Searching over 5,500,000 cases.

Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.

Securities and Exchange Commission v. McGinn, Smith & Co., Inc.

United States District Court, N.D. New York

February 17, 2015

MCGINN, SMITH & CO., INC. et al., 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, and U.S. ATTORNEY'S OFFICE FOR ND/NY, Intervenors.


WILLIAM J. BROWN, ESQ., Phillips, Lytle LLP, Buffalo, NY, E. STEWART JONES, JR., ESQ., Office of E. Stewart Jones, Jr., Troy, NY, WILLIAM J. DREYER, ESQ., BENJAMIN W. HILL, ESQ., Dreyer, Boyajian Law Firm, Albany, NY, JAMES D. FEATHERSTONHAUGH, ESQ., Featherstonhaugh, Wiley Law Firm, Albany, NY, JAMES D. LINNAN, ESQ., Linnan, Fallon Law Firm, Albany, NY. for the Defendants/Relief Defendants and Intervenors: 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; and Third Albany Income Notes, LLC, Timothy M. McGinn, David L. Smith, Lynn A. Smith, Geoffrey R. Smith, Individually and as Trustee of the David L. and Lynn A. Smith Irrevocable Trust U/A 8/04/04, and Lauren T. Smith.

Nancy McGinn, Pro Se, Troy, NY.


GARY L. SHARPE, Chief District Judge.

I. Introduction

Plaintiff the United States Securities and Exchange Commission (SEC) commenced this civil enforcement action against defendants David Smith and Timothy McGinn, along with various entities owned and controlled by McGinn and Smith: McGinn, Smith & Co, Inc. (MS & Co.), McGinn, Smith Advisors, LLC ("MS Advisors"), McGinn, Smith Capital Holdings Corp. ("MS Capital"), First Advisory Income Notes, LLC (FAIN), First Excelsior Income Notes, LLC (FEIN), First Independent Income Notes, LLC (FIIN), and Third Albany Income Notes, LLC (TAIN), [1] (collectively, the "MS Entities"), alleging violations of §§ 5(a), [2] 5(c), [3] and 17(a)[4] of the Securities Act of 1933 ("Securities Act"), § 10b of the Securities Exchange Act of 1934 ("Exchange Act"), [5] and Rule 10b-5 thereunder, [6] § 15(c)(1) of the Exchange Act, [7] and Rule 10b-3 thereunder, [8] and §§ 206(1), (2), and (4) of the Investment Advisors Act of 1940, [9] and Rule 206(4)-8 thereunder.[10] ( See generally 2d Am. Compl., Dkt. No. 334.) The SEC additionally asserts claims of fraudulent conveyance in violation of § 276 of the New York Debtor and Creditor Law against McGinn, Smith, defendants Lynn A. Smith[11] ("L. Smith"), Geoffrey R. Smith ("G. Smith"), individually and as Trustee of the David L. and Lynn A. Smith Irrevocable Trust U/A 8/04/04 (the "Smith Trust"), Lauren T. Smith ("L.T. Smith"), [12] and pro se defendant Nancy McGinn[13] ("N. McGinn"). ( Id. ¶¶ 206-11.) L. Smith and N. McGinn are also named as relief defendants for allegedly receiving and retaining ill-gotten gains.[14] ( Id. ¶¶ 203-05.)

Pending is the SEC's motion for summary judgment.[15] (Dkt. No. 708.) In its motion, the SEC seeks sanctions in the form of disgorgement of profits, an injunction prohibiting McGinn and Smith from committing future securities laws violations, an order barring McGinn from serving as an officer or director, and civil monetary penalties. (Dkt. No. 708, Attach. 1 at 14-31.) Further, the SEC seeks to include in a disgorgement order assets held solely in L. Smith and N. McGinn's names, along with assets held by the Smith Trust. ( Id. at 18-29.)

