SEC Charges Adviser With Fraud Tied to “Death Puts”
The Commission’s enforcement division and inspectors at OCIE continue to work closely and have developed a series of cases in recent months. One of the more unusual proceeding spawned through this relationship is the action involving a hedge fund, its owner and “death puts.” In the Matter of Donald F. Lathen, Jr., Adm. Proc. File No. 3-17387 (August 15, 2016).
Respondents in the proceeding are: Mr. Lathen, Eden Arch Capital Management, LLC and Eden Arc Capital Advisers. Mr. Lathen is the sole owner, control person, CEO and CFO of Capital Management, a registered investment adviser between October 31, 2012 and February 23, 2016. Capital Advisors is owned by Mr. Lathen. It receives incentive fees. The firm’s general partner is Eden Arc Capital Partners, L.P., a pooled investment vehicle created by Mr. Lathen.
In March 2011 Mr. Lathen began obtaining subscriptions for Capital Partners or the Fund. Its investment strategy centered on acquiring medium and long term bonds and certificates of deposit that had “survivor options” or “death puts.” Investments wee thus on fixed income securities that could be sold back to the issuers – the put – at par plus interest in the death of the holder. By acquiring the instruments at a discount and selling them back at par plus interest the Fund hoped to profit.
Key to the strategy was acquiring the instruments in joint accounts so that the death put could be exercised promptly. To implement this strategy Mr. Lathen began signing up terminally ill Participants. The Fund paid them $10,000 each to become a joint owner of the securities. While the securities were obtained for the Fund, the joint interests were titled to the Participant and either Mr. Lathen or a designated person as a nominee for the Fund. This is because only a natural person could hold the death put. Accordingly, appropriate documents were executed designating Mr. Lathen and others as nominees for the Fund.
Over 60 Participants signed up. Since May 2011 the Fund has purchased about 2350 instruments from dozens of issuers through joint accounts in the name of the Participant and Mr. Lathen or the nominee. To exercise the death benefits Mr. Lathen or the nominee had to assert the claim with the issuer in their name and complete the necessary documentation, representing that they personally were entitled to the death benefit. In fact those representations were false since the Fund acquired the rights and at all times accounted for them in their books and records and financial statements.
From inception the Fund has earned over $9.5 million in profits, largely through early redemption of the bonds and CDs held in the joint accounts. In January 2013 Mr. Lathen replaced the documents executed previously regarding the nominee relationship with other agreements that changed his relationship with the Fund to one of borrower. This permitted him to borrow Fund money. The loans could be made on a non-recourse bases at a rate of prime plus three percent.
Respondents have profited from these arrangements by charging management fees that ranged between 0.5% and 2% of AUM. At the same time the instruments were held in joint accounts and were not in the name of the of the Fund or an account that contained only fund assets under its name as agent or trustee for the Fund as required by the Custody Rule.
The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206(4) and Rule 206(4)-2. The proceeding will be set for hearing.