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8/2/2019 SEC Response to Motion to Dismiss - LPHI and Peden
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UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF TEXAS
AUSTIN DIVISION
_____________________________________________
SECURITIES AND EXCHANGE COMMISSION, :
:Plaintiff, : Civil Action No.: 1:12-cv-00033
:v. :
:LIFE PARTNERS HOLDINGS, INC., BRIAN D. :PARDO, R. SCOTT PEDEN, AND :DAVID M. MARTIN, :
:Defendants. :
:
RESPONSE TO LIFE PARTNERS
HOLDINGS, INC, AND SCOTT PEDENS MOTION TO DISMISS
DATED: April 2, 2012 Respectfully submitted,
/s/ Jason C. Rodgers
Jason C. Rodgers
Texas Bar No. 24005540Toby M. GallowayTexas Bar No. 00790733Michael D. KingTexas Bar No. 24032634
U.S. Securities and Exchange CommissionBurnett Plaza, Suite 1900801 Cherry Street, Unit #18Fort Worth, TX 76102-6882(817) 978-1410 (jcr)
(817) 978-4927 (fax)Attorneys for Plaintiff Securities and ExchangeCommission
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TABLE OF CONTENTS
TABLE OF CONTENTS ......................................................................................................... ii-iii
TABLE OF AUTHORITIES ................................................................................................ iv-viii
I. Introduction .......................................................................................................................1
II. The Complaint States Claims for Violations of the Antifraud Provisions Based on
Defendants Misrepresentations and Omissions ...............................................................2
A. The Rule 12(b)(6) Standard. .................................................................................2
B. The Complaint States a Claim for Violations of the Antifraud Provisions Based on
Defendants Misrepresentations About LE Underestimation ...............................3
III. The Complaint Alleges Violations of the Antifraud Provisions with theParticularity Required Under Rule 9(b), and With Allegations That
Compel the Inference of Scienter .....................................................................................5
A. Scienter Under the Antifraud Provisions ..............................................................6B. Pleadings Standards for Scienter and Particularity Under Rule 9(b) ....................7C. Allegations of Conscious Behavior Support the Inference of Scienter ................8
1. Life Partners, through Pardo, arranged for the LEs it used to be materiallyshort...........................................................................................................8
2. Peden tried to cover up the Companys practice of systematicallyusing short LEs to broker life settlements...............................................10
3. The Complaint alleges a track record of chronic LE underestimationsthat further support the inference of scienter ..........................................11
4. Defendants continued the Companys practice of systematicallyUsing underestimated LEs, despite red flags that called the
Practice into question, which Defendants ignored ..................................14
D. Allegations of Motive Further Support the Inference of Scienter ......................16IV. Well-Pleaded Allegations Support Plaintiffs Claims for Accounting Fraud .................16
A. Under Its Policy of Partial Revenue Recognition, Life PartnersRecognized Revenue Prematurely, in a Manner Inconsistant With GAAP ........18
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B. Pardo and Peden Established Life Partners Policy of Premature RevenueRecognition, and Directed Martin to Follow the Policy After He
Became CFO .......................................................................................................18
C. Rescissions Exposed the Impropriety of Life Partners RevenueRecognition Policy ..............................................................................................20
D. Pardo and Peden Facilitated the Accounting Fraud Through Deceit ..................21E. Defendants Employed Premature Revenue Recognition as a
Matter of Course .................................................................................................22
F. The Complaint Adequately Alleges Accounting Fraud Based on ImproperImpairment of Company-Owned Policies ..........................................................22
V. The Court States Claims Under Rule 10b-5(a) and (c), of the Exchange Act,
and Sections 17(a) (1)-(3) of the Securities Act .............................................................23
VI. The Court Should Deny the Motion on the Rest of Grounds It Raises...........................24
VII. Conclusion .................................................................................................................25
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TABLE OF AUTHORITIES
FEDERAL CASES
Aaron v. SEC,
446 U.S. 680 (1980) .........................................................................................................................6
Abrams v. Baker Hughes Inc.,
292 F.3d 424 (5th Cir. 2002) .........................................................................................................18
In re Apple Computer Sec. Litig.,
886 F.2d 1109 (9th Cir.1989) ........................................................................................................15
Ashcroft v. Iqbal,
556 U.S. 662 (2009) .........................................................................................................................2
Bailey v. Linsco/Private Ledger Corp.,
136 F.R.D. 11 (D. Me. 1991) .........................................................................................................12
Bell Atlantic Corp. v. Twombly,
550 U.S. 544 (2007) .........................................................................................................................2
Belodoff v. Netlist, Inc.,
No. SACV-07-00677, 2009 WL 2777320 (C.D. Cal., Sept 1, 2009) ..............................................4
Broad. v. Rockwell Intl Corp.,
642 F.2d 929 (5th Cir.), cert. denied, 454 U.S. 965 (1981) .............................................................6
Chu v. Sabratek Corp.,
100 F. Supp. 2d 815 (N.D. Ill. 2000) .............................................................................................16
In re Daou System Inc,
411 F.3d 1006 (9th Cir. 2005) .......................................................................................................19
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Ernst & Ernst v. Hochfelder,
425 U.S. 185 (U.S. 1976) .................................................................................................................6
Freudenberg v. Etrade Fin. Corp.,
712 F. Supp. 2d 171 (S.D.N.Y 2010)...............................................................................................3
In re GlenFed, Inc. Sec. Litig.,
42 F.3d 1541 (9th Cir. 1994) ...........................................................................................................7
Graham v. SEC,
222 F.3d 994 (D.C. Cir. 2000) .......................................................................................................23
Guidry v. Bank of LaPlace,
954 F.2d 278 (5th Cir. 1992) ...........................................................................................................7
Hollinger v. Titan Capital Corp.,
914 F.2d 1564 (9th Cir. 1990) .......................................................................................................15
Howard v. SEC,
376 F.3d 1136 (D.C. Cir. 2004) .....................................................................................................23
Huddleston v. Herman & MacLean,
640 F.2d 534 (5th Cir.), aff'd in part, rev'd in part on other grounds, 459 U.S. 375 (1983) ..........3
In re IKON Office Solutions, Inc.,
277 F.3d 658 (3d Cir 2002)..............................................................................................................6
Janus Capital Group, Inc. v. First Derivative Traders,
131 S. Ct. 2296 (2011) ...................................................................................................................23
Kurtzman v. Compaq Computer Corp.,
No. H-99-779, 2002 U.S. Dist. LEXIS 26569 (S.D. Tex. Mar. 30, 2002) ....................................13
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Litwin v. Blackstone Group, L.P.,
634 F.3d 706 (2d Cir.), cert. denied, 132 S.Ct. 242 (2011) .............................................................3
Lormand v. US Unwired, Inc.,
565 F.3d 228 (5th Cir. 2009) andIn re Prudential Sec. Inc. L.P Litig., 930 F.Supp. 68, 72
(S.D.N.Y. 1996) ...............................................................................................................................3
Lovelace v. Software Spectrum, Inc.,
78 F.3d 1015 (5th Cir. 1996) .....................................................................................................6, 16
Novak v. Kasaks,
