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Securities and Exchange Commission v. Mcginn

May 6, 2011

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
MCGINN, SMITH & CO., INC; MCGINN, SMITH ADVISORS, LLC; MCGINN, SMITH CAPITAL HOLDINGS CORP.; FIRST ADVISORY INCOME NOTES, LLC; FIRST EXCELSIOR INCOME NOTES, LLC; FIRST INDEPENDENT INCOME NOTES, LLC; THIRD ALBANY INCOME NOTES, LLC; TIMOTHY M. MCGINN; DAVID L. SMITH; LYNN A. SMITH; NANCY MCGINN; GEOFFREY R. SMITH; LAUREN T. SMITH; FINRA AND THE FINRA EMPLOYEES; AND GEOFFREY R. SMITH, TRUSTEE OF THE DAVID L. AND LYNN A. SMITH IRREVOCABLE TRUST U/A 8/04/04, DEFENDANTS, LYNN A. SMITH AND NANCY MCGINN, RELIEF DEFENDANTS, AND GEOFFREY R. SMITH, TRUSTEE OF THE DAVID L. AND LYNN A. SMITH IRREVOCABLE TRUST U/A 8/04/04, INTERVENOR.



The opinion of the court was delivered by: Gary L. Sharpe District Court Judge

MEMORANDUM-DECISION AND ORDER

I. Introduction

Plaintiff the United States Securities and Exchange Commission (SEC) commenced this action against defendants McGinn, Smith & Co, Inc., McGinn, Smith Advisors, LLC, McGinn, Smith Capital Holdings Corp., First Advisory Income Notes, LLC, First Excelsior Income Notes, LLC, First Independent Income Notes, LLC, Third Albany Income Notes, LLC, Timothy McGinn, and David Smith, alleging various violations of the Securities Act of 1933,*fn1 the Securities Exchange Act of 1934,*fn2 the Investment Advisors Act of 1940,*fn3 and the Investment Company Act of 1940.*fn4 (See Am. Compl. ¶¶ 139-165, Dkt. No. 100.) The SEC additionally asserted claims of fraudulent conveyance under the New York Debtor and Creditor Law against defendants Timothy McGinn, David Smith, Lynn Smith, Nancy McGinn, Lauren Smith, and Geoffrey Smith, individually and as Trustee of the David L. and Lynn A. Smith Irrevocable Trust U/A 8/04/04. (See id. at ¶¶ 169-73; see also Feb. 14, 2011 Substitution Order, Dkt. No. 281.) Lynn Smith and Nancy McGinn were also named as relief defendants, for allegedly receiving and retaining fraudulently and illegally obtained proceeds, of which the SEC seeks disgorgement. (See Am. Compl. ¶¶ 166-68, Dkt. No. 100.) Pending are Lynn Smith's motion to be dismissed as defendant and relief defendant, (Dkt. No. 224), and the Trust, Geoffrey Smith, and Lauren Smith's motion to dismiss, (Dkt. No. 283). For the reasons that follow, Lynn Smith's motion is denied, the Trust defendants' motion is granted in part and denied in part, and the SEC is granted limited leave to re-amend its complaint.

II. Standard of Review

The standard of review under FED. R. CIV. P. 12(b)(6) is well established and will not be repeated here. For a full discussion of the standard the court refers the parties to its decision in Ellis v. Cohen & Slamowitz, LLP, 701 F. Supp. 2d 215, 217-18 (N.D.N.Y. 2010).

III. Discussion*fn5

A. Relief Defendant Status

A "nominal" or "relief" defendant is "a person who can be joined to aid the recovery of relief without an assertion of subject matter jurisdiction only because [s]he has no ownership interest in the property which is the subject of the litigation." SEC v. Cherif, 933 F.2d 403, 414 (7th Cir. 1991); see also SEC v. Colello, 139 F.3d 674, 677 (9th Cir. 1998) ("[T]he SEC may name a non-party depository as a nominal defendant to effect full relief in the marshalling of assets that are the fruit of [an] underlying fraud."). Federal courts have jurisdiction over and "may order equitable relief against" a relief defendant in a securities enforcement action if she: "(1) has received ill-gotten funds; and (2) does not have a legitimate claim to those funds." SEC v. Cavanaugh, 155 F.3d 129, 136 (2d Cir. 1998) (citation omitted); see also Cherif, 933 F.2d at 414 n.11 ("A court can obtain equitable relief from a non-party against whom no wrongdoing is alleged if it is established that the non-party possesses illegally obtained profits but has no legitimate claim to them."). And "once jurisdiction over the [relief] defendant is established[,] ... it is unnecessary to obtain subject matter jurisdiction over [her]." Cherif, 933 F.2d at 414 (citation omitted).

