Page 1
Sales of Fractional Interests in Life Settlements Fall Within Securities Act—Ninth Circuit
Opinion Acknowledged Federal Split, Says Such Policies Qualify as ‘Investment Contracts’
By a MetNews Staff Writer
The Ninth U.S. Circuit Court of Appeals held yesterday that fractional interests in life insurance policies, purchased from the original insureds based on a strategic decision that the death benefit will likely come due before the premium payments deplete the value, are “securities” within the meaning of federal law because the profits come from the “efforts of others,” namely the investment firms selling the products.
At issue is whether the practice of selling the fractioned interests in the life settlements—which originally emerged during the 1980s AIDS crisis when terminally ill patients began selling their policies to investors to fund their care—falls within the regulatory scheme of the Securities Act of 1933. The question arose after Pacific West Capital Group (“PWCG”) began strategically buying the products with an eye toward resale.
In April 2015, the Securities and Exchange Commission sued the company, the trust it established to serve as the owner of the policies, PWCG’s founder, Andrew B. Calhoun IV, among other officers, and three individual sales agents, Brenda Barry, Eric Cannon, and Caleb Moody, alleging that the defendants violated §5 of the Securities Act by offering and selling unregistered products and by failing to register as broker-dealers. They asserted:
“During the period from 2004 through November 2014, Pacific West received approximately $45.9 million of the total $99.9 million raised from investors as its ‘margin,’ on the sales of life settlements.”
Yesterday’s decision, authored by Senior Circuit Judge Richard R. Clifton and joined in by Circuit Judges Ronald M. Gould and Gabriel P. Sanchez, found that the products qualify as “securities” and so are subject to the act, siding with two U.S. Circuit Courts of Appeals on the issue and declining to follow a contrary ruling by the U.S. Circuit Court of Appeals for the District of Columbia.
In so ruling, they held that a broker’s “pre-purchase activities” may be taken into account in determining whether a product is subject to federal securities laws.
Selection of Policies
PWCG selected policies based on determinations that the insureds were likely to die in four to seven years. The company developed a three-tiered system for making premium payments.
The “primary” reserve held enough money to pay on policies for six to nine years.
If those funds were depleted, the premiums would be pulled from a fund comprised of 1% of all invested capital or from the “general reserve,” holding excess money attributable to policies where the insureds had died earlier than anticipated.
After the system failed because too many of the original insureds lived longer than the company had anticipated, approximately 150 investors were called upon to pay the premiums on the policies underlying their fractional interests, which amounted to an aggregate sum of more than $1.7 million.
Calhoun and PWCG were also charged with securities fraud, and each settled with the commission after agreeing to pay millions in disgorgement and hundreds of thousands of dollars in penalties. After claims against all other parties had been resolved, the SEC moved for summary judgment against Barry, Cannon, and Moody.
Senior District Court Judge Dean Pregerson of the Central District of California granted the agency’s motion in 2023, finding that the life settlements were securities and that the defendants had failed to establish an applicable exemption. He later ordered Barry to pay $227,000, Cannon to pay $219,000, and Moody to pay $180,000, representing one-third of the commissions received by each agent on sales of fractional interests.
Pregerson also ordered each defendant to pay civil penalties of $15,000 and enjoined Cannon from future violations of securities laws, finding that he had limited recognition of his wrongdoing and represented that he intended to remain in the financial services industry.
Definition of ‘Security’
Clifton noted that the Securities Act defines “security” broadly as including an “investment contract” and that the 1946 U.S. Supreme Court decision in U.S. Securities and Exchange Commission v. W.J. Howey Company established that a scheme will be considered such an agreement if it involves the contribution of money to a common enterprise and the profits come solely from the “efforts of others.”
Saying that the case turns on the “others” element, Clifton commented that “if an investor is dependent on a seller to provide efforts that could lead to profits, then the…requirement is satisfied.” Applying these principles, he opined:
“[T]hree features of PWCG’s life settlements—its selection of specific policies on certain terms, its construction and operation of its premium reserve system, and the fractionalized nature of the interests—together satisfy the…requirement that profits come ‘from the efforts of others.’ ”
Turning to the selection of policies, he pointed out that the company emphasized its expertise in choosing policies in its promotional materials and remarked:
“Investors understood PWCG to be recommending policies to them and found the curation valuable, including the assessment that the insured would likely die soon enough to make the purchase profitable.”
Rejecting the defendants’ argument that the profits were not dependent on PWCG but on the longevity of the original insureds, he said:
“Defendants confuse ‘profit’ with ‘payout.’…[A]n investor’s profit…depends not just on an insured’s death but also on the price that PWCG secured for that policy and on the number and size of additional premium payments needed to maintain the policies.”
Pre-Purchase Activities
Clifton said that “[w]e agree with the Eleventh and Fifth Circuits that pre-purchase activities can be relevant for evaluating whether profits can be expected to come from the efforts of others,” reasoning that “a bright line between pre- and post-purchase activities would be inappropriately formalistic given the purpose and function of the federal securities laws.”
Adding that “a disregard of pre-purchase efforts could open loopholes,” he wrote:
“If courts discounted pre-purchase entrepreneurial efforts in assessing whether a transaction was an investment contract, then promoters could front-load their activities before any investor provides consideration for a legal interest.”
Concluding that the company’s reserve structure “is another feature that supports our conclusion” that the profits are based on the “efforts of others,” Clifton said that the “system played a significant role in whether investors would profit.” He reasoned:
“[P]rofitability turned on how skillfully PWCG structured that system. If PWCG estimated insureds’ lifespans poorly, as it did, then that would undermine investors’ profits by increasing the cost investors would have to pay to maintain the policies.”
As to the fractionalized nature of the investors’ interests, he declared:
“Each policy had multiple investors with fractional interests, sometimes as many as fifty to seventy. Investors could not calculate premium payments themselves. They relied on PWCG…to decide when to make premium payments and issue premium calls. If the reserve system broke down and some investors did not pay premium calls, PWCG would have to decide whether its own money would cover any potential shortfalls.”
Turning to the disgorgement order, he said:
“Defendants argue that the district court erred in awarding disgorgement because disgorgement requires pecuniary harm to victims and no pecuniary harm exists since investors are projected to recover the money they invested.
“We affirm the district court’s finding of pecuniary harm. Buyers of PWCG’s fractional interests in life settlements suffered pecuniary harm through the loss of the time value of their money.”
The case is U.S. Securities and Exchange Commission v. Barry, 23-2699.
Copyright 2025, Metropolitan News Company