Will SEC's life settlement proposal kill industry?

On Thursday, a government task force recommended treating life settlements as securities, thus bringing the instruments under tighter regulatory scrutiny. On Friday, some market participants backed the idea. But others bashed the plan, claiming that such a proposal would place sizable burdens on providers — and offer little added protection for institutional investors. “You will have those who are currently involved in life settlements who won't be able to afford the initial and ongoing cost of compliance, so you'll likely see a reduction in the overall number of providers,” said Boris Ziser, a partner at Stroock & Stroock & Lavan LLP. An SEC task force yesterday released a report recommending that the regulator push Congress to expand the federal definition of “security” to apply to life settlements. Under such a setup, all market intermediaries — including the providers buying up the insurance policies, as well as life settlement brokers — would be required to register with the SEC and the Financial Industry Regulatory Authority Inc., as well as subscribe to best-execution and suitability rules. At the moment, settlements based on variable-life policies are already treated as securities, and while federal courts have reached different conclusions on whether fractional interests in settlements are securities, market participants consider them as such. If the task force suggestion becomes law, however, market participants will face some serious hurdles. For starters, providers promoting life settlements would have to become or buy a registered broker-dealer. What's more, settlement brokers — already under state insurance regulators' jurisdiction — would have to become securities-registered. Few providers currently have a broker-dealer affiliate, Mr. Ziser said. Further, defining life settlements as securities wouldn't offer protection to the institutional investors who are buying up the policies, said James W. Maxson, who is of counsel and co-chairman of the life settlements group at Morris Manning & Martin LLP. In fact, he believes it would likely limit those investors' access to the policies. “Those institutional investors tell the providers what policies they want and the parameters in which they can buy them,” he said. “That's not the same situation in which you have a promoter of an investment finding Moms and Pops, and saying, ‘This life settlement is a great asset for you. Invest in it.'” Applying the “security” label to all life settlements ignores specific situations in which the life settlement isn't necessarily an investment contract, the attorney added. But Mr. Maxson does believe that life settlements ought to be treated as securities when individual investors are doing the buying. Indeed, one market participant believes that applying Finra suitability and supervision standards to all life settlement transactions would be a plus for both individual investors and broker-dealers. “I hope it becomes a security so it's black and white for all,” said Caleb J. Callahan, vice president of investment services for ValMark Securities Inc., a broker-dealer that also works with life settlements. “But [the Securities and Exchange Commission] also needs to make sure the legal standard and monitoring processes are specific.” He added that in the long term, clearer oversight might encourage a stronger life settlements market. “One could argue that a layer of bureaucracy will make it harder to raise funding in a damaged marketplace,” Mr. Callahan said. “But you could also say that if you're an [institutional] investor, you like seeing clear lines and definitions, and that you're comfortable putting the money up if you know people are licensed as securities intermediaries,” he said. Others agreed. “I not only endorse and embrace [the recommendation], I appeared before the Senate's Committee on Aging and recommended that they change the definition of securities to include life settlements,” said Fred J. Joseph, securities commissioner in Colorado. Mr. Joseph's office had also talked with the SEC's task force as it gathered information for the report. “I said that [changing the definition of “security”] is the key — the cornerstone — here.”