SEC Charges That "Bonded Life Settlement"
Plan Was Ponzi Scheme
Stephen Barrett, M.D.
In August 2007, the U.S. Securities and Exchange Commission filed suit to stop a $25 million Ponzi scheme that victimized hundreds of investors who bought fractional ownership interests in life insurance policies. The suit charges that Donald Neuhaus of Redding, California, his daughter Kimberley Snowden, and their company Secure Investment Services, Inc., engaged in securities fraud by falsely promising safe, secure, and profitable interests in life insurance policies known as "viaticals" while failing to disclose the dire financial condition of the investment venture. According to the complaint (shown below), Neuhaus and Snowden:
- Sold shares of "bonded life settlements" by representing that investors' money would be used to purchase and pay future premiums on life insurance policies.
- Promised returns up to 125% when the insured person died.
- Used investors' money for their own personal use and to cover premiums on other insurance policies owned by other investors. This constituted a Ponzi scheme in which money from new investors is used to conceal misrepresentations to earlier investors.
- Failed to inform investors that the enterprise was on the brink of collapse, and that investors risked losing everything if the policies expired due to lack of payment.
- Misled investors by providing life expectancy estimates "certified" by George Kindness, a convicted felon who had falsely represented himself as a medical doctor.
- Falsely claimed that the investments were protected by bonding companies.
Shortly after the suit was filed, a federal judge granted the SEC's request to temporarily prohibit further sales, freeze the defendants' assets, and appointing a receiver to take control of operations in order to manage and preserve remaining investor funds.
In a parallel action, the government also filed criminal charges against Neuhaus; Snowden; four sales agents (Robert Eberle, Clifford Palm, and Robert Koppel); and two others (David Goldenberg, and Mark Eric Wolok) who had provided the useless "surety bonds." Neuhaus died in November 2007.
HELANE L. MORRISON (Cal. Bar No. 127752)
JOHN S. YUN (Cal. Bar No. 112260)
PATRICK T. MURPHY (Admitted in New York)
THOMAS J. EME (Admitted in Illinois)
LLOYD A. FARNHAM (Cal. Bar No. 202231)
Attorneys for Plaintiff
SECURITIES AND EXCHANGE COMMISSION
44 Montgomery Street, 26th Floor
San Francisco, California 94104
Telephone: (4 15) 705-2500
Facsimile: (41 5) 705-2501
UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF CALIFORNIA
SECURITIES AND EXCHANGE COMMISSION,
INVESTMENT SERVICES, INC.,
Case NO. 2 :07-cv-0 1724-LEW-CMK
DEMAND FOR JURY TRIAL
Plaintiff Securities and Exchange Commission (the "Commission") alleges:
SUMMARY OF THE ACTION
1. This civil enforcement action involves a fraudulent scheme whereby Defendants sold fractional ownership interests in a particular life insurance policy to a specific group of investors, and then failed—without warning or disclosure—to use those investors' money to cover the future premium payments on their specific policy. Instead, those investors' money was rapidly depleted to pay Defendants' business and personal expenses and to cover the premiums on other insurance policies (owned by different groups of investors) that would otherwise lapse for non-payment of premiums. Defendants are therefore operating a "ponzi" scheme whereby every new investor is being defrauded to provide the cash needed to conceal Defendants' misrepresentations to an earlier group of investors.
2. Defendants Donald F. Neuhaus and Kimberly A. Snowden have operated this scheme through at least one of their corporations—Defendants Secure Investment Services, Inc., American Financial Services, Inc., and Lyndon Group, Inc.—since at least 2001 and have raised over $25 million from hundreds of investors in more than twenty states. After representing that they will reserve investor funds to pay future premiums on the life insurance policy being sold, Defendants commingle and spend the funds immediately. Consequently, Defendants can meet future premium obligations exceeding $3 million only by fraudulently raising funds from new investors. As their scheme has been heading for collapse, Neuhaus and Snowden have transferred at least $740,000 in investor funds to themselves.
