Largely overlooked in the wake of financial regulatory reform, on July 22 two government agencies released reports discussing the regulation of life insurance settlements.
The law firm of Sidley Austin, LLP. noted Monday, August 17, that in response to the growing life settlement market and inconsistent regulation thereof, the Government Accountability Office (GAO) and a Task Force of the Securities and Exchange Commission (SEC) each separately recommended steps be taken to regulate life settlements more consistently and to increase protection for policy owners, investors and intermediaries.
The reports observe that regulation of life settlements is not consistent among states. Notably, the reports also focus on the question of whether and when life settlement investments or transactions should be regulated as securities transactions for purposes of the federal securities laws.
According to the law firm’s analysis, while the Task Force Report states that life settlements are treated as “securities” under the securities laws of most states, the reports note that the treatment of life settlements at the federal level is less clear. While variable life policies are recognized as securities, and thus are subject to applicable rules of the SEC and the Financial Industry Regulatory Authority (FINRA), as well as to state securities regulation, courts have reached inconsistent results when presented with questions regarding whether certain investment transactions in non-variable life policies have involved the offer and sale of “securities” under federal securities laws.
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SEC Life Settlement Task Force’s Response to the Inconsistent Regulation of Life Settlements
According to Sidley Austin, the SEC’s Task Force Report made recommendations based on the current inconsistent regulation of life settlements at the state and federal levels, including:
o First, the SEC should consider recommending to Congress that the definition of “security” in the Securities Act of 1933 (the Securities Act), the Securities Exchange Act of 1934 (the Exchange Act) and the Investment Company Act of 1940 (the “Investment Company Act”) be amended to include all life settlements (i.e., including a settlement of an individual, non-variable policy, as well as the sale of fractionalized interests in such a policy or policies). The Task Force notes that this would provide for greater consistency in regulation under federal law, as well as provide clear regulatory authority for the SEC and FINRA in policing the life settlement market. In particular, the Task Force Report identifies a number of perceived legal and regulatory benefits that would flow from the treatment of all life settlements as securities, for federal securities law purposes:
- Registration and regulation of life settlement market intermediaries as “broker-dealers” under the Exchange Act.
The Task Force Report concludes that, to the extent life settlements are deemed “securities” for purposes of the Exchange Act, life settlement brokers, providers and producers (sometimes collectively referred to in the report as “market intermediaries”) would be required to register as broker-dealers with the SEC and become a member of
at least one SRO -presumably FINRA. Focusing upon the many obligations that broker-dealers owe to their customers (e.g., the duty of best execution and prohibitions against excessive commissions and unsuitable recommendations), the SEC Task Force seems to support this conclusion by emphasizing how both the policy owners/sellers and the policy purchasers/investors would benefit from such protections.
- Offers and sales of life settlements would be subject to registration under the Securities Act, absent an available exemption. The Task Force Report notes that all offers and sales of life settlements would be required to be registered with the SEC pursuant to the Securities Act, absent an available exemption.
- Federal securities law anti-fraud liability; private right of action for misstatements and omissions. The Task Force Report notes that an amendment to the “security” definition under the Securities Act and the Exchange Act would also have the effect of subjecting life settlement transactions to the general anti-fraud provisions of those statutes, including providing a private right of action for misstatements and omissions in connection with the offer and sale of a life settlement.