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UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF TEXAS
AUSTIN DIVISION
SECURITIES AND EXCHANGE COMMISSION, :
Plaintiff,
v.
LIFE PARTNERS HOLDINGS, INC., BRIAN PARDO,R.SCOTTPEDEN,AND DAVID M. MARTIN
Defendants.
Civil Action No.: 1-12-cv-00033
DEFENDANTS LIFE PARTNERS HOLDINGS, INC. AND R. SCOTT PEDEN'S MOTION TO DISMISS AND BRIEF IN SUPPORT
J Pete Laney State Bar No. 24036942 E-Mail: jpete@jpetelaney.com
LAW OFFICES OF J PETE LANEY 1122 Colorado Street Suite 111 Austin, TX 78701-2159 Tel: (512) 473-0404 Fax: (512) 672-6123
Elizabeth L. Yingling State Bar No. 16935975 E-Mail: elizabeth.yingling@bakermckenzie.com Laura J. 0 'Rourke State Bar No. 24037219 E-Mail: laura.orourke@bakermckenzie.com Will R. Daugherty State Bar No. 24053170 E-Mail: wil1.daugherty@bakermckenzie.com
BAKER & McKENZIE LLP 2300 Trammell Crow Center 2001 Ross Avenue Dallas, TX 75201 Tel.: (214) 978-3000 Fax: (214) 978-3099
ATTORNEYS FOR DEFENDANTS, LIFE PARTNERS HOLDINGS, INC. AND R. SCOTT PEDEN
Case 1:12-cv-00033-JRN Document 12 Filed 02/29/12 Page 1 of 32
TABLE OF CONTENTS
I. PRELIMINARY STATEMENT ......................................................................................... 1
II. BACKGROUND ................................................................................................................. 2
III. STANDARDS ON A MOTION TO DISMISS .................................................................. .4
IV. ARGUMENTS AND AUTHORITIES ................................................................................ 5
A. Plaintiff Failed to Adequately Plead a Section 10(b) Claim based upon Alleged Short Life Expectancies ............................................................................... 5
1. Plaintiff Failed to Adequately Plead Motive ................................................. 6
2. Plaintiff Failed to Adequately Plead Conscious Behavior and Failed to Adequately Plead Material Misstatements or Omissions .............................. 8
a. Neither Dr. Cassidy's Methodology nor Peden's Alleged Incorrect Descriptions thereof Impose Liability on Defendants ............................. 8
b. Defendants did not Know that Dr. Cassidy's LEs were Materially Short ......................................................................................................... 9
c. Plaintiffs Allegation that LPHI Artificially Inflated its Revenues Defies Common Sense ........................................................................... 13
d. The Contingency Discussed in the Risk Disclosures had not Occurred ................................................................................................. 14
e. Plaintiff Failed to Adequately Allege Misrepresentations by Pardo ..... 17
B. Plaintiff Failed to Adequately Plead a Section 10(b) Claim for Accounting Fraud ..................................................................................................... 18
1. Plaintiff Failed to Plead Scienter with Respect to Revenue Recognition .................................................................................................. 18
2. Plaintiff Failed to Plead Scienter with Respect to Impairment .................... 20
C. Plaintiff Failed to Adequately Plead an Insider Trading Claim against Peden ........ 22
D. Plaintiff Failed to Adequately Plead a Section 17(a) Claim ................................... .23
E. Plaintiff Failed to Adequately Plead Section 13 Claims and Claims for Violations of Various Exchange Act Rules ............................................................................... 24
IV. CONCLUSION ........................................................................................................ 26
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TABLE OF AUTHORITIES
Page(s) CASES
Aaron v. SEC, 446 U.S. 680 (1980) ................................................................................................................. 23
ABC Arbitrage v. Tchuruk, 291 F.3d 336 (5th Cir. 2002) ..................................................................................................... 5
Abrams v. Baker Hughes, Inc., 292 F.3d 424 (5th Cir. 2002) ........................................................................................... 7, 8,20
Ashcroft v. Iqbal, 556 U.S. 662, 129 S. Ct. 1937 (2009) ............................................................................ 4, 10, 17
Bell At!. Corp. v. Twombly, 550 U.S. 544 (2007) ................................................................................................................... 5
Belodoffv. Netlist, Inc., No. SACV 07-00677 DOC (MLGx), 2009 U.S. Dist. LEXIS 78309 (C.D. Cal. September 1, 2009) ........................................................................................... 16, 17
Dirks v. SEC, 463 U.S. 646 (1983) ................................................................................................................. 22
Dorsey v. Portfolio Equities Inc., 540 F.3d 333 (5th Cir. 2008) ............................................................................................... 3, 11
Ellington Mgmt. Group, LLC v. Ameriquest Mortgage Co., No. 09 Civ. 0416 (JSR), 2009 U.S. Dist. LEXIS 91204 (S.D.N.Y. Sept. 29, 2009) ............... 14
Gonzalez v. Bank of Am. Ins. Servs., No. 11-20174,2011 U.S. App. LEXIS 25237 (5th Cir. Dec. 12,2011) ................................ 5, 9
In re Enron Corp. Sec. Litig., 258 F.Supp. 2d 576 (S.D. Tex. 2003) ...................................................................................... 17
In re Novatel Wireless Sec. Litig., No. 08cv1689 AJB RBB, 2011 U.S. Dist. LEXIS 135602 (S.D. Cal. Nov. 23,2011) ........... 18
In re Sterling Foster & Co. Sec. Litig., 222 F. Supp. 2d 289 (E.D.N.Y. 2002) ..................................................................................... 14
In re Sun Microsystems, Inc. Sec. Litig., No. C 89 20351 RPA, 1990 U.S. Dist. LEXIS 18740 (N.D. Cal. Aug. 20,1990) .................. 12
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In re Verifone Sec. Litig., 11 F.3d 865 (9th Cir. 1993) ..................................................................................................... 18
Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011) ............................................................................................................. 24
Jarrett v. Chase Home Fin. LLC, No. 3:10-CV-1907-M, 2011 U.S. Dist. LEXIS 47317 (N.D. Tex. May 3,2011) ..................... 5
Kurtzman v. Compaq Computer Corp., No. H-99-779, 2002 U.S. Dist. LEXIS 26569 (S.D. Tex. Mar. 30, 2002) ........................ 12, 20
Lovelace v. Software Spectrum, Inc., 78 F.3d 1015 (5th Cir. 1996) ................................................................................................. 3, 6
Nathenson v. Zonagen, Inc., 267 F.3d 400 (5th Cir. 2001) ..................................................................................................... 8
Gran v. Stafford, 226 F.3d 275 (3rd Cir. 2000) ................................................................................................... 17
Plotkin v. IP Axess Inc., 407 F.3d 690 (5th Cir. 2005) ................................................................................................... 17
SEC v. Adler, 137 F.3d 1325 (11th Cir. 1998) ............................................................................................... 23
SEC v. Cohen, No. 4:05-CV-371-DJS, 2007 U.S. Dist. LEXIS 28934 (B.D. Mo. Apri119, 2007) .... 19, 20, 25
SECv. Gann, No. 3:05-CV-0063-L, 2006 U.S. Dist. LEXIS 9955 (N.D. Tex. Mar. 13,2006) ................... .23
SEC v. Guenther, 395 F. Supp. 2d 835 (D. Neb. 2005) ................................................................................. .18, 19
SECv. Horn, No. 10-CV-955, 2010 U.S. Dist. LEXIS 135000 (N.D. Ill. Dec. 16,2010) ........................... .23
SEC v. Kelly, No. 08-Civ-04612 (CM), 2011 U.S. Dist. LEXIS 108805 (S.D.N.Y. Sept. 22,2011) ........ 5, 24
SEC v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996) ........................................................................................... 2, 8, 14
SEC v. Morgan Keegan & Co., No. 1:09-cv-1965-WSD, 2011 U.S. Dist. LEXIS 71481, (N.D. Ga. June 28,2011) ................ 9
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SEC v. Shanahan, 646 F.3d 536 (8th Cir. 2011) ............................................................................................... 6, 20
SEC v. Shanahan, No. 4:07CV270JCH, 2010 U.S. Dist. LEXIS 2101 (E.D. Mo. Jan. 12,2010) ........................ 25
SEC v. Shapiro, No. 4:05-CV-364, 2008 U.S. Dist. LEXIS 17039 (E.D. Tex. March 5, 2008) .......................... 5
SEC v. Steffes, No. 10-CV-6266, 2011 U.S. Dist. LEXIS 85496 (N.D. Ill. Aug. 3,2011) ............................. 23
