WHAT’S IN A NAME? TEXAS SUPREME COURT CLARIFIES WHAT CONSTITUTES A “SECURITY.”

Life Partners, Inc. v. Arnold

Life Partners Holdings, Inc. v. State of Texas

Supreme Court of Texas, Nos. 14-0122 & -0226 (May 8, 2015)

Consolidated Opinion by Justice Boyd

Joshua Kipp

Often we rely on a particular label to define what something is. When determining whether a particular offering is a “security” under the Texas Securities Act, that doesn’t work. Merely calling it something else is not enough. The Supreme Court of Texas will look at the economic ramifications of the offering and decide whether the offering is a “security.” If the offering is a “security,” there can be significant repercussions.

Life Partners has been engaged in the business of buying existing life insurance policies from those whose lives the policies insure, and then selling interests in those policies to others for over 20 years. These transactions are referred to as “life settlements” when the insured is elderly or “viatical settlements” when the insured is terminally ill. Life Partners has consistently marketed these offerings as something other than securities—“life settlements” and “viatical settlements.”

Last week, the Supreme Court of Texas ruled that Life Partners’ product was an “investment contract” and thus a “security” under the Texas Securities Act. Under the Texas Securities Act, a “security” is defined broadly as “any limited partner interest in a limited partnership, share, stock, treasury, stock, ... investment contract, or any other instrument known as a security, whether similar to those herein referred to or not.” The Court clarified that (1) “the Texas Securities Act’s definition of ‘securities’ must be construed broadly to maximize the protection it provides to investors, while focusing on the economic realities of the transaction regardless of any labels or terminology the parties may have used”; (2) an “investment contract” for the purposes of the Texas Securities Act “means a contract transaction, or scheme through which a person pays money to participate in a common venture or enterprise with the expectation of receiving profits, under circumstances in which the failure or success of the enterprise, and thus the person’s realization of the expected profits, is at least predominately due to the entrepreneurial or managerial, rather than merely ministerial or clerical, efforts of others”; and (3) “the entrepreneurial or managerial efforts that are relevant to this inquiry ... include those that are made prior to the transaction as well as those that are made after.”

In arriving at this ruling, the court relied on and interpreted federal precedent. However, the court departed from the decision of the D.C. Circuit in S.E.C. v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996), determining that the assessment whether the expected profits were due to the “efforts of others” could take into account pre-investment efforts. This expansion from looking only at post-investment efforts of others—which the D.C. Circuit had found “merely ministerial or clerical” and thus not causing “life settlements” and “viatical settlements” to be “investment contracts” or “securities”—to looking at both pre- and post-investment efforts of others could open the door to questions regarding how the security-versus-non-security line is drawn for other investments in the future.