Securities and Exchange Commission v. McGinn, Smith & Co, Inc. et al
Filing
478
MEMORANDUM-DECISION and ORDER. IT IS HEREBY ORDERED that Timothy McGinn's motion for the release of assets from the preliminary injunction to pay attorney's fees and costs in the parallel criminal action 439 is GRANTED in part and DENIED in part as set forth in this Order; 2) David Smith's motion for the release of assets from the preliminary injunction to pay attorney's fees and costs in the parallel criminal action 440 is GRANTED in part and DENIED in part as set forth in this Order; and 3) The Trust's motion for the release of assets from the preliminary injunction to pay past and future expenses, to reimburse David Smith and his wife for Trust expenses they paid, and for payment of attorney's fees and costs in this action 441 is DENIED in all respects. Signed by Magistrate Judge David R. Homer on 4/4/2012. (mab)
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF NEW YORK
SECURITIES AND EXCHANGE
COMMISSION,
Plaintiff,
v.
No. 10-CV-457
(GLS/DRH)
TIMOTHY M. McGINN; DAVID L. SMITH;
and GEOFFREY R. SMITH, Trustee of the
David L. and Lynn A. Smith Irrevocable
Trust U/A 8/04/04,
Defendants.
APPEARANCES:
OF COUNSEL:
DAVID STOELTING, ESQ.
Attorney for Plaintiff
Room 400
3 World Financial Center
New York, New York 10281
KEVIN McGRATH, ESQ.
LARA MEHREBAN, ESQ,
JOSHUA M. NEWVILLE, ESQ.
DREYER BOYAJIAN LLP
Attorney for Defendant David Smith
75 Columbia Street
Albany, New York 12210
WILLIAM J. DREYER, ESQ.
E. STEWART JONES, PLLC
Attorney for Defendant Timothy McGinn
29 Second Street
Troy, New York 12180
JAMES C. KNOX, ESQ.
FEATHERSTONHAUGH, WILEY &
CLYNE, LLP
Attorney for Defendant Trust
Suite 207
99 Pine Street
Albany, New York 12207
JAMES D. FEATHERSTONHAUGH, ESQ.
SCOTT J. ELY, ESQ.
DAVID R. HOMER
U.S. MAGISTRATE JUDGE
MEMORANDUM-DECISION AND ORDER
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
2
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.
3
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,
4
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.
5
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.1
1
The SEC contends that if the Court finds McGinn’s representations sufficient, an
evidentiary hearing should be scheduled to permit the SEC to examine the credibility of
these assertions. However, the SEC has had two years to investigate and discover
whatever may be relevant to McGinn’s financial condition, including financial and business
records seized by law enforcement authorities through search warrants and depositions of
McGinn and his wife, also a defendant in this action. If the SEC possessed any evidence
contradicting McGinn’s assertions, they would no doubt have presented it in opposition to
this motion. No contradictory evidence has been presented and, therefore, no question of
fact has been raised necessitating an evidentiary hearing. The fact alone that McGinn
was previously found in contempt of the preliminary injunction for his conduct of a new
business enterprise, without more, will not suffice to undermine the credibility of McGinn’s
representations as to his financial condition. See Dkt. No. 207 (decision finding McGinn in
contempt of preliminary injunction). Accordingly, the SEC’s request for an evidentiary
hearing as to McGinn’s financial condition is denied.
6
b. Smith
For his part, Smith currently has no source of income. Smith Decl. at ¶ 5.2 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.3
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.
2
Smith advises that his principal residence is now in foreclosure for nonpayment of
the mortgage. Smith Reply Decl. (Dkt. No. 456-1) at ¶ 5.
3
The SEC also requests an evidentiary hearing as to Smith’s representations of
need if found sufficient by the Court. As to Smith, however, the SEC proffers evidence
that would undermine the credibility of his representations. The SEC first asserts that from
July to September, 2011, Smith and his wife rented their residence in Saratoga County
during the local horse racing season for a total of $14,000 which neither Smith nor his wife
have ever disclosed. Stoelting Decl. (Dkt. No. 448-1) at ¶ 2. Second, the SEC asserts
that in the Summer of 2011, the Smiths paid $3,338.40 for an engagement party at a
Saratoga-area golf course. Id. at ¶ 3. Smith has not denied these assertions. See Smith
Reply Decl. While this conduct in fact undermines the credibility of Smith’s assertions,
notwithstanding Smith’s diminished credibility, it remains clear from this record that Smith
lacks access to sufficient unrestrained resources to pay even a minimal portion of the legal
fees and costs he is likely to incur in defending the criminal case. The SEC has proffered
no other evidence to indicate the existence of other resources from which Smith might
draw to meet legal expenses and, therefore, no question of fact has been raised to
warrant an evidentiary hearing. Accordingly, the SEC’s request as to Smith on this issue
is also denied.