SEC v. Truong, 98 F. Supp. 2d 1086 (N.D. Cal. 2000) ..................................................................................... 22
Southland Sec. Corp. v. Inspire Ins. Solutions Inc., 365 F.3d 353 (5th Cir. 2004) ..................................................................................................... 6
Tuchman v. DSC Comm 'ns Corp., 14 F.3d 1061 (5th Cir. 1994) ............................................................................................. 5, 6,8
United States v. Lloyds TSB Bank PLC, 639 F. Supp. 2d 326 (S.D.N.Y. 2009) ...................................................................................... 10
Vachon v. Baybanks, Inc., 780 F. Supp. 79 (D. Mass. 1991) ............................................................................................. 14
STATUTES
15 U.S.C. §78j(b) ................................................................................................................... passim
OTHER AUTHORITIES
Fed. R. Civ. P. 8(a) ............................................................................................................. 1,24,25
Fed. R. Civ. P. 9(b) ................................................................................................................ passim
Fed. R. Civ. P. 12(b)(6) ........................................................................................................ 1,24,25
21 5t Services, Life Settlement Services, Issues and Answers on 21 5t Services' Mortality Study, http://www.21stservices.com/science/cdrg.aspx ........................................................... .4
A. Hasan Qureshi and Michael V. Fasano, "Measuring Actual to Expected Accuracy for Life Settlement Underwriting," Reinsurance News, July 2010, Issue 68 .................................. 4
Ed Mohoric, FSA, MAAA, and Robert O. Kinney, M.D., FLMI, "Life Settlement Mortality Considerations and Their Effect on Portfolio Valuation," March 1, 2008 ............... .4
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Joseph T. King Jr., MD, MSCE, et al., Long-Term HIVIAIDS Survival Estimation in the Highly Active Antiretroviral Therapy Era, Medical Decision Making, Jan.-Feb. 2003 ............ 3
Michael L. Closen, Symposium on Health Care Policy: What Lessons Have We Learned from the AIDS Pandemic: Article: The Decade of Supreme Court Avoidance of AIDS: Denial of Certiorari in HIV-AIDS Cases and its Adverse Effects on Human Rights, 61 Alb. L. Rev. 897 (1998) ............................................................................................................. 3
Paul Siegert, Evolution of Life Expectancies in the Life Insurance Secondary Market ... Current Trends and New Developments, Life Insurance Settlement Series Edition No. VI (Aug. 4, 2010) ................................................................................................................ 8
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Case 1:12-cv-00033-JRN Document 12 Filed 02/29/12 Page 6 of 32
UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF TEXAS
AUSTIN DIVISION
SECURITIES AND EXCHANGE COMMISSION, :
Plaintiff,
v.
LIFE PARTNERS HOLDINGS, INC., BRIAN PARDO, R. SCOTT PEDEN, AND DAVID M. MARTIN
Defendants.
Civil Action No.: 1-12-cv-00033
DEFENDANTS LIFE PARTNERS HOLDINGS, INC. AND R. SCOTT PEDEN'S MOTION TO DISMISS AND BRIEF IN SUPPORT
Defendants, Life Partners Holdings, Inc. ("LPHI") and R. Scott Peden ("Peden")
(collectively "Defendants"), file this Motion to Dismiss, pursuant to Rules 8(a), 9(b), and
12(b)(6) of the Federal Rules of Civil Procedure, and respectfully show the Court as follows:
I. PRELIMINARY STATEMENT
Plaintiff seeks to hold Defendants liable for alleged misrepresentations and omissions in
violation of the federal securities laws. However, in fact, the Complaint contains only partial
disclosures and blatant misrepresentations of fact. By way of example, Plaintiff claims that
reports Life Partners, Inc. ("LPI") filed with the Texas Department of Insurance established that
insureds underlying 80% of matured policies facilitated by LPI using Dr. Donald Cassidy's life
expectancy estimates had outlived those estimates. In truth, more than 44% of those insureds
died at or prior to the estimates provided by Dr. Cassidy, making Plaintiff s 80% figure an
impossibility.
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In addition, although the bulk of the Complaint is devoted to LPI's business practices in
facilitating viatical and life settlements, and although Plaintiff misleadingly defines "Defendant[]
Life Partners Holdings, Inc." to specifically include LPI, LPI is not a party to this action, nor
could it be. More than a decade ago, Plaintiff sued LPI, claiming that the viatical settlements it
facilitated were securities under the federal securities laws - Plaintiff lost that case. See SEC v.
Life Partners, Inc., 87 F.3d 536, 549 (D.C. Cir. 1996). Now, well aware of its lack of
jurisdiction, Plaintiff attempts to bootstrap a case regarding LPI's business practices into one of
securities fraud by way of risk disclosures contained in LPHI's Forms 10-K. However,
Plaintiffs attempt to do so falls woefully short of the pleading requirements set forth in the
Federal Rules of Civil Procedure.
In short, and despite more than a year of investigation and Plaintiffs receipt of millions
of pages of documents, the Complaint, riddled with conclusory and misleading assertions, is
devoid of facts sufficient to plead the claims on which Plaintiff seeks relief.
II. BACKGROUND
LPHI is a publicly-traded company and the parent company of LPI since 2000. LPI, a
private company incorporated in 1991, is engaged in the secondary market for life insurance
known generally as "life settlements." Defendant Brian D. Pardo ("Pardo") is the CEO and
Chairman of the Board for LPHI and has held those positions since 2000. Peden is the General
Counsel, Secretary and Board member for LPHI, and has held those positions since 2000. He is
also the President of LPI. Defendant David M. Martin ("Martin") is the CFO of LPHI and LPI.
Martin became the CFO in February 2008.
When LPI commenced business in 1991, it facilitated the sale of viatical settlements,
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which are life insurance policies sold by a tenninally-ill person to another party.! More than
ninety percent (90%) of the viatical settlements that LPI facilitated were for viators living with
AIDS.2 Although only first identified in the early 1980s, as of mid-1997, more than 500,000
people in the U.S. had been diagnosed with AIDS, and approximately half of those had died.3 In
order to address this catastrophic illness, a multitude of experimental drugs were introduced,
with mixed results. As of 2003, studies emerged indicating that antiretroviral therapy appeared
to prolong survival in HIV/AIDS patients by 4 to 6 years, although "no long-tenn survival data
[was yet] available.,,4 Such antiretroviral therapy had been introduced in response to a prior drug
therapy thought to be significantly life-sustaining, but which was later shown to provide only a
one-time, six-month benefit.s The foregoing exemplifies the era of uncertainty in which AIDS
patients lived during the first three decades of the known existence of the disease. While,
ultimately, medical discoveries resulted in the extension of the lives of AIDS patients, such
longevity extensions could not have been predicted, but rather, were only detennined in
hindsight, after lengthy in-depth studies.
In light of the unprecedented medical breakthroughs in the treatment of AIDS patients,
beginning in fiscal year 2004, LPI began facilitating retail life settlements. 6 A life settlement
involves the sale of a life insurance policy by an insured who is not tenninally-ill but, rather, is a
1 LPHI 2006 Form 10-KSB, p. 3, found at www.sec.gov. On a motion to dismiss, the Court may rely on '''matters of which a court may take judicial notice.'" Dorsey v. Portfolio Equities Inc., 540 F.3d 333, 338 (5th Cir. 2008)(quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322 (2007)). This includes documents required to be filed with the SEC. See Lovelace v. Software Spectrum, Inc., 78 F.3d 1015, 1018 (5th Cir. 1996). 2 LPHI 2005 Form 10-KSB, p. 6, found at www.sec.gov. 3 Michael L. Closen, Symposium on Health Care Policy: What Lessons Have We Learnedfrom the AIDS Pandemic: Article: The Decade of Supreme Court Avoidance of AIDS: Denial of Certiorari in HIV-AIDS Cases and its Adverse Effects on Human Rights, 61 Alb. L. Rev. 897, at 906 (1998). 4 Joseph T. King Jr., MD, MSCE, et al., Long-Term HIVIAIDS Survival Estimation in the Highly Active Antiretroviral Therapy Era, Medical Decision Making, Jan.-Feb. 2003, at pp. 9-10, 14. 5Id. at p. 15. 6 LPHI 2004 Form 10-KSB, p. 3, found at www.sec.gov.
