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

Filing 904

MEMORANDUM-DECISION and ORDER - That the Rabinovich's letter motion to file a sur-reply (Dkt. No. 892) is DENIED. That the Receiver's motion for an order approving of his distribution plan and authorizing interim distributions (Dkt. No. 847) is GRANTED. Signed by Senior Judge Gary L. Sharpe on 10/31/2016. (jel, )

UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF NEW YORK
________________________________
SECURITIES AND EXCHANGE
COMMISSION,
1:10-cv-457
(GLS/CFH)

Plaintiff,
v.
MCGINN, SMITH & CO., INC.
et al.,
Defendants
JAT CONSTRUCTION CO., INC.
DEFINED BENEFIT PENSION
PLAN et al.,
Investors,
and
U.S. ATTORNEY’S OFFICE FOR
ND/NY,

Intervenor.
________________________________
APPEARANCES:
OF COUNSEL:
FOR THE PLAINTIFF:
U.S Securities and Exchange
Commission
3 World Financial Center
New York, NY 10281

DAVID P. STOELTING, ESQ.
HAIMAVATHI V. MARLIER, ESQ.
JACK KAUFMAN, ESQ.
JOSHUA M. NEWVILLE, ESQ.
KEVIN P. MCGRATH, ESQ.
LARA S. MEHRABAN, ESQ.

FOR THE DEFENDANTS, INVESTORS,

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

WILLIAM J. BROWN, ESQ.

JAT Construction Co., Inc. Defined
Benefit Pension Plan, Joseph Allegretta,
and Suzanne Allegretta
McNamee, Lochner Law Firm
KEVIN LAURILLIARD, ESQ.
677 Broadway
Albany, NY 12207-2503
Stan Rabinovich and Eva Rabinovich
Glavin, Glavin Law Firm
69 Second Street
P.O. Box 40
Waterford, NY 12188
Certain Investors1
Weir & Partners LLP
767 Third Avenue, 30th Floor
New York, NY 10017

JAMES H. GLAVIN, IV, ESQ.

BONNIE R. GOLUB, ESQ.
WALTER WEIR, JR., ESQ.

RBS Citizen, N.A.

1

Attorneys Golub and Weir represent numerous investors all of whom are identified in
the notice of appearance. (Dkt. No. 860.) The court subsequently ordered that the objection
filed on behalf of these investors be withdrawn as to investors Ronald and Linda Broast. (Dkt.
No. 893.)

2

Cooper, Erving Law Firm
39 North Pearl Street, 4th Floor
Albany, NY 12207

MICHAEL A. KORNSTEIN, ESQ.

David G. Newcomb
Pro Se
224 Independence Way
Mount Bethel, PA 18343
Judith A. Newcomb
Pro Se
224 Independence Way
Mount Bethel, PA 18343
FINRA & the FINRA Employees
National Association of Securities
Dealers, Inc.
1735 K Street N.W.
Washington, D.C. 20006

TERRI L. REICHER, ESQ.

HON. RICHARD S. HARTUNIAN
United States Attorney
445 Broadway
Albany, NY 12207-2924

ELIZABETH C. COOMBE
Assistant U.S. Attorney

Gary L. Sharpe
Senior District Judge
MEMORANDUM-DECISION AND ORDER
I. Introduction
The court-appointed receiver, William Brown, moves for an order to
approve a plan of distribution of estate assets and to authorize interim
distributions. (Dkt. No. 847.) The four sets of investors who object to the
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plan are JAT Construction Co., Inc. Defined Benefit Pension Plan, Joseph
Allegretta, and Suzanne Allegretta (collectively, “JAT investors”), (Dkt. No.
856), Certain Investors2, (Dkt. No. 862), Stephen Fowler, (Dkt. No. 865),
and Eva Rabinovich and Stan Rabinovich, (Dkt. No. 868), (collectively,
“Rabinovich investors”). For the reasons the follow, the Receiver’s motion
is granted.3
II. Background
A.

Summary of the Plan
The facts giving rise to the Receiver’s motion are well known to the

parties, detailed in the court’s previous decisions, (Dkt. Nos. 807, 816), and
will not be repeated here. The Receiver proposes to distribute
approximately $22 million in receivership funds4 from entities controlled or
owned by defendants Timothy M. McGinn and David L. Smith (“MS

2

The Certain Investors are named in their attorney’s notice of appearance. (Dkt.

