For Life Partners Holdings Shareholders (Nasdaq:LPHI), it has been one heck of a ride – but now it is over.

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Citron has to give credit where credit is due — CEO Brian Pardo has truly been a visionary in the life settlements industry.   Although he has had more than his share of critics, he has spent the past decade avoiding regulation while returning significant returns to LPHI stockholders.

All good things must come to an end, however, and now the final chapter is being written for Life Partners.  The SEC and Wall St. have decided to move in on life settlement industry and it is Citron’s opinion that this sea change will be at the expense of Life Partners Holdings. Until now the life settlement industry has been a financial product marred with controversy, but the new task force and the effects of commoditization are going to change the landscape – dramatically and permanently.

When you consider the spectrum of opportunities for abuse in this space, including potential senior financial abuse, the larcenous opportunities inherent in stranger-owned policies, Ponzi schemes, independence-compromised life expectancy medical evaluations, in addition to abusive commission charges, it’s no surprise that government regulation is an unavoidable reality.

Background

As an investor, if you know just one thing about LPHI, that one thing must be a clear understanding of exactly how it has generated its profits over the last several years.  As documented in a report Citron published about LPHI in February 2009, LPHI acts as a broker in a relatively small number of life settlement transactions – in which it brings a transaction between settler(seller) and investors (buyer) together.  The spreads on its deals are of unprecedented size in its industry – they are so exaggeratedly large that these “commissions” are approaching the average life settlement payout industrywide.  This is like paying a 50% commission to sell a house, a business, or a stock!!!

Life Partners has been able to carve out such fat deals only because its business practice is to maintain a complete lack of transparency on these niche transactions.  LPHI recruits investors through a questionable network of unlicensed investment marketers (see below), and makes offers to settlors counting on the fact that they can’t access a transparent market to obtain, and benefit by, the price discovery afforded by multiple offers.
http://citronresearch.com/index.php?s=LPHI&submit=Search
Shirking what should have been its fiduciary duty to disclose spreads to both buyers and sellers in its transactions, Life Partners entire business model is built on the absence of a transparent market for life settlements.

If its spreads were even halved, the minimal likely outcome of the market forces described below, LPHI’s financial performance evaporates like a puddle on a hot summer day.

Look out, here comes the sheriff !

Just this month we see:
The SEC has Established Internal Task Force to Examine the Life Settlements Business: http://www.lifeandhealthinsurancenews.com/News/2009/9/Pages/SEC-Eyes-Secondary-Market.aspx
The House Financial Services Committee to Examine Life Settlements Securitization: http://www.lifeandhealthinsurancenews.com/News/2009/9/Pages/Panel-To-Look-At-Life-Settlement-Securitization.aspx

Be Careful what you say … because it just might come back and bite you.

In April, in an attempt to thwart any federal regulation, Life Partners’ president Scott Peden pleaded  before Congress to keep government regulation out of his industry, Peden refers to sophisticated investors adding liquidity to a market and not the realities of radio commercials, feeder funds, and unregulated policy providers that feed his company’s transactions. http://aging.senate.gov/minority/_files/hr207sp.pdf

Previously, upon fighting off regulation from the SEC, LPHI CEO Brian Pardo gloated,

“We have consistently maintained that we are not in the business of securities and, with little or no justification, the SEC has doggedly pursued this case over four years in a blatant attempt to expand its regulatory turf,” Pardo said. Pardo said he now believes the SEC will “go back into its corner”, but “nothing surprises me anymore when it comes to the SEC, this is truly an out of control federal agency.”

http://www.allbusiness.com/legal/trial-procedure-decisions-rulings/7299548-1.html
Citron asks one but pointed question:  What does LPHI have to hide that makes them act like regulation is kryptonite to them?  Citron believes it is the spreads….and the sleight-of-hand by which they are maintained.

LPHI and its Undisclosed Regulatory Actions

Life Partners has had their share of litigation with state authorities, and has historically found room to maneuver in a few states, but the last year has seen even that door rapidly closing.  In a disturbing act of silence, Life Partners never disclosed to the investing public the consent order signed the last week of July of this year with the Sate of Florida.  No press release – and no 8-K.  This consent order restricts LPHI from doing business in Florida, by far the largest state for life settlements, until is registers as a Florida Viatical  Provider.  As of this date, we have no proof that LPHI has even attempted to register.   Lastly, the consent order requires LPHI to pay the State of Florida a fine of $770,000.  Why no proper disclosure?  http://www.floir.com/pdf/LifePartnersInc90164007-CO.pdf

Not more than a year ago, Life Partners faced the same battle in Colorado, who admonished them for selling policies via radio commercials promising high returns through unregulated securities brokers: http://www.dora.state.co.us/Securities/pdf_forms/enforcement/lifepartners-summaryorder.pdf