3. Defendants also have concealed from investors significant risks relating to the policy they are purchasing. The amount of future premiums that must be reserved is tied to the estimated future life expectancy of the person being insured. Those life expectancy estimates have been consistently too low, and many of them were provided by someone whom Defendants learned to have falsely claimed to be a medical doctor. Additionally, Defendants represented that bonding companies would step in and pay investors their return if the insured lived beyond the estimated life expectancy. That representation was false and misleading because Defendants knew or were reckless in not knowing that the bonding companies were unlicensed, and had a dubious reputation.
4. Operating on nothing but borrowed time and misappropriated funds, Defendants' scheme must be stopped to protect investors. The Commission brings this action to enjoin Defendants from further violations of the antifraud and registration provisions of the federal securities laws. The Commission also asks that the Court appoint a receiver and grant other equitable relief to marshal and protect investor assets, and order the Defendants to disgorge their ill-gotten gains and pay civil money penalties.
JURISDICTION AND VENUE
5. The Commission brings this action pursuant to Sections 20(b) and 20(d) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. $9 77t(b) and 77t(d)] and Sections 21(d) and 21(e) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. $5 78u(d) and 7 8u(e)].
6. This Court has jurisdiction over this action pursuant to Sections 20(d)(l) and 22(a) of the Securities Act [15 U.S.C. $5 77t(d)(l) and 77v(a)] and Sections 21(d)(3), 21(e), and 27 of the Exchange Act [15 U.S.C. $5 78u(d)(3), 78u(e), and 78aa]. Defendants, directly or indirectly, have made use of the means and instrumentalities of interstate commerce or of the mails in connection with the acts, transactions, practices, and courses of business alleged in this complaint.
7. Venue is proper in this District pursuant to Section 22(a) of the Securities Act [15 U.S.C. $ 77v] and Section 27 of the Exchange Act [15 U.S.C. $ 78aa]. Neuhaus and Snowden reside in the District, and the principal place of business of the remaining Defendants is located in the District. Also, acts, practices, and courses of business alleged in the complaint occurred in the District. This action has been filed in the Sacramento Division according to Local Rule 3- 120(d) because the case arises from acts, practices, and courses of business that occurred in Shasta County, California.
8. Secure Investment Services, Inc. ("SIS"), American Financial Services, Inc. ("AFS"), and Lyndon Group, Inc. ("Lyndon Group") (collectively "the corporate defendants") are corporations that Donald Neuhaus and Kimberly Snowden have used to operate the fraudulent scheme at various times. SIS and Lyndon Group were incorporated in Nevada and AFS was incorporated in Wyoming. All have their principal places of business in Redding, California. Since approximately May 2005, the scheme has been primarily operated through SIS.
9. Donald F. Neuhaus ("Neuhaus"), age 76, resides in Redding, California. Neuhaus has served as an officer and/or director for each of the corporate defendants and controls them along with co-defendant Kimberly Snowden. Together with his wife, Neuhaus owns the corporate defendants. Neuhaus is familiar with the flow of funds through the investment program; he monitors corporate bank account balances and activity; and he participates in managing business expenses.
10. Kimberly A. Snowden, age 42, resides in Redding, California, and is Neuhaus's daughter. She has served as an officer and/or director for each of the corporate defendants and also as their Director of Operations and Controller. Snowden keeps SIS's books and financial statements, she has control over SIS's bank accounts, and she writes the checks to pay premiums on the life insurance policies.
A. Defendants Are Selling Securities to Elderly Investors
11. Defendants offer and sell securities that take the form of fractionalized interests in life insurance policies, so-called "bonded life settlements" or "bonded senior settlements." By representing that investors will receive returns on these investments as high as 125 percent, Defendants have sold over 40 policies to at least 500 investors in over 20 states including California, Florida, and Texas, and have obtained over $25 million in investor proceeds.
12. Investors are typically solicited by a network of sales agents recruited by Defendants. The sales agents use internet websites, advertisements, mailings, seminars, and other means to solicit investors. Investors have been encouraged to place their retirement savings in Defendants' program and many have done so. Many investors are in their 50s, 60s7 and 70s.
