Description

We think that Stonemor is an interesting short with asymmetric risk/reward given its tight spread to its cash merger price and the risk that the deal is not approved and stock trades either back down to its undisturbed price or close to zero given that it is close to insolvency.  The situation is rather bizarre so a brief timeline is below with less of an emphasis on the business fundamentals (you can reference the prior Stonemor short on VIC to learn more about this morbid company) and more emphasis on the deal dynamics:

• Stonemor was a basket case of a company that paid a dividend it could not sustain and repeatedly needed rescue financing.  Cemetery and funeral homes receive cash upfront from customer who purchase “pre-need” funeral services and the company gets to hold on to this “float” and keep the investment income.  In 2019, a NY hedge fund called Axar Capital provided debt financing and invested in the common stock of Stonemor and started to encourage the company to invest its “float” not in public stocks and bonds or mutual funds, but exotic private credit investments through Axar’s own commingled funds and investments.  Axar kept buying more Stonemor stock and now owns almost 75% of the company.  Along the way, Axar made offers to buy the entire company.

• In May, Axar offered a nearly 50% premium to buy Stonemor at $3.50 per share and the stock is now trading less than 2% below that deal price. 

• We believe that Stonemor’s related party investments with Axar have violated its respective state regulations and that the transaction should not be approved. 

• It appears that some bondholders also share that view, as holders of $100 million of the company’s $400 million senior secured notes claimed that the Axar investments and the company’s disclosure violated the terms of the bond indentures.  Stonemor then bought these bondholders out at par to ensure they go away and don’t make more noise, using more than half of the company’s dwindling cash balance. 

• The deal was originally scheduled to close in the fall of 2022, but has been delayed a bit with a shareholder vote scheduled for Nov 1 and various unnamed regulatory approvals required

We believe that Stonemor is fundamentally worth zero, that it would trade down to its undisturbed price of $2 if the deal breaks and the 1.7% gross return to the $3.50 is too tight reflecting a 95% chance of closing. 

Stonemor Evolution of its Trust Asset Investments and Fundamentally Solvency:

We’ll discuss further what is in this “Other Investment Fund” category and why we believe it’s inappropriate but the above shows how the asset breakdown of Stonemor’s merchandise trusts have changed over the years as Axar has had more influence over the company.  The separate trusts for Perpetual care are similar and the total trust assets for the most recent period are also shown. Compare this with the two closest peers, Carriage Services and Service Corp, which have much more transparent and appropriate investments:

In the Appendix, we will show some of the inappropriate investments that are in the Stonemor portfolio, why we think the investment income recognition is wrong and some of the issues that these factors raise for the company with regulators and bondholders.

Meanwhile, on a fundamental basis, Stonemor’s performance has been abysmal, with core EBITDA (excluding investment income from the trust and working capital flows from changes in deferred revenue) being negative, the company breaching a covenant at 3.5x secured net leverage (on their aggressive definition of EBITDA) and the company’s liquidity becoming increasingly strained:

Unlike its peers, Stonemor adds back “changes to deferred revenues” (as if it is some high growth software company) to get to its adjusted EBITDA.  Even including this, the company is now above 3.5x leverage, which doesn’t trigger a technical default, but restricts Permitted Investments in some of its subsidiaries.  We believe this may be one of the reasons that Axar wants to take the company private at a price that does not make sense under normal analysis, because Stonemor would not longer be required to publish SEC filings (since its remaining bonds would be unregistered) and therefore there would be less disclosure and scrutiny around Axar's investments.

The company’s cash balance has also declined due to this odd hush-money that they gave to dissident bondholders (more on that later):

The did just raise more debt from Signature Bank, but this is only exacerbating their financial trouble. 