In this Memorandum-Decision and Order, the court addresses only the following: (1) whether McGinn and Smith violated the securities laws; and (2) whether the SEC is entitled to the sanctions its seeks against McGinn and Smith. The court reserves judgment with respect to the assets held solely by L. Smith, N. McGinn, and the Smith Trust, and will consider the issues related to those assets in a later decision. For the reasons that follow, the SEC's motion is granted in part and denied in part.

II. Background[16]

Before delving into the salient facts and winding procedural history, it is worth establishing a big-picture framework for this case. Generally, the SEC alleges that McGinn and Smith, individually and through the various entities that they owned and controlled, orchestrated an elaborate Ponzi scheme, [17] which spanned over several years, involved dozens of debt offerings, and bamboozled hundreds of investors out of millions of dollars. ( See generally 2d Am. Compl.) More specifically, the SEC alleges that, between 2003 and 2010, McGinn and Smith raised over $136 million in over twenty unregistered debt offerings, including the Four Funds-FAIN, FEIN, FIIN, and TAIN-and various trust offerings, by representing that investor money would be "invested, " when instead it was "funneled" into various entities owned or controlled by McGinn and Smith. ( Id. ¶¶ 1-3.) The money was then used to fund unauthorized investments and unsecured loans, make interest payments to investors in other entities and offerings, support McGinn and Smith's "lifestyles, " and cover the payroll at MS & Co. ( Id. )

On April 20, 2010, in order to halt what it viewed as an ongoing fraud, the SEC filed a complaint and order to show cause, seeking emergency relief. (Dkt. Nos. 1, 4.) On the same day, the court granted the SEC's application, and temporarily froze assets of McGinn, Smith, and the MS Entities, along with certain assets of L. Smith and N. McGinn. (Dkt. No. 5.) As relevant to the pending motions, the following assets remain frozen: (1) all assets held by McGinn, Smith, and the MS Entities, (Dkt. No. 61; Dkt. No. 86 at 42), (2) assets held in L. Smith's name, including a checking account, (Dkt. No. 86 at 42), a brokerage account, ( id. ), and proceeds from the sale of a vacation home in Vero Beach, Florida, ( id. ; Dkt. No. 263, ); (3) assets held by the Smith Trust, (Dkt. No. 194 at 23); and (4) assets held by N. McGinn, including proceeds from the sale of the McGinns' property in Niskayuna, New York, (Dkt. No. 233; Dkt. No. 276; Dkt. No. 426).

It should also be noted at the outset that, in addition to the case at bar, a parallel criminal case was brought against McGinn and Smith ("MS Criminal Case"). See United States v. Timothy M. McGinn and David L. Smith, 1:12-cr-28. This civil action was stayed pending the outcome of the MS Criminal Case. (Dkt. No. 474.) After a four-week jury trial before District Judge David N. Hurd, McGinn and Smith were found guilty of conspiracy to commit mail and wire fraud, mail fraud, wire fraud, securities fraud, and filing false tax returns. (Pl.'s Statement of Material Facts (SMF) ¶ 50, Dkt. No. 711; Dkt. No. 712, Attachs. 5, 6.) Once the stay was lifted in this case, (Dkt. No. 589), the court set a briefing schedule for the now pending dispositive motions. (Dkt. Nos. 672, 695.)

A. Facts[18]

The scheme to defraud alleged by the SEC revolves primarily around three different types of offerings: (1) the Four Funds, (2) approximately twenty separate trust offerings (the "Trust Offerings"), [19] and offerings through McGinn Smith Transaction Funding Corporation (MSTF). (2d Am. Compl. ¶¶ 39-67, 68-103; Pl.'s SMF ¶¶ 9-14.) Below, the Four Funds and Trust Offerings are discussed separately, while facts relevant to the MSTF offering are interspersed throughout.