13. Defendants obtain the life insurance policies from various policy brokers, paying the brokers a fraction of the policy's face amount. Upon selling a policy to investors, Defendants record the investors as beneficiaries and owners of the policy on the insurance company's records. As the investment is structured, when the insured on the policy dies, the insurance company should pay each investor a pro rata share of the policy face amount that equals his or her original investment plus the return.
14. For the insured on each policy, Defendants obtain a purported life expectancy estimate, which includes information on the insured's age and health status. These supposed estimates typically project that the insured will die in three to six years and, by extension, project when the investor will receive a return. Defendants provide the life expectancy estimates to investors, either directly or through sales agents. Many of the investments are supposedly "bonded" so that if the insured lives beyond the life expectancy, then, after a waiting period, the bonding company will purchase the policy from the investors, paying them the amount they would otherwise receive from the insurance company upon the death of the insured. Defendants provide copies of the purported bonds to investors either directly or through sales agents.
15. After a policy is sold to investors, premiums on the policy must be paid to prevent it from lapsing. The purchase agreements typically state that included in what investors pay is an amount sufficient to pay policy premiums for the life expectancy of the insured plus the typical bond waiting period (twelve months), and that Defendants will use this amount to pay the premiums. The investors are therefore passive participants, with their role limited to signing purchase documents and paying for the investment.
B. Defendants Falsely Represent that Future Premiums are Covered
16. As Defendants know, when a policy is sold to investors, a portion of the investor funds must be set aside in an amount sufficient to pay future premiums on the policy for the period of the life expectancy plus the bond waiting period. The investor purchase agreements typically contain the following representations by Defendants: "All of the following costs associated with the purchase of an interest of [sic] a policy are included in the investment amount . . . A premium payment for a minimum of one year beyond the projected life expectancy of the insured, or until the policy is purchased by the bonding company, whichever comes first." "SIS may escrow funds for future premium payments for a minimum of twelve (12) months beyond the projected life expectancy of the insured, or longer at SIS's discretion . "Future premiums, for a minimum of the life expectancy of the insured plus twelve (1 2) months, or longer at the SIS's discretion, shall be paid by SIS . . ." In other documents, Defendants have similarly represented to investors that they will "set aside" or "escrow" investor money to cover future premiums.
17. These representations are false. Future premium payments are "not included in the investment amount" because Defendants do not "escrow," "set aside," or otherwise reserve investor funds for payment of future premiums. Rather, since at least June 2005, Defendants have secretly commingled investor funds immediately upon receiving them and used them to pay premiums on any policy they previously sold, to purchase policies, to pay sales commissions, and to cover any other expense of the scheme. Defendants have not reserved sufficient funds to pay future premiums on previously sold policies, meaning those premiums can be "paid by SIS" only if Defendants raise new money from new investors in new policies.
18. As of June 30,2007, even though Defendants were obligated to pay at least $3.1 million in premiums on policies they had already sold if the insured lives until the end of the bond waiting period, the investor money for those policies had already been depleted. In addition, as detailed below, as of June 30 Defendants owed $1,000,000 in "self-insurance" to investors in two policies. As of June 30, Defendants had approximately $162,000 in corporate bank accounts, and as of July 3 1 the accounts contained approximately $63,000. Defendants cannot meet their premium and self-insurance obligations without raising money from new investors. If Defendants fail to meet premium obligations, policies may lapse and cause investors to lose their entire investment.
19. Lacking cash, Defendants at times use the cash value of the policies to cover premiums. "Cash value" refers to funds that can accumulate within a policy and are held by the insurance company. Cash value is an asset that belongs to the owners of the policy, and generally can be loaned to the owner or used to pay premiums in lieu of cash payments. The purchase agreements contemplate only cash payments of premiums. Defendants have not informed investors or potential investors that they deplete policy cash value to cover premiums.
20. From the amount that each investor pays for the investment, Defendants take as much as 20% and use it pay commissions to the sales agent. The agents may spend a few hours effecting an investment and thereby earn a 20% commission on $50,000, $100,000, $200,000 or more. Defendants have not disclosed the commissions to investors or potential investors nor ensured that the sales agents disclose them.