Dissident bondholder claims and Odd Pay off

In an 8K, Stonemor stated the following after paying $42.7 million to buy $35 million of bonds from dissident holders (the “Sellers”) through an opaque LLC with Fortress buying another $65 million:

https://www.sec.gov/Archives/edgar/data/1753886/000095017022013084/ston-20220720.htm 

The Sellers had raised certain issues based on disclosures included in Item 13 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021, including issues relating to compliance by the Company with certain covenants under the Indenture dated as of May 11, 2021 pursuant to which the Company Notes were issued (the “Indenture”) and the adequacy of the disclosures by the Company in the offering materials pursuant to which the Company Notes were offered and sold. Throughout its discussion with the Sellers, the Company was and remains firmly convinced that there was no merit to the issues raised by the Sellers. However, in the interest of avoiding additional cost as well as distraction and disruption of its management, the Company agreed to facilitate the consummation of the transactions contemplated by the Purchase Agreement but does not intend to facilitate the purchase of other Company Notes in any similar transactions. In connection with closing under the Purchase Agreement, the Company also agreed to have its entire $42.7 million capital contribution to the LLC used as part of the purchase price paid to the Sellers and to reimburse the Sellers for certain legal fees. In consideration for the purchase of the Sellers’ Company Notes and the reimbursement of the Sellers’ legal fees, the Sellers acknowledged that there was no merit to the issues they had raised.

The company claims that there was no merit to these claims, but why did they pay $7.2 million in “legal fees” on $35 million of bonds, effectively 20% above face value?  There was no lawsuit filed, no complaint made and it stretches the imagination to think that noteholders could have spent $7 MILLION on drafting one letter to Stonemor that says “Hey, you guys are being shady, give us par”.  Why was Fortress bought it to buy bonds at par?  This bizarre transaction raises more questions than it answers.  At a minimum, we think this confirms that something is wrong behind the scenes at Stonemor.  You can also see all the issues in the Related Party Transaction section of the 10K and in the Appendix below.

Why should this be blocked?

If you look at the nature of the actual investments, it’s pretty clear to us that these are not appropriate investments for trusts that follow the typical “prudent” or “reasonable man” standards that all pensions, trusts and other regulated endowed asset vehicles follow. 

• A 15% loan to real estate developers

• 18.75% mezzazine loan to a hotel?

• $30 million loan to Payless Shoe, which went bankrupt not once but twice and is controlled by Axar

Stonemor claims that these blue-chip investments actually made $23 million in interest (for an 8% yield on principal), paid out $3 million in capital gains and realized gains, AND were marked up $13 million (+3%) in the 1H of 2022 when bonds and equities were down 20% and credit spreads widened significantly. 

https://www.sec.gov/Archives/edgar/data/1753886/000095017022017101/ston-20220630.htm

Compare that to the performance of Service Corp’s trust assets:

https://www.sec.gov/Archives/edgar/data/89089/000008908922000052/exhibit991q222earningsrele.htm

It is clear to us that Stonemor’s investments are not appropriate for a regulated entity.  For example, there are various state laws (like in Tennessee, where the company operates) that prevent this sort of related party transactions with trust assets:

https://law.justia.com/codes/tennessee/2010/title-62/chapter-5/part-4/62-5-407

(e)  It is unlawful to loan pre-need funeral trust funds to a pre-need seller, an affiliate of a pre-need seller, or any person directly or indirectly engaged in the burial, funeral home, or cemetery business. Furthermore, the pre-need seller's interest in the trust shall not be pledged as collateral for any loans, debts, or liabilities of the pre-need seller and shall not be transferred to any person without the prior written approval from the commissioner and the trustee.

In fact there are some regulators that have started to push back on Axar’s aggressive involvement, notably the Michigan state insurance regulatory that intervened on Stonemor’s investment in a bankrupt Michigan insurer called Pavonia   (which was part of the insurance empire that this crook Greg Lindberg cobbled together before bribing officials and being convicted: https://www.wsj.com/articles/insurance-executive-greg-lindberg-sentenced-to-seven-years-and-three-months-in-prison-11597877367)

Axar’s application to buy Pavonia: https://difs.state.mi.us/FormA/Mainview/OpenPDF?BlobID=1511022

Axar’s use of Stonemor funds to do so:

At the closing of the transactions contemplated by the Holdco Loan Assignment on October 6, 2021, our trusts paid the Initial Lender $28.7 million in cash, which equaled the then outstanding principal balance of the loan under the Holdco Loan Agreement (the “Holdco Loan”).