7
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 membership bond
a. Purchased in 2000
b. Estimated value: $10,000
c. Likely proceeds: $7,000
5. Waterville Golf Links membership initiation fee
a. Purchased in 2003
b. Estimated value: $25,000
c. Likely proceeds: $20,000
6. Watches and jewelry
a. Purchased 2002 through 2006
b. Estimated value: $10,000
c. Likely proceeds: $3,500
7. Boca Raton residence
a. Purchased in 2007
b. Estimated value: $495,000 less commission; ($29,700) less debt and
taxes ($425,000) leaving an estimated net equity of $40,300
c. Likely proceeds: $20,000
8. Furniture and personal property at Boca Raton residence
a. Purchased in 2007
b. Estimated value: $10,000
c. Likely proceeds: $6,000
9. Bank account:
a. Value: $9,480
8
10. Retirement Account
a. Value: $7,350
TOTAL:
Estimated value: $231,130
Likely proceeds: $128,330
Id.
The amended complaint in this action alleges that the unlawful conduct of McGinn
and Smith commenced in September 2003. Am Compl. (Dkt. No. 100) at ¶ 34. In
granting the SEC’s motion for the preliminary injunction, the Court found a substantial
likelihood that the SEC would succeed in proving this allegation. MDO I at 30-31. The
SEC now contends that any asset acquired or maintained by McGinn after September
2003 is subject to disgorgement for the benefit of investors, whether as the proceeds of
McGinn’s unlawful activities or because unlawful proceeds were commingled with
untainted assets to such an extent that tainted and untainted funds became
indistinguishable. Pl. Mem. of Law (Dkt. No. 448) at 12-13. The SEC does not challenge
McGinn’s motion as to McGinn’s retirement account (Item No. 10) and appears not to
object to the sale of the Boca Raton residence (Item No. 7). Id. (arguing that the property
is tainted from its maintenance through unlawful proceeds but stating that the asset likely
has no value and the SEC would support its sale). The Receiver, but not the SEC, asserts
that there is no evidence that (1) the desk or rugs (Item Nos. 2 and 3) belong to McGinn
rather than to the defendant business entities, and (2) the two golf club memberships
(Item Nos. 4 and 5) were purchased with McGinn’s personal funds rather than those of the
defendant business entities. Receiver’s statement (Dkt. No. 465) at ¶ 5(a) & (b). Neither
the SEC nor the Receiver challenges the timeshare unit, jewelry, or the household
9
furniture (Item Nos. 1, 6, and 8).4 The SEC does contend that the bank account (Item No.
9) is tainted. Pl. Mem. of Law at 13.
As to the bank account, the SEC has proffered evidence that the $9,480 in the
account when it was frozen on April 20, 2010 derived from unlawful activities and is,
therefore, tainted. See Palen Decl. (Dkt. No. 448-2) at ¶¶ 6-7. This evidence suffices to
satisfy the SEC’s burden of demonstrating taint and McGinn’s motion as to this bank
account will be denied. As to the other nine items for which McGinn has sought release
from the asset freeze, however, the SEC has either not opposed McGinn’s motion or has
only raised questions about possible taint, which fails to satisfy its burden of demonstrating
taint. Accordingly, McGinn’s motion as to the other nine items will be granted.
b. Smith
Smith and his family own a variety of assets totaling in value over $7 million. MDO I
at 6-12; Smith Decl. at ¶ 7. Most are frozen directly by the preliminary injunction. See
MDO I, MDO II. Others, such as retirement accounts, are beyond the reach of the asset
freeze by operation of law unless and until Smith withdraws the funds into his possession
at which point they become subject to the asset freeze. See Dkt. No. 221 at 3-4 (denying
Smith’s motion to release a retirement account). Thus, such assets remain in legal limbo
4
Certain of the rugs and jewelry, the furniture, and the Boca Raton residence were
acquired after September 2003. McGinn Decl., Sch. A. This would appear to afford the
SEC a basis for arguing their taint, but no such argument is made here. It does not
appear that the Receiver has taken any steps to take possession of or liquidate those
items to date, possibly because a cost-benefit analysis leads to the conclusion that it
would cost more to do so than would likely be obtained from their liquidation. In any
event, no claim of taint has been asserted with respect to these items.
10
for the foreseeable future. Those assets remain beyond the reach of the SEC unless
Smith chooses to withdraw funds from those accounts, which Smith has no present
incentive to do, and beyond Smith’s reach as a practical matter, since the SEC will restrain
any withdrawn funds at the moment of their withdrawal.
Smith makes several arguments in support of his motion. First, he contends that,
even if the SEC prevails on all its claims against him, the amount of the proceeds he is
alleged to have received from unlawful activity is no more than $1.5 million and, since his
assets in total greatly exceed this amount, sufficient funds exist to insure full payment of
any judgment even if the requested assets are released for his legal costs. Smith Reply
Decl. at ¶¶ 14-17. In this action, however, the SEC alleges a loss to investors of at least
$80 million, which represents the maximum possible judgment against Smith. See Am.