No. 860.)
3

The Rabinovich investors apparently move for leave to file a sur-reply in opposition to
the Receiver’s motion. (Dkt. No. 892.) Consistent with the court’s previous order, (Dkt.
No. 891), the motion is denied.
4

The Receiver notes that approximately $5 million of this total was the subject of an
appeal to the Second Circuit and would, therefore, be held back pending the outcome of the
appeal. (Dkt. No. 847, Attach. 2 ¶ 16.) Since the filing of the Receiver’s motion, the Second
Circuit has affirmed this court’s decision. (Dkt. No. 894.) Accordingly, that amount is included
in the Receiver’s proposed interim distribution.

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Entities”). (Dkt. No. 847, Attach. 2 ¶¶ 3, 16; Dkt. No. 847, Attach. 3 at 28.)
He has recommended that an interim distribution at this time is in the best
interest of the MS Entities and the investors of the MS Entities. (Dkt.
No. 847, Attach. 3 at 2.) The Receiver will continue to recover assets from
the MS Entities and intends to make further distributions once those assets
are obtained. (Id. at 10.)
The Receiver’s proposed distribution plan pools the assets of the MS
Entities and distributes the pooled assets to investors on a pro rata basis.
(Id. at 11.) Accordingly, an investor’s pro rata share is the ratio of the
allowed amount of the investor’s claim to the aggregate of all allowed
claims. (Id. at 12.) The Receiver does not give effect to any prereceivership subordination arrangements governing the investors’
investments with the MS Entities, which the Receiver maintains will ensure
an equitable distribution among the investors. (Id.) Additionally, to avoid
“a disproportionate or double recovery,” the Receiver requires investors to
certify whether they have applied for or received collateral recovery for
their claimed losses. (Id. at 11.) If an investor has received a collateral
recovery, that amount will be offset from their recovery under the
receivership estate. (Id.) The Receiver advocates that this offset will treat
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investors’ claims equally “with respect to the percentage of their allowed
claim amounts they recover from all sources as of the date of the
payments.” (Id.)
The Receiver calculated the amount of each investor’s claim
according to the net investment method. (Id. at 12.) As such, the claims
are equal to the amount of the investor’s initial investment less any
distribution before the Receiver’s appointment. (Id.) The Receiver
characterizes all payments to investors as a return of principal unless the
investor was provided with tax forms indicating that the payment was a
payment of interest. (Id.)
The Receiver also proposes to establish a reserve fund for claims
initially deemed by him as disputed, contingent, or unliquidated. (Id. at 13.)
These claims are excluded from this interim distribution. (Id.) However,
the Receiver will file a subsequent motion notifying the court of the
disputed claims and allow those investors to file objections, which the court
will ultimately rule on. (Id.) Funds will be reserved for these claims
throughout the procedure for disputed claims. (Id.)
B.

Objections
1.

Fowler and Certain Investors
6

The objections of Fowler and Certain Investors largely overlap. They
both principally object to the collateral offset provision, arguing that it is
vague, ambiguous, improper, and inequitable. (Dkt. No. 862, Attach. 2 at
3-7; Dkt. No. 865, Attach.1 at 6-12.) Specifically, Certain Investors
contend that the provision is vague and ambiguous because the Receiver
does not explain by what amount their recovery from third parties will
reduce their recovery from the receivership estate. (Dkt. No. 862, Attach. 2
at 3.) Additionally, both argue that the offset is improper because the
Receiver steps in the shoes of the MS Entities and could not have pursued
their same claims against third parties. (Id. at 5; Dkt. No. 865, Attach. 1 at
6-8.) To that end, both contend that the Receiver effectively and
improperly assigned their third party recoveries to the receivership estate.
(Dkt. No. 862, Attach. 2 at 5; Dkt. No. 865, Attach. 1 at 6-8.) Finally, both
assert that the provision is inequitable because it penalizes and
disincentivizes investors from pursuing claims against third parties. (Dkt.
No. 862, Attach. 2 at 5; Dkt. No. 865, Attach. 1 at 6-8.)
2.

Rabinovich Investors

In his initial review, the Receiver disputed the Rabinovich investors’
claim. (Dkt. No. 868, Attach. 1 ¶ 3.) First, the Rabinovich investors object
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that they are denied due process because their claim is excluded from this
interim distribution. (Dkt. No. 868 at 3-4.) Second, they contend that all
claimants must be treated equally and receive a distribution at the same
time. (Id. at 4-5.)
3.

JAT Investors

The JAT investors object, arguing that the Plan fails to specifically
state whether they will receive a distribution for their claims and by what
percentage. (Dkt. No. 856 ¶ 3.)
C.