Recently, Axar advised us that the state insurance regulators had advised Axar that regulatory approval of the transaction between Axar and Holdco would not be granted because the contemplated purchase price included a $40 million note to be issued to Holdco, and, as a result, after further negotiations, that Holdco and Axar entered into a purchase agreement dated January 20, 2022, which provided for a cash purchase price of $75 million, less the outstanding amounts owed to our trusts under the Amended Holdco Loan Agreement and a fee that remained payable to the Initial Lender.

Therefore, with more sunlight on this topic, we believe that it is possible that other state regulators, notably PA and WV, where the company has the highest state exposure, would also see it fit to not give regulatory approval for this.  We have written letters to the certain relevant attorney generals, state funeral association directors and insurance regulators and local politicians.

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In conclusion:  we think that this deal may close, and we will lose 1.7%.  There is a chance that it does not get approval and we could make 30-50% and perhaps more.  We believe the chance of the latter is much higher than the <5% being assigned by the market.  The company pays no dividend and the borrow rebate is actually a +2.58%, so if this deal takes 6 months to close, you actually get close to breakeven.

Where could we be wrong?

• Another bidder or Axar pays more: 

• We think it is unlikely that Axar offers more because the merger proxy background shows the negotiations that it took to get him up to $3.50, from his original offer in 2020 at $0.67 per share

• We also think it is extremely unlikely that another buyer emerges because a) the go-shop period came and went and no one was interested and b) Axar’s involvement here makes Stonemor very unattractive (in our view) to other buyers

The Go-Shop Period expired on July 23, 2022. During the Go-Shop Period, Duff & Phelps contacted five potential strategic buyers and 32 potential financial buyers that the Conflicts Committee and Duff & Phelps believed could have an interest in reviewing the opportunity and had the financial ability to pursue a potential strategic transaction with the Company, including Party A. On July 9, 2022, following a direct inquiry from Duff & Phelps, Party A declined to participate in the Go-Shop Process. None of the parties contacted entered into a confidentiality agreement with the Company or otherwise pursued a transaction that would be an alternative to the Merger.

• Regulators approve the merger:  It’s actually pretty likely, especially because the merger agreement hasn’t specified exactly which regulatory bodies approval is needed from.  The primary regulators, we believe, are state regulators for financial product or insurance divisions. SEC approval is not needed and since everything is being disclosed (even if it is shady) and shareholders are actually benefitting here, we don’t think that the SEC will be an intervening regulatory body.

• Deal breaks and stock goes up for some reason:  The merger projections actually have the company hitting a hockey-stick and making a ton of money.  I guess that may happen . . . but given that EBITDA went negative in 2Q22 and this company has been a disaster for so long, I doubt it.

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Why would Axar buy this?  This is a question that has been bugging us, frankly.  Axar (and founder Andrew Axelrod) are not dumb, so why would they buy something that appears insolvent?  Obviously there is the benefit of having $1 billion of captive trust assets that you can do all sorts of shady things with outside of the public eye.  But there may actually be a case that Axelrod is such a good operator that in private, he can turn this business around and get it to have 20% EBITDA margins like its peers and this is a steal at $3.50.  Maybe.  Axar’s cost basis in the company is probably $1.45, so he’s put in $130 million to get his stake, it’ll cost him another $100 million to buy out the remainder, and he gets to use $1 billion as he likes and maybe turns around the company?  Perhaps.  Only he knows.

Documents

Merger Proxy                             https://www.sec.gov/Archives/edgar/data/1753886/000114036122028383/ny20004944x1_prem14a.htm

Fairness Opinion Presentation    https://www.sec.gov/Archives/edgar/data/1753886/000114036122028406/ny20004944x2_exc2.htm

Fortmore LLC                                  https://www.sec.gov/Archives/edgar/data/1753886/000095017022013084/ston-ex10_1.htm

Debt Payoff 8K                 https://www.sec.gov/Archives/edgar/data/1753886/000095017022013084/ston-20220720.htm

Merger PR                   https://www.sec.gov/Archives/edgar/data/1753886/000095017022010622/ston-ex99_1.htm

Appendix

Indenture Conflicts 

Certain Related Party Transactions With Axar Likely Violated StoneMor’s Indenture but Did Not Trigger Event of Default

 Relevant Item:

StoneMor Debt Documents

Cemetery and funeral home owner and operator StoneMor is currently in the process of going private. Axar Capital Management, the owner of about 75% of StoneMor’s common stock as of July 25, 2022, entered into a merger agreement with StoneMor on May 24 pursuant to which it will acquire the remaining shares of StoneMor, likely sometime this fall.