Compl. at ¶ 1 & pp. 41-44. Therefore, on this record, it appears that the amount of Smith’s
assets subject to the asset forfeiture still falls far short of the amount which the SEC has
demonstrated will likely be ordered disgorged at the conclusion of this action.
Smith also seeks release of assets which have already been found subject to the
preliminary injunction. These include the stock account, certain real property, and a trust
account. See MDO I, MDO II. All of these assets have previously been the subject of
extensive litigation in this action, the SEC has demonstrated that all are properly subject to
the asset freeze, and the evidence as to all demonstrates that all are tainted either as the
proceeds of unlawful activity or as so commingled in unlawful proceeds that any untainted
portions cannot reasonably be severed. See MDO I, MDO II. Smith’s motion as to these
assets, therefore, is denied.
A different record is presented as to Smith’s retirement accounts, however.
11
According to Smith, his 401-k account has a present value of $310,000. Smith Decl. at ¶
7. The SEC has proffered evidence that of that amount, $129,000 was contributed by
Smith or his company since September 2003. Dkt. No. 448-2 at 5. These contributions
constitute proceeds from the allegedly unlawful activities as discussed above. However,
while technically commingled with the untainted funds already contributed to the account
before September 2003, they are reasonably severable given the nature of a 401-k
account. Depending on the growth of the account since September 2003, any such
growth can be reasonably apportioned between contributions before September 2003 and
those after that date. However, the SEC has offered no evidence as to those figures. On
this record, therefore, the SEC has met its burden of demonstrating that $129,000 of the
$310,000 in the 401-k is tainted as the proceeds of unlawful activity but that the remaining
approximately $181,000 is not. Accordingly, Smith’s motion is granted to the extent of
$181,000 in the 401-k account but otherwise denied as to that account.
Smith also seeks a release of an Individual Retirement Account (IRA) currently
valued at approximately $41,000. Smith Decl. at ¶ 7. However, the SEC has produced
evidence that as of September 2003, the account held approximately $4,419. Dkt. No.
448-2 at 7. Since September 2003, contributions to the account totaling $18,000 have
been made from sources which are tainted by involvement in the allegedly unlawful
activities. Id. Thus, beyond these contributions, the fund has grown by approximately
$18,581. Although not a precise methodology, this accrued interest may be approximately
but reasonably apportioned by allotting 20% ($3,716, the pre-September 2003
contributions constituting that percentage of the total contributions) to the original
contributions of $4,419 and 80% ($14,865, the post-September 2003 contributions
12
constituting that percentage of the total contributions) to the later contributions of $18,000.
Thus, Smith’s motion will be granted as to $8,135 from his IRA and will otherwise be
denied as to funds from that account.
3. Reasonableness
As noted, both McGinn and Smith estimate that their legal costs will amount to at
least $300,000 each through the end of the criminal proceedings. These costs are
principally a function of the hourly rate charged by their counsel multiplied by the number
of hours to be expended. The hourly rate for purposes of this motion is governed by
standards of reasonableness, not simply the rate charged by the particular attorney,
although the rate charged by the attorney in question must be considered. See Lore v.
City of Syracuse, 670 F.3d 127, 175-76 (2d Cir. 2012); Arbor Hill Concerned Citizens
Neighborhood Ass'n v. County of Albany and Albany County Bd. of Elections, 522 F.3d
182, 186 n. 3 (2d Cir. 2008).
McGinn’s counsel states that he is charging an hourly rate of $500 for the lead
attorney and $250 for associates. See Knox Reply Decl. (Dkt. No. 461-1) at ¶ 9. Smith’s
counsel states that he is charging an hourly rate of $350. Dreyer Reply Decl. (Dkt. No.
456-2) at ¶ 4. The highest hourly rate found reasonable in this district to date appears to
be $345. See Aquent, LLC v. Atlantic Energy Servs., Inc., No. 1:09-CV-0524 (LEK/DRH),
2012 WL 1005082, at *3 (N.D.N.Y. Mar. 23, 2012) (Kahn, J.); see also Jimico Enterprises,
Inc. v. Lehigh Gas Corp., No. 1:07–CV–0578, 2011 WL 4594141, at *10 (N.D.N.Y. Sept.
30, 2011) (Suddaby, J.) (awarding attorneys' fees with hourly rates of $300.00 for partners
and $180.00 for an associate). Given their exceptional abilities, experience, and
13
reputations the undersigned takes notice that lead counsel for both McGinn and Smith
would no doubt be entitled to hourly rates at the maximum amounts found reasonable in
this district.