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senior citizen over the age of sixty-five.? Notably, because insurance companies generally do not
sell life insurance policies to senior citizens and, accordingly, do not have sufficient actuarial
data to track the mortality of such persons, there has been a lack of sufficient experience with
long-term mortality rates for the life settlement industry. For example, a March 1, 2008 public
report noted that "[t]he long-term experience in life settlement mortality is unknown. Short-term
experience is only beginning to emerge."s Indeed, as of July 2010, commentators were still
debating the methodology to be utilized in measuring the accuracy of life expectancies in the life
settlement market. 9
Despite the very public uncertainty regarding life expectancies experienced by all
companies in the viatical and life settlement market, and despite LPHI's repeated risk disclosures
regarding the impossibility of predicting any person's life expectancy exactly, Plaintiff, by the
Complaint, seeks to hold Defendants liable because - according to Plaintiff - the life expectancy
assessments made by a non-party medical doctor were not always "accurate." The fallacy of
Plaintiffs premise is ultimately the reason why the Complaint fails to state a claim for relief.
III. STANDARDS ON A MOTION TO DISMISS
A motion to dismiss should be granted where a plaintiff is unable to delineate "enough
facts to state a claim to reliefthat is plausible on its face." Ashcroft v. Iqbal, 556 U.S. 662, 129 S.
Ct. 1937, 1949 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). "The
Court will not accept 'threadbare recitals of the elements of a cause of action, supported by mere
conclusory statements,' which 'do not permit the court to infer more than the mere possibility of
7 Id. 8 Ed Mohoric, FSA, MAAA, and Robert O. Kinney, M.D., FLMI, "Life Settlement Mortality Considerations and Their Effect on Portfolio Valuation," March 1, 2008, at p. 6; see also 21 st Services, Life Settlement Services, Issues and Answers on 21 st Services' Mortality Study, http://www.21stservices.comlscience/cdrg.aspx ("[T]he [life settlement] industry has such a small data pool that mortality results are extremely volatile. The full shape of the mortality curve is not yet fully known."). 9 A. Hasan Qureshi and Michael V. Fasano, "Measuring Actual to Expected Accuracy for Life Settlement Underwriting," Reinsurance News, July 2010, Issue 68, at p. 26.
DEFENDANTS LIFE PARTNERS HOLDINGS, INC. AND R. SCOTT PEDEN'S MOTION TO DISMISS AND BRIEF IN SUPPORT - Page 4
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misconduct.'" Jarrett v. Chase Home Fin. LLC, No. 3:10-CV-1907-M, 2011 U.S. Dist. LEXIS
47317, at *7-8 (N.D. Tex. May 3, 2011)(quoting Iqbal, 129 S. Ct. at 1949-50). In short, a district
court "'retain[ s] the power to insist upon some specificity in pleading before allowing a
potentially massive factual controversy to proceed. '" Twombly, 550 U.S. at 558.
Because Plaintiff has asserted claims of securities fraud, the Complaint must satisfy the
heightened pleading requirements of Rule 9(b). In order to state a claim under Rule 9(b),
plaintiffs generally must plead the who, what, where, and when of the alleged fraud. ABC
Arbitrage v. Tchuruk, 291 F.3d 336, 349 (5th Cir. 2002); see also Gonzalez v. Bank of Am. Ins.
Servs., No. 11-20174, 2011 U.S. App. LEXIS 25237, at *8-9 (5th Cir. Dec. 12, 2011) (a
complaint must state the "time, place and contents of the false representations, as well as the
identity of the person making the misrepresentation and what [that person] obtained thereby").
IV. ARGUMENTS AND AUTHORITIES
A. Plaintiff Failed to Adequately Plead a Section lOeb) Claim based upon Alleged Short Life Expectancies.
In order to state a claim under Section 1 O(b) and Rule 10b-5 promulgated thereunder,
Plaintiff must allege that each of the Defendants: (1) used a fraudulent device, made a material
misrepresentation or omission, or committed an act that operated as a fraud or deceit; (2) in
connection with the purchase or sale of a security; and (3) acted with scienter. 10 SEC v. Shapiro,
No. 4:05-CV-364, 2008 U.S. Dist. LEXIS 17039, at *10 (E.D. Tex. March 5, 2008). To
adequately plead scienter, Plaintiff "must set forth specific facts that support an inference of
fraud." Tuchman v. DSC Comm 'ns Corp., 14 F.3d 1061, 1068 (5th Cir. 1994). Although a
10 Other than reciting the elements of Rule 1 Ob-5( a) and 1 Ob-5( c) claims, Plaintiff failed to allege any facts to support such claims separate and apart from its misrepresentation claim under Rule lOb-5(b). Compl., ~157(i),(ii). However, "where the primary purpose and effect of a purported scheme is to make a public misrepresentation or omission, courts have routinely rejected the SEC's attempt to bypass the elements necessary to impose 'misstatement' liability under subsection (b) by labeling the alleged misconduct a 'scheme' rather than a 'misstatement. '" SEC v. Kelly, No. 08-Civ-04612 (CM), 2011 U.S. Dist. LEXIS 108805, at *8 (S.D.N.Y. Sept. 22, 2011). Accordingly, Plaintiffs claim for liability claims under Rule 10b-5(a) and (c) claims must be dismissed.
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finding of scienter may be based upon "severe recklessness," "[i]t is insufficient to show that a
defendant should have known that a material statement or omission was false or misleading."
SEC v. Shanahan, 646 F.3d 536, 544 (8th Cir. 2011). "Alleged facts are sufficient to support an
inference of scienter if they either (1) show a defendant's motive to commit securities fraud, or
(2) identify circumstances that indicate conscious behavior on the part of the defendant."
Lovelace, 78 F.3d at 1018. In the absence of sufficient allegations of motive, "the strength of the
circumstantial allegations [indicating conscious behavior on the part of the defendant] must be
correspondingly greater." Tuchman, 14 F.3d at 1068. Further, when assessing allegations of
scienter relating to a corporate defendant, courts must address the allegations of scienter as to
each individual officer defendant to determine whether the complaint satisfies the heightened
pleading requirements of scienter. Southland Sec. Corp. v. Inspire Ins. Solutions Inc., 365 F.3d
353, 366 (5th Cir. 2004).
Plaintiff s "disclosure" fraud claims are premised upon the unsupported allegation that
"Life Partners systematically used materially underestimated LEs"ll and that Defendants
misrepresented "that the underestimation ofLEs was a contingent risk." I 2 Yet, Plaintiff failed to
adequately plead motive, knowledge, or a material misstatement or omission, and thus, the
"disclosure" claims must be dismissed.
1. Plaintiff Failed to Adequately Plead Motive.
Plaintiff does not plead motive with respect to Defendant Martin.13 In fact, the
Complaint's only allegations of motive are that Defendants Pardo and Peden sold LPHI stock. 14
However, allegations of insider trading by corporate defendants are only probative of scienter if
11 "LEs" is a shorthand term for life expectancy estimates. 12 Compl., ~~1, 10. 13 See generally, Compl. 14 Compl., ~~14, 138-43.