21. Although Defendants lack money to cover their obligations, Neuhaus and Snowden have transferred substantial funds from corporate bank accounts to themselves. From June 2005 to the present, Neuhaus has received at least $500,000 in investor funds from SIS's bank accounts. Snowden has received at least $240,000 in investor funds from the accounts during the same time frame.
C. Defendants Are Not Providing "Self-insurance"
22. In September 2003, AFS purported to provide the bond or "self-insurance" for two policies that were to pay investors a combined return of $1,000,000. Defendants did not set aside or segregate funds needed to perform on the "self-insurance" if necessary, and today the corporate defendants lack the funds to perform.
23. In June 2007, Neuhaus sent a letter telling investors in the policies that once they submit certain paperwork giving up their ownership in the policies, they will receive their share of the $1,000,000 payout. As Defendants know but have not disclosed to investors, they do not have $1,000,000 and can only obtain it by fraudulently raising new money.
D. Defendants Have Failed to Disclose to Investors that Life Expectancy Estimates are Falsely Certified and Unreliable
24. In the investor purchase agreements, Defendants represent to investors: "All life expectancies of insured [sic] will be determined by an independent reviewing physician taking into account the insured's age, current medical history, and, where applicable, insurance industry actuarial guidelines." Most of the life expectancies Defendants have provided to investors are in the form of written "certificates" bearing the name of AmScot Medical Labs, Inc. ("AmScot") or Midwest Medical Review LLC ("Midwest"). Many of the certificates under the AmScot name bear the name "George Kindness, M.D." and many bear his signature.
25. Contrary to the purchase agreement and the certificates, George Kindness is not an M.D. or physician. Furthermore, a federal grand jury indicted Kindness along with AmScot in November 2003 on 21 counts involving conspiracy and fraud in the introduction of 7 COMPLAINT misbranded and adulterated drugs into commerce. The indictment includes an allegation that Kindness falsely represented himself to be an M.D. In July 2005, both Kindness and AmScot pled guilty to one count of the indictment, and in September 2006 both were convicted.
26. No later than September 2005, an investor informed Neuhaus that Kindness is not an M.D. and had been indicted. No later then mid-2005, Snowden learned that Kindness was involved in adverse legal proceedings and she later learned that he had been convicted of a crime.
27. After Kindness was indicted, the certificates Defendants provided to investors switched from bearing the AmScot name to bearing the bearing Midwest name, and Kindness's name no longer appeared on the certificates. Kindness controls both AmScot and Midwest and continues to provide input on Midwest's operations. AmScot and Midwest certificates exhibit certain characteristics--including an "Amscot Midwest'' fax header line, identical fax numbers, the names of the same purported physicians, and similar formats--which Neuhaus and ,Snowden observed and which made it obvious to them that Midwest is a continuation of AmScot's operation.
28. Defendants have not disclosed to investors or potential investors that Kindness is not a medical doctor, that he and AmScot have criminal records, and that Midwest is a continuation of AmScot's operation. These undisclosed facts indicate that AmScot and Midwest life expectancy estimates are unreliable; that investors may have to wait longer for returns; and that policies may lapse from lack of funds to make premium payments and investors will lose their entire investment.
29. Since 2003, Defendants have also obtained life expectancy estimates from an entity named 21" Services. Some of the 21" Services estimates cover the same insured for which AmScot or Midwest had earlier prepared a certificate that was provided to investors. Many of these 21St Services life expectancy estimates are years longer than the estimate in the AmScot or Midwest certificate. After receiving consistently longer estimates from 21St Services, Defendants continued to sell policies on the basis of AmScot or Midwest estimates only.
30. At present, insureds on at least 20 policies sold by Defendants remain alive beyond the end of the life expectancy estimate, some by two or three years. Defendants have not disclosed to investors or potential investors that insureds are outliving life expectancies in this manner.
