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Securities and Exchange Commission v. Timothy M. Mcginn; David L. Smith; and

April 4, 2012


The opinion of the court was delivered by: David R. Homer U.S. Magistrate Judge


On July 7, 2010, an order was entered granting in part the motion of plaintiff Securities and Exchange Commission (SEC) for a preliminary injunction freezing certain assets of the defendants for the benefit of investors pending the outcome of this action. Dkt. No. 86 ("MDO I"). Presently pending are the motions of defendants Timothy M. McGinn ("McGinn"), David L. Smith ("Smith"), and Geoffrey R. Smith, Trustee of the David L. and Lynn A. Smith Irrevocable Trust U/A 8/04/04 ("Trust") for orders releasing assets from the preliminary injunction. Dkt. Nos. 439-41. The SEC opposes the motions. Dkt. Nos. 447, 448. For the reasons which follow, the motions of McGinn and Smith are granted in part and denied in part, and the Trust's motion is denied in its entirety.

I. Background

The SEC commenced this action on April 20, 2010 with the filing of a complaint alleging that McGinn and Smith operated an Albany-based financial services company and related entities through which they defrauded investors of over $80 million in violation of § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a); § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); Rule 10b-5 under the 1934 act, 17 C.F.R. § 240.10b-5; and related provisions. Compl. (Dkt. No. 1) at ¶¶ 7-12. In decisions filed July 7 and November 22, 2010, familiarity with which is assumed, the SEC's motion for a preliminary injunction was granted in principal part freezing the assets of McGinn and Smith, including the Trust. MDO I; Dkt. Nos. 96 (preliminary injunction), 194 ("MDO II"). Those assets remain frozen pending resolution of this action.

As part of a criminal investigation into the activities of McGinn and Smith, federal law enforcement authorities executed a series of search warrants at the residences and businesses of McGinn and Smith on April 19 and 20, 2010. MDO I at 6 n.10. The criminal investigation proceeded as this civil action progressed through discovery, ending in the return of an indictment against McGinn and Smith on January 26, 2012 for charges related to the subject matter of this action. See United States v. McGinn, No. 12-CR-28 (DNH) (N.D.N.Y. filed Jan. 26, 2012). McGinn and Smith entered pleas of not guilty to those charges and the case is now proceeding through its initial stages. Discovery has been completed in this action and, as dispositive motions were due to be filed, the motion of intervenor United States was granted staying this action pending completion of the criminal action. Dkt. No. 474. McGinn and Smith are each represented by the same counsel in both the civil and criminal actions.

II. Discussion

A. McGinn and Smith Motions

McGinn and Smith both seek orders unfreezing assets to pay the costs of their defenses against the criminal charges, including their attorneys' fees. Dkt. Nos. 439, 440. Both men estimate that each will require at least $300,000.00 to pay the attorneys' fees and costs arising from the criminal indictment through the trial of that case. Knox Decl. (Dkt. No. 439-3) at ¶ 9; Dreyer Decl.(Dkt. No. 440-3) at ¶¶ 9-14. Each asserts that because of the asset freeze, each lacks sufficient resources to pay the attorneys whom they have retained to represent them in the criminal case. McGinn Decl. (Dkt. No. 439-2) at ¶ 12; Smith Decl. (Dkt. No. 440-2) at ¶ 8. Both seek orders releasing certain assets from the asset freeze to pay attorneys' fees and costs.

The preliminary injunction freezing the defendants' assets was entered to insure the availability of those assets to compensate the alleged victims of defendants' conduct in the event the SEC prevails in this action. See MDO I at 12-15. It was entered upon a showing by the SEC, in part, that the SEC was likely to prevail on the merits of its claims as to McGinn and Smith. Id. at 27-31. Where, as here, those charged with criminal offenses seek to lift an asset freeze to obtain funds for the payment of legal fees and costs, there is brought into conflict the competing interests of allegedly defrauded investors in obtaining the return of funds and those of the criminal defendants under the Fifth and Sixth Amendments in obtaining sufficient funds to retain the counsel of their choice.

