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

United States District Court, N.D. New York

March 30, 2015

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
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

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[Copyrighted Material Omitted]

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[Copyrighted Material Omitted]

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FOR U.S. Securities and Exchange Commission, PLAINTIFF: DAVID P. STOELTING, ESQ., HAIMAVATHI V. MARLIER, ESQ., JACK KAUFMAN, ESQ., JOSHUA M. NEWVILLE, ESQ., KEVIN P. MCGRATH, ESQ., LARA S. MEHRABAN, ESQ., New York, NY.

FOR 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, DEFENDANTS/RELIEF DEFENDANTS AND INTERVENORS: WILLIAM J. BROWN, ESQ., Phillips Lytle LLP, Buffalo, NY.

FOR Timothy M. McGinn, DEFENDANTS/RELIEF DEFENDANTS AND INTERVENORS: E. STEWART JONES, JR., ESQ., Office of E. Stewart Jones, Jr., Troy, NY.

FOR David L. Smith, DEFENDANTS/RELIEF DEFENDANTS AND INTERVENORS: WILLIAM J. DREYER, ESQ., BENJAMIN W. HILL, ESQ., Dreyer, Boyajian Law Firm, Albany, NY.

FOR Lynn A. Smith, DEFENDANTS/RELIEF DEFENDANTS AND INTERVENORS: JAMES D. FEATHERSTONHAUGH, ESQ., Featherstonhaugh, Wiley Law Firm, Albany, NY.

FOR 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, DEFENDANTS/RELIEF DEFENDANTS AND INTERVENORS: JAMES D. LINNAN, ESQ., Linnan, Fallon Law Firm, Albany, NY.

Nancy McGinn, DEFENDANT/RELIEF DEFENDANT AND INTERVENOR, Pro se, Troy, NY.

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MEMORANDUM-DECISION AND ORDER

Gary L. Sharpe, Chief United States 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), Third Albany Income Notes, LLC (TAIN),[1] (collectively, the " MS Entities" ), alleging multiple violations of the federal securities laws. ( 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,

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Smith, defendants Lynn A. Smith[2] (" 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" ),[3] and pro se defendant Nancy McGinn[4] (" N. McGinn" ). ( Id. ¶ ¶ 206-11.) L. Smith and N. McGinn are also named as relief defendants for allegedly receiving and retaining ill-gotten gains, of which the SEC seeks disgorgement. ( Id. ¶ ¶ 203-05.)

Pending are L. Smith's motion for summary judgment, (Dkt. No. 696), G. Smith, L.T. Smith, and the Smith Trust's motion for summary judgment, (Dkt. No. 704), and the remainder of the SEC's motion for summary judgment, upon which the court previously reserved judgment, (Dkt. No. 708; Dkt. No. 708, Attach. 1 at 14-29, 32-40). For the reasons that follow, the remainder of the SEC's motion is granted, and L. Smith and the Smith Trust's motions are denied.

II. Background[5]

Before addressing the facts and arguments at issue here, the court first outlines where it has been and where it is going. In a Memorandum-Decision and Order dated February 17, 2015 (MDO I), the court granted the SEC's motion to the extent that it sought entry of summary judgment on its first, second, third, fourth, and sixth causes of action, all of which alleged violations of the federal securities laws. (Dkt. No. 807 at 20-37.) Further, the court granted the SEC's requests for an injunction against McGinn and Smith and an order barring McGinn from serving as an officer or director of a publically traded corporation, but denied the SEC's request for civil monetary penalties. ( Id. at 46-53.) Additionally, while the court found that the SEC had demonstrated that disgorgement of profits was an appropriate sanction, the court reserved judgment on the amount to be disgorged, pending the SEC's submission of more detailed evidence. ( Id. at 37-46.) The court also noted that the SEC had not moved for summary judgment as against the Four Funds, despite the fact that two claims were asserted against them, and directed the SEC to inform the court what it intended to do with those claims. ( Id. at 53-54.) Finally, the court reserved judgment on the portion of the SEC's motion seeking disgorgement of assets held by L. Smith, N. McGinn, and the Smith Trust. ( Id. at 56.)

In this Memorandum-Decision and Order, the court again considers the SEC's

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request for disgorgement of profits, and also addresses the disputes surrounding certain assets that remain frozen. The relevant assets include the following: (1) assets held in L. Smith's name, including (a) a checking account with Bank of America (the " Checking Account" ), (Dkt. No. 86 at 42), (b) a stock account maintained at RMR Wealth Management, LLC (the " Stock Account" ), ( id. ), and (c) proceeds from the sale of a vacation home in Vero Beach, Florida (" Smith Vero Beach Home" ), ( id. ; Dkt. No. 263 at 10-11,); (2) assets held by the Smith Trust, (Dkt. No. 194 at 23); and (3) assets held by N. McGinn, including proceeds from the sale of the McGinns' property in Niskayuna, New York (" Niskayuna Property" ), (Dkt. No. 233; Dkt. No. 276; Dkt. No. 426).[6] The court also considers certain transfers that have been made from the Smith Trust since this action was commenced, which the SEC alleges were fraudulent under New York law.

