Sec. & Exch. Comm'n v. Smith

798 F.Supp.2d 412

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,

v.Lynn A. SMITH, Defendant.Jill A. Dunn, Esq.; David M. Wojeski; Thomas J. Urbelis, Esq.; and James D. Featherstonhaugh, Esq., Non–Parties.

No. 10–CV–457 (GLS/DRH).

United States District Court, N.D. New York.

July 20, 2011.

David Stoelting, Esq., of Counsel: Kevin McGrath, Esq., Lara Shalov Mehreban, Esq., Haimavathi V. Marlier, Esq., Joshua Newville, Esq., New York, NY, for Plaintiff.

Featherstonhaugh, Wiley & Clyne, LLP, of Counsel: James D. Featherstonhaugh, Esq., Stephen B. Hanse, Esq., Scott J. Ely, Esq., Albany, NY, for Defendant Lynn A. Smith and Non–Party James D. Featherstonhaugh.

Steinberg & Cavaliere, LLP, of Counsel: Benjamin Zelermyer, Esq., White Plains, NY, for Non–Party Jill A. Dunn.Wilson, Elser, Moskowitz, Edelman & Dicker LLP, of Counsel: Fred N. Knopf, Esq., White Plains, NY, for Non–Party David M. Wojeski.¹Carter, Conboy, Case, Blackmore, Maloney & Laird, P.C., of Counsel: Michael J. Murphy, Esq., Albany, NY, for Non–Party Thomas J. Urbelis.Conn, Kavanaugh, Rosenthal, Peisch & Ford, LLP, of Counsel: Thomas E. Peisch, Esq., Erin K. Higgins, Esq., Boston, MA, Attorney for Non–Party Thomas J. Urbelis.

MEMORANDUM–DECISION AND ORDER

DAVID R. HOMER, United States Magistrate Judge.

Presently pending is the motion of plaintiff Securities and Exchange Commission (“SEC”) for an order awarding sanctions against defendant Lynn A. Smith and non-parties Jill A. Dunn, Esq. (“Dunn”), David M. Wojeski (“Wojeski”), and Thomas J. Urbelis, Esq. (“Urbelis”) as well as leave to pursue discovery on the issue of sanctions as to non-party James D. Featherstonhaugh, Esq. (“Featherstonhaugh”). Dkt. No. 261. All such individuals oppose the motion. Dkt. Nos. 300–10. For the reasons which follow, the SEC's motion is granted in part and denied in part.

I. Background

For a more complete description of the background of this action, see Mem.-Decision & Order filed May 9, 2011 Dkt. No. 321, 2011 WL 1770472 (district court's decision denying motions to dismiss of certain defendants); Mem.-Decision & Order filed Nov. 22, 2010 (Dkt. No. 194) (“MDO II”), 752 F.Supp.2d 220 at 222–23, 225–33; and Mem.-Decision & Order filed July 7, 2010 (Dkt. No. 86) (“MDO I”), 752 F.Supp.2d 194 at 199–204, 214–219; see also Mem.-Decision & Order filed Jan. 11, 2011 (Dkt. No. 254) (“MDO III”) (denying the trust's motion for reconsideration of MDO II). As relevant to the pending motion, defendants Timothy M. McGinn (“McGinn”) and David L. Smith formed McGinn, Smith & Co., Inc. (“MS & Co.”) in 1981 with a principal place of business in Albany, New York. MDO I at 199. Through its own employees and through related entities, MS & Co. offered financial services to clients, including investment advice, stock brokerage services, and investments in securities which it sold. Id. Lynn Smith is married to David Smith. Id. In 2004, David and Lynn Smith created the David L. and Lynn A. Smith Irrevocable Trust U/A 8/04/04 (“Trust”) for the benefit of the Smiths' two adult children. Id. at 199, 203–04. The SEC was created, inter alia, to regulate the purchases and sales of securities and acts to enforce compliance with laws and regulations governing such transactions. See 15 U.S.C. § 78a et seq.

On April 20, 2010, the SEC commenced this action by filing a complaint alleging that Timothy McGinn, David Smith, and their company defrauded investors of over $80 million through violations 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. To preserve defendants' assets for the benefit of investors in the event it prevails here, the SEC simultaneously sought and received a temporary restraining order (“TRO”) (1) appointing a receiver to take possession of defendants' assets and of MS & Co. and its related entities, (2) freezing defendants' assets pending the outcome of this action, (3) freezing the assets of Lynn Smith, (4) ordering verified accountings, and (5) granting related relief. Dkt. Nos. 4, 5. A receiver was appointed and the assets of the defendants and Lynn Smith were frozen pending a hearing. TRO at 7. Among the assets frozen was the Trust. Id.

