New SEC Proceeding

In August 2016, the SEC filed cease and desist proceedings against a U.S. private fund and its manager. The action alleges that the manager solicited terminally ill patients to open brokerage accounts that would hold instruments with survivor options, and, upon their deaths, the private fund received significant funds upon early redemptions. The SEC's complaint can be found at the following link: https://www.sec.gov/litigation/admin/2016/33-10120.pdf.

The suit alleges that the fund recruited terminally ill patients at nursing homes and hospices. The fund paid cash to these individuals to use their names on joint brokerage accounts with the fund manager. These accounts would hold investments that had survivor option features, and, upon the death of the terminally ill patient, the redemption proceeds would be paid to the investment fund. The proceeding challenges these practices on two principal grounds:

  • falsely claiming that the deceased individuals jointly owned the instruments, when the private fund was the true owner; and
  • violating the SEC's custody rules under the Investment Advisers Act by placing the fund's investment assets in the names of the fund manager and the deceased individuals.

The Fund's Investment Strategy

The fund's investment strategy was unusual: purchasing discounted instruments that had a survivor option feature, and then exercising the right when the terminally ill patient passed away. The investment plan was described in the fund's private placement memorandum.

How were the terminally ill patients solicited? The fund manager allegedly created a new company, and used contacts at nursing homes and hospices to identify terminally ill patients. These patients were offered a cash payment to use their names on joint accounts, which were opened on behalf of the fund manager, on the one hand, and the patient, on the other hand. The fund manager then purchased instruments with survivor options in the secondary market at a price that was well under par and placed them in the relevant accounts, where they were held until the death of the patient.

Responses by Issuers

In a prior issue of this publication, we discussed the use of survivor options in structured notes and structured CDs and the possibility for abuse. In response to these potential abuses, some issuers have implemented terms in their survivor options that have a longer required holding period before exercise, or that can only be exercised by the initial purchaser of the instrument. In addition, some issuers have been more active in attempting to identify vulture-type schemes of this type, by looking for holders who are filing repeat claims for survivor option redemptions.