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the trading occurs in suspicious amounts or at suspicious times. Abrams v. Baker Hughes, Inc.,
292 F.3d 424, 435 (5th Cir. 2002). As to Peden, Plaintiffrelies on a June 18, 2007 sale of LPHI
stock, but alleges no facts establishing that the amount of the trade was suspicious. IS In fact,
public filings establish that, after his sale, Peden retained 44,097 (pre-split) shares of LPHI stock
(over 81% of his shares).16 Moreover, the timing of the sale was not suspicious, given that the
sale occurred more than fifteen (15) months after Peden purportedly became aware that Life
Partners systematically underestimated LEs.17 Finally, because the price of LPHI stock
increased substantially after his stock sale, Peden clearly did not sell to "maximize personal
profit" or to prevent imminent losses in the value of his shares. 18
Similarly, Plaintiff cites Pardo Family Trust stock sales, without any allegations that such
sales were in suspicious amounts or at suspicious times. 19 Rather, according to the Complaint,
the first sale occurred one (1) year after Pardo purportedly knew of the underestimation of LEs.2o
In addition, the Complaint also alleges that, as of June 2010, Pardo directly or indirectly owned
more than 50% of LPHl,21 Had Pardo been in possession of material non-public infonnation and
intended to "maximize his personal profit," one would think he would have caused the Pardo
Family Trust to dispose of significant shares long before news of the SEC investigation hit the
market. Nor are there allegations in the Complaint that the sales were unusual or out of line with
historical trades for Pardo or the Pardo Family Trust. See Abrams, 292 F.3d at 435 (allegations
of insider trading not probative of scienter because no allegations that the sales were "out of line
with prior trading practices or at times calculated to maximize personal profit"); see also
15 CompI., ~~138-43. 16 See Form 4 Statement of Changes in Beneficial Ownership of Securities filed on June 25, 2007, a true and correct copy of which is included in the Appendix as Exhibit A. 17 See CompI., ~138. 18 See http://finance.yahoo.com/gihp?s=LPHI+Historical+Prices. 19 See CompI., ~139. 20 See CompI., ~139. 21 CompI., ~23.
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Nathenson v. Zonagen, Inc., 267 F.3d 400,420-21 (5th Cir. 2001).
Finally, the absence of allegations that Defendant Martin engaged in improper trading
activity further establishes that Pardo's and Peden's sales do not support an inference of scienter.
See Abrams, 292 F.3d at 435 (unsual sales by one insider "do not give rise to a strong inference
of scienter" when other defendants did not sell shares). Accordingly, Plaintiff's allegations
concerning Pardo's and Peden's stock sales are insufficient to support an inference of scienter
based upon motive, and therefore, Plaintiff's allegations of conscious behavior are subject to a
more stringent standard for establishing scienter. See Tuchman, 14 F.3d at 1069.
2. Plaintiff Failed to Adequately Plead Conscious Behavior and Failed to Adequately Plead Material Misstatements or Omissions.
a. Neither Dr. Cassidy's Methodology nor Peden's Alleged Incorrect Descriptions thereof Impose Liability on Defendants.
Plaintiff alleges that Dr. Cassidy's practices in projecting LEs for LPI's use in facilitating
life settlements deviate from the purported "standard practices" in the life settlement industry
because he is a medical doctor and not an actuary, and because he uses mortality data generated
by the U.S. Govemment.22 However, because this is not a suit against LPI, its use of Dr. Cassidy
and, thus, his methodology, are not at issue, nor could they be since the life settlement
transactions are not securities under the federal securities laws.23
Knowing this, Plaintiff attempts to bootstrap Dr. Cassidy's methodology into a claim for
securities fraud when it alleges that Peden, in October and November 2008, misrepresented "to
an investor" and to a non-investor, respectively, that Dr. Cassidy used a different actuarial table
22 See Compl., ~~5, 32, 35. Defendants dispute that a "standard practice" actually exists in the industry and, to the extent it exists, the timing of when such "standard practice" emerged. See, e.g., Paul Siegert, Evolution of Life Expectancies in the Life Insurance Secondary Market ... Current Trends and New Developments, Life Insurance Settlement Series Edition No. VI (Aug. 4, 2010)("[U]nderwriting guidelines vary substantially among LE underwriters, and most of the life settlement underwriters have developed unique mortality curves based on their own experience of mortality patterns."). 23 See SEC v. Life Partners, 87 F.3d at 549; see also 15 U.S.C. §78j(b) (requiring misstatements or omission "in connection with" the purchase or sale of a security).
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than what he was actually using.24 The foregoing allegations fail to set forth the time and place
for the statements, the identities of the persons to whom the statements were made, and what
Peden "obtained thereby." Therefore, the allegations are insufficient under Rule 9(b). Gonzalez,
2011 U.S. App. LEXIS 25237, at *8-9.
Moreover, for Peden's alleged statements to be actionable, such statements must have
been made "in connection with" the purchase or sale of a security.25 Thus, Peden's November
2008 statement to a non-investor cannot give rise to liability or establish a strong inference of
scienter. Nor does Peden's October 2008 statement to an alleged "investor" give rise to such
liability or establish scienter. More specifically, the Complaint refers to purchasers of viatical
and life settlements as "investors," as distinguished from its references to "shareholders" of
LPHI,26 thereby confirming that Peden's October 2008 statement was not made to a purchaser of
LPHI securities and, thus, was not made "in connection with" the purchase or sale of a security.27
In short, both Dr. Cassidy's methodology and Peden's alleged incorrect statements
related thereto are red herrings, providing no basis for liability or a finding of scienter against
any Defendant.
b. Defendants did not Know that Dr. Cassidy's LEs were Materially Short.
Plaintiffs repeated allegations that Defendants knew Dr. Cassidy's LEs were materially
short not only defy logic, but also are refuted by the very documents on which Plaintiff
purportedly relies in support of its claim.
24 Compl., ~~43-44. 25 15 U.S.C. §78j(b). 26 Compare Compl., ~~2, 3, 4, 5, 9, 11 with ~~1, 14. 27 Moreover, even a purportedly inaccurate statement by Peden to a "shareholder" would not alter the total mix of information available to LPHI's shareholders, thus precluding any liability with respect to that statement. See, e.g., SEC v. Morgan Keegan & Co., No. 1:09-cv-1965-WSD, 2011 U.S. Dist. LEXIS 71481, at *31-37 (N.D. Ga. June 28, 2011)(rejecting SEC's argument that statements made to four investors were sufficient to impose liability, holding that "[t]he SEC must do more than show a few isolated instances of alleged ... misconduct to obtain the relief it seeks.").
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As conceded in the Complaint, Dr. Cassidy did not begin providing LE estimates to LPI
until after his predecessor, Dr. Kelly, passed away.28 Thus, Dr. Cassidy's first LE estimates were
not provided until October 1999.29 According to Plaintiff, the average LE generated by Dr.
Cassidy from 2000-2005 was 3.8 years. 30 By way of example, then, the insureds underlying
policies facilitated for the first half of calendar year 2000 would not have reached the estimated
LE until, on average, the latter half of calendar year 2003. For policies facilitated in latter half of
calendar year 2000, the insureds would not have reached the estimated LE until, on average, the
first half of calendar year 2004, and so on.
Despite the foregoing, Plaintiff relies on LPHI Audit Committee minutes discussing the
nine months ended November 30, 2002 in alleging that "at least as early as 2003, it was apparent
... that the LEs used ... were materially short.,,31 Plaintiff then assumes that the reference in
the minutes related to Dr. Cassidy's LEs when Plaintiff alleges that Pardo and Peden did not
"determine why Life Partners was not seeing the expected number of maturities based on
Cassidy's LEs.,,32 However, neither the minutes nor Plaintiffs conclusory allegation establish
"knowledge" regarding the purported inaccuracy of Dr. Cassidy's LEs as of November 2002,
especially when considered in light of Dr. Cassidy's 3.8 year average LE. As the U.S. Supreme
Court has noted, "[ d]etermining whether a complaint states a plausible claim for relief will, ...
be a context-specific task that requires the reviewing court to draw on its judicial experience and
common sense." Iqbal, 129 S.Ct. at 1950; see also United States v. Lloyds TSB Bank PLC, 639
F. Supp. 2d 326, 342 (S.D.N.Y. 2009)(applying common sense in rejecting the Government's
28 CompI., ~5. 29 Dr. Kelly passed away on September 20, 1999. See the redacted, certified copy of Dr. Kelly's death certificate, included in the Appendix as Exhibit B. 30 CompI., ~40. 31 CompI., ~49 (emphasis added). 32 CompI., ~50.
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claim of securities fraud). Common sense dictates that Plaintiffs conclusory leap of faith must
be rejected as a basis for imposing knowledge, and thus, securities fraud liability on Defendants.
What is most shocking about the Complaint's allegations is the inexcusable
misrepresentation of LPI's annual filings with the Texas Department of Insurance ("TDI").
