Feds want to get their hands on life settlements, observers say

As states propose and pass rules for oversight of life settlement transactions, industry participants wonder just how far the Securities and Exchange Commission will reach into the market to provide uniform guidance on disclosure and broker registration.

“I can think of 12 to 15 cases in the last 12 months in which investors lost hundreds of millions of dollars on these transactions,” said Larry Rybka, president of ValMark Securities Inc. in Akron, Ohio. “The SEC definitely needs to be more involved in that area.”

Although the SEC’s involvement in the life settlement market already comes into play for variable-life-insurance policies as well as the securitization of policies, a letter sent recently by SEC Chairman Mary L. Schapiro to Sen. Herbert Kohl, D-Wis., who is chairman of the Senate Special Committee on Aging, suggested that the commission will also look at the registration of life settlement providers and brokers. The SEC declined to comment further.

Life settlements involve the sale of an insurance policy on a person’s life to a third-party investor.

The SEC’s role in life settlements came up before Mr. Kohl’s committee during an April 29 hearing on the issue. There, he had state regulators and representatives from the life insurance industry and two life settlement firms speak about fraudulent schemes — such as stranger-originated life insurance practices — and asked them to formulate ways to improve regulatory oversight.

Some federal paths into life settlements have already been forged.

For example, the Financial Industry Regulatory Authority Inc. of New York and Washington covered life settlements in its Notice to Members 06-38 in 2006. The notice discussed the use of suitability standards and due diligence for broker-dealers who recommend the sale of an existing variable-life-insurance policy to a third party.

That rule, along with landmark enforcement proceedings in SEC v. Lydia Capital LLC — a case that involved investments in fraudulent life settlements — have paved the way for the commission to step in, perhaps as early as this year, Mr. Rybka said.

State regulators have addressed life settlement problems by inspecting providers and transactions that they think are suspicious, but they would like a uniform solution for issues such as consumer and investor disclosures and licensing.

There is no definition in the Securities Act of 1933 of life settlements, and a 1996 case in the U.S. Circuit Court for the District of Columbia, SEC v. Life Partners Inc., led to a decision that the purchase of settlements for private clients isn’t the same as a securities transaction.

However, a number of states have pursued cases challenging the decision. For example, Fred J. Joseph, securities commissioner in Colorado, pursued Waco, Texas-based Life Partners Inc. in civil court in 2007 for selling unregistered securities in his state.

In that case, a Colorado state appeals court said it was “not persuaded” by SEC v. Life Partners and ruled against the company.

Now in Colorado, third-party investment interests in a life insurance policy must be registered and sold by individuals who are securities-licensed.

Mr. Joseph, who is also president of the North American Securities Administrators Association Inc. in Washington, said that the majority of states consider investments in life settlements to be securities transactions.

“Maybe I’m promoting the fact that we need to make it clear at the federal level that this is a security,” he said. Once the SEC does this, uniform licensing mandates for the parties involved will have to follow, Mr. Joseph added.

Also, in the past, life settlement providers haven’t responded well to probes from state regulators. Inquiries from securities or insurance commissioners have led to lawsuits against the regulators, with the firms disputing the commissioners’ jurisdiction.

Experts think that the SEC could handle the additional regulatory load of life settlements, but it would likely need to work with state regulators to be effective. Federal intervention would likely require cooperation from states, said Stephan R. Leimberg, chief executive of Leimberg Information Services Inc., a Fernandina Beach, Fla., financial legislation and regulation analysis service.

“No state person wants to have the [feds] take over, but it’s clear from the Madoff scandal and the subprime problems that the agencies need to cooperate with each other,” he said.

Mr. Joseph said state securities regulators do generally cooperate with the SEC, but that the NASAA hasn’t been in touch with the commission on how the two would work in tandem on life settlements.

However, opponents of federal regulation say that the SEC would be incapable of handling complaints directly, as state commissioners do. The system — in which states adopt life settlements model acts from the National Association of Insurance Commissioners of Kansas City, Mo., or the National Conference of Insurance Legislators in Troy, N.Y. — establishes licensing and disclosure requirements without help from the federal government, they say.

“You would have a bifurcated system and confusion on how things would play out” with a federal system, said Susan Nolan, executive director of the NCOIL. “The legislators are close to the consumers buying the products, so they’re the best ones to regulate,” she said.

The Internal Revenue Service recently published guidance on taxing life settlements — both the lump sum that the seller receives and the income tax that the buyer pays upon receiving the insured’s death benefit. The move signals that the federal government is ready to act, Mr. Rybka said.

“Remember that Ms. Schapiro was the big senior executive in Finra and that this was her No. 2 issue when she was there,” he said.

“She’s been looking at it for two years,” Mr. Rybka said. “I expect something significant from the SEC on this.”

E-mail Darla Mercado at [email protected].

Related Topics: Money Management Institute (MMI), Securities and Exchange Commission