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

Filing 684

MEMORANDUM-DECISION AND ORDER denying 660 Motion to Amend Documentation. It is hereby ORDERED that the Trust's motion to amend its documentation to delete the provisions authorizing the Trust to enter into the private annuity agreement with David and Lynn Smith is DENIED. Signed by Magistrate Judge Christian F. Hummel on 2/21/2014. (dpk)

UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF NEW YORK

SECURITIES AND EXCHANGE COMMISSION,
Plaintiff,
v.

No. 10-CV-457
(GLS/CFH)

McGINN, SMITH & CO., INC., et al.,
Defendants.

APPEARANCES:

OF COUNSEL:

UNITED STATES SECURITIES &
EXCHANGE COMMISSION
Attorney for Plaintiff
Room 400
3 World Financial Center
New York, New York 10281

KEVIN McGRATH, ESQ.
DAVID STOELTING, ESQ.

LINNAN & FALLON, LLP
Attorney for Defendant Trust, Geoffrey
Smith & Lauren T. Smith
61 Columbia Street
Suite 300
Albany, New York 12210

JAMES D. LINNAN, ESQ.

CHRISTIAN F. HUMMEL
U.S. MAGISTRATE JUDGE
MEMORANDUM-DECISION AND ORDER
Presently pending before the Court is a motion from counsel for the David L. and Lynn
A. Smith Irrevocable Trust U/A 8/04/04 (“the Trust”) and the Trust beneficiaries, Geoffrey
and Lauren Smith, to amend the Trust to delete the provisions authorizing the Trust to enter
into the private annuity agreement with David and Lynn Smith. Dkt. No. 660. Plaintiff
Securities and Exchange Commission (“SEC”) opposes the motion. Dkt. No. 673. For the
reasons which follow, the motion is denied.

I. Background
A. Prior Court Orders
For a more complete description of the background of this action, specifically the
creation of the Trust, discovery and impact of the annuity agreement, and dispute over who
has a beneficial interest in the Trust, see S.E.C. v. McGinn, Smith & Co., 752 F. Supp. 2d
194 (N.D.N.Y. 2010) (finding that the Trust was not jointly owned or otherwise an asset of
David Smith and denying to include the Trust in the asset freeze); S.E.C. v. Wojeski, 752 F.
Supp. 2d 220 (N.D.N.Y. 2010) (reconsidering prior asset freeze order and subsequently
modifying said order to include the Trust) aff’d 432 Fed. App’x 10 (2d Cir. 2011); S.E.C. v
Smith, 798 F. Supp. 2d. 412 (N.D.N.Y. 2011) (issuing sanctions against Lynn Smith, the
Trust’s attorney and trustee and disgorging funds from Lynn Smith for their conduct in
connection with concealing the existence of the annuity agreement) aff’d in part 710 F.3d 87
(2d Cir. 2013) (upholding sanctions and disgorgement order against Lynn Smith for her bad
faith in not revealing her interest in the Trust).

B. Amendment of the Trust Documents
As is relevant to the current motion, with the shift in current tax laws, gift taxes will no
longer be imposed upon the corpus of the Trust; therefore, the Trust wishes to amend its
creation documents to terminate the annuity agreement as its stated purpose by its counsel,
creators, and beneficiaries, to shield the Trust from gift taxes, is no longer present. Linnan
Decl. (Dkt. No. 660-1) ¶¶ 9-11. Accordingly, pursuant to New York State Estates, Powers
and Trusts Laws (“N.Y.E.P.T.L.”) § 7-1.9, the Trust asserts its “absolute right to amend the
provisions of the Trust . . . regardless of the purpose or motive for the amendment.” Id. ¶¶