More specifically, Plaintiff represented that "[t]he reports filed by Life Partners for 2003 through
2009 reveal that insureds underlying approximately 80% of matured policies that the Company
brokered had outlived Cassidy's LEs.,,33 To the contrary, however, the TDI reports establish that
45.6% of the matured policies from 2003-2009 that were arguably based on Dr. Cassidy's LEs
actually matured before, or in the month of, the estimated LE.34 Moreover, the reports
establish that an additional 14.64% of the policies matured within 1 year of the LE projection,
and another 12.97% matured within 2 years of the LE projection.35 Therefore, more than 73%
of the maturities from 2003-2009 were on, before, or within 2 years of Dr. Cassidy's estimates-
hardly an indication that Dr. Cassidy's LEs were 8 to 9 years off.36
In addition to the foregoing, Plaintiff provides its own table in the Complaint, from
unknown origin, claiming that it purports to depict the policies exceeding Dr. Cassidy's LEs "for
the universe of policies from which his success rate is measurable.,,37 However, the chart and
surrounding allegations fail to satisfy the Rule 9(b) requirements, as the chart fails to specifically
allege the source of the information, and fails to specify whether each of the Defendants received
such information, in what form, when, and whether the conclusions Plaintiff now draws were
drawn by Defendants during the relevant time periods. Absent that information, the chart and
33 Compl., ~51. 34 Included in the Appendix as Exhibits C-l through C-7 are true and correct copies of the portions of LPI's reports filed with the TDI from 2003-2009 showing the maturities during each of those respective years. It is appropriate for Defendants to include same with the Motion to Dismiss because they are referred to in the Complaint. Dorsey, 540 F.3d at 338. Exhibit D in the Appendix is a chart summarizing the Cassidy-related data set forth in Exhibit C. 35 See Exhibits C and D in the Appendix. 36 See Compl., ~40. 37 Compl, ~~41, 54.
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associated allegations must be rejected. See Kurtzman v. Compaq Computer Corp., No. H-99-
779, 2002 U.S. Dist. LEXIS 26569, at *10-18, 38-50 (S.D. Tex. Mar. 30, 2002)(rejecting
scienter claims based on general references to reports where there were no allegations about the
actual contents of the reports, whether defendants read the reports, or whether the information in
the reports had been reported to defendants).
One of the Complaint's more puzzling allegations is the contention that LPHI "disclosed
in its periodic filings with the Commission that it advanced money to pay premium payments ...
when the amounts escrowed for premiums was depleted.,,38 Plaintiff then uses this public
disclosure to support its allegation that Defendants knew the LEs were short.39 If, in fact,
Plaintiff is correct, and the disclosure of the "steady" increase in premium payments imputed
knowledge to Defendants of the LE underestimation, then, because that increase was publicly
disclosed, the public, in tum, was provided with the knowledge of the LE underestimation, and
Plaintiffs fraud claim vanishes. See, e.g., In re Sun Microsystems" Inc. Sec. Litig., No. C 89
20351 RP A, 1990 U.S. Dist. LEXIS 18740, at * 7 (N.D. Cal. Aug. 20, 1990)("If the material
containing the alleged omission actually discloses the facts that plaintiffs claim are absent there
is obviously no omission.").
Plaintiff next alleges that a "consultant" retained by a "firm" in 2006 recommended in a
"report" that LPI "track, analyze and validate" Dr. Cassidy's LEs.40 This allegation fails to
satisfy Rule 9(b) because it fails to specifically identify the "firm," the "report," to whom the
report was provided, and when the report was provided. Further, and more importantly, the
allegation fails to support any basis for the imputation of knowledge of the alleged
underestimation of LEs - indeed Plaintiff makes no claim that the report so found. Thus, this
38 Compl., ~52. 39 Compl., ~52. 40 Compl., ~53.
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allegation must also be disregarded.
Finally, Plaintiff relies on a complaint filed by, and a subsequent settlement LPI made
with, the Colorado Securities Division as apparent support for Defendants' knowledge of the
underestimation of LEs.41 Importantly, Plaintiff does not allege that the Colorado action was
based, in whole or in part, on Dr. Cassidy's LEs. Indeed, the only allegation regarding LEs
contained in the Colorado Securities Commission's 17-page complaint is the one quoted by
Plaintiff.42 It is impossible to discern from this one statement whether the allegation related in
any way to Dr. Cassidy's LEs. Notably, the publicly-available settlement of the Colorado case
contained no findings or admissions regarding the accuracy or inaccuracy of Dr. Cassidy's LEs,
as the settlement only related to the claim by Colorado that the life settlements were securities
under Colorado law.43 Thus, Plaintiffs reliance on the Colorado case is yet another red herring,
having no bearing on this case or on Defendants' alleged knowledge of the asserted
underestimation of LEs.
c. Plaintiff's Allegation that LPHI Artificially Inflated its Revenues Defies Common Sense.
Perhaps the most obvious example of Plaintiff s attempt to bootstrap a business practices
case against a private company not engaged in the sale of securities into a federal securities fraud
case against the public parent company is the following allegation:
Using Cassidy's materially short LEs enabled Life Partners to artificially inflate its revenues, as the Company extracted significantly more money from investors than it would have had it priced life settlements based on appropriately
41 CompI., ~55. 42 See CompI., ~55 (quoting from the Colorado complaint the following allegation: "the high frequency rate in which viators outlived life expectancies predicted by Life Partners."). See First Amended Complaint for Injunctive and Other Relief filed in Joseph v. Life Partners, Inc., Case No. 2007 CV 5218, ("Colorado Action"), a true and correct copy of which is included in the Appendix as Exhibit E. 43 See Stipulation for Permanent Injunction and Other Relief, filed in the Colorado Action, and attached order of Permanent Injunction and Other Relief, a true and correct copy of which is included in the Appendix as Exhibit F. Conveniently omitted from the Complaint is a reference to the Stipulation that resolved the action, wherein the Colorado Securities Commission represented that "no investor has alleged or asserted any impropriety against Defendants with respect to their investment . . . ."
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developed LEs. During fiscal years 2006 through 2011, Life Partners extracted more than $400 million of revenue from the life settlement transactions it brokered.44
On its face, this allegation is nonsensical, as how could LPI (or LPHI) have artificially inflated
revenues if, as the Plaintiff concedes, LPI actually received $400 million in revenues? In reality,
Plaintiff is not complaining that LPI (or LPHI) claimed it made $400 million in revenues when,
in fact, it did not. Rather, Plaintiff asserts that, in its opinion, LPI received too much money
from the facilitation of life settlement transactions, i.e., from non-securities transactions: "Thus,
by overvaluing its policies using materially short LEs, Defendants were able to extract from
investors ... approximately $555 million more than they could have reasonably expected to earn
using appropriately developed LEs.,,45 However, Plaintiff lacks jurisdiction to complain of those
transactions in light of SEC v. Life Partners, Inc.46
d. The Contingency Discussed in the Risk Disclosures had not Occurred.
Plaintiff seeks to reverse-engineer a business practices case into a securities fraud case by
threading its claims through a risk disclosure contained in LPHI's Forms 10-K, only portions of
which Plaintiff quoted in the Complaint. However, because the risk disclosures were accurate,
and the "contingency" addressed by the disclosures had not occurred, Plaintiff s claims based on
such disclosures must be dismissed.47
44 Compl., '1145 (emphasis added). 45 Compl., '1148. 46 Further, Plaintiffs hypothetica1s regarding how LPI might have priced a particular policy with a six-year LE, as opposed to a four-year LE, (Compl., '1147), and what the returns on investment might be with "appropriately developed LEs" (Compl., '1148) fails to satisfy the heightened pleading requirements of Rule 9(b). See, e.g., Ellington Mgmt. Group, LLC v. Ameriquest Mortgage Co., No. 09 Civ. 0416 (JSR), 2009 U.S. Dist. LEXIS 91204, at *10 (S.D.N.Y. Sept. 29, 2009)(rejecting, under Rule 9(b), plaintiffs' attempt to substitute "indirect, hypothetical allegations for more directly applicable factual allegations"); In re Sterling Foster & Co. Sec. Litig., 222 F. Supp. 2d 289,307 (E.D.N.Y. 2002); Vachon v. Baybanks, Inc., 780 F. Supp. 79, 82 (D. Mass. 1991). 47 Plaintiffs quotation from the risk disclosure contained in LPHI's 2006 Form lO-K is inappropriate, as Plaintiff has not asserted claims against Defendants based on the 2006 Form lO-K. It is also unclear whether or not Plaintiff is asserting a claim related to LPHI's 2011 Form lO-K, as discussed infra. See Compl., '11'11147,152,162, 168, 175, 178,181,182.
