Death Be Not Proud Or Profitable In SEC Fraud Case

November 7, 2016

Death is an uneasy topic for many to contemplate. In the financial services sector, however, the inevitability of death is a critical factor when implementing an investment strategy and estate planning. Taken a step further, death may even offer investment opportunities. A recent Securities and Exchange Commission case demonstrates how issues of mortality raise troubling legal and regulatory concerns.

Case In Point 

On Aug. 15, 2016, the Securities and Exchange Commission ("SEC") filed an Order Instituting Administrative and Cease-and-Desist Proceedings ("OIP") against 
  • Eden Arc Capital Management, LLC ("EACM"), an SEC-registered investment adviser from October 31, 2012 to February 23, 2016;
  • Eden Arc Capital Advisors, LLC ("EACA"), the general partner of Eden Arc Capital Partners, LP; and
  • Donald F. "Jay" Lathen, Jr. ("Lathen"), the sole owner and control person, CEO, CFO and Chief Compliance Officer of EACM and 100% owner of EACA.
EACM is the adviser to Eden Arc Capital Partners, LP ("EACP") from which it receives management fees with different investors paying from .5% to 2% of assets under management. 

EACA receives incentive fees from EACP ranging from 16% to 30% of fund profits, with different investors paying different fees. 

Related party EACP was a pooled investment vehicle started in 2011 by Respondent Lathen and grew to approximately $52 million of assets and 22 investors

In the Matter of Donald F. ("Jay") Lathen, Jr.; Eden Arc Capital Management, LLC; and Eden Arc Capital Advisors, LLC, Respondents (OIP; '33 Act REl. No. 10120; /34 Act Rel. No. 78572; Invest. Adv. Act Rel. No. 4485; Invest. Co. Act Rel. No. 32214; Admin. Proc. File No. 3-17387 / August 15, 2016). Under the "Summary" heading of the OIP, it is asserted that:

1. Since approximately March 2011, Respondents engaged in a fraudulent scheme involving the establishment of a fund that would profit from the use of misrepresentations and omissions of material facts to issuers of medium and long-term bonds and notes ("bonds") by falsely portraying Lathen and other individuals as owners of those bonds, in order to redeem the instruments prior to maturity at par pursuant to survivor options, in violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibit fraudulent conduct in the offer and sale of securities and in connection with the purchase or sale of securities.

2. Since approximately October 2012 through approximately February 2016, EACM willfully violated Section 206(4) of the Advisers Act and Rule 206(4)-2 thereunder (the "custody rule") and Lathen willfully aided, abetted, and caused EACM's custody rule violations by failing to custody the funds and securities of EACM's client, Eden Arc Capital Partners, LP ("EACP" or the "Fund") in an account under EACP's name or in an account that contained only clients' funds and securities, under EACM's name as agent or trustee for the clients. Instead, Lathen and EACM placed EACP's funds and securities in brokerage accounts titled in the name of Lathen and various third parties.

NOTE: The OIP merely contains allegations and respondents are presumed innocent unless and until proven guilty beyond a preponderance of the evidence.

The SEC Press Release

In more lurid detail. it is alleged in pertinent part in "Hedge Fund Manager Charged in Scheme Involving Terminally Ill" (SEC Press Release 2016-162; August 15, 2016: 

The Securities and Exchange Commission today announced fraud charges against a hedge fund manager and his firm accused of paying terminally ill individuals to use their names on purportedly joint brokerage accounts so he could purchase investments on behalf of his hedge fund and redeem them early by invoking a survivor's option.

An SEC examination of investment advisory firm Eden Arc Capital Management uncovered the scheme alleged by the SEC Enforcement Division in an order instituted today.  Donald Lathen of New York City allegedly used contacts at nursing homes and hospices to identify patients with less than six months to live, and he successfully recruited at least 60 of them by paying $10,000 apiece to use their names on accounts. When a patient died, Lathen allegedly redeemed investments in the accounts by falsely representing to issuers that he and the terminally ill individuals were joint owners of the accounts.  Lathen's hedge fund was the true owner of the survivor's option investments.  Issuers paid out more than $100 million in early redemptions as a result of the alleged misrepresentations and omissions by Lathen and Eden Arc Capital . . .

Motion for Summary Disposition

Respondents moved for summary disposition, which was denied by the SEC Administrative Law Judge ("ALJ") because he found that genuine issues regarding material facts remained notwithstanding the arguments in the motion.  In the Matter of Donald F. ("Jay") Lathen, Jr.; Eden Arc Capital Management, LLC; and Eden Arc Capital Advisors, LLC, Respondents (Order Denying Leave For Summary Disposition; Admin. Proc. Rulings Rel. No. 4168; Admin. Proc. File No. 3-17387 / September 19, 2016). As the ALJ characterized Respondents' motion:

Respondents' argument is that under New York law, the accounts were presumptively valid  joint tenancies with rights of survivorship and that there is no evidence to overcome that presumption. Absent such evidence, Respondents assert that it is a fact that Lathen was the true surviving joint tenant and that he was entitled to exercise the survivor options and receive the resulting funds. Whether he or the Participants were nominees of the Fund is, in Respondents' view, irrelevant. See Preh'g Tr. 11-12.