StoneMor has a series of 8.5% secured senior notes due 2029, which prior to Aug. 26 were the company’s only outstanding debt. On Aug. 26, the company entered into a secured $45 million revolving facility. Both pieces of debt will stay in place after the merger closes.

On July 26, StoneMor disclosed that it arranged for Fortress and its affiliates to purchase $100 million of its secured notes from certain bondholders. According to the company, the selling bondholders “had raised certain issues based on disclosures included in Item 13 of the [2021 10-K] …, including issues relating to compliance by the Company with certain covenants under the [secured notes’] Indenture … and the adequacy of the disclosures by the Company in the offering materials pursuant to which the [secured notes] were offered and sold.”

Although StoneMor “remains fully convinced” that the bondholders’ claims had no merit, it (along with Axar) agreed to arrange for the bond purchase “in the interest of avoiding additional cost as well as distraction and disruption of its management.” As consideration for the purchase, the selling bondholders “acknowledged that there was no merit to the issues they had raised,” and they and StoneMor exchanged mutual releases.

This article will examine the Item 13 disclosures in StoneMor’s 10-K from a covenants perspective to identify the issues likely raised by the bondholders and discuss their merit. 

Disclosed Affiliate Transaction Problems

Item 13 of StoneMor’s 10-K for the year ended Dec. 31, 2021, discusses “Certain Relationships and Related Transactions,” namely those with Axar, the controlling shareholder. The sole member of Axel’s general partner is Andrew Axelrod, who is the chairman of StoneMor’s board of directors. All of the below information is from Item 13 of the 10-K.

On Feb. 1, 2021, Cornerstone, a wholly owned subsidiary of StoneMor, entered into a subadvisor agreement with Axar. This agreement was reviewed and approved by the appropriate board committees.

Nevada Company Shares

On March 9, 2021, the company purchased approximately 27% of the common stock of a Nevada company for a purchase price of $18 million. Axar had originally agreed to acquire the shares, but instead recommended to Cornerstone (per the subadvisor agreement) that StoneMor trusts purchase the shares instead, which they did through an assignment. At the time, Axar represented to Cornerstone that it was not affiliated with the Nevada company in any way.

As of the March 31 date of the 10-K, however, Axar had “recently represented” to StoneMor that at the time the purchase agreement was signed and at all times thereafter until the transaction was completed, certain of Axar’s affiliated funds owned 14% of the Nevada company’s common stock and Axelrod had been elected to the board of directors of the Nevada company on Dec. 31, 2020.

Because StoneMor did not know about Axar’s involvement with the Nevada company, the appropriate board committees did not review or approve the purchase of the Nevada company shares.

REIT Transaction

On May 15, 2021, StoneMor trusts invested $26 million into participating in a secured loan made by a REIT to certain real estate developers. This investment was recommended to Cornerstone by Axar; at the time of the recommendation, Axar did not disclose any relationship with the REIT.

Axar later informed StoneMor that an Axar fund formerly controlled the REIT’s management company. Axar retained a 4.7% interest in the REIT management company and is entitled to 8.75% of any returns after a 6% return to other investors, and Axar is entitled to a consulting fee of $300,000 per annum. In addition, Axelrod served on the REIT’s board, including as chairman, from 2018 until November 2021.

Because StoneMor did not know about Axar’s involvement with the REIT, the appropriate board committees did not review or approve the investment in the loan participation.

The loan was repaid in full on Dec. 16, 2021, and the company has no ongoing interest in the REIT.