1. The Four Funds

The Four Funds were single purpose, New York limited liability companies formed between September 2003 and October 2005. (Pl.'s SMF ¶ 9.) The private placement memoranda (PPM) for each of the Four Funds were substantively identical, and each offered $20 million worth of notes, with the exception of TAIN, which offered $30 million. ( Id. ¶ 11.) The offerings had three tranches of notes, which paid quarterly interest of 5% to 10.25%, and promised a return of principal at maturity, in one, three, or five years. ( Id. ) Smith was primarily responsible for the Four Funds and their investment decisions. ( Id. ¶ 159.)

The PPMs stated that the net proceeds would be used "to acquire various public and/or private investments." (Dkt. No. 722 at 15; Dkt. No. 723 at 15; Dkt. No. 724 at 15; Dkt. No. 760, Attach. 1 at 2.) The PPMs further stated that the Four Funds "may acquire such [i]nvestments directly, or from... an affiliate... or... managing member that has purchased the [i]nvestment, " and that, if any of the Four Funds purchases an investment from a managing member or affiliate, the fund will "pay the same price for the [i]nvestment that [it] would have paid if [it] had directly purchased the [i]nvestment." (Dkt. No. 722 at 15; Dkt. No. 723 at 15; Dkt. No. 724 at 15; Dkt. No. 760, Attach. 1 at 2.)

McGinn and Smith, however, engaged in a course of conduct and dealings that were contrary to the PPMs. First, investor proceeds from the Four Funds were used to purchase contracts from pre-2003 trust offerings, which had begun to fail, for more than their initial cost, or to make loans to pre-2003 trusts for the purpose of redeeming or making interest payments to investors. (Pl.'s SMF ¶¶ 75-97, 172; Dkt. No. 712 ¶¶ 8-29, 32-34, 36.) Second, the Four Funds used investor money to directly invest in, rather than purchase investments from, affiliates. (Pl.'s SMF ¶¶ 98-119.) Indeed, in a November 2007 letter, Smith wrote that:

One of the more troubling aspects of the [Four Funds] investments has been my willingness to make substantial investments in affiliated entities, both because they were available and in some cases... new investments were needed to support past investments. Thus, ... the pattern was often the same; invest more money to support the original investment.

(Dkt. No. 714, Attach. 1 at 3-4.) Many of the affiliated investments, however, provided no cash flow to the Four Funds, and were ultimately considered worthless. (Dkt. No. 712 ¶¶ 30-35.) Finally, proceeds from the Four Funds were funneled through MSTF and then used to pay MS & Co.'s payroll.[20] (Pl.'s SMF ¶¶ 138, 169, 170, 171; Dkt. No. 724, Attach. 16 at 43-44.)

In late 2007, Smith received an email from David Rees-the comptroller at MS & Co., whose responsibilities included preparing and maintaining the firm's financial statements-which showed a $48.8 million deficit in the Four Funds. (Pl.'s SMF ¶¶ 160, 163.) Nevertheless, Smith continued to solicit new investments in the Four Funds. ( Id. ¶ 164.) In early 2008, interest payments to junior note holders were first reduced, and then later eliminated, which constituted a default. (Pl.'s SMF ¶¶ 137, 141; Dkt. No. 727 at 4; Dkt. No. 727, Attach. 1 at 2) The reduction, and subsequent elimination, of interest payments were attributed to the collapse of various debt and credit markets and the "sub prime mess." (Dkt. No. 727 at 2; Dkt. No. 727, Attach. 1.) Certain preferred investors, however, continued to receive interest payments, but those payments came from MTSF funds, not proceeds from the Four Funds.[21] (Pl.'s SMF ¶¶ 168, 170; Dkt. No. 724, Attach. 16 at 41-42.) Finally, in October 2008, Smith sent a letter to all note holders in all tranches of the Four Funds, which outlined a restructuring plan, extended the maturity dates of the notes, reduced interest payments for all tranches, and forfeited all future fees due to MS & Co. (Pl.'s SMF ¶¶ 142-44; Dkt. No. 741, Attach. 3.)

