Definition of a Security. Life Partners, Inc (LPI), facilitates the sale of life insurance pol-icies that are owned by persons suffering from AIDS (acquired immune deficiency syndrome) to investors at a discount. The investors pay LPI, and LPI pays the

Question

policyholder. Typically, the policyholder, in turn, assigns the policy to LPI, which also obtains the right to make LPI's president the beneficiary of the policy. On the policyholder's death, LPI receives the proceeds of the policy and pays the investor. In this way, the terminally ill sellers secure much-needed income in the final years of life, when employment is unlikely and medical bills are often staggering. The SEC sought to enjoin (prevent) LPI from engaging in further transactions on the ground that the investment contracts were securities, which LPI had failed to register with the SEC in violation of securities laws. Do the investment contracts meet the definition of a security discussed in this chapter? Discuss fully.

Answer 1

Definition of a security
The federal district court in which this case was brought held that the investment contracts were securities within the meaning of the Securities Act of 1933—a "contract, transaction or scheme whereby a person invests his money (1) in a common enterprise and (2) is led to expect profits (3) solely from the efforts of the promoter or a third party." The court acknowledged that the efforts of the promoter, after the investment, were "ministerial in nature" but emphasized that the pre- and post-investment efforts should be looked at as a whole. The court also stated that the post-investment efforts were "critical since the promoter, not the investor, has the contractual relationship with the insurer."
On appeal, the U.S. Court of Appeals for the District of Columbia reversed and remanded the case. The court agreed that the contracts met the first two parts of the test, but disagreed that they also satisfied the third element. The pooling of investment funds, shared profits, and shared losses was "sufficient to satisfy the common enterprise requirement." The profit element requires that expected profits "be in the form of a financial return on the investment." In this case, "[t]he buyer is obviously purchasing . . . for the prospect of a return on his investment." The third element—"that the profits expected by the investor be derived from the efforts of others"—was not met, however, because "the promoter's efforts [do not] have a predominant influence upon investors' profits." Instead, "it is the length of the insured's life that is of overwhelming importance to the value" of the investment.