Counsel for both McGinn and Smith estimate that the criminal case may not be tried
for nine to twelve months. This estimate is reasonable, although probably underestimated,
given the complexities of the criminal charges, the lengthy period of time over which they
stretch, and the number of individuals and entities involved in the subject matter of the
case. The government’s investigation took at least two years to complete and involved the
execution of at least eight search warrants. Coming atop the SEC’s related enforcement
action here and a prior administrative proceeding involving related matters, the volume of
materials to be amassed and reviewed by counsel for McGinn and Smith is massive and
will require extraordinary time to complete. Therefore, if this case proceeds through trial,
the estimates of McGinn and Smith that their legal costs will expend total hours amounting
to at least $300,000 each in fees and costs is entirely reasonable.
There remains uncertainty as to the number of hours that will actually be required,
however. The criminal case could end tomorrow with the dismissal of charges, plea
bargained guilty pleas, or other eventualities short of a trial. If so, a lesser amount of legal
costs will be incurred. So that reasonable but not excessive fees are paid, counsel for
McGinn and Smith will be required to document their time and expenses before funds are
released for payment of legal costs. The procedure and standards for the award of
attorney’s fees and costs to a prevailing party under 42 U.S.C. § 1988 provides useful
guidance for both the parties and the Court in this regard. See also Dkt. No. 201
(application of Receiver for payment of attorney’s fees and costs with supporting
14
documentation). Because, if publicly filed, such applications could reasonably reveal
defense strategies, investigative efforts, and other matters implicating the Fifth and Sixth
Amendment rights of McGinn and Smith, such applications may be made to the chambers
of the undersigned ex parte and in camera and will be filed by the undersigned in the
docket of this case under seal.
Although payment to counsel for McGinn and Smith may not be made until
authorized by the Court upon the application discussed above, Smith and McGinn may
proceed to liquidate the assets released herein and to deposit the proceeds of that
liquidation into the escrow accounts of their counsel. Counsel shall maintain those
liquidated funds in their respective escrow accounts pending approval of payments and
any further order of the Court.
In summary, then, the motions of McGinn and Smith are granted and denied as
follows:
A. McGinn’s motion is granted to the extent that Item Nos. 1-8 and 10 are
released from the preliminary injunction solely for the payment of legal costs according to
the procedure summarized below in subparagraphs C, D, and E and is denied as to Item
No. 9;
B. Smith’s motion is granted as to $181,000 from his 401-k account and
$8,135 from his IRA and is otherwise denied;
C. On or before May 1, 2012, McGinn and Smith shall file an accounting
under oath in the public docket of this case setting forth the total amounts obtained from
the liquidation of each asset released from the preliminary injunction herein, all costs and
deductions from that amount, the net amount delivered to their counsel for deposit in
15
counsels’ respective escrow funds, and a certification that (1) none of the funds from these
liquidated assets have been used for any purpose other than legal costs billed by their
counsel, and (2) all proceeds from the liquidation of these assets, after deducting any
applicable costs, have been paid to their counsel for deposit in counsels’ respective
escrow accounts;
D. Counsel for McGinn and Smith shall deposit funds received from their
clients as the proceeds of the released assets in their respective escrow accounts pending
further order of the Court;
E. After May 1, 2012, counsel for McGinn and Smith may apply to the
undersigned, ex parte and in camera, for the payment of the attorney’s fees and costs
incurred to that date in accordance with the procedures for the award of such fees and
costs under 42 U.S.C. § 1988, such applications will be filed in the docket of this case
under seal although orders ruling on such applications will be filed in the public docket,
and the Court will determine those applications under the standards applicable under §
1988;
F. Further applications may be made thereafter by counsel for McGinn and
Smith as deemed appropriate by them; and
G. If a time is reached where funds obtained from the liquidation of the
assets released herein are depleted for either McGinn or Smith, that defendant is granted
leave to file another motion for the release of other assets for the payment of legal costs.
16
B. The Trust’s Motion
In MDO I, the Court found that the SEC had failed to demonstrate a likelihood that it
would succeed in proving that David Smith was a beneficial owner of the Trust. MDO I at
41. The Trust and the Great Sacandaga Lake camp (“camp”) owned by David Smith’s
wife, Lynn Smith, were released from the asset freeze. Id. at 42. On August 3, 2010, the
SEC obtained an order again freezing the Trust based on new evidence uncovered by the
SEC that at the creation of the Trust in 2004, the Trust had contracted with David Smith
and his wife to pay annual amounts of almost $500,000 to the Smiths from the Trust
beginning in 2015. Dkt. No. 104. After briefing and a limited evidentiary hearing, the
Court found in a decision filed November 22, 2010 that with the newly discovered
evidence, the SEC had demonstrated a likelihood that it would succeed in proving that
David Smith possessed a beneficial interest in the Trust and the Trust was restrained
under the terms of the preliminary injunction. MDO II at 23;5 see also Dkt. No. 96. The
assets of the Trust have remained under the asset freeze of the preliminary injunction to
date. Its assets have a present estimated value of approximately $2.6 million in cash and
investments plus the camp, valued at approximately $600,000. Pl. Mem. of Law (Dkt. No.