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The following language is an excerpt from the risk disclosure contained in LPHI's 2008
Form 10-KJA. While some of the wording changed slightly, this excerpt is substantially the
same as that contained in each of LPHI's Forms 10-K for fiscal years 2007-2011:
Life expectancies are generally estimated from standard medical and actuarial data based on the historical experiences of similarly situated persons. The data is necessarily based on averages involving mortality and morbidity statistics. The outcome of a single settlement may vary significantly from the statistical average. It is impossible to predict anyone insured's life expectancy exactly. To mitigate the risk that an insured will outlive his or her predicted life expectancy, we price life settlements to yield competitive returns even if this life expectancy prediction is exceeded. . ..
If we underestimate the average life expectancies and price our transactions too high, our purchasers will not realize the returns they seek, demand may fall, and purchasers may invest their funds elsewhere . ...
We cannot assure you that, despite our experience in settlement pricing, we will not err by underestimating or overestimating average life expectancies or miscalculating reserve amounts for future premiums. If we do so, we could lose purchasers or policy sellers, and those losses could have a material adverse effect on our business,jinancial condition, and results of operations.48
Accordingly, the fact that LEs could be underestimated and the potential negative impact
underestimation could have on future business operations was clearly disclosed as a risk. There
is nothing even arguably misleading about the foregoing that needed to be corrected.
Plaintiff asserts, however, that LPHI had a duty to disclose that the "contingency" had
already occurred.49 Plaintiffs assertion is misplaced. The "contingency" disclosed in the above-
quoted risk disclosure is a contingency that, to the extent life expectancies are underestimated
and LPI prices the transactions too high, then LPI could lose purchasers or could lose policy
sellers, and those losses could then have a material adverse effect on the "business, financial
48 LPHI 2008 Form lO-KI A, p. 11 (emphasis added). True and correct copies of excerpts from LPHI's Forms lO-K for 2007-2011, setting forth the applicable risk disclosures, are contained in the Appendix at Exhibits G - K. 49 Compl., ~56.
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condition, and results of operation.,,5o Such a contingency did not occur, and Plaintiff has not
contended otherwise. 51
On this issue, Belodoffv. Netlist, Inc., is instructive. 52 In that case, plaintiff alleged that
the defendant failed to disclose that customer demand for its products was in significant
decline. 53 The court originally dismissed the complaint based, in part on this allegation, but gave
plaintiff leave to amend, holding that if the defendant "already knew that its customers were
significantly reducing their orders at the time of the lPO and had been for some time, Defendants
[sic] representation of such an event as a contingency in the risk disclosure statement would be
deceitful.,,54 In dismissing the same claim from plaintiffs second amended complaint, the court
noted that the sales figures set forth in defendant's public filings demonstrated "an increase and
flat-lining of sales up and through the lPO," thereby defeating plaintiffs claim that defendants
knew of the "significant decline in customer demand. 55 Likewise, in this case, LPHI's business,
financial condition, and operations for fiscal years 2007-2010, consistently exhibited dramatic
improvement, with revenues increasing from $30.3 million in fiscal year 2007 to $108.8 million
in fiscal year 2010, and net income increasing from $3.8 million in fiscal year 2007 to $26.1
million in fiscal year 2010.56 Such figures refute Plaintiffs claim that LPHI failed to disclose a
known risk. This is especially true in light of the inadequacy of Plaintiffs allegations regarding
Defendants' knowledge of the purported underestimation of LEs, as discussed, supra. For the
50 See id. 51 See generally, Compl. 52 No. SACV 07-00677 DOC (MLGx), 2009 U.S. Dist. LEXIS 78309 (C.D. Cal. Sept. 1,2009). 53 2009 U.S. Dist. LEXIS 78309, at *19. 54 [d. at *8. 55 [d. at *22-26. 56 See excerpt from LPHI's 2011 Form 10-K, in the Appendix as Exhibit K. While LPHI's revenue and net income decreased in fiscal year 2011 from fiscal year 2010, the 2011 numbers were still dramatically higher than those posted in fiscal years 2007 and 2008. Importantly, to the extent Plaintiff contends that the 2011 risk disclosure was materially misleading, Plaintiff ignores the disclosure in the same Form 10-K describing Plaintiffs allegations regarding the inaccuracy of the LEs. See Exhibit K. Thus, any claim regarding the 2011 Form 10-K must be dismissed as failing to allege a material misstatement or omission.
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same reasons, Plaintiff s claim that Defendants' risk disclosure was misleading because it failed
to disclose "a material trend impacting [LPHI's] revenues" in contravention of Item 303 of
Regulation S-K must also be rejected. See Belodoff, 2009 U.S. Dist. LEXIS 78309 at *27-28.57
e. Plaintiff Failed to Adequately Allege Misrepresentations by Pardo.
Plaintiff alleges that Defendant Pardo misrepresented the rates of return for LPI
customers in October 2007 and October 2008 conference calls.58 However, Plaintiff fails to
specify any documents establishing that the ROls were inaccurate, and whether and how Pardo
knew they were inaccurate at the time of his statements. 59 Thus, the allegation violates Rule 9(b)
and must be rejected. See Plotkin v. IP Axess Inc., 407 F.3d 690,696 (5th Cir. 2005).
In addition, Plaintiffs allegation that LPI, when conveying "historic ROI," did not take
into account "policies that remained active beyond their LE,,,60 must be rejected as defying
common sense. It goes without saying that a life insurance policy that is still "active" is a policy
for which the insured is still living. Because purchasers of viaticals or life settlements do not
receive death benefits until the insured has died, it would be impossible to provide an accurate
ROI for "active" policies, for such cannot be appropriately calculated until there are "returns" to
calculate. 61 Thus, common sense requires a rejection of this allegation. See Iqbal, 129 S.Ct. at
1950. Further, to the extent, by this claim, Plaintiff is alleging that Defendants had a duty to
predict or speculate what the ROls would be for policies that will mature in the future, such an
57 Notably, "a violation ofItem 303 's reporting requirements does not automatically give rise to a material omission under Rule 10b-5." Gran v. Stafford, 226 F.3d 275, (3rd Cir. 2000); see also In re Enron Corp. Sec. Litig., 258 F.Supp. 2d 576, 633 n.63 (S.D. Tex. 2003). 58 Compl., ~~6l-62. 59 Compl., ~62. 60 See Compl., ~63. 61 See, e.g., Return on investment, http://financial-dictionary.thefi·eedictionary.com/return+on+investment, at p. 1 (citing Farlex Financial Dictionary) (ROI defined as "[t]he money that a person or company earns as a percentage of the total value invested."); Return on Investment (RO!): Meaning and Use, http://www.solutionmatrix.com/returnon-investment.html at p. 2 ("Return on investment is frequently derived as the 'return' (incremental gain) from an action divided by the cost of that action.").
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allegation must also be rejected. See, e.g., In re Verifone Sec. Litig., 11 F.3d 865, 868-869 (9th
Cir. 1993)(rejecting securities fraud allegations based on failures to make a forecast of future
events).
B. Plaintiff Failed to Adequately Plead a Section 1 OCb) Claim for Accounting Fraud.62
Plaintiff alleges that Defendants are liable under Section 1 O(b) because LPHI issued a
Restatement regarding a variety of accounting issues, including revenue recognition. 63 However,
Plaintiff has failed to adequately allege scienter, necessitating dismissal of this claim. This is
especially true with respect to Defendants Pardo and Peden who are not alleged to be
accountants or to have any accounting expertise sufficient to challenge the treatment given to any
particular transaction. See In re Novatel Wireless Sec. Litig., No. 08cv1689 AJB RBB, 2011
U.S. Dist. LEXIS 135602, at *41 (S.D. Cal. Nov. 23,2011). Furthermore, even as to Defendant
Martin, who was the CFO for only part of the time the SEC alleges Defendants engaged in
accounting fraud, Plaintiff makes no allegations that he was aware of any wrongdoing or directed
any improper activity. Accordingly, the "accounting fraud" claims must be dismissed.