216 F.3d 300 ..................................................................................................................................21
In re Novatel Wireless Sec. Litig.,
No. 08cv1689, 2011 U.S. Dist. LEXIS 135602 (S.D. Cal. Nov. 23, 2011) ..................................18
Priester v. Lowndes County,
354 F.3d 414 (5th Cir. 2004) ...........................................................................................................2
In re Remec Inc. Sec. Litig.,
702 F. Supp. 2d 1202 (S.D. Cal. 2010) ..........................................................................................18
Rothman v. Gregor,
220 F.3d 81 (2d Cir. 2000).............................................................................................................21
Rubinstein v. Collins,
20 F.3d 160 (5th Cir. 1994) .............................................................................................................3
SEC v. Cohen,
No. 4:05CV371-DJS, 2007 U.S. Dist. LEXIS 28934 (E.D. Mo. April 19, 2007) .........................21
SEC v. Cuban,
620 F.3d 551 (5th Cir. 2010) ...........................................................................................................2
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SEC v. Diversified Indus. Inc.,
465 F. Supp. 104 (D.D.C. 1979) ......................................................................................................7
SEC v. Guenthner,
395 F. Supp. 2d 835 (D. Neb. 2005) ................................................................................................6
SEC v. Hughes Capital Corp.,
124 F.3d 449 (3d Cir. 1997).............................................................................................................6
S.E.C. v. Kelly,
No. 08 CIV 4612, 2011 U.S. Dist. LEXIS 108805 (S.D.N.Y. Sept. 22, 2011) .............................23
SEC v. Kornman,
391 F. Supp. 2d 477 (N.D. Tex. 2005) ............................................................................................7
SEC v. Lybrand,
200 F. Supp. 2d 384 (S.D.N.Y. May 10, 2002) .............................................................................23
SEC v. McNulty,
137 F.3d 732 (2nd. Cir. 1998)........................................................................................................24
S.E.C. v. Mercury Interactive, LLC,
No. 5:07-cv-02822, 2011 WL 5871020 (N.D.Cal. Nov. 22, 2011) ...............................................23
SEC v. Mozillo,
Number CV 09-3994-JFW, 2010 WL 3656068 (C.D. Cal. Sept. 16, 2010) ..................................15
S.E.C. v. Pentagon Capital Mgmt. PLC et al,
No. 08 Civ. 3324, 2012 WL 479576 (S.D.N.Y. Feb. 17, 2012) ....................................................23
SEC v. Santos,
2003 U.S. Dist. LEXIS 20239 (N.D. Ill. Nov. 4, 2003)...................................................................7
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SEC v. Shanahan,
646 F.3d 536 (8th Cir. 2011) .........................................................................................................20
SEC v. Sharp Capital, Inc.,
1999 U.S. Dist. LEXIS 5837 (N.D. Tex. 1999) .........................................................................7, 12
SEC v. System Software Associates, Inc.,
145 F. Supp. 2d 954 (E.D. Ill 2001)...................................................................................16, 20, 24
SEC v. World-Wide Coin Inv., Ltd.,
567 F. Supp. 724 (N.D. Ga. May 23, 1983) ...................................................................................24
Shushany v. Allwaste, Inc.,
992 F.2d 517 (5th Cir. 1993) ...........................................................................................................6
In re Sun Microsystems, Inc. Sec. Litig.,
Number C 89 20351 RPA, 1990 U.S. Dist. LEXIS 18740 (N.D. Cal. Aug. 20, 1990) ..................15
Tuchman v. DSC Communications Corp.,
14 F.3d 1061 (5th Cir. Tex. 1994) ...................................................................................................6
United States ex rel. Johnson v. Shell Oil Co.,
183 F.R.D. 204 (E.D. Tex. 1998)...................................................................................................12
United States ex rel. Willard v. Humana Health Plan of Texas Inc.,
336 F.3d 375 (5th Cir. 2003) ...........................................................................................................6
Woodward v. Metropolitan Bank of Dallas,
522 F.2d 84 (5th Cir. 1975) ...........................................................................................................23
Wu v. Tang,
No. 3:10-CV-0218, 2011 U.S. Dist. LEXIS 4489 (N.D. Tex. Jan. 14, 2011) .................................6
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I. Introduction
The Complaint details a systemic disclosure and accounting fraud orchestrated by the
senior-most executives at Defendant Life Partners Holdings, Inc. (LPHI), a public company.
This is not a business practices case. LPHI and Peden (Defendants), along with Defendant
Brian D. Pardo, misrepresented, in public filings, risks to LPHI from the operations of its
wholly-owned subsidiary, Life Partners, Inc. (LPI, together with LPHI, Life Partners or the
Company).1
The Complaint alleges the circumstances surrounding the fraud in thorough and vivid
detail, that sets forth the roles that Pardo, Peden, and Martin played in the fraud. The grounds
LPHI and Peden advance in their motion to dismiss (the Motion) to dispute the sufficiency of
the Complaints allegations are aimed at evidentiary matters that Plaintiff need not have pled to
support the inference of scienter. LPHI and Peden parse the Complaints allegations to suit their
purposes, in an effort to paint Defendants misconduct in a less egregious light. Plaintiff has
adequately pled scienter. The Court should deny the Motion.
LPHI, Peden, and Pardo (Defendants), along with Defendant CFO David
Martin, filed financial statements with the Commission that misrepresented the Companys net
income. The false financial statements resulted from numerous accounting improprieties that
Defendants instituted as a matter of Company policy and concealed from Life Partners auditor
by backdating documents.
1 Because there is no meaningful distinction between LPHI and LPI, Plaintiff refers to each in this Response, as itdoes in the Complaint, as Life Partners, or the Company.
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II. The Complaint States Claims for Violations of the Antifraud Provisions Based on
Defendants Misrepresentations and Omissions
The Complaint alleges securities-law violations based on misrepresentations and
omissions in LPHIs public filings, as well as misrepresentations Pardo made in conference calls
with analysts and shareholders.2 In the public filings, Defendants falsely represented that
underestimated LEs posed a contingent risk to LPHIs business, when they knew that the risk
was an existing reality. In actual practice, Defendants systematically used short LEs to broker
life settlements, and they did so to inflate LPHIs revenues. Cplt 1, 4, 10, 45-57, 138, 152.
Defendants, thus, misled shareholders about highly material information. Cplt. 3-4, 27, 29, 42-
44, 45-48, 152. Defendants also failed to disclose the material trend of chronic LE
underestimation in the MD&A section of LPHIs forms 10-K and 10-KSB.3 Cplt. 10, 59,
152. As a result of these misrepresentations and omissions, Defendants violated the antifraud
provisions.4
A. The Rule 12(b)(6) Standard
Cplt. 151-160.
Motions to dismiss are viewed with disfavor and rarely granted. Priester v. Lowndes
County, 354 F.3d 414, 418 (5th Cir. 2004). Under Rule 12(b)(6), a complaint must contain
sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face.
2 In the Motion, Defendants dispute the sufficiency of the Complaints allegations that Pardo mademisrepresentations in the conference calls. Pardo raises the same ground in his motion to dismiss. [Doc. No. 14-1].For the sake of economy, Plaintiff responds to this ground in its response to Pardos motion. Because Pardosmotion to dismiss overlaps with the Motion in several other regards, Plaintiff incorporates its response to Pardosmotion in full herein.3
In furtherance of their accounting fraud scheme, Defendants misrepresented the Companys revenue recognitionpolicy in public filings with the Commission. Cplt. 89-94; See also Cplt. 74-80 (describing Companysimproper policy of premature revenue recognition).4 Section 17(a) of the Securities Act of 1933 (15 U.S.C. 77q(a)), Section 10(b) of the Securities Exchange Act
of 1934 (15 U.S.C. 78j(b)), and Exchange Act Rule 10b-5 (17 C.F.R. 240.10b-5) (the antifraud provisions),prohibit any person in the offer, sale or purchase of securities from (a) employing any device, scheme, or artifice todefraud; (b) making any untrue statement of a material fact or omitting to state a material fact necessary in order tomake the statements made, in light of the circumstances under which they were made, not misleading; or (c)engaging in any act, practice, or course of business which operates or would operate as a fraud or deceit upon anyperson.