447 at 11. The Trustee of the Trust is now Geoffrey Smith, David Smith’s son and one of
the two beneficiaries of the Trust. G. Smith Decl. (Dkt. No. 441-3) at ¶ 1.
The Trust now moves to release sufficient assets of the Trust to pay the following
expenses and for an order authorizing its Trustee to expend the Trust’s assets for certain
5
The Trust’s motion for reconsideration of this decision was denied on January 11,
2011. Dkt, No. 254 (“MDO III”). The Trust appealed, but the Second Circuit affirmed the
decisions freezing the Trust’s assets. See Smith v. S.E.C., 432 Fed.Appx. 10 (2d Cir.
Aug. 8, 2011).
17
purposes in the future:
1. Expenses related to the Trust totaling approximately $18,319.62;
2. Reimbursement to David Smith and his wife for expenses they paid on
behalf of the Trust totaling approximately $16,996.27;
3. Taxes owed for 2011 in an amount yet unknown;
4. Attorney’s fees and costs owed to the Trust’s law firm of
Featherstonhaugh, Wiley & Clyne, LLP (“Law Firm”) totaling $117,462.93;
5. Future expenses as they are incurred; and
6. Authority for the Trustee to manage the Trust’s investments.
Trust Mem. of Law (Dkt. No. 441-1) at 1-2.
1. Expenses and Taxes
Items 1 - 3, 5, and 6 all raise the threshold question of who is responsible for
managing the Trust and paying its ongoing expenses. The Trust contends that Geoffrey
Smith, as Trustee, is responsible for its management. In MDO II, the assets of the Trust
were frozen under the terms of the preliminary injunction, which assigned responsibility for
management of all such frozen assets to the Receiver. MDO II at 23 (“The SEC’s motion
for a preliminary injunction as to the Trust . . . is GRANTED . . . .”); see also Preliminary
Inj. (Dkt. No. 96) at § VIII - XIV (granting the Receiver the powers to take control over,
manage, and pay the expenses of assets subject to the preliminary injunction). Thus,
while Geoffrey Smith remains the Trustee of the Trust as an entity, control and
management over all assets of the Trust have been removed to the Receiver. It is,
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therefore, the Receiver, not the Trustee, who is responsible for, and has sole control over,
the management of the Trust’s assets, including the payment of all expenses, investment
decisions, the preservation or sale of assets, and the like.
The Trust contends that it exists by virtue of state law and that N.Y. Est. Powers &
Trust Law § 1-2.7 and related provisions oblige the Trustee to manage a trust’s assets and
pay its expenses. Trust Mem. of Law at 5-6. However, the Trust has cited no authority for
its proposition that state law supersedes the federal law which authorized the preliminary
injunction. That injunction was upheld on the Trust’s appeal and, therefore, it is now the
law of the case that management of the Trust’s assets for the duration of this action is
committed to the Receiver. See Novella v. Westchester County, 661 F.3d 128, 138 (2d
Cir. 2011) (“[t]he law of the case doctrine requires a court to adhere to its own decision at
an earlier stage of the litigation absent cogent or compelling reasons not to, . . .”) (internal
quotation marks omitted); see also Mem.-Decision & Order filed Feb. 1, 2011 (Dkt. No.
263) (authorizing the sale of the Smiths’ Florida home by the Receiver and denying Lynn
Smith’s motion that she oversee the sale), aff’d, 653 F.3d 121 (2d Cir. 2011). Pending the
outcome of this action, the Trustee has no duty or authority to act in any way with respect
to the Trust’s assets.
This includes the camp. As discussed in MDO I and II, the camp was titled to David
Smith’s wife, Lynn. The camp was frozen by the TRO but then released from the TRO
along with the assets of the Trust in MDO I on July 7, 2010. In the weeks thereafter, the
Trust purchased title to the camp from Lynn Smith for $600,000 and the sale was
completed before the assets of the Trust were re-frozen on August 3, 2010. See Dkt. No.
261-6 at 6; G. Smith Decl. at ¶¶ 6, 7. Thus, as an asset of the Trust at the time the Trust’s
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assets were re-frozen on August 3, 2010, the camp became subject to the management of
the Receiver under the terms of the preliminary injunction.
