the jurisdiction of the SEC because they meet the test of being an "investment contract," which is explicitly defined as a security in the federal securities laws.
Over six decades of case law, including the seminal case, SEC v. W.J. Howey Co., have refined the test for determining when an investment constitutes a security. Why the SEC apparently believes the traditional Howey analysis is insufficient to police investments in life settlements is unclear. This conclusion is particularly perplexing when reviewed through the lens of the last fifteen years of state and federal case law. With only one notable exception, every case which has considered the issue of whether investments in life settlements are securities has concluded that they are. The one exception, SEC v. Life Partners, decided by the D.C. Circuit in 1996, is generally considered to have reached an incorrect conclusion.
In sum, the life settlements industry already is a comprehensively regulated industry. While it may be true that the regulation is not perfect, that does not make the life settlements industry unique. Rather than take the sweeping step of amending federal securities laws to define all life settlements as investments, and potentially significantly reduce a policy owner's ability to exercise their right to sell their policy into the secondary market, the SEC should continue to adhere to its tried and true investment contract analysis to determine whether any particular life settlement investment program involves the issuance or sale of a security.
James W. Maxson is Of Counsel in the firm's Insurance and Reinsurance Practice and co-chair's the firm's Life Settlement Practice. Mr. Maxson concentrates his practice in corporate and regulatory matters for the life settlement industry, as well as focusing on mergers and acquisitions and securities transactions. Mr. Maxson received his bachelor's degree from Denison University and law degree from the Ohio State University College of Law.