Hotel Loan

On May 17, 2021, at Axar’s recommendation, StoneMor trusts provided a $33 million mezzanine loan to a hotel investor and developer and certain of its subsidiaries (together, the “Hotel Fund”); funds and other accounts affiliated with or managed by Axar provided a $10 million loan to the Hotel Fund at the same time and on the same terms as the trusts’ loans.

Although a draft of the loan agreement provided to Cornerstone and the trusts stated that funds and other accounts affiliated with or managed by Axar also intended to participate in the loan facility on the same terms and conditions as the StoneMor trusts, none of Cornerstone, the trusts or Axar recognized that such participation was a related party transaction. Therefore, the appropriate board committees did not review or approve the Hotel Fund loan.

Insurance Holding Company Loan

On Sept. 27, 2021, StoneMor trusts spent $29 million to acquire a loan to an insurance holding company (“Holdco”) from the initial lender and, on the same day, entered into an amendment to such loan agreement.

Also on Sept. 27, Axar and Holdco entered into a letter agreement pursuant to which Holdco agreed, at Axar’s option, to sell its wholly owned insurance company subsidiary to Axar for a purchase price of $100 million, subject to customary conditions. A fee letter was also signed. After additional negotiations, Holdco and Axar entered into a purchase agreement on Jan. 20, 2022, that provided for a cash purchase price of $75 million. The completion of the subsidiary purchase would cause the loan to become due and payable in full.

Although Axar’s letter agreement with Holdco and the fee letter were referenced in the loan amendment, Axar did not provide a copy of or disclose the terms and provisions of such letter agreements to Cornerstone, so neither Cornerstone nor the StoneMor trusts was aware of Axar’s right to acquire the insurance subsidiary from Holdco. As a result, the appropriate board committees did not review or approve the loan assignment and amendment.

Discovery and Resolution

StoneMor’s management flagged the Nevada company share purchase and Hotel Loan transactions as related party transactions in February 2022 in connection with preparing the company’s annual financial statements. This triggered further investigation of all of Axar’s recommendations to Cornerstone, which revealed Axar's interests in the REIT transaction and insurance holding company loan assignment.

StoneMor’s management determined that the company’s controls and procedures did not adequately identify related party transactions. As a result, Cornerstone began to require specific certifications from Axar as to any recommended investments, and as of March 31 (the date of the 10-K), the board’s independent review of Axar was ongoing.

On April 19, 2022, at the board’s recommendation, the subadvisor agreement with Axar was terminated and Axar agreed to waive $219,000 in fees.

Discussions with Axar as to the take-private transaction, which had started in September 2021, were paused in March 2022 in light of the board’s investigation into the related party transaction issues but had “recently resumed” as of May 13. The merger agreement was signed on May 24 and includes language that expressly excluded any effects from the Item 13 disclosures from the definition of “Company Material Adverse Effect,” including any default under the indenture.

Likely Bondholder Claims and Their Merits

The only information that StoneMor has provided about the bondholder claims is that they raised issues based on the Item 13 disclosures, “including issues relating to compliance by the Company with certain covenants under the Indenture … and the adequacy of the disclosures by the Company in the offering materials pursuant to which the Company Notes were offered and sold.”

We will examine potential claims under both the preliminary offering memorandum, dated April 19, 2021, and the indenture, dated May 11, 2021.

Adequacy of OM Disclosures

As of the date of the preliminary OM, the only Item 13-related party transaction that had occurred was the Nevada company share purchase, which took place in March 2021. The OM discloses the subadvisor agreement with Axar but does not mention the Nevada company share purchase in its “Certain Relationships and Related Party Transactions” disclosure, presumably because the company had yet to identify it as a related party transaction.

The bondholders likely argued that the omission of the Nevada company share transaction from the OM made it false and/or misleading, which would violate SEC rule 10b-5. A full analysis of this claim would require investigations of fact and a review of relevant SEC case law, neither of which we can provide here.

Indenture Violations

Although StoneMor did not disclose which indenture covenants the bondholders alleged were violated, the Transactions with Affiliates covenant in section 5.11 of the indenture is the obvious starting place.