The SEC thereafter moved for sanctions against, inter alia, Lynn Smith and that
motion was granted as to her in a decision filed July 20, 2011. Dkt. No. 342 (“MDO IV”).6
That decision stated in part as follows:
As to the Great Sacandaga Lake property, it appears that the Trust has
taken title to that property from Lynn Smith in the sale which occurred in July
2010. Therefore, if Lynn Smith fails to return to the Receiver by September
1, 2011 the full amount of the $600,000.00 sale price of the property plus
closing costs, the Receiver may proceed in whatever manner he deems
economically most feasible to maximize the return on this property. This may
include the sale or rental of the property, or portions thereof, depending on
the receiver’s determination of market conditions. Lynn Smith and the Trust
shall cooperate reasonably with the Receiver and any designee to facilitate
the sale or rental of the property.
MDO IV at 41. Lynn Smith did not redeem the camp. Therefore, at least since September
1, 2011, the Receiver has possessed the sole authority to manage the camp under the
terms of the preliminary injunction, including the responsibility to pay necessary expenses
and the authority to rent or sell the camp as the Receiver deems in the best interests of
the investors.
As to reimbursement to David Smith and his wife for expenses previously paid for
the camp on behalf of the Trust, those expenses principally include property taxes,
maintenance charges, utility costs, and insurance. First, it appears that the Smiths and
their family resided at and had use of the camp while it was frozen under the control of the
Receiver and paid no rent for its use. The value of their use of the camp would be offset
6
An appeal of that decision is currently pending in the Second Circuit. Dkt. Nos.
351, 355-57
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against the expenses they paid and would substantially, if not completely, negate those
expenses. Second, their voluntary payment of these expenses without the prior approval
of the Receiver, who was then responsible for the camp’s management, does not oblige
reimbursement after-the-fact. Third, these expenses were paid by the Smiths, not the
Trust. It is the Smiths, therefore, who may seek reimbursement for these expenses from
the Receiver, who may or may not determine to reimburse such expenses, in whole or in
part, if their payment is deemed to have been in the best interests of the investors. Third,
even if reimbursement were ordered, the payment for the reimbursement of those
expenses would be subject to restraint under the terms of the preliminary injunction
freezing the assets of David Smith and his wife and would, therefore, remain within the
control of the Receiver, albeit in a different category. Accordingly, the Trust’s motion to
release funds to reimburse David Smith and his wife for paying these expenses is denied.
For these reasons, then, the Trust’s motion as to the present and future payment of
expenses and taxes as set forth in Items 1-3, 5, and 6 of the Trust’s motion is denied.
2. Attorney’s Fees and Costs
In Item 4 of its motion, the Trust seeks the release of assets to compensate the
Law Firm for $117,462.93 in attorney’s fees and costs. By way of background, the Law
Firm also represents Lynn Smith and the Smiths’ two children, Geoffrey and Lauren, as
well as the Trust. In July 2010 while the assets of the Trust were unfrozen, the Trust paid
approximately $100,000 to its prior counsel. Dkt. No. 261-6 at 6. After the assets of the
Trust were re-frozen on August 3, 2010, another law firm was retained by the Trust
through the filing of MDO II in November 2010 and thereafter moved for release of Trust
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assets to pay its fees and expenses totaling $83,628.05. Dkt. Nos. 229, 255. That motion
was denied on February 11, 2011. Dkt. No. 277. Neither the fees nor the costs for which
compensation is sought here are itemized nor is there any indication whether all or any
portion of those fees and costs have been apportioned among the other parties the Law
Firm represents in this action.7
As a general rule, the standard governing the determination of this motion is
whether the Trust has demonstrated that release of the assets to pay attorney’s fees and
costs would be “in the best interests of the defrauded investors.” S.E.C. v. Grossman, 887
F. Supp. 649, 661 (S.D.N.Y. 1995), aff’d, 101 F.3d 109 (2d Cir. 1996). There is no doubt
that the Trust is authorized by its originating document to pay attorneys’ fees and related
costs incurred on behalf of the Trust. Dkt. No. 277 at 5. The holding in MDO II, however,
subjected the Trust’s assets to the asset freeze in the preliminary injunction. Thus, the
Trust’s motion invokes not the authority of the Trust to pay legal fees and costs but the
discretion of the Court to permit such payments from frozen assets. The asset freeze
serves to protect the interests of investors in obtaining the return of funds if the SEC
proves in this action that defendants obtained the investments by fraud. MDO I at 14;
7
The Law Firm indicates only that it will submit its itemized records to the Court for
ex parte, in camera review at the request of the court. See Featherstonhaugh Decl. (Dkt.
No. 441-2) at ¶ 8. Any such submission would necessarily include the billing records for
the Law Firm’s other clients in this case to determine which fees are attributable to the
Trust and which to the other clients. Moreover, the submissions are protected from
disclosure only to the extent that they reveal communications between the Law Firm and
its clients. See DiBella v. Hopkins, 403 F.3d 102, 120 (2d Cir. 2005) (“In New York,
attorney time records and billing statements are not privileged when they do not contain
detailed accounts of the legal services rendered.”); Gary-Friedrich Enterprises, LLC v.