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When Defendants spoke to LE underestimation in the Companys Risk Disclosures, they
misrepresented it as contingent risk, rather than the existing risk it posed as a systematic practice.
Cplt. 57. In Defendants words, they disclosed the risk that LEs couldbe underestimated.
Motion, p. 14-15. Because Defendants knew that Life Partners systematically used
underestimated LEs to broker life settlements, the disclosure that LEs couldbe underestimated
was false and misleading. SeeHuddleston v. Herman & MacLean, 640 F.2d 534, 544 (5th Cir.)
(To warn that the untoward may occur when the event is contingent is prudent; to caution that it
is only possible for the unfavorable events to happen when they have already occurred is
deceit.), affd in part, revd in part on other grounds, 459 U.S. 375 (1983).
6
Having spoken on
the subject, Defendants owed a duty to shareholders to speak the full truth regarding the reality
and future consequences of LE underestimation, which they failed to do.7
The contingency that the disclosures misrepresented was LE underestimation itself, not,
as Defendants urge, the adverse impact that underestimation would have on the Companys
financial condition. Defendants falsely represented underestimation to be a mere possibility
when, in fact, they knowingly relied on underestimated LEs to achieve the Companys financial
results. Cplt. 3-4, 10, 42-44, 49-58, 61-63, 152. Indeed, they misrepresented underestimation
as a potential, rather than actual, risk to conceal the Companys practice from the public, so that
6 See also Lormand v. US Unwired, Inc., 565 F.3d 228, 249 (5th Cir. 2009)(holding that company officials
engaged in fraud by omitting known risks to their business plan, although they recognized signs that the dangersthey privately predicted had already materialized) andIn re Prudential Sec. Inc. L.P Litig., 930 F.Supp. 68, 72(S.D.N.Y. 1996) (concluding that [g]eneral risk disclosures in the face of specific known risks which border on
certainties does not bespeak caution and provide[] no protection to someone who warns his hiking companion towalk slowly because there might be a ditch ahead when he knows with near certainty that the Grand Canyon lies onefoot away.).7 See, e.g., Lormand, 565 F.3d at 249 ([W]e have long held under Rule 10b-5, a duty to speak the full truth
arises when a defendant undertakes to say anything.) (quotingRubinstein v. Collins, 20 F.3d 160, 170 (5th Cir.1994)). Defendants also owed shareholder an independent duty, under Item 303 of Regulation S-K, 17 C.F.R. 229.303(a)(3)(ii), to disclose the known trend of chronic LE underestimation. Cplt. 8-13, 42-44, 49-55, 61-63,152. See Litwin v. Blackstone Group, L.P., 634 F.3d 706, 716 (2d Cir.) (allegations that trend was known andreasonably likely to have a material impact state a claim), cert. denied, 132 S.Ct. 242 (2011); Freudenberg v. EtradeFinancial Corp., 712 F. Supp. 2d 171, 180 (S.D.N.Y 2010).
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Defendants could continue to use it to inflate Life Partners revenues.8
The Complaint alleges that Life Partners revenue was artificially inflated in this regard,
not that the revenue itself was artificial. Indeed, the Company could not sustain its financial
performance but for its chronic use of underestimated LEs. Cplt 3-5, 29, 45-48. Defendants
used underestimated LEs to extract revenue from investors at dramatically higher levels than the
Company could achieve had Defendants brokered life settlements based on appropriately
developed LEs.
In so doing, Defendants
deceived shareholders, and violated the antifraud provisions. Belodoff v. Netlist, Inc., No.
SACV-07-00677, 2009 WL 2777320 (C.D. Cal., Sept 1, 2009), therefore, is not instructive. The
Companys financial performance does not cure or belie the misrepresentation and omissions of
which Plaintiff complains. To the contrary, it is a byproduct of Defendants fraud.
9 The extraordinary gap between the money Life Partners collects using
underestimated LEs versus what it could collect if it discontinued the practice shows not that
Defendants engaged in the practice merely to boost Life Partners financial performance, but to
continue the Company as a going concern.10
8 Full disclosure would have jeopardized the practice. As Defendants acknowledge in the Companys annual
Risk Disclosures, LE underestimation posed the risk of causing investor demand for life settlements to decline. See,e.g., Cplt. 56 (lose purchasers). Full disclosure would have informed investors that, due to the Companys use of
underestimated LEs, Defendants charge too much for life settlements. Armed with this information, investors wouldshop elsewhere. Defendants, thus, had a strong motive to issue misleading public statements that deceived theCompanys shareholders.9 See Cplt. 47 (alleging pricing illustration showing life settlements unprofitable but for use of underestimatedLEs); Cplt. 138 (Life Partners could not sustain revenues and profit margins at the levels it reported without thecontinued use of underestimated LEs).10 From 2009 through 2010, Defendants brokered policies for $555 million more than they were actually worth byovervaluing them with underestimated LEs. With actual worth, based on sound LEs, of $39 million, Defendantsovervalued the Companys life settlements, and what they collected from investors, by an astonishing 1,423%.Cplt. 48.
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III. The Complaint Alleges Violations of the Antifraud Provisions with the Particularity
Required Under Rule 9(b), and With Allegations That Compel the Inference of
Scienter
The Complaint alleges that Life Partners systematically used underestimated LEs to
artificially inflate the Companys revenues and profit margins, and that Defendants knew the
Company engaged in this practice. Cplt. 1, 10, 42, 138, 140. Far from alleging Defendants
knowledge with conclusory allegations, the complaint identifies the circumstances surrounding
the fraud in scrupulous detail. From the circumstance alleged it is obvious, and certainly
reasonably inferable, that Pardo and Peden were complicit in the Companys practice of
systematically using underestimated LEs. Pardo arranged the practice, and tried to sustain it in
the face of increasing scrutiny. Confronted with queries by investors, licensees, and the
Companys auditors, Peden lied and made misleading statements to cover it up. In addition,
Defendants consciously disregarded red flag after red flag that called the practice into question,
as well as their own track record of chronic LE underestimation. The Complaints allegations of
conscious behavior need not be enhanced with allegations of motive to support the inference of
scienter. Nonetheless, the allegations of motive in the Complaint, which extend beyond insider
trading, are compelling and further support the inference of scienter.
A. Scienter Under the Antifraud Provisions
Violations of the antifraud provisions require scienter. Aaron v. SEC, 446 U.S. 680, 701
(1980).11
Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (U.S. 1976). Scientermay be established by
showing intentional or severely reckless conduct. Broad v. Rockwell Intl Corp., 642 F.2d 929
Scienter is the mental state embracing intent to deceive, manipulate or defraud.
11There is no scienter requirement for Securities Act Sections 17(a)(2) and (3). Aaron, 446 U.S. at 701-02
(1980). Rather than scienter, mere negligence suffices. Id. Negligence has been defined as the failure to exercisereasonable care or competence in communicating business information. SEC v. Hughes Capital Corp., 124 F.3d449, 453 (3d Cir. 1997). Thus, even if the SEC had failed adequately to allege scienter, which it has not, theCommissions 17(a)(2) and (3) claims would survive.