2. The Trust Offerings [22]

Beginning in October 2006, MS & Co. was the sales agent for the Trust Offerings, which sold trust certificates. (Pl.'s SMF ¶ 12.) Investors in the Trust Offerings were promised interest payments ranging from 7.75% to 13% per year, and a return of principal at maturity, which ranged from fifteen months to five years. ( Id. ¶ 13.) Investors were advised that the proceeds raised by the Trust Offerings, minus certain disclosed fees and deal costs, would be invested in specific streams of receivables, such as the purchase of contracts for security alarm services, broadband cable services, telephone services, and luxury cruises. ( Id. ¶¶ 146, 147.)

For each Trust Offering, however, less than the amount represented in the PPM was actually invested in the identified streams of receivables. Specifically, the PPMs promised that, in aggregate, 85% of money raised from investors would be invested in the disclosed assets, but, in fact, only 58% of the money was invested as promised. (Dkt. No. 712 ¶ 44, at 40, 62.) Moreover, the funds raised from the Trust Offerings paid fees to MS & Co. in excess of the fees disclosed in the PPMs. Indeed, although the PPMs disclosed combined maximum underwriting and other fees payable to MS & Co. of up to $3.2 million, from October 2006 through December 2009, MS & Co. received over $6.4 million in connection with the Trust Offerings, and, further, Smith, McGinn, and Matthew Rogers, a former senior managing director at MS & Co., personally took approximately $4.7 million from funds raised from the Trust Offerings. ( Id. ¶¶ 46, 47, at 40, 42-43, 62; Pl.'s SMF ¶¶ 59, 150-51.)

Furthermore, like the Four Funds offerings, the investments that were made by the Trust Offerings did not generate sufficient returns to cover interest and principal payments owed to investors. Thus, contrary to the terms of the PPMs, in many instances, McGinn and Smith used investor funds from one offering-including the various Trust Offerings, the Four Funds, and MSTF-to cover interest and principal payments in other Trust Offerings. (Pl.'s SMF ¶¶ 197, 198, 201, 203; Dkt. No. 712 ¶ 52.) The Firstline Trust 07, Firstline Sr. Trust 07, Firstline Trust 07 Series B, and Firstline Sr. Trust 07 Series B offerings (collectively, the "Firstline Trusts") are good examples.

The Firstline Trusts raised money from investors, which was then loaned to Firstline, Inc., an alarm company in Utah. (Pl.'s SMF ¶ 225.) The investors were to receive monthly payments from Firstline's revenue stream. (Dkt. No. 712 ¶¶ 55, 56.) Firstline, however, filed for bankruptcy on January 25, 2008, and, after filing, failed to make its payments on the loans. (Pl.'s SMF ¶ 228.) The Firstline Trusts then used approximately $2 million from MSTF and other Trust Offerings, including TDM Cable Trust 06, TDM Verifier Trust 07R, and Integrated Excellence Jr. Trust 08, to pay interest to investors. ( Id. ¶¶ 229, 233, 237, 238, 241; Dkt. No. 725, Attach. 4.) Further, although McGinn and Smith knew about Firstline's bankruptcy almost immediately, they did not disclose this information to investors, or to their brokers, who continued to sell Firstline certificates after the bankruptcy, without informing potential investors of Firstline's financial condition. (Pl.'s SMF ¶¶ 231, 232, 235, 236, 244.) Investors were not informed about Firstline's bankruptcy until September 2009, and, although they were told that they would continue to receive monthly payments from Firstline receivables, money paid to investors in Firstline, in fact, again came from other Trust Offerings. ( Id. ¶¶ 248, 250.)