Marvel Enterprises, Inc., No. 08 Civ. 1533(BSJ)(JCF), 2011 WL 2623458, at *3 (N.D.N.Y.
June 21, 2011). Thus, any such records would be filed in the docket of this case after the
redaction of privileged communications.
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S.E.C. v. Infinity Group Co., 212 F.3d 180, 197 (3d Cir. 2000) (“A freeze of assets is
designed to preserve the status quo by preventing the dissipation and diversion of
assets.”) (citations omitted). On this motion, therefore, the issue presented is not simply
whether the Trust may incur and pay such legal fees and costs – it may – but whether a
balancing of the interests of investors in preserving assets for possible later restitution is
outweighed by the interests of the Trust in paying the Law Firm’s fees and costs. See
S.E.C. v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1106 (2d Cir. 1972).
The balance of interests required here differs in an important respect from that
required above on the similar motions of McGinn and Smith. The standard for unfreezing
assets to pay legal fees incurred while defending a civil action is different than that utilized
for a criminal action. S.E.C. v. FTC Capital Markets, Inc., No. 09-CV-4755 (PGG), 2010
WL 2652405, at *3 n.1 (S.D.N.Y. June 30, 2010) (citing S.E.C. v. Stein, No. 07-CV-3125
(GEL), 2009 WL 1181061 (S.D.N.Y. Apr. 30, 2009) (holding that the “touchstone of the
inquiry [whether or not to unfreeze assets to subsidize attorneys fees in a civil case] is
equity.”); S.E.C. v. Coates, No. 94-CV-5361 (KMW), 1994 WL 455558, at *3 (S.D.N.Y.
Aug. 23, 1994) (“Although a court may impose an asset freeze in a civil case,
notwithstanding a companion criminal case, these circumstances dictate that the court pay
particular attention to the defendant’s Fifth and Sixth Amendment rights.”); see also
Commodity Futures Trading Comm’n v. Walsh, Nos. 09-CV-1749 (GBD), 09-CV-1750
(GBD), 09-CR-722 (MGC), 2010 WL 882875, at *2 (S.D.N.Y. Mar. 9, 2010) (explaining
that special consideration arises in actions identical to the present which involve “asset
freeze orders in civil actions, with Defendants also being tried in a parallel criminal
proceeding,” due to the “unique circumstances requir[ing] the court to pay particular
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attention to the Defendants’ Fifth and Sixth Amendment rights.”).
Thus, in the cases of McGinn and Smith, their interests carry greater weight in the
balance of interests than do those of the Trust here. McGinn and Smith seek the release
of assets to pay attorney’s fees and costs in connection with their criminal case, not this
civil action. Unlike this action, the criminal action implicates the Fifth and Sixth
Amendment rights of McGinn and Smith to a fair trial and the effective assistance of
counsel. The Trust in this civil action does not enjoy the protections afforded criminal
defendants and, therefore, the weight accorded its interest in the balancing of interests is
correspondingly less.
For at least four reasons, the balance of interests here weighs decidedly in favor of
denying the Trust’s motion for payment of its attorney’s fees and costs. First, the total
amount of investor funds obtained through defendants’ alleged fraud far exceeds the value
of assets frozen by the SEC for the benefit of those investors in the event the SEC prevails
in this action. Compare Am. Compl. at ¶¶ 1, 6 (alleging losses to over 900 investors of
approximately $84 million) with, e.g., MDO I at 6-12 (less than $10 million likely will be
available to repay defrauded investors). There is no likelihood, then, that a surplus will
exist from the frozen assets in the event the SEC prevails in this action. The investors, on
whose behalf the assets were frozen, thus possess a heightened interest in having those
assets maintained without further diminution pending the outcome of this action. This
interest far outweighs that of the Trust in paying the charged fees and costs before this
action is fully resolved.
Second, the Trust was subjected to the asset freeze after a determination that
David Smith possessed a beneficial interest in the Trust. MDO II at 20-23. In these
24
circumstances, the Trust must be viewed as an asset of David Smith. So viewed, the asset
freeze over the Trust should not be lifted absent a showing that David Smith is unable to
satisfy obligations related to those assets from other, unfrozen sources. Smith has
submitted a sworn statement of his assets in connection with his own motion here. Dkt.
No. 440-2. That submission lists assets of significant value, but (1) virtually all are now
frozen under the preliminary injunction, and (2) those portions which are available are
ordered herein released to pay his criminal defense attorney. Ordinarily, these facts might
weigh in favor of the Trust. However, the SEC has proffered evidence, unrefuted by the
Trust or Smith, that in 2011, the Smiths received $14,000 for the rental of their Saratoga
Springs residence for the racing season and that in the summer of 2011, the Smiths paid
$3,338.40 for an engagement party. Stoelting Decl. at ¶¶ 2, 3. This evidence indicates
both that David Smith has other income and assets not presently subject to the asset
freeze from which attorneys’ fees and costs can be paid and that he continues to incur
non-essential expenses the payment of which could have been made for attorney’s fees
and costs. Therefore, the declared need for release of the funds is diminished by the
access to other funds and the expenditure of available funds on non-essential costs rather
than legal costs.