A. Facts[7]

The facts in this case read like a script from a hyperlink cinema--a film genre known for interwoven storylines between multiple characters, plot twists, and a chronology that is not altogether linear.[8] This case includes a cast of characters comprised of individuals whose audacity knows no bounds, and a recurring theme of insatiable greed. Below--in little vignettes--the court explains how each defendant ended up here and which of his or her assets the SEC seeks to disgorge.

1. L. Smith

L. Smith and Smith have been married for over forty years. (Dkt. No. 23 ¶ 11.) Together, they have two children and, over the years, amassed great wealth, complete with ski condominiums and beach homes. ( Id. ¶ ¶ 22-23; Pl.'s Statement of Material Facts (SMF) ¶ ¶ 363, 364, Dkt. No. 711.) Although the SEC does not ask, nor does the law require, the court to determine the extent to which L. Smith knew of her husband's fraudulent scheme, her actions, described throughout this opinion, carry with them a circumstantial stench. The assets of hers at issue here include the Stock Account, Checking Account, and Smith Vero Beach Home.

a. Stock Account

Throughout their marriage, the Stock Account was used by the Smiths to fund multiple purchases--from mundane household expenses to lavish homes--and to provide short-term cash infusions to struggling MS Entities. Although L. Smith has always maintained that she inherited the Stock Account, along with property on the Great Sacandaga Lake, from her father after he passed away in 1969, and that they " have always been [her] separate property," (Dkt. No. 23 ¶ ¶ 13, 17), the SEC has submitted evidence establishing that the Stock Account, in fact, was opened on November 21, 1991 with Bear Stearns, and was funded with cash and securities from a joint account, (Pl.'s SMF ¶ ¶ 338, 339; Dkt. No. 738, Attach. 8; Dkt. No. 745, Attachs. 2, 3; Dkt. No. 746, Attach. 3). Further, since at least 1991, Smith made most of the investment decisions and had full trading

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authorization over the Stock Account. (Pl.'s SMF ¶ ¶ 357-58; Dkt. No. 737, Attach. 10.) Smith also decided whether the Stock Account would make investments in any of the MS Entities, and if such investments were made, L. Smith was unaware of them. (Dkt. No. 742, Attach. 11 at 20.)

The Stock Account was also used to fund common expenses and purchase assets that benefited both Smith and L. Smith. For example, the Smiths used funds from the Stock Account to purchase their primary residence in Clifton Park, New York, a ski condominium in Vermont, another residence in Saratoga Springs, New York, and the Smith Vero Beach Home. (Pl.'s SMF ¶ ¶ 362-64, 370.) Additionally, the Smiths used the Stock Account to fund L.T. Smith and G. Smith's college tuition and various individual retirement accounts (IRAs). ( Id. ¶ ¶ 367-69.) Other miscellaneous expenses funded by the Stock Account included golf club dues, federal and state taxes, car payments, and insurance. ( Id. ¶ 373.)

Smith also contributed assets to the Stock Account after it was opened. Specifically, Smith obtained a $150,000 loan from MS & Co., which was used to partially fund the purchase of 40,688 shares in ALBANK Financial Corporation--later converted to Charter One stock. ( Id. ¶ ¶ 375, 378-80.) Although the shares were issued in April 1992, the stock was not deposited into the Stock Account until September 18, 1992. ( Id. ¶ ¶ 379, 381.) Ultimately, this proved to be an extremely successful and profitable investment, and, by October 2002, the Stock Account held 105,000 shares of Charter One stock, which were worth over $3 million. ( Id. ¶ ¶ 385-88.)

The assets held by the Stock Account were also utilized to provide short-term loans to the MS Entities and to make personal loans to McGinn. Between 1999 and 2010, approximately $17.2 million was transferred from the Stock Account to various MS Entities, but, during the same time period, only $13.7 million was transferred from the MS Entities back to the Stock Account. ( Id. ¶ ¶ 400-01; Dkt. No. 712 at 68-69.[9] ) For example, during this time period, $7.9 million was transferred from the Stock Account to Capital Center Credit Corporation (" C-4" ), which was owned by McGinn and Smith, but only approximately $7.2 million was transferred from C-4 back to the Stock Account. (Pl.'s SMF ¶ ¶ 402-03; Dkt. No. 712 at 68.) Further, also during this time period, $300,000 was transferred from the Stock Account to MS & Co., but only $29,500 was

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transferred from MS & Co. back to the Stock Account. (Dkt. No. 712 at 68.) Additionally, in 2003, a $900,000 loan was made to McGinn, and, later, another $15,000 loan was made to McGinn from the Stock Account. (Pl.'s SMF ¶ ¶ 466-67; Dkt. No. 742, Attach. 11 at 4-5.)