Here, the SEC alleges that during the period of the defendants' fraudulent conduct-which is laid out with considerable detail and specificity-Lynn Smith, without providing any consideration, "received more than $1.8 million from [David] Smith and the McGinn Smith Entities," including "$375,000 in December 2007; $325,000 in June and July 2009; $100,000 in March 2010; ... $185,000 in October 2006 and May 2007[;] ... [and] many other payments from McGinn Smith Entities." (Am. Compl. ¶¶ 81, 107-08, Dkt. No. 100.) The SEC further alleges that Lynn Smith maintained a brokerage account at McGinn, Smith & Co, which she "allowed [David] Smith, [Timothy] McGinn and the McGinn Smith Entities to draw upon ... for business and personal needs without restrictions, and [which] served as a de facto financing arm for [David] Smith and [Timothy] McGinn and the McGinn Smith Entities during the period of the fraud." (Id. at ¶ 109.) "L[ynn] Smith allowed [David] Smith to use the Stock Account as a personal line of credit to further his personal and professional interests. Internal e-mails during the period of the fraud show McGinn Smith employees freely transferring money into and out of the Stock Account, which contained ill-gotten gains." (Id.) In October 2002, $3 million in Charter One stock was shifted from this Stock Account to a McGinn Smith Entity account, with the Smiths as the signatories. (See id. at ¶¶ 110-112.) The following year, the stock was shifted back into Lynn Smith's possession, whereafter her husband "deposited significant personal assets into the Stock Account, including cash of $38,430, the proceeds of a trust amounting to $326,304, and a note receivable totaling $410,000." (Id. at ¶ 113.)

By 2009-after the Financial Industry Regulatory Authority (FINRA) began investigating McGinn, Smith & Co.'s activities-"[David] Smith and L[ynn] Smith began moving assets that had been jointly held into solely L[ynn] Smith's name." (Id. at ¶ 115; see also id. at ¶ 114 (citing to an email sent by David Smith on January 14, 2009, to Timothy McGinn, which stated that "Lynn and I have to shift money around between us").) This asset shifting, all of which was done "without consideration," included: "L[ynn] Smith open[ing] up a checking account in her name for the first time and ... depositing assets into this account which had previously been deposited into a joint account, including [David] Smith's paychecks"; and the transfer of "a house in Vero Beach, Florida ... to L[ynn] Smith after being previously held in joint ownership." (Id. at ¶¶ 116-18, 136-37.) Based on these alleged activities, the SEC claims that:

Relief Defendant[] L[ynn] Smith ... [was a] recipient[], without consideration, of proceeds of the fraudulent and illegal sales of securities alleged[;] ... profited from such receipt or from the fraudulent and illegal sales of securities alleged ... by obtaining illegal proceeds under circumstances in which it is not just, equitable, or conscionable for them to retain the illegal proceeds[;] ... [and has] been named as a Relief Defendant for the amount of proceeds by which [she] has been unjustly enriched as a result of the fraudulent scheme or illegal sales transactions. (Id. at ¶ 167.) Consequently, the SEC demands that "L. Smith ... disgorge any ill-gotten gains." (Id. at ¶ 18.)

In light of these allegations, the court is satisfied that the SEC has met the two elements that qualify Lynn Smith as a relief defendant. First, with heightened particularity, the complaint identifies an array of unlawfully obtained funds and assets that Lynn Smith received, oversaw, used, and maintained in her possession. Second, the alleged source of these funds and assets and the manner in which they were obtained by and transferred to Lynn Smith sufficiently establish that she does not have a legitimate claim to them. Therefore, the court concludes that, at a minimum, jurisdiction exists over Lynn Smith as a relief defendant. Lynn Smith's motion to be dismissed as a relief defendant is denied.

B. New York Debtor and Creditor Law

Under § 276 of the New York Debtor and Creditor Law, "[e]very conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors." N.Y. DEBT. & CRED. LAW § 276. "Where a conveyance ... is fraudulent as to a creditor, such creditor, when his claim has matured, may, as against any person except a purchaser for fair consideration without knowledge of the fraud at the time of the purchase, ... [h]ave the conveyance set aside ... to the extent necessary to satisfy his claim ...." Id. § 278(1)(a). In order to make out a claim under § 276 for fraudulent conveyance, a party must meet FED. R. CIV. P. 9(b)'s heightened standard by pleading with ...


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