In United States v. Monsanto, 491 U.S. 600 (1989), the criminal defendant was charged with narcotics offenses and the government obtained an order restraining his assets for possible criminal forfeiture as proceeds of criminal activity. The defendant sought to use those assets to pay legal fees. The Supreme Court held that while a criminal defendant has the Sixth Amendment right to retain the counsel of his or her choice, the defendant may not use funds obtained from criminal activity to do so. Id. at 603; S.E.C. v. Cherif, 933 F.2d 403, 416-17 (7th Cir. 1991) (holding that a criminal defendant may not "spend another person's money" to retain counsel). On remand, the Second Circuit Court of Appeals held that such a restraint could be continued only where the government demonstrated that the assets being restrained were the proceeds of criminal activity even where a defendant demonstrated a need to obtain funds from the assets to retain counsel to defend the criminal charges. United States v. Monsanto, 924 F.2d 1186, 1203 (2d Cir. 1991).

In S.E.C. v. Coates, No. 94 CIV. 5361 (KMW), 1994 WL 455558 (S.D.N.Y. Aug. 23, 1994), as here, the defendant in a civil enforcement action brought by the SEC was also named as a defendant in a parallel criminal action. The defendant moved to release certain assets subject to a preliminary injunction to retain an attorney in the criminal proceeding. Id. at *3. The court held that on such a motion, the factors considered in Monsanto for criminal cases applied equally in an SEC civil enforcement action and, therefore, assets should continue to be restrained if traceable to criminal activity but, if not, could be released to permit a criminal defendant to retain the counsel of his or her choice. Id. Coates has repeatedly been cited by other courts in the Southern District where such actions most frequently arise as persuasive authority for the applicable analysis in these circumstances. See, e.g., United States v. Bonventre, No.S2 10 Cr. 228(LTS), 2011 WL 1197853, at *6 (S.D.N.Y. Mar. 30, 2011); S.E.C. v. FTC Capital Markets, Inc., No.09 Civ. 4755(PGG), 2010 WL 2652405, at *3 (S.D.N.Y. June 30, 2010); S.E.C. v. Cobalt Multifamily Investors, ILLC, No. 06Civ.2360(KMW)(MHD), 2007 WL 1040309, at *3 n.10 (S.D.N.Y. Apr. 2, 2007).

Thus, where a defendant in a civil enforcement action seeks to lift an asset freeze to retain counsel in a parallel criminal action, a court must determine whether (1) the defendant has demonstrated a need for the relief; (2) if so, the defendant has demonstrated that the assets for which release is sought are traceable to criminal activity; and (3) the defendant has shown that the value of the assets sought to be released is reasonable.

1. Necessity

As to the first factor, both McGinn and Smith have demonstrated a need for the release of assets to pay counsel in their criminal case.

a. McGinn

McGinn now resides in Boca Raton, Florida with his wife. McGinn Decl. at ¶¶ 1, 7. He earns approximately $2,800 monthly as a sales representative and receives an additional monthly amount of $1,876 from Social Security. Id. at ¶¶ 5, 6. His wife, also a defendant in this civil action, currently receives $375 monthly in unemployment benefits. Id. at ¶ 7. Against this approximate monthly income of $5,051, McGinn and his wife pay monthly expenses of approximately $4,500. Id. at ¶ 8. Even if his wife's unemployment benefits were to continue without end and they incurred no additional expenses beyond their normal monthly expenses, Smith still falls far short of possessing sufficient unrestrained resources to pay any legal fees and costs reasonably incurred in his criminal case.*fn1

b. Smith

For his part, Smith currently has no source of income. Smith Decl. at ¶ 5.*fn2 It further appears at this point that the SEC has brought within the reach of the preliminary injunction all assets in which Smith holds any interest which could reasonably be used to pay legal costs and fees. No other means of paying those costs and fees appears nor has any been suggested by the SEC. Accordingly, Smith as well has met his burden of demonstrating a need for the relief sought here.*fn3

2. Taint

a. McGinn

As to the second factor, McGinn identifies ten assets from which he contends he could obtain approximately $128,330 upon their liquidation. McGinn Decl. at Sch. A.

Those assets are as follows:

1. Timeshare unit in Colorado

a. Purchased in 1991.

b. Estimated value: $35,000

c. Likely proceeds: $25,000

2. Antique Chinese war lord desk

a. Purchased in 1995

b. Estimated value: $15,000

c. Likely proceeds: $5,000

3. Nine oriental rugs

a. Purchased 1997 through 2007

b. Estimated. value: $64,000

c. Likely proceeds: $25,000

4. Pine Tree Golf Club ...

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