These transfers from the Stock Account were typically made pursuant to Letters of Authorization (LOAs), which reflected L. Smith's signature. (Pl.'s SMF ¶ ¶ 432-33.) At times, however, Smith directed employees to cut and paste L. Smith's signature onto the LOAs. ( Id. ¶ ¶ 434-45.) Additionally, L. Smith signed multiple blank LOAs, which contained no information regarding the amount to be transferred or the transferee, and, after signing them, provided the LOAs to Smith to effectuate transfers from the Stock Account. ( Id. ¶ 436; Dkt. No. 745, Attach. 9 at 175-77; Dkt. No. 745, Attach. 10 at 13-15.) Smith then gave the blank LOAs to an employee, who kept them in his desk drawer until Smith provided him with wiring instructions. (Pl.'s SMF ¶ 437; Dkt. No. 745, Attach. 9 at 177.) L. Smith could not explain the business reason behind many of the transfers, at times did not recall certain transfers at all, and, with respect to the loans made to McGinn, never spoke to McGinn regarding the loans, and has not been repaid in full. (Pl.'s SMF ¶ ¶ 463-64; Dkt. No. 742, Attach. 11 at 4-5.)

b. Smith Vero Beach Home

In 2001, the Smiths used money from the Stock Account to purchase the Smith Vero Beach Home. (Pl.'s SMF ¶ 364.) The home was purchased in both Smith and L. Smith's names, and they paid approximately $1,389,000. ( Id. ¶ 365.)

In December 2008, a statement of claim was filed with the Financial Industry Regulatory Authority (FINRA) by Duckkyu Chang and Kee Chang, customers of McGinn and Smith, seeking compensatory damages in the amount of $2,577,000, punitive damages, commissions, interest, and attorneys' fees. ( Id. ¶ 577; Dkt. No. 740, Attach. 6 at 16.) McGinn and Smith, along with, among others, MS & Co., MS Advisors, MS Capital, and William Lex, an MS & Co. broker, were named as respondents. (Pl.'s SMF ¶ 576; Dkt. No. 740, Attach. 6 at 16.) Additionally, in January 2009, FINRA began investigating McGinn, Smith, and MS & Co. for potential securities laws violations. (Dkt. No. 192, Attach. 3 ¶ 9.)

Also in January 2009, Smith stated in a letter to Martin Finn, the Smiths' financial planner, " I am interested in reducing my exposure to personal liability as a result of the very litigious business that I am in. You mentioned transferring my share in the Vero Beach and Saratoga residences to Lynn or a Trust." (Pl.'s SMF ¶ 555.) Finn responded that it was more beneficial for the Smiths to continue to own the Smith Vero Beach Home jointly as tenants by the entirety. (Dkt. No. 729, Attach. 4 at 2.) Contrary to this advice, in September 2009, the Smiths transferred the vacation home from joint ownership to L. Smith's name alone. (Pl.'s SMF ¶ 567; Dkt. No. 14 at 1, 6.)

On December 31, 2009, the Chang FINRA arbitration panel held that MS & Co., Lex, and Smith were jointly and severally liable for $805,111 in compensatory damages and other fees. (Dkt. No. 740, Attach. 6 at 16-25.) Soon thereafter, in a letter regarding " options to consider in addressing the Chang award," Smith noted that he was " foolishly compromising the rest of [his] life," and would " be forever burdened with at the very least a lien on [his] wages, and there is some risk that the equity that is not in [his] wife's name or protected by Trusts could be served with a lien to satisfy the judgments." (Dkt. No. 737, Attach. 1 at 1; Pl.'s SMF ¶ 556.)

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Smith further noted that the " equity is primarily in the form of two properties," including his " home in Florida (transferred to [his] wife solely . . . )." (Dkt. No. 737, Attach. 1 at 1.)

c. The Checking Account

Since they married in 1968, Smith and L. Smith maintained a joint checking account, into which they deposited their paychecks and from which they paid bills. (Pl.'s SMF ¶ 558.) In the summer of 2009, L. Smith opened a Checking Account at Bank of America in her name only. ( Id. ¶ 560.) Thereafter, Smith and L. Smith transferred the assets in their joint checking account to L. Smith's Checking Account, and Smith's payroll checks were then deposited into L. Smith's Checking Account. ( Id. ¶ 561.)

2. The Smith Trust, L.T. Smith, and G. Smith

As noted above, in the early 1990s, Smith caused the Stock Account to purchase 40,688 shares of stock in ALBANK, later to become Charter One, for $406,880. (Pl.'s SMF ¶ ¶ 375-76, 380.) By October 2002, through bank mergers and acquisitions, the number of shares had increased to 105,000 and their value to over $3 million. ( Id. ¶ ¶ 385-88.) On May 4, 2004, Charter One publicly announced that, on August 31, 2004, it would be acquired in an all-cash deal by Citizens Financial Group, which would ...


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