Assuming that Respondents are correct that the only issue is whether Lathen and the Participants established valid joint tenancies in the accounts-in other words, assuming the issuers would not have cared that their securities were purchased with capital supplied by the Fund and that the Participants' terminal conditions made near-term exercise of the survivor options likely-Respondents' motion for leave shows that they will not be able to demonstrate that material facts are not in dispute.

As Respondents note, in New York the creation of a joint account with rights of survivorship raises a presumption that the joint tenancy is valid. N.Y. Banking Law § 675(b). This presumption may be rebutted by "clear and convincing" evidence "sufficient to support an inference that the joint account had been opened in that form as a matter of convenience only." In re Estate of Coddington, 391 N.Y.S.2d 760, 761-62 (N.Y. App. Div. 1977). "In a true joint account, each party has the right to withdraw one half of the funds during the lifetime of both  tenants." In re Estate of Zecca, 544 N.Y.S.2d 40, 41 (N.Y. App. Div. 1989) (internal citation omitted). This means that "at the time the account was opened, there must have been a present gift from the original donor to the cotenant of one half of the account which each could withdraw unilaterally while both were alive." Id.; see In re Estate of Stalter, 703 N.Y.S.2d 600, 602 (N.Y. App. Div. 2000) ("the key underlying issue" is "decedent's intent at the time that the account . . . was created"). It is thus "well settled that the presumption" of validity "may be rebutted by evidence showing" that the funding joint tenant did not "inten[d] . . . [to] confer[] a present beneficial interest on the" other joint tenant at the time the account was opened. In re Friedman, 478 N.Y.S.2d 695, 696 (N.Y. App. Div. 1984), aff'd, 475 N.E.2d 454 (N.Y. 1984); see Fischedick v. Heitmann, 699 N.Y.S.2d 508, 509 (N.Y. App. Div. 1999); Cinquemani v. Cinquemani, 346 N.Y.S.2d 875, 877-78 (N.Y. App. Div. 1973). If such evidence is presented, the party asserting the existence of the presumption must do more than simply rely on the fact of the statutory presumption. Phelps v. Kramer, 477 N.Y.S. 2d 743, 745 (N.Y. App. Div. 1984); see Brezinski v. Brezinski, 463 N.Y.S.2d 975, 977 (N.Y. App. Div. 1983) (explaining that if the presumption of validity is rebutted, the burden shifts to the joint tenant claiming the presumption's benefit to show there was an "inten[t] to make a gift of the funds").

Pages 3 -4 of the Order Denying Leave

Subpoena

As the case makes its way towards a hearing, Respondents sought the issuance of a subpoena from the ALJ directing the SEC to produce "communications between it and the Financial Industry Regulatory Authority and various state and federal authorities related to their investigations of Respondents." The SEC Division of Enforcement ("Enforcement") opposed that request citing the privileged nature of such communications to the SEC from "law enforcement authorities." 

In Camera Submission

In grappling with the competing positions, the AWLJ directed Enforcement to produce a detailed privilege log. In the Matter of Donald F. ("Jay") Lathen, Jr.; Eden Arc Capital Management, LLC; and Eden Arc Capital Advisors, LLC, Respondents (Order Requiring In Camera Submission; Admin. Proc. Rulings Rel. No. 4322;; Admin. Proc. File No. 3-17387 / November 4, 2016).  As explained by the ALJ [Ed: footnotes omitted]:

The Division responded with a letter in which it explained its position, a declaration authored by its counsel, Judith Weinstock, and a privilege log. The privilege log lists a series of forty documents-emails, email chains, and letters-all of which the Division asserts are protected by the work-product and common interest doctrines and Section 24(f).  Ms. Weinstock declares that after the Division's investigation began, she communicated with FINRA and various state and federal regulatory and law enforcement authorities about the investigation. Decl. at 1-2. She asserts that

These communications were in furtherance of the Division's investigation and in contemplation of litigation. The correspondence includes, for example, attorneys' mental impressions of the pertinent facts, and information about the Division's investigative strategy, with an eye toward litigation.The communications also include exchanges of information between the Division and the agencies listed above, as well as strategic and timing discussions. The communications also reveal information about FINRA's examination and investigation, as well as inquiries from other agencies. The communications do not contain Brady material.

Id. at 2.