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(5th Cir.), cert. denied, 454 U.S. 965 (1981). Severe recklessness is defined as (1) an extreme
departure from the standards of ordinary care and (2) a present danger of misleading buyers or
sellers of securities that is either known to the defendant or is so obvious that the defendant must
have been aware of it. Shushany v. Allwaste, Inc., 992 F.2d 517, 521 (5th Cir. 1993).12 Scienter
may be pleaded with allegations showing conscious behavior or motive. Wu v. Tang, No. 3:10-
CV-0218, 2011 U.S. Dist. LEXIS 4489, *17-18 (N.D. Tex. Jan. 14, 2011) (allegations showing
defendant was aware representation was false sufficed to plead scienter).13
B. Pleadings Standards for Scienter and Particularity Under Rule 9(b)
Rule 9(b) provides that conditions of a persons mind may be alleged generally and
relaxes the particularity requirements for scienter. United States ex rel. Willard v. Humana
Health Plan of Texas Inc., 336 F.3d 375, 384 (5th Cir. 2003). The Complaints allegations must
set forth specific facts that support an inference of fraud. Id. The allegations need not support
a strong inference of scienter, as the heightened pleading requirements of the PSLRA do not
apply to enforcement actions. Kornman, 391 F.Supp.2d 477, 494 (N.D. Tex. 2005). In non-
PSLRA cases such as this, when a complaint alleges with particularity the circumstances
constituting fraud, as required by the rule, then generally it will also have set forth facts from
which an inference of scienter could be drawn. In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541,
1546 (9th Cir. 1994).
12
Evidence of the mental state for scienter under the antifraud statues is the same, whether the violations are dueto accounting fraud or misrepresentations. Lovelace v. Software Spectrum, Inc., 78 F.3d 1015, 1020 (5th Cir. 1996).Defendants cite SEC v. Guenthner, 395 F. Supp. 2d 835 (D. Neb. 2005) to urge a different standard for accountingfraud violations. In Guenthner, a district court in Nebraska applied the standard for scienter that the Third Circuitapplies to Section 10(b) cases against auditors for failing to uncover deficiencies in the financial statements of theirclients. Id. at *40 (citingIn re IKON Office Solutions, Inc., 277 F.3d 658, 668 (3d Cir 2002)).13 Defendants claim that, under Tuchman v. DSC Communications Corp., 14 F.3d 1061 (5th Cir. Tex. 1994),Plaintiffs allegations of conscious behavior are subject to a more stringent standard, because, according toDefendants, the Complaint fails to allege motive. The Complaint does allege motive, but, in any event, Tuchman isa PSLRA case, and does not apply here.
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Rule 9(b) requires allegations of fraud to be pleaded with particularity. The purpose of
Rule 9(b) is to facilitate a defendants ability to respond to and prepare a defense to charges of
fraud. SEC v. Sharp Capital, Inc., No. 3-98-CV-2792-G, 1999 U.S. Dist. LEXIS 5837 (N.D.
Tex. 1999). What constitutes particularity will necessarily differ with the facts of each case.
Guidry v. Bank of LaPlace, 954 F.2d 278, 288 (5th Cir. 1992). Plaintiffs are not required to plead
detailed evidence or state all facts relevant to the case to satisfy Rule 9(b). Sharp, 1999 U.S.
Dist. LEXIS 5837 at *4 (citing SEC v. Diversified Indus. Inc., 465 F. Supp. 104, 111 (D.D.C.
1979) (stating that the details of the scheme were sufficient because they adequately apprised
the defendants of the basic transactions and enabled them to prepare a defense). Evidentiary
details, such as specific dates for each transaction, are not required to be pled in the complaint,
but are appropriate for discovery and trial. SEC v. Santos, No. 02C8236, 2003 U.S. Dist. LEXIS
20239, *9 (N.D. Ill. Nov. 4, 2003).
C. Allegations of Conscious Behavior Support the Inference of Scienter
The Complaints allegations of conscious behavior standing alone support the inference
of scienter. In their motion, Defendants fail to address the bulk of these allegations. Instead,
they urge dismissal under the theory that Defendants never had notice that the LEs were
underestimated. Plaintiffs claims, however, do not depend on a notice theory of liability, and
Court should reject Defendants attempts to recast Plaintiffs claims. The Complaints
allegations show that Defendants were complicit in the Companys systematic use of materially
short LEs.
1. Life Partners, through Pardo, arranged for the LEs it used to be
materially short
Until his death in 1999, Life Partners obtained all the LEs it used to broker life
settlements from Dr. Jack Kelly (Kelly). Cplt. 5. Kelly was co-founder and part-owner of
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the Company. Id. At Kellys funeral, Pardo met Dr. Donald Cassidy (Cassidy), for the first
time, and hastily arranged for Cassidy to replace Kelly. Cplt. 5-6, 31. Cassidy had shared
office space with Kelly in Reno, Nevada, but the two had never worked together. Cplt. 30.
Cassidy had no actuarial training or experience rendering LEs. Cplt. 7, 32. Pardo instructed
Cassidy to review Kellys LE files to determine how they were doing it. Cplt. 6, 31. Within
days of the funeral, Cassidy began providing Life Partners with LEs using Kellys methodology,
in exchange for $500 per LE. Cplt. 5, 30-33. From that point forward, Cassidy handled all of
Life Partners retail life expectancy work. Cplt. 33.
The methodology that Cassidy adopted from Kelly deviates from standard practices in the
life settlement industry. Cplt. 36-39. Since Cassidy began providing LEs to Life Partners over
ten years ago, he has never changed or evaluated the methodology. Cplt. 7, 37. Neither he nor
Defendant has ever evaluated his track record, or otherwise reviewed historical LEs for accuracy.
Id. Cassidys failure to factor historical experience into his LE underwriting methodology
deviates from standard practices in the life settlement industry. Cplt. 36-39.
In Cassidy an individual with no actuarial training or experience who was unqualified
to underwrite LEs Pardo found someone who was willing to supply Life Partners with the short
LEs that it needed to sustain the Companys revenues. Cplt 3, 5-8, 29-33, 34-41. Pardos
actions in replacing Kelly with a totally unqualified and inexperienced LE underwriter, and
instructing him to follow the methodology that Kelly had employed, strongly suggest that the
Company itself, through Pardo, implemented the practice of systematically using short LEs to
broker life settlements. Indeed, Pardos choice of Cassidy ensured that Life Partners would be in
a position to continue to receive and use underestimated LEs. The Companys revenues depend
on extracting more for life settlements than they are worth by overvaluing policies through the
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use of underestimated LEs. Cplt 3, 8, 10, 27, 45-48. If Defendants brought in a qualified life
expectancy underwriter who provided reasonable LEs, then the Company would lose the
windfall revenues it sought to achieve.
Scienter is obvious from these allegations. They support the inference that Pardo and
Life Partners rigged the system first through Kelly and then through Cassidy to enable the
Company to broker policies based on short LEs. As alleged in the Complaint, Life Partners
practice in this regard was systematic, i.e., something Defendants achieved knowingly, by
design. The misrepresentations they made about the practice being a contingent risk, and their
failure to disclose the trend that inevitably resulted from the practice, therefore, constitute
knowing violations of the antifraud provisions.
2. Peden tried to cover up the Companys practice of systematically
using short LEs to broker life settlements
Pedens complicity in Life Partners practice of systematically using underestimated LEs
is evident from misrepresentations he made to cover up the practice.14
Peden also misled the Companys auditors to cover up the Companys systematic use of
underestimated LEs. In response to E&Ys request for data to support the LEs underlying the
Cplt. 11-13, 42-44. The
Complaint does not urge the misrepresentations Peden made as independent violations of the
antifraud provisions, but to further support the inference of scienter. Because Plaintiff does not
allege them as violations, they need not be alleged with the specificity required by Rule 9(b).
Even so, the allegations do identify the month and year they were made, to whom they were
made, and what Peden obtained thereby the cover up.
14 Peden misrepresented, both to an investor and to an investor agent (licensee), that Cassidys LEs were based on
a mortality table that is widely used in the life settlement industry, when, in fact, Peden knew that Cassidy did notuse the table. Cassidy actually used a census table, and his use of the census table deviated from standard practicesin the life settlement industry. Peden lied about Cassidys methodology because he knew it was unsound, and that itresulted in chronic LE underestimation. Cplt 11-12, 42-44.