-2-

12-13. The creators of the Trust, David and Lynn Smith, have submitted affidavits
“agree[ing] to amend the original Trust and . . . renounc[ing] any and all rights [they] may
have now or in the future to any benefits from the Trust by way of the Declaration of Trust
and the Private Annuity Contract executed pursuant to the terms of the Declaration of
Trust.” Lynn Smith Aff. (Dkt. No. 660-3) ¶ 1; David Smith Aff. (Dkt. No. 660-4) ¶ 1;
see also Second Lynn Smith Aff. (Dkt. No. 662) ¶¶ 2-3, 10-12 (restating the purpose of the
requested amendment given the change in the tax laws, as well as the desire of both Lynn
and David Smith to amend Trust documents to void the annuity contract and any future
interest to which it entitled them); Dkt. No. 662-4 (explaining changes to estate and gift tax
laws). The beneficiaries of the Trust and current trustee, Geoffrey and Lauren Smith, also
submitted affidavits echoing their parents’ sentiments that, given the change in the IRS
laws, the amendment of the Trust would be in the best interest for all involved and
consenting to its modification, specifically the termination of the annuity contract.
See Geoffrey Smith Aff. (Dkt. No. 660-5), Lauren Smith Aff. (Dkt .No. 660-6).
The SEC opposes the current motion arguing that the (1) trustee lacks the authority to
modify the Trust under the asset freeze order; (2) motion to modify the asset freeze is not in
the best interests of the investors; and (3) N.Y.E.P.T.L. does not supercede the present
injunction and is irrelevant to the present motion. Pl. Memorandum of Law (Dkt. No. 673).
The Trust contends that (1) it is the creators and beneficiaries of the Trust who must reach
an agreement to the modification, not the trustee; (2) public policy behind the N.Y.E.P.T.L.
was “to enhance, not restrict the modifiability of trusts . . . supplementing the courts’ broadbased equitable authority to permit deviation to effectuate a trust’s purpose;” and (3) the
best interests of the investors is irrelevant as the operable question deals “with a very
narrow and unique issue of the Creator’s rights under New York State [law] . . . to amend a
-3-

‘Trust Document’ and whether or not that right can be abridged by the mere pendency of a
potential claim.” Trust Reply (Dkt. No. 678).

II. Discussion
New York State law provides, in pertinent part, that “[u]pon the written consent . . . of all
the persons beneficially interested in a trust . . . the creater of such trust may revoke or
amend the whole or any part thereof by a[ written] instrument . . . .” N.Y.E.P.T.L. § 7-1.9(a).
Accordingly, pursuant to state law, all that is needed is the consent of all beneficiaries and
the grantor of the trust may amend or revoke it. Further, counsel for the Trust advocates
that David and Lynn Smith can renounce their interests in the Trust, namely the money
which they would have received pursuant to the annuity agreement, according to
N.Y.E.P.T.L. § 2-1.11(c) as the “statute creates a legal fiction that allows distributees to
avoid attachment by creditors or the payment of taxes.” Trust Memorandum of Law (Dkt.
No. 668-1 at 8-9) (quoting United States v. Comparato, 22 F.3d 455, 457 (2d Cir. 1994)
(citations omitted)).
However, the Trust is presently part of a preliminary injunction which froze certain
assets, including the corpus of the Trust, and appointed a Receiver to oversee such frozen
assets. The terms of that injunction prohibit, inter alia the Trust or Smiths making “any
withdrawal, transfer, pledge, encumbrance, assignment, dissipation, concealment or other
disposal of any assets, funds, or other property . . . .” Dkt. No. 4 at p. 7 § II. While the Trust
contends that the injunction and asset freeze are “merely . . . provisional remed[ies],” (Trust
Reply at 5), the importance of these remedies have already been determined by the Court.
Further, the Trust has again failed to cite any authority for the proposition that state law
supercedes the federal law which authorized the pending injunction.
-4-