In the early 1990s, David and Lynn Smith purchased 40,000 shares of stock at the initial offering of an Albany-area bank for $400,000. MDO I at 203–04. By August 2004, through bank mergers and acquisitions, the number of shares had increased to approximately 100,000 and their value to over $4 million. Id. at 203–04. With that stock, David and Lynn Smith created the Trust for the benefit of their two children, now ages thirty-one and twenty-eight. Id. at 204. Urbelis was selected by the Smiths as Trustee of the Trust and remained in that position until his resignation on April 22, 2010. Urbelis Dep. Tr. (Dkt. No. 66–1) at 10–11, 49–51; T. 312–13, 320, 323, 388–89.² Urbelis had remained friends with the Smiths since childhood and the families spent significant time together each year. Urbelis Dep. Tr. at 7–10; T. 313, 389, 507, 566. Urbelis was employed as a lawyer in Boston specializing in real estate and municipal law. Id. at 5–6; T. 313.

After Urbelis resigned as Trustee on April 22, 2010, Wojeski was appointed as the new Trustee at the behest of Dunn, the Trust's attorney. Wojeski Aff. (Dkt. No. 306) at ¶ 3. Following entry of the TRO, the Trust moved to intervene and for an order lifting the TRO as to the Trust. Dkt. No. 39. An evidentiary hearing on that motion was held on June 9–11, 2011 at which the Trust contended that, contrary to the contentions of the SEC, David Smith held no interest in the Trust after its creation in 2004. MDO I at 218–19. Finding that David and Lynn Smith had created an irrevocable trust in which they held no interest of any kind after its creation in 2004, the Court denied the SEC's motion for a preliminary injunction as to the Trust, the Trust's motion to unfreeze the Trust from the TRO was granted, and control of the Trust's assets was returned to the Trust. Id. at 217–19, 219–20. Central to this finding was the absence of any evidence that David Smith held any present or future interest in the Trust. Id. at 217–19. In the next two weeks, the Trust disbursed over $1 million of its approximately $4 million in assets for attorneys' fees and other expenses more fully described infra. MDO II at 222.

Two weeks later, the SEC discovered that notwithstanding the purported irrevocable character of the Trust, the Smiths and Urbelis as Trustee entered into a second agreement effective August 31, 2004 entitled “Private Annuity Contract Between David L. Smith & Lynn A. Smith as Transferors and the David L. & Lynn A. Smith Irrevocable Trust U/A dated August 31, 2004, Transferee.” Dkt. No. 103–3 (“Annuity Agreement”). The Annuity Agreement required the Trust to make annual payments from the Trust to the Smiths of $489,932.00 beginning September 26, 2015 and continuing until the last of David or Lynn Smith died or the annuity was exhausted. Id. When the payments commenced in 2015, the Smiths would be ages 69 and 70 with the longest life expectancy of either being fifteen years. Dkt. No. 103–4. Assuming no other distributions from the Trust, the distributions under the Annuity Agreement would exhaust the Trust's assets with the fifteenth and final payment to the Smiths. Id. If the Trust assets were not exhausted before the last of the Smiths died, the remaining assets would remain with the Trust for the benefit of the Smiths' children. Dkt. No. 103–3.

The Annuity Agreement constituted conclusive evidence of David Smith's ongoing interest in the Trust, the issue central to the determination of the SEC's motion for a preliminary injunction as to the Trust and the Trust's cross-motion to lift the TRO. See MDO I, MDO II. Prior to and at the June evidentiary hearing, the SEC sought discovery of all documents related to the Trust and of any interest the Smiths retained in the Trust. MDO II at 228–31; Stoelting Decl. (Dkt. No. 103–2) at ¶¶ 9–34. Lynn Smith filed a required financial disclosure statement omitting any reference to an interest in the Trust and testified at a deposition and at the evidentiary hearing that she retained no interest in the Trust.³ Dkt. No. 19 (Lynn Smith financial statement); Stoelting Decl. (Dkt. No. 103–2) at ¶¶ 12–14 (Lynn Smith response to SEC's document demand); (Lynn Smith Aff. filed 5/26/10) (Dkt. No. 34) at ¶ 6 (“From the time the trust was created in August 2004, my husband and I have had no interest in or expectation of an interest in the ... Trust. It exists solely, exclusively and permanently for the benefit of our children.”); Lynn Smith Dep. Tr.(Dkt. No. 46–3) at 39–41, 79–87; T. 303–11, 320, 388, 391–92. Lynn Smith's explanation for her failure to disclose the Annuity Agreement was that she had simply forgotten about it. Lynn Smith Aff. filed Mar. 21, 2011 (Dkt. No. 303–1) at ¶ 5 (“To this day, I do not recall signing the annuity agreement, although it is clearly my signature on the agreement, and until it was produced in late July 2010 and explained to me by Mr. Featherstonhaugh, I did not recall that this agreement even existed or that I had a future interest in the Trust in the form of annuity payments beginning in 2015.”).⁴

Since the decision on July 7, 2010 removing the Trust from the TRO, three copies of the Annuity Agreement have surfaced—one from Urbelis, a second from David Smith, and a third from law enforcement authorities.⁵ Urbelis, had maintained a copy of the Annuity Agreement at his home separately from his other records regarding the Trust which he kept at his office. Urbelis Aff. (Dkt. No. 309) at ¶¶ 10, 11. Urbelis resigned as Trustee of the Trust on April 22, 2010, two days after the commencement of this action and the execution of the search warrants. Id. at ¶ 15....