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Companys life settlements, Peden (and Martin) gave E&Y a misleading chart that understated
the extent to which the Company used underestimated LEs. Cplt. 13, 127. Peden omitted from
the chart information on the extent to which insureds had outlived LEs for active policies15
brokered by the Company.16
3. The Complaint alleges a track record of chronic LE underestimation
that further supports the inference of scienter
Id. Peden withheld the information to conceal Life Partners
systematic use of underestimated LEs from the Companys auditors, which further supports the
inference that Peden was aware of the practice.
In addition to the Complaints allegations that Defendants implemented and covered up
the Companys practice of systematically using underestimated LEs, the Complaint alleges a
track record of chronic LE underestimation from which the practice was obvious to Defendants.
Defendants dispute the record by recasting what the Complaint alleges they knew so as to
confine their experiences to Life Partnerss LE track record with Cassidy alone. Defendants
conscious behavior in falsely representing the use of underestimated LEs as a contingent risk,
and failing to disclose the known trend of underestimated LEs, was informed, however, by Life
Partners entire track record.
That track record consists of the use Life Partners made of the LEs it obtained from both
Cassidy and Kelly. Defendants ignore the Complaints allegations that, before, Cassidy, Life
Partners obtained LEs from Kelly that were based on the same flawed underwriting
methodology. Cplt. 5-6. The Complaint alleges that the Company had engaged in the practice
15 In the vernacular of the life settlement industry, a policy matures when the insured under the policy dies.Until that time, the policy is active. Whether LEs have been underestimated is determinable for both maturedpolicies and active policies beyond LE. For active policies beyond LE, the fact that Cassidy underestimated theinsureds life expectancies is knowable.16 Despite the fact that Life Partners experienced an alarming rate of insureds outliving LEs for active policies, thechart deceptively limited the Companys LE track record to matured policies. Of the roughly 4,000 active policiesthat Life Partners had brokered at the time, insureds under 1,200 of those policies had already outlived CassidysLEs. The chart Peden gave E&Y, however, omitted this information.
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matured policies on file with TDI. The Complaint alleges that, of roughly 4,000 active policies
that the Company had brokered as of August 2010, insureds under roughly 1,200 of those
policies have outlived LE.19 Defendants do not dispute this allegation. The Chart in Paragraph
41 sets forth the rates insureds have outlived Cassidys LEs for the set of policies from which his
success rate is measureable, which consists of both matured policies and active policies beyond
LE.20 As alleged in the chart, approximately 91% of these policies failed to mature within the
time frame Cassidy estimated. Defendants systematic use of underestimated LEs is thus
obvious even putting aside the use the Life Partners made of Kellys LEs, and viewing the
Companys track record under Cassidy alone.
21
Defendants protest that the chart in paragraph 41 is of unknown origin, but, as alleged
in paragraph 54 of the Complaint, Defendants are the source of the data. It comes from the
Companys internal policy tracking system. It is objective, historical operational data that is
basic to the only business that Life Partners engages in. It is nothing like the financial forecasts
at issue in Kurtzman v. Compaq Computer Corp., No. H-99-779, 2002 U.S. Dist. LEXIS 26569
(S.D. Tex. Mar. 30, 2002). Defendants in that case made optimistic statements about sales and
demand, and plaintiffs alleged the defendants knew about reports that showed a downturn in the
19 For a description of the distinction within the life settlement industry between active and matured policies,
see note 14 above.20 The chart in Paragraph 41 refers to matured policies and active policies for which the LE has come and passedcollectively as Policies Exceeding LEs.21
In paragraph 41, Plaintiff has alleged evidentiary detail it is not required to plead at all under Rule 9(b), muchless with the additional detail Defendants claim the rule requires. The rule requires the who, what, when, where,and how of the false representations, not of evidence alleged in support. United States ex rel. Johnson v. Shell OilCo., 183 F.R.D. 204, 206 (E.D. Tex. 1998) ([9(b)] is a simple rule. The Complaint must contain the who, what,when, where and how, of the false representation.). Defendants read Rule 9(b) as requiring plaintiffs to pleadevidentiary detail sufficient to prove a fraud claim, a reading courts uniformly reject. See e..g., Sharp Capital, Inc.,1999 U.S. Dist. LEXIS 5837, *4 ([C]ourts have never required a plaintiff to plead detailed evidence in itscomplaint.);Bailey v. Linsco/Private Ledger Corporation, 136 F.R.D. 11, 13-14 (D. Me. 1991) (holding that whileRule 9(b) requires allegations of fraud to contain some factual detail, it does not require plaintiffs to pleadevidentiary details sufficient to prove a claim of fraud).
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companys business when they made the optimistic statements.22
4. Defendants continued the Companys practice of systematically using
underestimated LEs, despite red flags that called the practice into
question, which Defendants ignored
In this case, by contrast,
Plaintiff asserts that over ten years of historical experience with short LEs reflects knowledge of
systematic underestimation. Defendants cannot dispute that they were aware of the Companys
experience with the LEs it used without conceding scienter i.e., that they consciously
disregarded the Companys systematic use of underestimated LEs.
Time and time again, Defendants were confronted with concerns about the Companys
practice of using underestimated LEs. Yet they never sought to evaluate or modify the
underwriting criteria on which the LEs were based. Cplt. 7, 33, 37. This shows not only that
they knew about the Companys practice, but also that they strove to keep it in place.
Defendants dispute the red flags alleged in the Complaint based on the same irrelevant
distinction they draw to dispute Life Partners track record of chronic LE underestimation i.e.,
by limiting the inferences to be drawn from those allegations to what they say about Cassidys
LEs, versus the Companys entire track record. As alleged in the Complaint, the Companys
audit committee urged Defendants in 2003 to obtain an independent review of Life Partners
underwriting criteria. Cplt. 49-50. In 2007, the Colorado Securities Commission (CSC)
brought an action against Defendants that confronted them with the high frequency rate at which
insureds outlived the Companys LEs. Cplt. 9, 55. These allegations support the inference of
scienter regardless of whether the LEs that concerned the audit committee and CSC came from
22 In Kurztman, Plaintiffs alleged that the company was aware of a downturn in its business based on internal daily
and weekly reports of declining sales and demand. The court deemed more specificity about the reports wasrequired to support an inference of scienter because, to state a claim, plaintiffs had to show that the reports reflectedbusiness problems during the relevant three-month class period that were not due to short-term fluctuations, butwere of considerable import, such that they indicated or determined the entire years results. Id. at *47-48.Kurtzman is further inapposite because it is a PLSRA case.
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Cassidy or Kelly.23
Nor do Defendants legitimately challenge the sufficiency of the Complaints allegations
about the other red flags that Defendants ignored. Defendants urge the Court to disregard any
inferences to be drawn from the allegation that they ignored the recommendation they received
in February 2006 to track, analyze, and validate Cassidys LEs (Cplt. 53) because, they
argue, the allegation does not satisfy Rule 9(b). The allegation is not subject to the rule but, even
so, the Complaint alleges who made the recommendation (a consultant who Defendants
permitted to conduct due diligence on the Companys operations), who received it (Pardo and
Peden), and when they received it (February 2006). In demanding more, Defendants again seek
to use Rule 9(b) to force Plaintiff to plead evidentiary detail sufficient to prove its case in the
Complaint, which the rule does not require.
Plaintiffs claims puts Defendants state of mind at issue, not Cassidys.
These allegations support the inference that Defendants were aware of the Companys practice of
systematically using short LEs.