1. Plaintiff Failed to Plead Scienter with Respect to Revenue Recognition.
"[T]o give rise to section 1 O(b) liability for fraud, the mere second-guessing of
calculations will not suffice; the [SEC] must show that defendants' judgment - at the moment
exercised - was sufficiently egregious that a reasonable accountant reviewing the facts and
figures should have concluded that the company's financial statements were misstated and that
as a result the public was likely to be misled." SEC v. Guenther, 395 F. Supp. 2d 835, 845 (D.
62 Although Plaintiff asserts Section 10(b) claims against Defendants "through November 2011," Plaintiff does not specify what statements made by Defendants in 2011 are false. While the Form 10-K that contained the restatements at issue was filed in November 2011, Plaintiff does not assert that any of the financial data was inaccurate. On its face, then, this claim fails to satisfy Rule 9(b). 63 See CompI., ~~64-137, 152.
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Neb. 2005). The Complaint fails to adequately allege that any of Defendants Pardo, Peden or
Martin (1) knew that revenue was not being properly recorded; (2) knew that the disclosed
revenue recognition policy was not being followed; or (3) knew that any backdating of
documents was occurring that could impact revenue recognition.64 Indeed, based upon the
Complaint's allegations, it appears that the backdating of documents occurred throughout the
year, and that such backdating did not occur only at quarter or year end in a concerted effort to
alter revenue. Further, the fact that restated revenues for fiscal years 2007-2010 and the first
three quarters of 2011 showed that, for some periods, revenue was understated, as opposed to
overstated, evidences a lack of intent to systematically overstate revenues. Absent allegations of
knowledge, participation or motive, Plaintiffs claims in this regard must be dismissed.
Strikingly similar claims made by Plaintiff in another case were rejected due to the same
deficiencies. In SEC v. Cohen, the SEC sued the CFO of a public company that issued an
accounting restatement as a result of improper revenue recognition.65 The SEC alleged that, as
the CFO, defendant knew that the company was prematurely recording revenue and, further, that
the CFO was motivated to manipulate the revenues in order to inflate the company's revenues
and earnings, facilitate the company's secondary offering, and derive personal gain from annual
bonuses and stock sales.66 After a bench trial, the court found that the SEC had failed to prove
scienter because (1) there was "no evidence that defendant knew the various managers assigned
to properly report the revenue were not performing their jobs correctly," and (2) there was "no
evidence that the managers were pressured by defendant to accelerate revenue.,,67 Further,
because the restatement of revenues resulted in both over- and understatements, the court found
64 See CompI., ~~69-118, 159. 65 No. 4:05CV371-DJS, 2007 U.S. Dist. LEXIS 28934, at *3, 25-27 (E.D. Mo. April 19, 2007). 66Id. at *48-53. 67Id. at *48-49.
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that it could not "discern a pattern where ... [the] revenue was strategically shifted.,,68 Finally,
the court rejected the argument that the CFO's single sale of stock "significantly below the all-
time high and at months away from the secondary offering" supported scienter.69 Although the
Cohen case was a bench trial in which the SEC had an opportunity to present evidence of
scienter, the fact that Plaintiff has not even asserted such allegations in this case - or, to the
extent it has, has only done so improperly - further highlights the necessity for dismissal of
Plaintiff s claims in this case.
Plaintiff improperly attempts to allege "knowledge" of improper revenue recognition
when it asserts that Martin reviewed and approved quarter-end accrual journal entries, and
asserts that Pardo and Peden "monitored daily, monthly, quarterly, and annual contract activity,
including contract funding status .... ,,70 However, Plaintiff fails to specifically identify to
which reports Plaintiff refers, and how those reports revealed to each Defendant that revenue was
being recognized improperly; therefore, the allegations are violative of Rule 9(b). See Abrams,
292 F.3d at 432; Kurtzman, 2002 U.S. Dist. LEXIS 26569 at *10-18, 38-50.71 Likewise,
Plaintiffs claim that "Pardo, Peden and Martin were aware of periodic cancellations and
rescission of Seller Agreements, which exposed the impropriety of Life Partners' revenue
recognition practices" is conclusory and fails to sufficiently state a claim for scienter.72 See SEC
v. Shanahan, 646 F.3d at 544.
2. Plaintiff Failed to Plead Scienter with Respect to Impairment.
Plaintiff s allegations regarding the calculation of impairment is premised on the same
faulty analysis of Dr. Cassidy's LEs discussed supra, coupled with improper conclusory claims.
68Id. at *51. 69!d. at *52-53. 70 Compl., ~73. 71 Plaintiff's allegations regarding auditor communications from 2004 (Compl., ~~81-83) must be disregarded, as Plaintiff makes no claims against Defendants for time periods prior to January 2007. 72 Compl., ~88
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For example, without any factual support, Plaintiff alleges that, "[d]espite their awareness that
these policies may have been impaired when acquired, Defendants failed to properly evaluate
potential impairment.,,73 This allegation fails to satisfy the pleading requirements for scienter.
Plaintiff further improperly alleges that "Pardo, Peden, and Martin understood that the
Company's impairment calculations depended on the validity of Cassidy's LEs.,,74 However,
Plaintiff provides no factual basis to support the claim that (1) the policies at issue were all
purchased using Dr. Cassidy's LEs, (2) Defendants Pardo, Peden and Martin knew, at the time
that the policies were purchased, that the policies were "impaired," or (3) assuming Defendants
knew the policies were impaired, that Defendants knew the extent of the impairment.
Next, Plaintiff contends that in the summer of 2010, in a response to a request by Ernst &
Young, Defendants Peden and Martin provided a chart "on the most recent 300 maturities of
viatical and life settlement policies sold by Life Partners.,,75 Plaintiff then attempts to attach a
nefarious motive to the provision of the chart, when it alleges that Peden and Martin "failed to
alert E&Y" that insureds underlying 1,200 of the outstanding policies had outlived Dr. Cassidy's
LEs.76 The absurdity of this claim is obvious - if, as readily admitted by Plaintiff, Peden and
Martin provided E& Y with the "most recent" maturities, how was E& Y misled? Plaintiff does
not allege that E& Y requested information regarding all outstanding policies, that Defendants
refused to provide that information, or that Defendants provided false information in response to
such hypothetical request. Absent such assertions, this allegation provides no basis to establish
scienter related to LPHI's impairment analysis.
73 Compl., ~119. 74 Compl., ~126. 75 Compl., ~127. 76 Compl., ~127.
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Plaintiff also alleges that E& Y recommended - in May 2010 - that LPHI conduct a
quarterly analysis of the accuracy of initial LEs to determine if adjustments needed to be made to
the underwriting process.77 Of course, this allegation undermines Plaintiff s claim that any of the
Defendants knew that Dr. Cassidy's LEs were significantly underestimated and, further,
undermines Plaintiffs claim that Defendants knew LPHI's impairment analysis was incorrect.