The Trust’s arguments seem to over simplify the applicability of § 7-1.9, or at least fail
to recognize the equitable powers and duties of the court. As noted by a bankruptcy case
from this district:
Even assuming the trusts are valid and irrevokable and have been
properly amended under NYEPTL § 7-1.9 . . . the Court is troubled
by the situation presented herein, where an individual is able to
shield $700,000.00 in trust originally for the benefit of his wife and
children and then file for bankruptcy and obtain discharge of all his
debts without apparently generating any creditor dividends . . . [A]n
injunction . . . is essential in order for the Court to preserve its
ability to make the necessary inquiry with regard to property of the
estate so that it can administer the liquidation of the bankruptcy
estate and safeguard the equality of any possible distribution to
creditors . . . Any other result would impair and perhaps defeat the
Court’s jurisdiction . . . , notwithstanding threatening the integrity of
the Code.
In re Steffan, 97 B.R. 741, 748 (Bankr. N.D.N.Y. 1989). While the Court recognizes that
this is not a bankruptcy matter and that the questions of law and jurisdiction are completely
different, the underlying sentiment that the bankruptcy court expresses, namely that §7-1.9
should not be used as a vehicle to circumvent bankruptcy and debt reasonably owed to
bonafide creditors, resonates with the logic behind the present order. This provision of state
law, which as noted before has not been demonstrated to trump the federally instituted
injunction order, should not be able to shield David or Lynn Smith from any potential
liabilities owed to the alleged victims arising from claims in the present case. To do so
would threaten the integrity of this Court, as well as the purpose and power of the injunction
order and asset freeze entered almost four years ago.
Further, while the Trust relies on the commentary behind N.Y.E.P.T.L. § 7-1.9 to argue
that public policy strongly favors the Trust creators’ right to amend the Trust, it is interesting
to note that the quoted commentary language directs the court to use its equitable powers
“to effectuate a trust’s purpose.” Trust Reply at 6. However, the purpose of the Trust in the
-5-

present action, and whether or not it provided David Smith with an ownership interest, has
been one of the most contested issues in the litigation thus far. Accordingly, prior to any
modifications being made, it seems imperative for the Court, in fairness to the parties and
investors, to discern what the Trust’s purpose was, as that will inform whether the corpus of
the Trust should remain with the Smith children or be available for the judgments which
David Smith has or may have imposed upon him.
As previously discussed by this Court, “[t]he 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.” S.E.C.
v. McGinn, No. 10-CV-457 (GLS/DRH), 2012 WL 1142516, at *2 (N.D.N.Y. Apr. 4, 2012);
see also S.E.C. v. Unifund SAL, 910 F.2d 1028, 1041 (2d Cir. 1990) (explaining that an
asset freeze is “ancillary relief to facilitate enforcement of any disgorgement remedy that
might be ordered in the event a violation is established at trial.”); 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.”). The freeze order is
intended to preserve the status quo of all assets unless and until litigation directs otherwise.
The defendants are asking the Court to upset the status quo by changing the underlying
Trust documents. While this is a different consideration than the prior requests for carveouts for various living expenses and fees, the undersigned is hard pressed not to apply the
same standard for modifying the asset freeze to upset the status quo. Thus the question is
again presented to the Court, despite the stated purpose of the asset freeze and language
of the injunction order, whether defendants have demonstrated that modification of the
Trust agreement to allow David and Lynn Smith to rescind any future interest in the Trust
would be “in the best interests of the defrauded investors.” S.E.C. v. Grossman, 887 F.
-6-

Supp. 469, 661 (S.D.N.Y. 1995) aff’d 101 F.3d 109 (2d Cir. 1996).
District courts have a well established “authority to freeze personal assets temporarily
and the corollary authority to release frozen personal assets, or lower the amount frozen.”
S.E.C. v. Duclaud Gonzalez de Castilla, 170 F. Supp. 2d 427, 429 (S.D.N.Y. 2001)
(citations omitted). In considering whether to modify an asset freeze, “the disadvantages
and possible deleterious effect of a freeze must be weighed against the considerations
indicating the need for such relief.” S.E.C. v. Manor Nursing Centers, Inc., 458 F.2d 1082,
1106 (2d Cir. 1972).
Preservation of the status quo is imperative for many of the same reasons as have
already been discussed in previous Court orders. 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. ¶¶ 1, 6 (alleging losses to over 900 investors of approximately $84 million)
with e.g., Dkt. No. 580 ¶¶ 8-9 (explaining total claims asserted against the McGinn Smith
Estate of approximately $125 million with objections of approximately $24 million leaving an
excess of $100 million in investor claims with a cash on hand value of $14 million, with just
under $3.4 million coming from frozen assets of the relief defendants). There still remains
no likelihood 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 the action.
Balancing against that, is the stated purpose for the modification of the Trust, namely
allowing the Smiths to carry out their intended purpose of leaving their children a gift taxfree legacy. The timing and content of this motion is curious given the fact that an identical
-7-