24
Defendants do not dispute that the premium payments that Life Partners advanced when
insured outlived their LEs, which increased over time with the rising incidence of insureds
outliving LEs, supports the inference of scienter. They instead argue that premium advances
Life Partners reported disclosed Defendants fraud to shareholders. The Court should disregard
this argument because it is based on the unfounded premise that premium advances somehow
disclosed the Companys practice of systematically using short LEs to the shareholders.
25
23 Paragraph 49 of the Complaint alleges that the audit committee expressed concern that the number of maturitieson the policies that the Company brokered was less than expected based on the LEs that Life Partners assigned tothose policies. (Emphasis added). Once again, Defendants seize on the reference to Cassidys LEs in thefollowing paragraph (Cplt. 50) to try to narrow Plaintiffs claims to the use Life Partners made of Cassidys LEs.See supra note 16 and accompanying text. As alleged in Paragraph 49, Plaintiffs claims are not so limited.24 See infra note 20 and accompanying text.25 The rising rate of premium advances that Life Partners reported do not actually disclose the facts that[Plaintiff] claim[s] are absent. In re Sun Microsystems, Inc. Sec. Litig., No. C 89 20351 RPA, 1990 U.S. Dist.LEXIS 18740, *7 (N.D. Cal. Aug. 20, 1990). Even if shareholders could somehow connect the dots, and conclude
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IV. Well-Pleaded Allegations Support Plaintiffs Claims For Accounting Fraud
Due to Life Partners practice of prematurely recognizing revenue, in a manner
inconsistent with GAAP, Defendants filed consolidated financial statements that misrepresented
the Companys net income. Cplt. 15-17, 68, 132, 137, 147, 152. Defendants also misstated
net income by inadequately recording impairment of Company-owned policies. Cplt. 119-
128. Financial statements filed with the SEC that do not conform to the requirements of GAAP
are presumptively misleading and inaccurate pursuant to SEC regulation. Chu v. Sabratek
Corp., 100 F. Supp. 2d 815, 820 (N.D. Ill. 2000) (citing See 17 C.F.R. 210.4-01 (a)(1)).
Defendants do not, and cannot, in view of the Restatement (Cplt. 68), dispute that they
misrepresented net income in Life Partners financial statements as a result of premature revenue
recognition and inadequate impairment of Company-owned policies. Cplt. 137. They dispute
only that the Complaints allegations supports the inference of scienter.
Defendants acted with scienter if they were severely reckless in publishing the false
statements of net income in the Companys financial statements.28
28 See supra note 11.
Allegations that Defendants
consciously published the false information or consciously disregarded the deviance from GAAP
support the inference of scienter. SEC v. System Software Assocs., Inc., 145 F. Supp. 2d 954,
958 (E.D. Ill 2001);Lovelace v. Software Spectrum, Inc., 78 F.3d at 1020. When such conscious
behavior is alleged, allegations of motive are unnecessary. System Software Assocs., Inc., 145 F.
Supp. 2d at 958. The Complaints allegations amply support the inference of scienter.
Defendants not only knew that statements of net income in the Companys financial statements
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were false, they engineered them to be so. The Complaint details systemic accounting fraud that
Pardo and Peden directed, Martin implemented, and each facilitated through deception.29
A. Under Its Policy of Partial Revenue Recognition, Life Partners Recognized
Revenue Prematurely, in a Manner Inconsistent With GAAP
Prior to fiscal year 2003, Life Partners recognized revenue from life settlement
transactions as of the closing date. Cplt. 74. In fiscal year 2003, Life Partners changed its
revenue recognition policy, and began recognizing revenue before the closing date. Id. When
the policy changed, Life Partners started recognizing partial revenue based upon the potential
sale of fractional interests in the policies it brokered. Cplt. 74-75. In so doing, Life Partners
began recognizing revenue from life settlement transactions in a manner inconsistent with
GAAP. Under GAAP, revenue from life settlements is recognizable when realized or realizable
and earned, which occurs no earlier than the closing date. Cplt. 76-80. The closing date
cannot occur until after investors have funded 100% of the interest in policy. Consequently, by
recognizing partial revenue from life settlement transactions as to which the Company had not
fully brokered all the interests in a given policy, Life Partners recognized revenue prematurely,
in a manner inconsistent with GAAP.30
29
In the Motion, Defendants dispute that the Complaints allegations of accounting fraud adequately pleadscienter as to Martin. Martin has filed a motion to dismiss on this ground. [Doc. No. 16]. For the sake of economy,Plaintiff confines this Response to the arguments Defendants make on their own and Pardos behalf, and will briefthe sufficiency of the Complaints scienter allegations against Martin in its opposition to Martins motion.30 In 2011, E&Y, the Companys auditor at the time, advised Defendants that Life Partners should be recordingrevenue at the time of the final closing of escrowed funds with the seller rather than at an earlier date[.] Cplt. 115 (emphasis added). After Pardo threatened to take action against E&Y unless it signed off on the Companys2011 financial statements as is, E&Y terminated its auditor engagement. Cplt. 117. E&Y also withdrew itsaudit report for the Companys 2010 financial statements. The auditor who preceded E&Y also withdrew its auditreport for the Companys 2009 financial statements. Cplt. 118.
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B. Pardo and Peden Established Life Partners Policy of Premature Revenue
Recognition, and Directed Martin to Follow the Policy After He Became
CFO
Plaintiff does not allege that Pardo and Peden must have known about partial revenue
recognition due to their positions as top executives.31 Rather, Pardo and Peden established Life
Partners policy of premature revenue recognition. Cplt. 89. In 2004, soon after the Company
started recognizing partial revenue from life settlement transactions, Pardo and Peden misled the
Companys auditor to get cover for the Companys practice of partial revenue recognition.
Cplt. 64, 81-84. They asked the auditor for guidance based on an incomplete and inaccurate
set of hypothetical assumptions. Cplt. 81-83. The assumptions Pardo and Peden presented
omitted a material feature of the Companys life settlement transactions,and mischaracterized
the criteria the Company used to recognize revenue. Cplt. 82-83. Pardo and Peden knew that
the assumptions they presented created a misleading picture of the Companys life settlement
transactions32 and revenue recognition practices.33
The assumptions that Pardo and Peden asked the auditor to consider presupposed that
Life Partners recognized revenue after it was in a position to sell 100% of the interests in a
policy, when, in reality, the Company recognized revenue before such time, when it had received
31 In re Novatel Wireless Secs. Litig., No. 08cv1689, 2011 U.S. Dist. LEXIS 135602, (S.D. Cal. Nov. 23, 2011), acase on which Defendants rely, is inapposite. In that case, the court found that [p]laintiffs have presented noevidence that defendants ever made decisions concerning how to account for any particular transactions, and basedits ruling on the notion that a CEO's responsibility to oversee the business[] . . . does not demonstrate [his]involvement in [accounting determinations]. Id., *40 (quotingIn re Remec Inc. Sec. Litig., 702 F. Supp. 2d 1202,1240 (S.D. Cal. 2010)). In re Novatel is further inapposite because the court considered an evidentiary record, notthe sufficiency of pleadings.32
Pardo and Peden omitted the contingency of rescission from the assumptions they asked the auditor to consider.Cplt. 82. Rescission is a contractual right under the transactional documents that the Company uses to broker lifesettlements, which Pardo and Peden knew. Cplt. 69-70.33 Pardo and Peden were aware of the process by which Life Partners recognized revenue, and, therefore, that theassumptions were misleading. As alleged in the Complaint, Pardo and Peden participated in and/or monitored theprocess by which the Company processed and recorded revenue from life settlement transactions. Cplt. 73. Thisallegation is not conclusory. Operational data is not comparable to the reports at issue in Kurztman, see infra note21 and accompanying text, orAbrams v. Baker Hughes Inc., 292 F.3d 424, 432 (5th Cir. 2002) (addressing [a]nunsupported general claim about the existence of confidential corporate reports that reveal information contrary toreported accounts[.]).