E. Defendants Have Failed to Disclose Risks Associated With the Bonds
31. Defendants' purchase agreements typically state that that the investment "shall carry an insurance bond" that will pay the investor "the full face value of their interest in the policy, should for any reason, the policy not mature within the limits indicated in the agreement." A policy "matures" when the insured dies. The purchase agreements also typically state that "included in the investment amount . . . [is] [tlhe Bonding Company fee for the life of the Agreement."
32. The purported bonds are, in fact, illusory because the bonding companies are unlicensed and have adverse regulatory histories. One such bonding company is International Fidelity & Surety Ltd. ("IFS"), purportedly based in the Pacific Island nation of Vanuatu. IFS has never been licensed to provide insurance in any state in the United States and has never been an authorized "surplus line insurer" in California. Since 2001, IFS has been the subject of state regulatory actions in Florida and Texas variously involving fraud, unauthorized issuance of insurance, and a "life settlement" investment program. Neuhaus, who previously worked in the insurance industry, chose IFS as a bonding company with the knowledge that it was not licensed to provide insurance anywhere in the U.S. In September 2005, an investor wrote to Neuhaus expressing concern that IFS was not licensed and headquartered in Vanuatu.
33. Defendants have also used the following purported bonding companies: Provident Capital and Indemnity Ltd. ("Provident"), purportedly based in Costa Rica; BALGI, purportedly based in Brunei; and Sino Reinsurance ("Sino") purportedly based in Australia. None of these companies has ever been licensed to provide insurance in any state in the U.S. None of the companies has ever been an authorized "surplus line insurer" in California, and Provident specifically appears on California's list of "unacceptable nonadmitted" insurance companies. Since 1992, Provident has been the subject of state regulatory actions in California, Florida, and Texas variously involving fraud, unauthorized issuance of insurance, and a "life settlement" investment program. Defendants have not disclosed the bonding companies' lack of licensure and adverse regulatory histories to investors.
F. Defendants Have Concealed Their Regulatory Problems
34. In February 2003, the California Department of Corporations ordered Neuhaus and AFS to cease selling investments of the type involved here. The order found that in selling the investments, Neuhaus and AFS made material misstatements and omissions of fact involving the bond, the return, liquidity, and licensing status. Defendants have not disclosed the order to investors or potential investors.
35. In April 2005, the Internal Revenue Service executed search warrants at AFS's office and Neuhaus's home. Soon after the search, AFS discontinued business operations and closed its bank accounts, and SIS was created and opened its own accounts at a different bank.
G. Sales Agents Under Defendants' Control Have Misrepresented the Investment
36. Many sales agents operate under written agreements with SIS. The agreements require the agents to obtain approval from SIS before using written promotional materials. Promotional materials distributed by sales agents to investors have made the following claims: (i) an independent escrow company "handles all the money transactions" including paying policy premiums; (ii) policy premiums will be paid because SIS "will have collected enough money to support the term of the investment plus an extra year"; (iii) the bonding company agrees to bond the investment on the basis of "a consensus of three medical opinions"; and (iv) the investment is "guaranteed" and has "little, if no, risk." As shown above, these claims are false and misleading.
H. Defendants have not registered any offering
37. Since at least 2001, Defendants have continuously offered for sale and sold their bonded life settlement investments as securities in public offerings to individual investors through their network of sales agents. No registration statement was filed with the Commission or was in effect with respect to these securities prior to the offer or sale of these securities.
FIRST CLAIM FOR RELIEF
Violations of Section 17(a) of the Securities Act
38. The Commission hereby incorporates paragraphs 1 through 37 by reference.
39. Defendants have, by engaging in the conduct set forth above, directly or indirectly, in the offer or sale of securities, by the use of means or instruments of transportation or communication in interstate commerce, or of the mails: (a) with scienter, employed devices, schemes, or artifices to defraud; (b) obtained money or property by means of untrue statements of material fact or by omitting to state material facts necessary in order to make statements made, in the light of the circumstances under which they were made, not misleading; and (c) engaged in transactions, practices, or courses of business which operated or would operate as a fraud or deceit upon the purchasers of such securities.