action could be completed, without the requirement of Court intervention, after the questions
regarding the ownership interests surrounding the Trust are determined assuming the Trust
and Lynn Smith are successful.1 There is still a year and a half before the annuity
agreement begins, plenty of time for this case to progress and allow for the resolution of
these important issues which remain at the heart of this contentious litigation. Waiting to
modify the Trust documents until that time seems to make the most sense, as there is no
prejudice to any of the Smiths to wait.
However, if the Trust assets are determined to be an asset of David Smith, thus subject
to the criminal judgment presently levied, See United States v. McGinn & Smith, No. 12-CR28 (DNH), Dkt. Nos. 104, 232 (judgement from the criminal case sentencing David Smith to
120 months imprisonment and issuing a restitution order of $5,989,736 of which
$5,748,722.00 is to be paid to the 841 victims and $241,014 is to be paid to the IRS), and
potentially any future civil judgments, any renunciation of interests at this point would be
rendered moot. While not directly on point, it appears that United States v. Comparato , 22
F.3d 455 (2d Cir. 1994) is somewhat instructive when discussing policy implications
regarding renunciation, ownership, and liens. Pursuant to the Second Circuit’s holding
rejecting the “contention that the . . . provision[s] of §2-1.11 [of the N.Y.E.P.T.L.] may defeat

1

The Court is also perplexed by the timing of this request given Lynn Smith’s most
recent motion seeking another modification to the asset freeze to carve-out money for her
living expenses which, she contends, far exceed her modest means. See, Dkt. No. 610.
One would think that the money promised by the annuity agreement, especially in the face
of her husband’s criminal conviction and sentence which have left her without a large
portion of her monthly income, as well as her own stated inability to earn more than what
she is presently receiving, is of utmost importance for her continued financial solvency
given the dire situation she recently proffered in her last motion to the Court. Id. The
undersigned will not comment on the veracity of David and Lynn Smiths’ stated intentions
in the present motion, but would be remiss in failing to acknowledge the apparent
inconsistency created by the proffers in the present motion as compared to that which was
last filed.
-8-

federal tax liens that attached prior to the attempted renunciations,” it stands to reason that
any renunciations in the face of an injunction order charging parties to maintain the status
quo or a criminal judgment would also be rejected. Id at 458. Accordingly, modification of
the Trust documents seems most appropriate at a later date if, as discussed supra, the
Trust is deemed not to have been an asset of David Smith.
Balancing these factors, the SEC, on behalf of investors, possesses a strong interest in
maintaining the assets and status quo of the Trust, presently frozen, without diminution
given the large sum of money which may potentially be owed by Smith. On the other hand,
in the event David Smith is not deemed to have a propriety interest in the Trust, modification
can then occur to terminate the annuity agreement and effectuate the presently stated
purpose of the Trust, a legacy from David and Lynn Smith to their children. Therefore, the
interests of the defrauded investors in preserving the frozen assets substantially outweighs
the interests of David and Lynn Smith to modify the Trust documents.

III. Conclusion
For the reasons stated above, it is hereby ORDERED that the Trust’s motion to amend
its documentation to delete the provisions authorizing the Trust to enter into the private
annuity agreement with David and Lynn Smith (Dkt. No. 660) is DENIED.

SO ORDERED.
Dated: February 21, 2014
Albany, NY

-9-