Regulation has always been the Achilles heel of Life Partners, as they have also had previous run-ins with Utah, Virginia, and Texas. http://www.lisassociation.org/vlsaamembers/states/files/utah_cases_State_of_Utah_Dept_of_commerce_Life_Partners_Order_to_Show_Cause.pdf

http://www.scotusblog.com/movabletype/archives/07-261_ob

Government oversight might be the least of their problems

Until now, Life Partners has been afforded the luxury of taking oversize commissions on select policies.  This is due primarily to the lack of transparency on their transactions, as there has not been much of a secondary market for Life Settlements.  That has just turned around as Wall St., in particular Goldman Sachs and Credit Suisse, now have established products that put policies into bonds, exactly like they did with mortgage backed securities.  In addition, Goldman Sachs has established a tradable index of life settlements. This will add the much need liquidity to the Life Settlement industry and will take the power out of the hands of these small unregulated operators. http://www.marketwatch.com/story/life-settlements-could-be-wall-streets-next-act-2009-09-06

This is how the business used to be:

For years LPHI has used feeder funds type organizations to funnel investors for their policies.  As you can tell from the links below, these are not exactly the Goldman Sachs of the world, rather they are these unregulated alternative investment firms that seem to operate in the grey zone. They run radio commercials and some represent “risk free high yield” investments.  These will now be a thing of the past.  State by state laws will give away to federal regulation.  Look at the names of some of the companies to get an idea of who is peddling the policies to potential investors.  Note how they invoke the claim of their relationship to Life Partners:

To illustrate the need for regulation that has finally come to this industry we need to look no farther than the list of companies that supply policies to Life Partners Holdings.  Citron has obtained a copy from the State of Texas of the 2008 providers.

2008 LPHI Providers (PDF)

Amongst the cast of characters, notice one of the providers is Life Insurance Settlements in Ft. Lauderdale Florida.  That company is run by none other than Stacy Schultz Steinger, the controversial sister in law of Leslie Steinger, architect of the $1 billion life settlement Ponzi scheme of Mutual Benefits.

http://blogs.browardpalmbeach.com/pulp/2009/04/stacy_steinger_schultz_life_insurance_exchange_leslie_mutual_benefits.php

http://www.lifeinsuranceex.com/executives.html

Something Just Doesn’t Smell Right

After years of uncovering fraud and failed business, there are a few red flags that investors should be concerned with.  While these are a sideshow with regard to the inevitable regulation of this industry, investors ignore them at their own peril

1. CEO Brian Pardo keeps his stock in the tax-haven county of Gibraltar.  As a matter of fact, the country of Spain is currently trying to get Gibraltar blacklisted as it shelters corrupt businesses.  As a matter of fact, Pardo’s trust shares an address with some of the more notorious offshore sports gambling outfits.

http://www.telegraph.co.uk/news/worldnews/1581954/Spain-wants-tax-haven-Gibraltar-blacklisted.html

http://www.secform4.com/filings/49534/000113959809000001.htm

2. LPHI’s website tell us that they are covered by two analysts: one being Taglich Brothers, whom they pay a monthly fee for coverage and Singular Research.  Life Partners has found it necessary to announce the coverage of their company by Singular.
http://www.reuters.com/article/pressRelease/idUS183715+05-Dec-2008+BW20081205

Singular has postured themselves as “independent” research and has been active in marketing the Life Partners stock.   http://seekingalpha.com/article/161763-life-partners-holdings-inc-in-singular-research-annual-best-of-the-uncovereds-conference-transcript

But a quick read of the Singular Disclosure shows that they are not as independent as they appear but rather they are an affiliate of Millennium Asset Management run by former stockjock.com publisher Robert Maltbie.

 http://www.singular-research.com/about/disclosure.htm

In fact, Maltbie sometimes appears as an analyst for Singular, and sometimes as an investment advisor.  Given these facts, Citron believes the financial relationship between itself, Singular, Millenium has not been fully disclosed.

3. Even LPHI’s auditor has found something funky in under the sheets.  As stated in their most recent 10-K:

“Life Partners Holdings, Inc. lacked adequate financial oversight including appropriate levels of monitoring and review.  Specifically, Life Partners Holdings, Inc. did not have a systematic procedure for ensuring that the disclosure and presentation of information in the financial statement footnotes would be presented in accordance with accounting principles generally accepted in the United States of America and the various regulatory requirements.  Additionally, Life Partners Holdings, Inc. did not have sufficient accounting oversight to ensure that the classification of all financial information is presented in accordance with accounting principles generally accepted in the United States of America.

In addition, Life Partners Holdings, Inc. lacked adequate internal controls to ensure the proper accounting treatment and financial reporting for new, emerging or non-routine business transactions, especially relating to the accounting for and disclosure of its various investment activities, most notably, its investments in life insurance policies and a limited partnership.”

http://www.sec.gov/Archives/edgar/data/49534/000114420409030009/v149169_10k.htm

This is especially troubling given that, in his last public company, the SEC filed a complaint against Mr. Pardo for falsifying financial reports to shareholders.  http://southflorida.bizjournals.com/southflorida/stories/1997/05/05/story7.html

Conclusion

Citron Research could go on and on about why LPHI’s financials don’t seem to make sense, but that would just be a sideshow to the main event.  After our first report we received a wave of emails from industry insiders explaining that Life Partners operates in the shadows outside the envelope of standard practice for the rest of the industry – and Citron believes that game is about to end.  Citron acknowledges that Mr. Pardo and Life Partners are no strangers to evading efforts to regulate them.  We are not cheerleaders for regulation, but, we are just calling it like it is.

Fair disclosure:  Principals of Citron Research are short LPHI stock with an affirmative borrows at US brokerage firms.