SEC Approval of the Plan
The SEC supports the Receiver’s Plan as the most equitable

approach to distribute recoveries to the investor victims. (Dkt. No. 884.)
The SEC also responds to the objections as discussed below. (Id. at 2-4.)
IV. Discussion
Courts have “broad authority to craft remedies for violations of the
federal securities laws,” including “the power to approve a plan of
distribution proposed by a federal receiver.” SEC v. Byers, 637 F. Supp.
2d 166, 174 (S.D.N.Y. 2009), aff’d sub. nom. SEC v. Orgel, 407 F. App’x
504 (2d Cir. 2010), aff’d sub. nom. SEC v. Malek, 397 F. App’x 711 (2d Cir.
2010); see SEC v. Credit Bancorp, Ltd., 290 F.3d 80, 82-83 (2d Cir. 2002).
8

As such, courts have the discretion to approve any receiver’s plan that is
“fair and reasonable.” SEC v. Wang, 944 F.2d 80, 81, 85 (2d Cir. 1991)
(holding that a distribution plan should be “reviewed under [the district]
court’s general equitable powers to ensure it is fair and reasonable”). In
exercising their discretion, courts “may defer to the receiver’s choices for
the plan’s details and should give substantial weight to the SEC’s views
regarding a plan’s merits.” SEC v. Amerindo Inv. Advisors Inc., No. 05 Civ.
5231, 2014 WL 2112032, at *14 (S.D.N.Y. May 6, 2014) (citing Byers, 637
F. Supp. 2d at 175).
Courts have routinely approved receivership plans recommending
pro rata distributions as fair and reasonable to compensate victims of
fraud. See, e.g., SEC v. Wealth Mgmt. LLC, 628 F.3d 323, 327, 334 (7th
Cir. 2010); Credit Bancorp, Ltd, 290 F.3d at 88-89. When “investors’
assets are commingled and the recoverable assets in a receivership are
insufficient to fully repay the investors, ‘equality is equity.’” Wealth Mgmt.
LLC, 628 F.3d at 333 (quoting Cunningham v. Brown, 265 U.S. 1, 13
(1924)). In particular, pro rata distributions are proper “where the funds of
the defrauded victims [ar]e commingled and where victims [ar]e similarly
situated with respect to their relationship to the defrauders.” Credit
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Bancorp, Ltd, 290 F.3d at 88-89. Notably, pro rata distributions are
“especially appropriate for fraud victims of a Ponzi scheme” because
whether “a particular customer’s assets are traceable is a result of merely
fortuitous fact that the defrauders spent the money of the other victims
first.” Id. at 89 (internal quotation marks and citations omitted).
Here, a pro rata distribution is fair and reasonable because the funds
were commingled and the victims are similarly situated. As detailed in the
court’s February 17, 2015 Memorandum-Decision and Order, investor
funds from one offering were regularly used to cover interest and principal
payments in other, separate offerings. (Dkt. No. 807 at 10-16.)
Additionally, rather than being invested, the funds were often funneled
through a separate entity to finance that entity’s payroll. (Id. at 11-12.)
Evidence of commingling is sufficient to satisfy this requirement of Credit
Bancorp. See Byers, 637 F. Supp. 2d at 178 (noting that “there [wa]s
some evidence that commingling occurred, and the law does not appear to
require more than that”).
The investor victims, here too, are similarly situated. To fall under
this designation, investors “need not be identical, but there should be a
reasonably close resemblance of facts and circumstances.” Byers, 637 F.
10