In its letter, the Division asserts that its communications constitute work product. It notes that the communications took place after its investigation started and "reflect [its] efforts to further its investigation." Letter at 1. It says the communications concern matters such as the sharing of relevant information between law enforcement agencies. Id. In addition to asserting that Section 24(f) applies, the Division argues that the common interest doctrine applies to its communications with other agencies because those agencies "have a 'unity of interest'" with the Division. Id. at 2.

Pages 1 - 2 of the In Camera Order

Work Product Doctrine

In considering Respondents' objections to the adequacy of the submitted privilege log and Enforcement's assertion of privilege, the ALJ noted that:

The work product doctrine protects tangible things prepared by or for a party or its representative "in anticipation of litigation." SEC v. Yorkville Advisors, LLC, 300 F.R.D. 152, 159 (S.D.N.Y. 2014); see Fed. R. Civ. P. 26(b)(3)(A). As the proponent of the privilege, the Division bears the burden to show that it applies. In re Subpoena Duces Tecum Issued to CFTC, 439 F.3d 740, 750 (D.C. Cir. 2006); United States v. Constr. Prods. Research, Inc., 73 F.3d 464, 473 (2d Cir. 1996). A privilege log must give enough detail to allow one to judge whether a document alleged to be privileged "is at least potentially protected from disclosure." Constr. Prods. Research, 73 F.3d at 473 (quoting Bowne of New York City, Inc. v. AmBase Corp., 150 F.R.D. 465, 474 (S.D.N.Y. 1993)); see Yorkville Advisors, 300 F.R.D. at 162-64. It is not sufficient to give a cursory description in a privilege log of the basis for a claim of privilege. Constr. Prods. Research, 73 F.3d at 473-74.

The Division's privilege log bears more than a passing resemblance to the privilege log the court found deficient in Yorkville Advisors. See 300 F.R.D. at 163-64. The court in Yorkville, relying on Construction Products Research, found the information provided in the Commission's privilege log was too cursory to support the Commission's privilege claims. Id. At 162-64. Such is the case here.

Pages 2 - 3 of the In Camera Order

In ordering Enforcement to submit the 40 items listed on its privilege log for in camera review, along with sufficient explanation as to why each item qualifies for work-product-protection and falls under the common interest doctrine, the ALJ held that:

Indeed, as Respondents note, the Division provides no evidence that communications from outside agencies were made by those agencies in anticipation of litigation. And while the Division relies on the common interest doctrine, that doctrine "is not a privilege in its own right." Hunton & Williams v. U.S. Dep't of Justice, 590 F.3d 272, 280 (4th Cir. 2010). It does not apply before the putative common interest is established. Id. at 285. When that might have occurred with respect to the communications at issue in this proceeding and whether a common interest was established between the entities communicating is not demonstrated by the evidence presented.

Page 3 of the In Camera Order

Bill Singer's Comment

An interesting glimpse into the procedural maneuvering before the onset of hearings. 

As referenced by the ALJ, Securities and Exchange Commission, Plaintiff, v. Yorkville Advisors, LLC, Mark Angelo, and Edward Schinik, Defendants (Opinion and Order, United States District Court for the Southern District of New York, 12-CIV-7728, February 27,2015), Magistrate Pitman awarded  defendants' counsel $21,619.63 in attorneys' fees and $431.73 in costs after finding, in pertinent part:

I concluded that the SEC's Privilege Logs failed to provide the information required by Federal Rule of Civil Procedure 26(b)(5), Local Civil Rule 26.2(a)(2)(A) and the Pilot Project's discovery procedures and that they lacked sufficient information to support the asserted claims of privilege. SEC v. Yorkville Advisors, LLC, supra, 300 F.R.D. at 164. In addition, I found that the SEC's submission of its Revised Privilege Log was untimely pursuant to Local Civil Rule 26.2(b) because it was served after defendants had filed their motion to compel and the SEC's justification for the delay in production was "totally inadequate." SEC v. Yorkville Advisors, LLC, supra, 300 F.R.D. at 165. I further determined that the new claims of privilege asserted for the first time in the Revised Privilege Log were untimely pursuant to Federal Rule of Civil Procedure 26(b)(5)(A)(i) and Local Civil Rule 26.2. SEC v. Yorkville Advisors, LLC, supra, 300 F.R.D. at 166. However, because I concluded that the statutory privilege afforded to Suspicious Activity Reports ("SARs") pursuant to the Annunzio-Wylie AntiMoney Laundering Act1 could not be waived, I held that the SEC could assert its privilege with respect to twenty-six SARs listed in the Revised Privilege Log. SEC v. Yorkville Advisors, LLC, supra, 300 F.R.D. at 167. Thus, "the SEC's unjustified failure to serve indices of privileged documents in a timely and proper manner operate[d] as a waiver of any applicable privilege, with the exception of the SARs privilege." SEC v. Yorkville Advisors, LLC, supra, 300 F.R.D. at 167. 

Pages 3 - 4 of the SDNY Opinion and Order