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a commitment to purchase as little as 2% of the interests in policy. Cplt. 83. Pardo and Peden,
thus, obtained approval (cover) for partial revenue recognition with a request for guidance
based on assumptions that assumed away the possibility of partial revenue recognition. Pardo
and Peden, thus, knew that partial revenue recognition was improper. The Court should,
therefore, deny the Motion on the strength of these allegations alone.34
After Martin joined the Company as CFO, Pardo and Peden directed him to follow the
Companys practice of premature revenue recognition. Cplt. 84. In April 2010, Pardo and
Peden sent Martin a memo that memorialized the revenue recognition policy that, according to
Pardo and Peden, Life Partners had regularly utilized since they obtained the (ill-gotten)
guidance they received from the Companys auditor in 2004. Cplt. 84. In the memo, Pardo
and Peden memorialized the revenue recognition criteria that the Company had used, and
described the Companys practice of partial revenue recognition.
35
34 Recognizing that these allegations alone suffice to adequately plead scienter, Defendants urge the Court to
disregard them, on the ground that Plaintiff makes no claims against Defendants for time periods prior to January2007. Motion, p. 20. n. 71. Plaintiff need not, of course, allege a violation in connection with misconduct thatforms the basis of its claims in order for that misconduct to be probative evidence of the violations Plaintiff doesallege. For the same reason, the risk disclosure in Defendants 2006 Form 10-K, Cplt. 56, has been properly pled,as evidence of the temporal scope of those practices, and that they remained consistent over time. See Motion, p. 14n. 47.
Pardo and Peden advised that
the Accounting Department could audit and test revenue recognition qualifications, but this
was in reference to the criteria described in the memo. Id. Martin implemented the premature
revenue recognition policy in his oversight of the Accounting Department. Cplt. 83, 89.
Scienter is obvious from these allegations. See In re Daou Sys. Inc, 411 F.3d 1006, 1023 (9th
Cir. 2005) (reversing district courts dismissal of PSLRA claims, holding that allegations that top
executives directed revenue recognition practices supported strong inference of scienter).
35 For a description of how the memo memorialized the policy, Paragraph 84 refers to paragraphs 76 and 82 of theComplaint. This is a typo. The cross reference should be to Paragraph 75. As set forth in Paragraph 75, the memodescribed the criteria by which the Company recognized partial revenue, and used the 2% revenue recognitionexample to illustrate the policy.
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C. Rescissions Exposed the Impropriety of Life Partners Revenue Recognition
Policy
Pardo and Peden knew from life settlement rescissions that Life Partners partial revenue
recognition policy was improper. Cplt. 87-88. Rescissions and cancellations occurred that
caused Life Partners to reverse in subsequent quarters revenues reported in previous quarters. Id.
Pardo and Peden were aware of the rescissions, and the revenue reversals the rescissions
caused.36 The occurrence of rescissions exposed the impropriety of Life Partners revenue
recognition policy. Cplt. 88. Rescissions required the reversal of partial revenue that the
Company previously recognized based on the assumption that 100% of the policy underlying the
life settlement would ultimately be sold. Pardo and Peden, thus, knew from the rescissions that
Life Partners recognized revenue prematurely.37
D. Pardo and Peden Facilitated the Accounting Fraud Through Deceit
See System Software Assocs., Inc., 145 F. Supp.
2d at 956, 958 (denying motion to dismiss, finding inference of scienter supported by allegations
that defendants recognized revenue from contracts despite knowledge that customer sued for
rescission).
Pardo and Peden misrepresented the Companys revenue recognition policy in public
filings. Cplt. 89-94. For instance, Pardo and Peden misrepresented that Life Partners
recognizes revenue at the time a life settlement closes, when, in reality, the Company recognized
36 As alleged in the Complaint, Pardo and Peden participated in and/or monitored the process by which the
Company processed and recorded revenue from life settlement transactions, and they monitored daily, monthly,quarterly, and annual contract activity, including contract funding status, through an internal, electronic databasethat holds all information related to a particular policy. Cplt. 73. These allegations are not conclusory. Seesupra note 32.37 Defendants reliance on SEC v. Shanahan, 646 F.3d 536 (8th Cir. 2011) is misplaced. In Shanahan, the courtruled on the sufficiency of an evidentiary record to support a finding of scienter, not on whether the complaintsallegations sufficed to support an inference of scienter. Furthermore, the court found that the evidence showed thatthe executive was aware that the Company backdated stock options, but failed to show that he was aware that thepractice had been not been properly disclosed. Id. at 544. In this case, by contrast, awareness of rescissions itself(the practice) suffices to show knowledge of the violation.
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partial revenue from life settlement transactions prior to closing. Cplt. 75, 90-91.38 Pardo and
Peden knew that the Company recognized partial revenue before closing, and, therefore, that
their representations were false.39 Life Partners stated revenue recognition policy, as
misrepresented by Pardo and Peden, was contrary to its actual policy, which supports the
inference of scienter.40 The Company-wide practice of backdating documents to conceal
premature revenue recognition from auditors further supports that inference.41
E. Defendants Employed Premature Revenue Recognition as a Matter of
Course
Cplt. 96-107.
Defendants engaged in premature revenue recognition as a business practice, consistently
employing the practice as a matter of course from fiscal year 2003 forward. Cplt. 137. Their
motive in doing so is implicit in the nature of the improper practice they employed. To
improperly accelerate revenue recognition at all times in order to make the Company appear as
profitable as possible. By their fraud Defendants achieved their goal. For each of fiscal years
2008 through 2010, Defendants overstated net revenues by (29%), (6%), and (13%). Defendants
constantly shifted revenue forward, not around discrete periods, so any understatements that
resulted do not create any inference contrary to fraudulent intent.42
38 As provided under the Companys own transactional documents, a life settlement closes when the policy ownergets paid. See Cplt. 72, 91 (closing occurs when seller gets paid). Policy owners do not get paid until, at theearliest, the Company brokers 100% of the interest in the policy. See Cplt. 79 (policy owners sell policies in asingle transaction, after the Company brokers 100% of the interests in the policy). It was the Companys policy,however, to recognize revenue partial revenue before it had brokered 100% of the interest in a policy, and thetransaction closed. Life Partners recognized partial revenue before life settlements closed, when investorscommitted to purchase as little as 2% of a given policy. Cplt. 75.39
See supra note 32.40 See Rothman v. Gregor, 220 F.3d 81, 85 (2d Cir. 2000) (reversing dismissal of PSLRA claims, holding thatreckless failure to follow announced accounting policy supported inference of scienter);Novak, 216 F.3d at 311(reversing dismissal of PSLRA claims, holding strong inference of scienter supported by allegations thatdefendants knowingly sanctioned procedures that violated the Companys own [accounting] policy, as stated in theCompany's public filings).41 The Complete alleges that Pardo and Peden knew, or were reckless in not knowing, that Life Partners backdateddocuments to conceal premature revenue recognition from the Companys auditor. Cplt. 15.42 Whatever Defendants make of understatements is, any event, a fact question. On this, and the other pointsDefendants raise under the case, SEC v. Cohen, No. 4:05CV371-DJS, 2007 U.S. Dist. LEXIS 28934 (E.D. Mo.