3. FINRA Proceedings

Eventually, McGinn and Smith's clients complained to authorities about how their investments were being handled, and, in January 2009, the Financial Industry Regulatory Authority (FINRA)[23] undertook an investigation of McGinn, Smith, and MS & Co. (Pl.'s SMF ¶¶ 4, 63, 64, 551; Dkt. No. 192, Attach. 3 ¶ 9.) On April 5, 2010, FINRA charged McGinn, Smith, and MS. & Co. with violating § 10(b) of the Exchange Act and Rule 10b-5 thereunder, along with various FINRA rules. (Dkt. No. 712, Attach. 14.) On September 14, 2011, FINRA issued a default decision, which barred McGinn and Smith from association with any FINRA member firm. (Dkt. No. 712, Attach. 15.) In addition to the action initiated by FINRA itself, some of McGinn and Smith's clients commenced arbitrations in FINRA, alleging, among other causes of action, unsuitable investments, negligence, breach of contract, breach of fiduciary duty, fraud, misrepresentations, and omissions, and seeking compensatory damages. ( See, e.g., Dkt. No. 740, Attach. 6 at 16-25.)

B. Procedural History

As noted above, on April 20, 2010, the SEC filed its complaint and an order to show cause, and, on the same day, the court entered an order temporarily freezing certain assets, pending a preliminary injunction hearing, and appointing a temporary receiver over the MS Entities' assets. (Dkt. Nos. 1, 4-5.) McGinn, Smith, and the MS Entities, through the receiver, consented to a preliminary injunction continuing the freeze of their assets. (Dkt. No. 61; Dkt. No. 87 at 40.) On July 22, 2010, the court entered a preliminary injunction order, which, among other things, confirmed the appointment of William Brown, Esq. as the Receiver over the assets of the MS Entities, pending the final disposition of the action. (Dkt. No. 96.)

Also as noted above, this case was stayed pending the completion of the MS Criminal Case. (Dkt. No. 474.) On October 11, 2012, a grand jury returned a superseding indictment against McGinn and Smith, which charged them each with one count of conspiracy to commit mail and wire fraud, nine counts of mail fraud, ten counts of wire fraud, six counts of securities fraud, and three counts of filing a false tax return. (Dkt. No. 712, Attach. 4.) Among other things, the superseding indictment alleged that McGinn and Smith made material misrepresentations and omissions in connection with the Trust Offerings, the Four Funds, and MSTF. ( See generally id. )

On February 6, 2013, the jury returned verdicts. (Dkt. No. 712, Attachs. 18, 19.) Both McGinn and Smith were convicted of conspiracy to commit mail and wire fraud, McGinn was convicted of seven counts of mail fraud, all ten counts of wire fraud, all six counts of securities fraud, and all three counts of filing false tax returns, and Smith was convicted of three counts of mail fraud, two counts of wire fraud, all six counts of securities fraud, and all three counts of filing false tax returns. (Dkt. No. 712, Attachs. 5, 6, 18, 19.) On August 7, 2013, Smith was sentenced to ten years imprisonment and was ordered to pay a $50, 000 fine, and McGinn was sentenced to fifteen years imprisonment and ordered to pay a $100, 000 fine. (Dkt. No. 712, Attach. 20 at 38-39, 40-41; Dtk. No. 713 at 32-33, 34-35.) The court also ordered that Smith and McGinn be held jointly and severally liable for a restitution payment of $5, 748, 722. (Dkt. No. 712, Attach. 20 at 35; Dkt. No. 713 at 29.) McGinn and Smith appealed their convictions, and the United States appealed as to the sentences only. (MS Criminal Case, Dkt. Nos. 237, 238, 249, 250.)

On September 3, 2013, the stay in this civil proceeding was lifted. (Dkt. No. 589.) Soon thereafter, briefing schedules were set, (Dkt. Nos. 672, 695), and the now-pending motions were filed.

III. Standard of Review

The standard of review pursuant to Fed.R.Civ.P. 56 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 Wagner v. Swarts, 827 F.Supp.2d 85, 92 (N.D.N.Y. 2011), ...

Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.