Supp. 2d at 179-80 (internal quotation marks and citation omitted). Victims
who invest in separate legal entities are similarly situated if their
investments were “part of a unified scheme to defraud.” Id. at 181 (internal
quotation marks and citation omitted). For example, in Byers, the court
found that investors were similarly situated because the separate entities
were commonly managed and investments were regularly pooled to offset
expenses across all entities. See id. at 180. As in Byers, the entities here
were all controlled by McGinn and Smith. (Dkt. No. 847, Attach. 2 ¶ 3.)
Additionally, as noted above, investor funds were transferred between
these entities to cover interest and principal payments. (Dkt. No. 807 at
10-16.) Accordingly, the investments fell under a common scheme to
defraud, rendering the investor victims similarly situated. Because the
funds were commingled and the investors are similarly situated, the court
finds that a pro rata distribution is a fair and reasonable remedy to
compensate the victims.
The court now turns to the filed objections. First, regarding the
objections of Fowler and Certain Investors, the collateral offset provision is
neither vague, improper, or inequitable. The Receiver explains that the
defrauded investors who receive third party recoveries will have their
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allotted distribution from the receivership estate reduced on a dollar for
dollar basis. (Dkt. No. 883 at 3-4.) This is confirmed by the offset
provision’s language that reductions will be by “such compensation actually
received.” (Dkt. No. 847, Attach. 2 ¶ 21.) Accordingly, the collateral offset
provision is not vague.
Nor is the collateral offset provision improper or inequitable. Courts
have regularly approved offset provisions in distribution plans. See, e.g.,
SEC v. Capital Consultants, LLC, 397 F.3d 733, 738-41 (9th Cir. 2005);
Wang, 944 F.2d at 87-88; In re The Reserve Fund Sec. & Derivative Litig.,
673 F. Supp. 2d 182, 201 (S.D.N.Y. 2009). Contrary to the contentions of
Fowler and Certain Investors, the Plan does not require an assignment of
third party recoveries to the receivership estate. (Dkt. No. 862, Attach. 2 at
5; Dkt. No. 865, Attach. 1 at 6-8.) Investors retain all of their third party
recoveries. (Dkt. No. 883 at 8.) In attempting to equalize recovery among
investors, the reduction ensures that no one investor recovers a
disproportionate percentage of their allowed claim after considering all
sources of recovery. (Dkt. No. 847, Attach. 2 ¶ 21.) As “equality is equity,”
Wealth Mgmt. LLC, 628 F.3d at 333 (internal quotation marks and citation
omitted), the collateral offset is a reasonable solution to allocating the
12

limited recoveries, see Official Comm. of Unsecured Creditors of
WorldCom, Inc. v. SEC, 467 F.3d 73, 84 (2d Cir. 2006) (explaining that
“[w]hen funds are limited, hard choices must be made”) (internal quotation
marks omitted).
Furthermore, the collateral offset is not inequitable. Fowler and
Certain Investors argue that the collateral offset provision is inequitable to
them. (Dkt. No. 862, Attach. 2 at 4-5; Dkt. No. 865 at 8-12.) Courts,
however, should consider all investor victims when crafting an equitable
remedy. See SEC v. Parish, No. 2:07-cv-00919, 2010 WL 5394736, at *9
(D.S.C. Feb. 10, 2010) (rejecting the objections of a minority of investors
that obstruct a fair result to the majority of investors). Here, as the SEC
explains, the vast majority of investors who do not otherwise qualify for
outside recovery would receive a smaller payout without the offset. (Dkt.
No. 884 at 3.) “An equitable plan is not necessarily a plan that everyone
will like.” Byers, 637 F. Supp. 2d at 168. In balancing the equities, the
court agrees that the collateral offset provision as drafted by the Receiver
is fair and reasonable.
Second, the Robinovich investors’ objections lack merit. As the SEC
notes, there is no authority, and the Robinovich investors fail to cite to any,
13

which requires the adjudication of their claim before an interim distribution
may be made. (Dkt. No. 884 at 3.) Moreover, the Robinovich investors will
not be prejudiced as the Plan reserves monies for disputed claims. (Dkt.
No. 847, Attach. 3 at 13); see SEC v. Michael Kenwood Capital Mgmt., 630
F. App’x 89, 91 (2d Cir. 2015) (affirming a district court’s approval of a
distribution plan and initial distribution when sufficient funds were “set
aside . . . in a reserve fund” for disputed claims).
Finally, the Receiver has already provided either an explanation for
or the information requested by the JAT investors. The Receiver
represents that the claims of the JAT investors are not listed as disputed,
contingent, or unliquidated, rendering them eligible for an interim
distribution. (Dkt. No. 883 at 14.) This information has been
communicated to the JAT investors. (Id.) Furthermore, the claims
procedure outlined by the Receiver lists the total assets available for
distribution and discusses expenses associated with the receivership
estate. (Dkt. No. 847, Attach. 2 ¶¶ 15, 16.) The Receiver correctly notes
that the exact percentage of any particular claim recovery is dependant
upon certain factors and a precise calculation is premature. (Dkt. No. 883
at 14-15.)
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In sum, the Receiver’s Plan represents an equitable balancing to
achieve a fair and reasonable result for all investors and an interim
distribution is appropriate at this time.
V. Conclusion
WHEREFORE, for the foregoing reasons, it is hereby
ORDERED that the Rabinovich’s letter motion to file a sur-reply (Dkt.
No. 892) is DENIED; and it is further
ORDERED that the Receiver’s motion for an order approving of his
distribution plan and authorizing interim distributions (Dkt. No. 847) is
GRANTED; and it is further
ORDERED that the Clerk provide a copy of this MemorandumDecision and Order to the parties.
IT IS SO ORDERED.
October 31, 2016
Albany, New York

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