40. By reason of the foregoing, Defendants have directly or indirectly violated Section 17(a) of the Securities Act [15 U.S.C. 5 77q(a)] and unless enjoined will continue to violate Section 17(a) of the Securities Act.
SECOND CLAIM FOR RELIEF
Violations of Section 10(b) of the Exchange Act and Rule lob-5 Thereunder
41. The Commission hereby incorporates Paragraphs 1 through 37 by reference.
42. Defendants, by engaging in the conduct set forth above, directly or indirectly, by use of means or instrumentalities of interstate commerce, or of the mails, or of a facility of a national security exchange, with scienter: (a) employed devices, schemes, or artifices to defraud; (b) made untrue statements of material fact or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and (c) engaged in acts, practices, or courses of business which operated or would operate as a fraud or deceit upon other persons, in connection with the purchase or sale of securities.
43. By reason of the foregoing, Defendants have directly or indirectly violated Section lo@) of the Exchange Act [15 U.S.C. 8 78j@)] and Rule lob-5 117 C.F.R. $8 240.10b-51 and unless enjoined will continue to violate Section 10(b) of the Exchange Act and Rule 1 Ob-5.
THIRD CLAIM FOR RELIEF
Violations of Section 5(a) and 5(c) of the Securities Act
44. The Commission hereby incorporates Paragraphs 1 through 37 by reference.
45. Defendants have, by engaging in the conduct set forth above, directly or indirectly, through use of the means or instruments of transportation or communication in interstate commerce or of the mails, offered to sell or sold securities or carried or caused such securities to be carried through the mails or in interstate commerce, for the purpose of sale or delivery after sale.
46. No registration statement was filed with the Commission or was in effect with respect to the securities offered by Defendants prior to the offer or sale of these securities.
47. By reason of the foregoing, Defendants have directly or indirectly violated Sections 5(a) and 5(c) of the Securities Act [15 U.S.C. $8 77e(a) and 77e(c)], and unless restrained and enjoined will continue to violate these provisions.
WHEREFORE, the Commission respectfully requests that the Court:
Temporarily, preliminarily, and permanently enjoin the Defendants, their agents, servants, employees, attorneys and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Sections 5(a), 5(c) and 17(a) of the Securities Act, [15 U.S.C. $8 77e(a), 77e(c) and 77q(a)], and Section lo@) the Exchange Act, [15 U.S.C. 8 78j(b)] and Rule lob-5 [17 C.F.R. 5 240.10b-51 thereunder.
Order Defendants to provide an accounting and disgorge their ill-gotten gains in an amount according to proof, plus prejudgment interest thereon.
Order Defendants to pay civil money penalties pursuant to Section 20(d)(l) of the Securities Act [15 U.S.C. 5 77t(d)(l)] and Section 21 (d)(3) of the Exchange Act [I 5 U.S.C. 5 78u(d)(3)].
Appoint a receiver over SIS, AFS, and Lyndon Group.
Enter an order freezing the assets of Defendants.
Retain jurisdiction of this action in accordance with the principles of equity and the Federal Rules of Civil Procedure in order to implement and carry out the terms of all orders and decrees that may be entered, or to entertain any suitable application or motion for additional relief within the jurisdiction of this Court.
Grant such other and further relief as this Court may deem just, equitable, and necessary.
Dated: August 23,2007
/S/ Thomas J. Eme
THOMAS J. EME
HELANE L. MORRISON
JOHN S. YUN
PATRICK T. MURPHY
LLOYD A. FARNHAM
Attorneys for Plaintiff
SECURITIES AND EXCHANGE COMMISSION
DEMAND FOR JURY TRIAL
The Commission hereby demands a jury trial.
Dated: August 23,2007 Respectfully submitted,
/S/ Thomas J. Eme
THOMAS J. EME
HELANE L. MORRISON
JOHN S. YUN
PATRICK T. MURPHY
LLOYD A. FARNHAM
Attorneys for Plaintiff
SECURITIES AND EXCHANGE COMMISSION COMPLAINT
This page was posted on March 22, 2008