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F. The Complaint Adequately Alleges Accounting Fraud Based On Improper
Impairment of Company-Owned Policies
Life Partners settled the suit CSC brought against the Company by agreeing to issue
refunds to Colorado investors, and take back their policy interest. Cplt. 55. In carrying the
policy interests it acquired from the settlement, the Company failed to properly evaluate potential
impairment. Cplt. 119. When Defendants evaluated for potential impairment, they used the
same flawed LEs that the Company originally assigned to the policies. Cplt. 67, 124. By
ignoring or misusing facts that existed at the time Life Partners issued its financial statements,
Defendants failed to evaluate potential impairment in a manner consistent with GAAP, and
materially understated impairment for the Companys investments in life settlements. Cplt.
120-124, 137. Defendants seek dismissal of this claim on the sole ground that the Complaint
fails to support the inference that Defendants knew the LEs on which the Company based its
impairment analysis were underestimated. As demonstrated above, the Complaints allegations
support the inference that Defendants were aware that the LEs underlying the Companys life
settlements were underestimated.
V. The Complaint States Claims Under Rule 10b-5(a) and (c), of the Exchange Act, and
Sections 17(a) (1)-(3) of the Securities Act
In a footnote, Defendants make the blanket assertion, with no supporting argument, that
the Complaint fails to allege any facts other than Defendants misrepresentations and omissions
in support of its scheme liability claims under Rules 10b-5(a) and (c) of the Exchange Act.
Motion, p. 5, n. 10. Apart from misrepresentations and omissions, the Complaint alleges a host
of manipulative and deceptive acts that support Plaintiffs claims for scheme liability under
April 19, 2007) is inapposite. The Cohen court decided the sufficiency of an evidentiary record to prove scienter,not allegations sufficient to plead it. The court found that defendant CFO relied on managers to record revenue, andthere was no showing that defendant knew of accounting irregularities at the time revenue was recorded. Id. at *49.*50 n. 9. Moreover, the accounting irregularities at issue resulted from computational errors. In this case, theaccounting policy itself was improper; Pardo and Peden directed the policy; and Martin knowingly implemented it.
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Rules 10b-5(a) and (c).43
In addition, the Complaint states a claim against Peden for violating Section 17(a) in
connection with the Companys January 2007 Form 10-QSB. Defendants argue that, under
S.E.C. v. Kelly, No. 08 CIV 4612, 2011 U.S. Dist. LEXIS 108805, at*8-15 (S.D.N.Y. Sept. 22,
2011), Peden cannot be liable for the filing because he did not sign it and thus did not make the
statement. In Kelly, the Court extended the holding inJanus Capital Group, Inc. v. First
Derivative Traders, 131 S.Ct. 2296 (2011), to claims brought pursuant to Section 17(a). Kelly,
however, is a minority decision. Under other, better-reasoned cases, Janus does not apply to
claims brought pursuant to Section 17(a).
Under S.E.C. v. Mercury Interactive, LLC, No. 5:07-cv-02822, 2011
WL 5871020 *2 (N.D.Cal. Nov. 22, 2011), the Complaint has stated a claim under Rule 10b-5(a)
and (c), based on Defendants misrepresentations and omission, because it has alleged conduct
beyond the misrepresentations.
44
VI. The Court Should Deny the Motion on the Rest of the Grounds It Raises
The Court should deny Defendants request to
dismiss Plaintiffs Section 17(a) claim against Peden.
In response to Section IV(E) of the Motion, Plaintiff has adequately alleged primary
violations in connection with claims three through seven of the Complaint, as well as Plaintiffs
claims for aiding and abetting violations45
43 These acts included document backdating, improper revenue recognition, systematic LE underestimation toinflate revenues, misrepresentations to auditors, and the 15-day business day policy by which the company held itsbooks open to record revenue in a reporting period before it could was properly recognizable under GAAP.
of (i) the antifraud provisions of the Exchange Act
44 SeeS.E.C. v. Pentagon Capital Management PLC et al, No. 08 Civ. 3324, 2012 WL 479576, at *41-42
(S.D.N.Y. Feb. 17, 2012).45 Exchange Act Section 20(e) states that any person who knowingly or recklessly provides substantial assistance
to another person in violation of the Act shall be deemed to be in violation of such provision to the same extent asthe person to whom such assistance is provided. 15 U.S.C. 78t(e). The SEC must allege facts that demonstrate:(1) a securities violation by the primary party; (2) the aider and abettor had a general awareness of his role in theviolation; and (3) the aider and abettor knowingly rendered substantial assistance in that violation. Woodward v.Metro Bank of Dallas, 522 F.2d 84, 94 (5th Cir. 1975) (citation omitted). As with primary violations, severerecklessness satisfies the knowledge requirement of the aiding and abetting standard. E.g., Howard v. SEC, 376F.3d 1136, 1142 (D.C. Cir. 2004); Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); SEC v. Lybrand, 200 F.Supp. 2d 384, 400 (S.D.N.Y. May 10, 2002).
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[Second Claim for Relief], (ii) the reporting provisions [Third Claim for Relief], and (iii) the
books and records and internal control provisions [Fourth Claim for Relief]. Cplt. p. 50-55.
Scienter is not an element of the reporting or record-keeping and internal controls provisions of
the federal securities laws.46
VII. Conclusion
For this reason, the heightened pleading requirement of Rule 9(b)
does not apply. SEC v.System Software Associates, Inc., 145 F.Supp.2d 954, 958 (N.D. Ill.
2001). Regardless, as set forth above (Sections III and IV), Plaintiff has alleged material
misstatements in the Companys public filings with which to support the foregoing claims. As
set forth in Section IV (A-F), the Complaint alleges Defendants were aware of the Companys
policy of prematurely recognizing revenue, and that they knew LEs were underestimated when
they evaluated potential impairment of Company-owned policy interests.
For the foregoing reasons, Plaintiff respectfully requests that the Motion be denied in all
respects, and that it be granted leave to amend for any respect as to which the Motion is not
denied.
46 See SEC v. McNulty, 137 F.3d 732, 740-41 (2nd. Cir. 1998); SEC v. World-Wide Coin Investments, Ltd., 567 F.
Supp. 724, 749-50 (N.D. Ga. May 23, 1983).
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DATED: April 2, 2012 Respectfully submitted,
/s/ Jason C. Rodgers
Jason C. RodgersTexas Bar No. 24005540Toby M. GallowayTexas Bar No. 00790733Michael D. KingTexas Bar No. 24032634
U.S. Securities and Exchange CommissionBurnett Plaza, Suite 1900801 Cherry Street, Unit #18Fort Worth, TX 76102-6882(817) 978-1410 (jcr)
(817) 978-4927 (fax)Attorneys for Plaintiff Securities and ExchangeCommission
CERTIFICATE OF SERVICE
I hereby certify that on the 2nd day of April, 2012, I electronically filed theforegoing document with the Clerk of the Court using the CM/ECF system, which will send
notifications of such filing to all counsel who have registered with the Court. All others wereserved a copy via U.S. mail.
/s/ Jason C. Rodgers
Jason C. Rodgers
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UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF TEXAS
AUSTIN DIVISION
_____________________________________________
SECURITIES AND EXCHANGE COMMISSION, :
:Plaintiff, : Civil Action No. 1:12-CV-33 JRN
v. :
:
LIFE PARTNERS HOLDINGS, INC., BRIAN D. :
PARDO, R. SCOTT PEDEN, AND :
DAVID M. MARTIN, :
:
Defendants. :
:
ORDER DENYING DEFENDANT BRIAN D. PARDO'S MOTION TO DISMISS
Upon consideration by the Court of Life Partners Holdings, Inc, and R. Scott Pedens
Motion to Dismiss, memorandum in support thereof, responses and the pleadings on file, Life
Partners Holdings, Inc, and R. Scott Pedens Motion to Dismiss is hereby DENIED.
Signed this __ day of ______________, 2012.
James R. NowlinUnited States District Judge
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