Third, for a variety of reasons, the amount of attorney’s fees and costs incurred by
the Trust would be substantially reduced before any assets are released to the point
where they could likely be paid from Smith’s available remaining assets. For example, a
substantial portion of the fees and costs are directly related to the Trust’s own misconduct,
and that of those acting on behalf of the “Trust, in concealing the existence of the Annuity
Agreement. See MDO I-IV. Moreover, assets would be released only to compensate for
25
those fees and expenses incurred on behalf of the Trust, not those incurred on behalf of
the Law Firm’s other clients in this action. If fees and costs were incurred jointly on behalf
of one or more other of those clients, the amount of assets released would be reduced by
those costs incurred on behalf of clients other than the Trust. See, e.g., Dkt. Nos. 247-1 at
¶ 4, 146-2 at ¶ 5 (showing that the Law Firm has already received approximately $115,000
for its representation of Lynn Smith).
Furthermore, assets would be released from the freeze only to pay reasonable fees
and costs, not simply all fees and costs incurred. See Bliven v. Hunt, 579 F.3d 204, 21213 (2d Cir. 2009); Tsombanidis v. West Haven Fire Dep’t, 352 F.3d 565, 580-81 (2d Cir.
2003). Generally, such fees and costs incurred are reduced by amounts charged for
litigation efforts which were unsuccessful. See Barfield v. New York City Health & Hosps.
Corp., 537 F.3d 132, 151-52 (2d Cir. 2008). Here, the Trust was unsuccessful on the
SEC’s motion for reconsideration, its own motion for reconsideration of MDO II, and its
appeal of those decisions. See MDO II; MDO III; Smith v. S.E.C., 432 Fed.Appx. 10.
Finally, as discussed above, the hourly rates charged by counsel are subject to the
determination by the standard in this circuit and not simply the amount an attorney
charges. All of these factors combine to demonstrate that the actual amount of attorney’s
fees and expenses which could be allowed for the release of assets is substantially less
than that claimed here by the Trust’s counsel and would appear to be within the ability of
Smith to pay without the release of any assets. Thus, the Trust has failed to demonstrate
that the reasonable amount of its fees and costs cannot be paid from presently available
funds. See S.E.C. v. Sekhri, No. 98 Civ. 2320(RPP), 2000 WL 1036295, at *2 (S.D.N.Y.
July 26, 2000),
26
Fourth, payment of the Trust’s legal fees and expenses at the conclusion of this
action remains possible if the Trust prevails.8 If the Trust prevails, its assets will be
released from restraint and the value of those assets clearly suffices to pay the accrued
attorney’s fees and costs.
Balancing these factors, the SEC, on behalf of investors, possesses a strong
interest in maintaining the assets of the Trust currently under the preliminary injunction
without diminution given the large amount which may potentially be owed by Smith. On
the other hand, Smith has assets outside those frozen by the preliminary injunction which
could be used to pay fees, he has paid non-essential expenses which could have been
used to defray the accrued attorney’s fees and costs, the total amount charged by the Law
Firm is well beyond what would be allowed, and it therefore appears that the reasonable
fees and costs of the Law Firm can be paid from available funds. Thus, the interests of
defrauded investors in preserving the frozen assets substantially outweighs the interests of
the Trust in releasing assets to pay attorney’s fees and costs. For these reasons, the
Trust’s motion as to such fees and costs is denied.
III. Conclusion
For the reasons stated above, it is hereby
ORDERED that:
1. McGinn’s motion for the release of assets from the preliminary injunction
8
The Trust joined in the motion of the United States to stay this action pending
completion of the criminal action against McGinn and Smith (Dkt. No. 474). See Record of
Proceedings on Mar. 15, 2012.
27
to pay attorney’s fees and costs in the parallel criminal action (Dkt. No. 439) is GRANTED
in part and DENIED in part as indicated above;
2. Smith’s motion for the release of assets from the preliminary injunction to
pay attorney’s fees and costs in the parallel criminal action (Dkt. No. 440) is GRANTED in
part and DENIED in part as indicated above; and
3. The Trust’s motion for the release of assets from the preliminary injunction
to pay past and future expenses, to reimburse David Smith and his wife for Trust
expenses they paid, and for the payment of attorney’s fees and costs in this action (Dkt.
No. 441) is DENIED in all respects.
IT IS SO ORDERED.
DATED: April 4, 2012
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