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Federal trial begins for partners accused of skimming millions

January 8, 2013
Updated 10:19 p.m.
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In this file photo from January 2012, Timothy M. McGinn, left, and David L. Smith, center, walk out of James T. Foley Federal Courthouse in Albany with their attorney, E. Stewart Jones, right.
Photographer: Patrick Dodson
In this file photo from January 2012, Timothy M. McGinn, left, and David L. Smith, center, walk out of James T. Foley Federal Courthouse in Albany with their attorney, E. Stewart Jones, right.

— Timothy McGinn and David Smith scrambled to create a back-dated trail of documents to cover their fraudulent activities as federal investigators began to close in on their Albany-based investment firm, the prosecutor told jurors during opening statements in their trial Tuesday.

The longtime business partners had skimmed millions of dollars from investors and were hurriedly trying to cover their tracks with bogus promissory notes produced by company accountants, Assistant U.S. Attorney Elizabeth Coombe explained. The documents were a desperate attempt to legitimize a business that paid them handsomely with untaxed fees they took from 20 entities they used to attract investors — many who would later lose vast sums of money when the scheme collapsed.

“This is a case about broken trust,” Coombe told the jury seated in U.S. District Court in Utica. “It’s about how these men — Timothy McGinn and David Smith — broke the trust of their investors.”

But defense attorneys told a vastly different story, characterizing the federal investigation as one that failed to grasp the legal business model used by the partners and didn’t take into consideration the economic turmoil that rocked their investment firm from the outset of the recession. The partners were actually mending some of the damage incurred by their investors and likely would have recouped much of their losses had the federal case not ground all their progress to a halt, said E. Stewart Jones, the defense attorney for McGinn.

“The real cause of this is a fundamental misunderstanding of the business model that is McGinn and Smith,” he said, his voice booming through the courthouse.

William Dreyer, Smith’s defense attorney, said the government’s case was based on a false premise that misidentified loans the partners made to themselves through the trust fund as fees. In truth, he said, the loans were a method through which they could protect investors during a tumultuous time in the national economy.

“Even during the crisis — when major banks were failing — the business model of McGinn and Smith remained intact and investors were getting paid,” he said.

Jurors got their first look at the convoluted criminal case that has roiled in federal court since prosecutors returned an indictment in late January 2011. And while the prosecution and defense team didn’t agree on much, both acknowledged the case is complex.

In total, the partners both face a 32-count indictment that could land them a 30-year stint in prison and a fine of as much as $1 million. Federal prosecutors accuse the partners of misleading clients about roughly $37 million they invested into 17 trust funds.

As a result, prosecutors say, investors were unaware the partners had diverted $4.1 million from the trusts to benefit themselves and Matt Rogers, a managing partner of their firm who has since pleaded guilty to one count of filing a false tax return. Coombe told jurors the partners used a host of workers at the firm to meticulously create documentation that made it seem like their shuffling of funds was legitimate.

“When regulators had found out what they had done, they did their best to cover it up,” she explained.

Coombe said the partners created the McGinn Smith Transaction Funding Corp. to solicit investments they would later use for business ventures that would pay their clients dividends. Only they used money from the fund to pay off clients in others outside the trust — so-called “preferred investors,” she said.

Meanwhile, they were also taking money from the trust to cover their own bankroll, Coombe said. They even took $1 million of the fund from $3 million they raised from investors, distributing the money among themselves and Rogers.

“Obviously, that’s a huge percentage,” Coombe told jurors.

In another instance, Coombe said the duo raised $7 million from four trusts affiliated with Firstline Security Inc., a Utah-based company selling residential alarm contracts. Shortly after the lending agreement was reached, Frontline landed in costly litigation with its dealer, ADT Security, and ultimately went into bankruptcy.

Coombe said McGinn and Smith concealed Firstline’s troubles from their investors for 19 months, starting in 2008. They moved more than $2 million from another fund to convince clients the company was beginning to pay dividends and even solicited additional investors, despite Firstline facing liquidation.

But Jones said businesses like Firstline were heavily connected to the real estate market and subsequently fell prey to its collapse. He said McGinn and Smith were doing everything to prevent investors from losing money when the government began to meddle.

“They were trying to deal with it and were dealing with it,” he said. “Then out of the blue, the government comes in and shuts them down.”

Dreyer characterized the firm’s investors as being “sophisticated” in the financial field, with more than $1 million to invest and an annual income of more than $200,000. He said these investors put money into the firm’s trusts anticipating interest rates up to 13 percent over five or six years.

McGinn and Smith then pulled money out of the trust to invest into operating companies, which then purchased assets. By doing this, Dreyer said the partners were able to protect investors from losses incurred by start-up ventures that failed, since the operating company was always responsible for the debt.

Dreyer acknowledged there were issues at the firm the partners were trying to correct. For example, he said they learned of problems with their reporting paperwork after the chief financial officer left.

“There were failures,” he said. “There’s no doubt about that.”

Prosecutors also called their first witness in the case, Steve Rowen, a federal Financial Industry Regulatory Authority examiner. He testified the promissory notes provided by the company appeared to be uncharacteristically uniform, despite being from different dates.

“They all appeared to be from the same template, just with different names, dates and amounts,” he said.

The federal indictment came after the U.S. Securities and Exchange Commission lodged a civil complaint against the firm in April 2010. Now stayed by the federal court, the civil case claimed McGinn and Smith orchestrated a scheme to raise more than $136 million from more than 900 investors by conducting more than 20 fraudulent debt offerings in four funds and various trusts.

 
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