The Transactions with Affiliates covenant requires that transactions among StoneMor and its affiliates involving an amount in excess of the greater of $2.5 million and 5% of consolidated cash flow be on arm’s length terms, subject to certain enumerated exceptions, including for agreements existing on the date of the indenture (which would include the Nevada company share purchase agreement).

Whether the other Axar-related party transactions - the REIT Transaction, Hotel Loan and Insurance Holding Company Loan - were on arm’s length terms is a factual question that would likely be vehemently argued by attorneys for both sides. Luckily for the bondholders, however, the covenant contains an additional requirement:

“[I]f such Affiliate Transaction involves an amount in excess of $15.0 million, the terms of the Affiliate Transaction are set forth in writing and a majority of either the Conflicts Committee … or the Board of 

Directors of the Company disinterested with respect to such Affiliate Transaction has determined in good faith that the [arm’s length terms] criteria … are satisfied and has approved the relevant Affiliate 

Transaction as evidenced by a resolution of the Board of Directors of the Company set forth in an Officers’ Certificate.”

This requirement was clearly not complied with, as StoneMor disclosed that the appropriate board committees did not evaluate or approve the applicable Axar transactions, all of which were over $15 million.

StoneMor’s disclosure implies that the bondholders raised issues with more than one covenant. Without further information, the only other covenant that seems probable is a “Trust Funds” covenant that provides that StoneMor “will not permit any of its Affiliates or any entity controlled or managed by an Affiliate … to have discretion over the investments or be compensated for discretion over the investments in the Trust Accounts.”

This seems like it could capture the subadvisor agreement, but since such agreement was in place prior to the indenture, and no reasonable company would agree to something it has already violated, it seems highly unlikely.

Indenture Events of Default

Even though StoneMor did breach the affiliate transactions covenant in the indenture, such breach did not cause an event of default.

An event of default caused by the failure of StoneMor to comply with the indenture covenants - other than the asset sale and change of control offer covenants, which are explicitly covered by a separate event of default - is subject to the below provision:

“[F]ailure to perform any other covenant or agreement of the Company or any of its Subsidiaries under the Indenture Documents for 30 days after written notice to the Company by the Trustee or the holders of at least 30% in aggregate principal amount of the Notes then outstanding voting as a single class” (emphasis added).

Under the indenture, the breach of a covenant does not in itself constitute an event of default. An event of default only occurs if the company has not cured such breach within 30 days after receiving a written notice of default from either the trustee or holders of 30% of the notes.

Receiving a notice of default would almost certainly be a material event and would require disclosure, and StoneMor has not disclosed any such notices. The bondholders who raised the concerns held $100 million of secured notes out of $400 million total, putting them at 25%, less than the required 30% threshold.

Even if StoneMor did receive a notice of default, the company would have a 30-day cure period. During that time, StoneMor could eliminate the offending investments or possibly comply retroactively with the affiliate transactions covenant. That covenant does not explicitly require that the appropriate board approval be received prior to the transactions, just that the terms be set forth to the appropriate board committee and that such committee approve the terms as being on arm’s length terms.

Conclusion

The recent StoneMor transaction provides an example of a company buying out potentially litigious bondholders even though such bondholders’ claims may or may not - and per the company, definitely did not - have any merit. Although the company almost certainly did breach the affiliate transactions covenant by not receiving the appropriate board approvals, such breach cannot be translated into an event of default without additional bondholder support, and other bondholders, who likely had the chance to join the initial group of complaining holders, are not likely to bring additional claims at this time.

Letter to Tennessee regulators

October 3, 2022

Commissioner Carter Lawrence

Tennessee Department of Commerce and Insurance

500 James Robertson Pkwy

Nashville, TN 37243-0565

[email protected]

Mr. Charles Rahm, President

Mr. Robert Gribble, Executive Director

Board of Funeral Directors, Embalmers and Burial Services

500 James Robertson Pkwy

Nashville, TN 37243-0565

[email protected]

VIA EMAIL AND OVERNIGHT COURIER

Ref: Possible Violation of Tennessee Code Sec. 62-5-407(e) by License Nos. 74, 75 and 76

Gentlemen:

            We are writing to you to bring to your attention some very troubling developments among several of the funeral homes under your jurisdiction. 

