Sec. & Exch. Comm'n v. Mcginn, Smith & Co.

• Decision Date: 17 February 2015
• Docket Number: 1:10-cv-457 (GLS/CFH)
• Court: U.S. District Court — Northern District of New York
• Parties: 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.

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. MCGINN, SMITH & CO., INC. et al., Defendants,LYNN A. SMITH, and NANCY MCGINN, Relief Defendants,andGEOFFREY 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.

1:10-cv-457 (GLS/CFH)

UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF NEW YORK

February 17, 2015

APPEARANCES:

FOR THE PLAINTIFF:

U.S Securities and Exchange

Commission

3 World Financial Center

New York, NY 10281

OF COUNSEL:

DAVID P. STOELTING

HAIMAVATHI V. MARLIER

JACK KAUFMAN

JOSHUA M. NEWVILLE

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

Phillips, Lytle LLP

One Canalside

125 Main Street

Buffalo, NY 14203

Timothy M. McGinn

Office of E. Stewart Jones, Jr.

28 Second Street

Jones Building

Troy, NY 12180

David L. Smith

Dreyer, Boyajian Law Firm

75 Columbia Street

Albany, NY 12210

Lynn A. Smith

Featherstonhaugh, Wiley Law Firm

99 Pine Street

Suite 207

Albany, NY 12207

Geoffrey R. Smith, Individually and as

Trustee of the David L. and Lynn A.

Smith Irrevocable Trust U/A 8/04/04,

KEVIN P. MCGRATH

LARA S. MEHRABAN

WILLIAM J. BROWN, ESQ.

E. STEWART JONES, JR., ESQ.

WILLIAM J. DREYER, ESQ.

BENJAMIN W. HILL, ESQ.

JAMES D.

FEATHERSTONHAUGH, ESQ.

and Lauren T. Smith

Linnan, Fallon Law Firm

61 Columbia Street

Suite 300

Albany, NY 12210-2736

Nancy McGinn

Pro Se

426-8th Ave.

Troy, NY 12182

JAMES D. LINNAN, ESQ.

Gary L. Sharpe Chief Judge

MEMORANDUM-DECISION AND ORDER

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. Smith¹¹ ("L. Smith"), Geoffrey R. Smith ("G. Smith"), individually and as Trustee of the David L. and Lynn A. Smith IrrevocableTrust U/A 8/04/04 (the "Smith Trust"), Lauren T. Smith ("L.T. Smith"),¹² and pro se defendant Nancy McGinn¹³ ("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. Background¹⁶

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 beforeDistrict 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. Facts¹⁸

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 relevantto 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 directlypurchased 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,...