C. Plaintiff Failed to Adequately Plead an Insider Trading Claim against Peden.
In order to state a claim of insider trading under Section 1 O(b), Plaintiff must plead that
Peden sold LPHI stock while in possession of material, non-public information, and with
scienter. See Dirks v. SEC, 463 U.S. 646, 653-54 (1983). However, "[c]ourts stress that the SEC
can not base insider trading actions on strained inferences and speculation." SEC v. Truong, 98
F. Supp. 2d 1086, 1098 (N.D. Cal. 2000).
Plaintiffs insider trading claim against Peden is based upon a single sale of a fraction of
Peden's holdings of LPHI shares that took place in June 2007.78 Plaintiff asserts that Peden had
the following non-public information in his possession when he made his single trade: "[I]t was
Life Partners' practice to systematically use materially short life expectancy estimates to broker
life settlements, and that this practice had the effects of artificially inflating the Company's
revenues and profit margins, and creating investor demand for the life settlements that Life
Partners brokered and that would not exist but for the Company's practice of doing SO.,,79 As
discussed in Sections A(2)(b),(c), and (d), the Complaint is devoid of sufficient allegations that
would establish Peden's possession of the alleged material, non-pUblic information. Indeed, the
fact that, according to Plaintiff, "Peden did not follow the recommendation to analyze Cassidy's
LEs" allegedly made by an undisclosed "firm" in 2006, only further supports the inference that
77 CompI., ~128. 78 CompI., ~139. 79 CompI., ~154.
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Peden was not in possession of material, non-pUblic infonnation.8o Further, any attempt by
Plaintiff to impute knowledge of the "non-public" infonnation concerning LEs to Peden because
that infonnation was accessible to him due to "the Company's internal policy tracking system,,81
is equally unavailing. See, e.g., SEC v. Horn, No. 10-CV-955, 2010 U.S. Dist. LEXIS 135000,
at *17 (N.D. Ill. Dec. 16, 2010) ("[P]roof of access to nonpublic infonnation is not proof of
possession of that infonnation."). Nor has Plaintiff alleged circumstantial evidence against
Peden, such as selling LPHI shares in suspicious amounts or at suspicious times. The absence of
such allegations lies in stark contrast to the more typical insider trading claims. See, e.g., SEC v.
Steffes, No. 10-CV-6266, 2011 U.S. Dist. LEXIS 85496, at *44-45 (N.D. Ill. Aug. 3, 2011)
(unusual trading in amounts and timing supported an inference of scienter); SEC v. Adler, 137
F.3d 1325, 1340 (11th Cir. 1998) (same).
Accordingly, because the Complaint fails to adequately allege scienter, Plaintiffs Section
1 O(b) claims of insider trading against Peden must be dismissed.
D. Plaintiff Failed to Adequately Plead a Section 17(a) Claim.
Plaintiffs Section 17(a) claim is premised upon January and February 2007 filings by
LPHI wherein Plaintiff alleges LPHI, Pardo and Peden made misrepresentations or omissions
regarding revenue recognition.82 To establish a violation of Section 17(a)(1), Plaintiff must
allege the defendants (1) made material misrepresentations or materially misleading omissions,
(2) in the offer or sale of securities, (3) with scienter. Aaron v. SEC, 446 U.S. 680,697 (1980).
The same elements apply under Sections 17(a)(2) and 17(a)(3), except that no scienter is
required. Id. Plaintiffs scienter allegations must be pled, as to each defendant, with requisite
particularity under Rule 9(b). See SEC v. Gann, No. 3:05-CV-0063-L, 2006 U.S. Dist. LEXIS
80 CompI., ~53. 81 CompI., ~54. 82 CompI. ~147.
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9955, at *9 (N.D. Tex. Mar. 13,2006).
The Section 17(a) claim based on LPHI's February 2007 public filings must be dismissed
because there were no LPHI filings in that month that referenced LPHI's revenue recognition
policies.83 Further, for each of the reasons set forth in Sections B(l) and C(l) herein, Defendants
cannot be liable under Section 17(a)(1) for the January 2007 Form 10-QSB because Plaintiff has
failed to sufficiently allege scienter. Finally, Defendants cannot be liable under Section 17(a)(2)
or (3) because Plaintiff cannot premise scheme liability on a misrepresentation claim. See SEC
v. Kelly, 2011 U.S. Dist. LEXIS 108805, at *8_15.84
E. Plaintiff Failed to Adequately Plead Section 13 Claims and Claims for Violations of Various Exchange Act Rules.
The Complaint's Third through Sixth Claims allege various violations of the Exchange
Act for the filing of false statements, the failure to maintain books and records, the failure to
maintain and implement internal accounting controls, and the making of false statements to an
accountant. 85 However, many of the same deficiencies previously discussed, similarly, require
dismissal of these claims.
For example, Plaintiffs reliance on the allegation that Defendants failed to disclose a
"material risk" to LPHI's business or a material trend impacting LPHI's revenues in support of
such claims must be dismissed, as Plaintiff has not plead a material misstatement with respect
thereto. 86 Likewise, Plaintiffs aiding and abetting claims against Defendants Pardo, Peden and
83 See Form 4 Statement of Changes in Beneficial Ownership of Securities filed on February 14,2007, and Form 8-K filed on February 20,2007, true and correct copies of which are included in the Appendix as Exhibits Land M. 84 Additionally, Peden cannot be liable for the January 2007 Form 10-QSB because he did not sign same and, thus, did not "make" the statement. See Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296, 2302-2305 (2011); SEC v. Kelly, 2011 U.S. Dist. LEXIS 108805, at *8-15. 85 CompI., pp. 50-53. 86 See Section A(2) herein. Plaintiff expressly relies on these allegations to support the Third Claim for Relief. CompI., ~162. It is unclear whether Plaintiff is relying on these allegations to support their remaining claims for relief. In that regard, the allegations fail to put Defendants on notice of the claims against them in violation of Rule 8(a) and 12(b)(6).
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Martin under the Third, Fourth and Fifth Claims for Relief must be dismissed because Plaintiff
has failed to allege that any of the Defendants knew of the problems with LPHI's revenue
recognition or impairment calculations. See SEC v. Cohen, 2007 U.S. Dist. LEXIS 28934, at
*53-59 (dismissing claims under Sections 13(a), 13 (b)(2), 13(b)(5) and related rules based upon
defendant CFO's lack of knowledge of the accounting issues and lack of evidence that defendant
directed someone to falsify company's books and records.). Such is especially true with respect
to Defendants Pardo and Peden, neither of whom are alleged to be responsible for the accounting
books and records or the internal controls related to accounting. See, e.g., SEC v. Shanahan, No.
4:07CV270JCH, 2010 U.S. Dist. LEXIS 2101, at * 15-18 (B.D. Mo. Jan. 12, 2010)(rejecting
Section 13(b )(2)(A) claim "in absence of evidence that defendant was responsible for the
corporation's books and records or for maintaining adequate controls").
Plaintiff s Sixth Claim is based on a conclusory allegation that the individual Defendants
made false and misleading statements "to an accountant.,,87 However, Plaintiff has failed to
adequately plead that any of Pardo, Peden or Martin, when they signed management
representation letters to the auditors,88 knew of the existence of any material errors in LPHI's
financial statements. Nor are there sufficient allegations that, at the time they signed those
letters, the individual Defendants knew that the system of internal controls was inadequate. Such
lack of knowledge (or pleading of same) is fatal to the Sixth Claim for Relief. See SEC v.
Cohen, 2007 U.S. Dist. LEXIS 28934, at *59-60.
87 Compl., ~178. 88 Defendants assume that Plaintiff is relying on the management representation letters to support this claim. However, Plaintiff fails to specify what statements they are relying on in support of their claim, in violation of Rules 8(a) and 12(b)(6).
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IV. CONCLUSION
For each of the reasons stated herein, Defendants respectfully request that the Motion be
granted in its entirety, and that Plaintiffs Complaint against them be, in all things, dismissed.
J Pete Laney State Bar No. 24036942 E-Mail: jpete@jpetelaney.com
LAW OFFICES OF J PETE LANEY 1122 Colorado Street Suite 111 Austin, TX 78701-2159 Tel: (512) 473-0404 Fax: (512) 672-6123
Respectfully submitted,
/s/ Elizabeth L. Yingling Elizabeth L. Yingling State Bar No. 16935975 E-Mail: elizabeth.yingling@bakem1ckenzie.com Laura J. O'Rourke State Bar No. 24037219 E-Mail: laura.orourke@bakermckenzie.com Will R. Daugherty State Bar No. 24053170 E-Mail: will.daugherty@bakem1ckenzie.com
BAKER & McKENZIE LLP 2300 Trammell Crow Center 2001 Ross Avenue Dallas, TX 75201 Tel.: (214) 978-3000 Fax: (214) 978-3099
ATTORNEYS FOR DEFENDANTS, LIFE PARTNERS HOLDINGS, INC. AND R. SCOTT PEDEN
CERTIFICATE OF SERVICE
I hereby certify that on February 29, 2012, I electronically filed the foregoing document
with the Clerk of the Court using the CMlECF system, which will send notification of such filing
to all counsel who have registered with the Court. All others were served a copy via U.S. mail.
/s/ Elizabeth L. Yingling
DALDMS1707410.5
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