            Forest Hill Funeral Home and Memorial Park – East (license no. 74) and Forest Hill Funeral Home and Memorial Park – Midtown (license no. 75) are licensed as Preneed Sellers and have been so licensed since November 9, 1994.  Forest Hills Funeral Home and Memorial Park – South (license no. 76) was licensed as a Preneed Seller from November 9, 1994 to January 31, 2022. 

            While Preneed Sales are not, to our knowledge, matters of public record, we think that to have maintained such licenses for so long means it is overwhelmingly likely that these entities have made preneed sales in Tennessee and that, pursuant to Tennessee law, assets are held in trust for such preneed purchasers.

            Section 62-5-407(e) of the Tennessee Code provides that:

            “It is unlawful to loan pre-need funeral trust funds to a pre-need seller, an affiliate of a pre-need seller, or any person directly or indirectly engaged in the burial, funeral home, or cemetery business. Furthermore, the pre-need seller's interest in the trust shall not be pledged as collateral for any loans, debts, or liabilities of the pre-need seller and shall not be transferred to any person without the prior written approval from the commissioner and the trustee.” (emphasis added)

According to The Jackson Sun, Forest Hill Funeral Home and Memorial Park[1] in Memphis, Tennessee and Highland Memorial Park in Jackson, Tennessee are among the eleven cemeteries and four funeral homes in Tennessee owned by StoneMor, Inc[2].

            According to Note 17 of the audited financial statements of StoneMor Inc. for 2021, as filed with the United States Securities and Exchange Commission on Form 10-K[3]:

            “In January 2020, the Company’s trusts completed the purchase of a $30 million participation in a new $70 million debt facility issued by a discount shoe retailer (the “Shoe Retailer”). Funds and accounts affiliated with Axar also invested $20 million in this facility. The investment was initially proposed by the Chairman of the Board, Mr. Axelrod. The investment was reviewed and approved in December 2019 in accordance with the Partnership’s governance policies in place at that time. At the time of the investment, the funds and accounts affiliated with Axar owned approximately 30% of the equity of the Shoe Retailer, and Mr. Axelrod served on the Shoe Retailer’s board of directors. The Company’s investment in the Shoe Retailer represented approximately 4% of the total fair market value of the Company’s trust assets when the investment was made.”

            At the time of the loan, Axar owned approximately 42% of StoneMor and Mr. Axelrod controlled Axar.[4]

Neither the Tennessee Prepaid Funeral Benefits Act nor Chapter 5 of Title 62 define affiliate.  In general, however, an entity is affiliated with a second entity if it controls the second entity, is controlled by the second entity or is under common control with the second entity. Commonly, affiliate status is presumed from 10% ownership.  In this case, because (i) StoneMor owns Forest Hill Memorial Park – East, Forest Hill Memorial Park – Midtown, and Forest Hill Memorial Park – South, (ii) Axar owned, at the time of the transactions in question far in excess of 10% of StoneMor, (iii) the person who controlled Axar, Mr. Axelrod, was chairman of the Board of StoneMor, (iv) Mr. Axelrod was a director of Shoe Retailer and (v) funds and accounts affiliated with Axar owned far in excess of 10% of Shoe Retailer, Shoe Retailer was an affiliate of Axar, StoneMor and each of Forest Hill Memorial Park – East, Forest Hill Memorial Park – Midtown, and Forest Hill Memorial Park – South.

As a result, the loan to Shoe Retailer violated the provisions of Section 62-5-407(e) of the Tennessee Code.

Note 17 of StoneMor’s Form 10-K for 2021 also discusses a number of other related party transactions between assets held in trust for preneed purchasers and StoneMor’s affiliates which may raise similar concerns.   A copy of Note 17 is attached hereto as Exhibit A for your reference.

While we are aware that you have conducted investigations of Forest Hill Memorial Park – East, Forest Hill Memorial Park – Midtown, and Forest Hill Memorial Park – South and imposed fines on them in other capacities, we do not know if these transactions have been brought to your attention or have been or are being currently investigated.  If not, we believe that they should be.

We also note that the Rule of the Department of Commerce and Insurance, Section 0780-05-10-.10 entitled “Investment of Trust Funds” provides in pertinent part as follows:

“(1) A financial institution acting as trustee of trust funds under these rules shall invest such funds

in accordance with applicable law. In so investing, such trustee shall exercise the judgement

and care under the circumstances then prevailing, which men of prudence, discretion and

intelligence exercise in the management of their own affairs, not in regard to the speculation,

but in regard to the permanent disposition of their funds, considering the probable income as well as the probable safety of their capital.” (emphasis added)

We recognize that there is some inherent subjectivity in this standard and people of good faith can have different views about the merits of particular investments; however, some of the investments disclosed in Note 17 seem highly speculative and may prove to be exceptionally risky in the current environment (such as loans to hotel developers in 2021 bearing an interest rate of 18.75% or the purchase of already defaulted loans to an insurance holding company contemplating a transaction with the entity controlling StoneMor at a double digit interest rate mostly payable in kind). 

In addition, nearly all of StoneMor’s trust assets now are invested in “other investment funds” which are largely unregulated.  By comparison, the company’s two closest peers (Carriage Services and Service Corp, respectively[5]) have the vast majority of their assets in more liquid and transparent public equity and debt securities and regulated mutual funds:

We do not suggest that investment in unregulated investment funds is, by itself, inappropriate or imprudent.  However, it does not appear to be a customary way of investing preneed trust funds and raises some concerns in light of the disclosed conflicts, speculative investments, related party transactions and violations of law which are apparent in the relationship between StoneMor and its trusts, as disclosed in Note 17 to StoneMor’s Form 10-K for 2021.

The Commissioner, should you find that the law has been violated, is empowered to enforce the Tennessee Prepaid Funeral Benefits Act by license suspension or revocation, civil penalties and injunctive relief. 

The Tennessee Prepaid Funeral Benefits Act also provides the extraordinary remedy of appointment of a receiver under certain circumstances, including where “[t]he pre-need seller has not maintained trust funds received from contracts in the manner required by this part;” and where “[t]here is reasonable cause to believe that there has been embezzlement, misappropriation, or other wrongful misapplication or use of trust funds or fraud affecting the ability of the pre-need seller to perform its obligations under pre-need funeral contracts sold or assumed by the pre-need seller” (emphasis added). 

While we recognize that the question of remedies is subject to any findings of an investigation and is committed to the Commissioner’s discretion, we draw the possibility of receivership to your attention because it may be the only way to ultimately ensure the safety of the trust funds, given the problematic transactions of which we are aware.

[1] Forest Hill Funeral Home and Memorial Park comprises three separate locations (East, South and Midtown), each licensed as a cemetery (license nos. 23, 24 and 25) and two of which, East (license no. 918) and Midtown (license no. 919), are licensed as an establishment in addition to their licenses as Preneed Sellers.

[2] According to the Form 10-K filed by StoneMor, Inc. with the US Securities and Exchange Commission for the year ended December 31, 2021.  We don’t have a complete list of these cemeteries and funeral homes; there may be additional licensed Preneed Sellers among them to which this letter would also be relevant.

[3] For your convenience, the relevant Form 10-K filing can be found here:  https://www.sec.gov/Archives/edgar/data/1753886/000095017022005236/ston-20211231.htm

[4] Mr. Axelrod continues to control Axar and Axar and its affiliates now own approximately 75% of StoneMor.

[5] Information for the trust assets can be found in the respective quarterly reports for Carriage Services (see page 21 of quarterly report for the quarter ended March 31, 2022 filed with the SEC) and for Service Corp (see page 15 of quarterly report for the quarter ended March 31, 2022 filed with the SEC).  Carriage Service assets above shown as the combination of cemetery and funeral trust assets.  

Disclaimer:  I, my firm, or my firm’s clients may have a position (long or short) in the securities discussed herein and may change such position without further notice.  This is not a recommendation to buy or sell any security.

Catalyst

Termination of merger agreement or lack or regulatory approval 

Increased bondholder dissent 

Liquidity issues if deal closing delayed