(Dow Jones) An enforcement case against a small brokerage in upstate New York shows that fraud may lurk not only on Wall Street, but also off the beaten track.
The Financial Industry Regulatory Authority, or Finra, charged McGinn, Smith & Co., Inc., an Albany, N.Y.-based brokerage, with securities fraud Monday in an alleged $89 million private placement scheme. Four offerings of unregistered securities by the brokerage, 150 miles from the nation's financial center, may have snagged as many as 515 investors in deals characterized by alleged self-dealing and failing to disclose critical facts to investors, according to Finra.
Finra accused McGinn, Smith of selling notes in fraudulent securities offerings by four limited liability companies, or LLCs and then investing the proceeds in at least two dozen companies which the firm's owners either controlled or in which they had a financial interest.
The affiliated companies included one set up to bundle together security alarm contracts and sell interests in them, and another that bundled cable contracts, according to a person familiar with the matter. The brokerage's co-owners, David L. Smith and Timothy McGinn, allegedly found ways to squeeze funds out of the affiliated companies, such as acting as trustees and receiving management fees, according to the person.
McGinn, Smith sold the notes between 2006 and 2008. Quarterly payments to investors trickled off in 2008 and stopped in 2009, according to James Shorris, Finra executive vice president and executive director of enforcement. About $51 million of the $89 million raised from investors went to the business entities in which the brokerage owners had interests, while a large percentage of the funds was returned to the brokerage and its owners through loans, transfers and commissions, according to Finra. At least $13 million is still unaccounted for, said Shorris.
The offerings weren't eligible for an exemption from securities registration-known as a Reg-D exemption-says Finra, because the brokerage allegedly sold the notes to as many as 250 unaccredited investors, exceeding the 35 allowed by Securities and Exchnage Commission rules, said Shorris. Accredited investors, by SEC standards, must have a net worth in excess of $1 million, including the value of their home, or earn $200,000 in individual income. The definition also includes couples with $300,000 in joint income.
David Smith, the brokerage's president, is also charged with securities fraud. He allegedly received nearly $600,000 in personal loans from the companies funded by the LLCs, says Finra.
The four LLCs defaulted on the notes in 2008, after McGinn Smith and its affiliates raked in nearly $7 million in fees and commissions through the offering, according to a Finra complaint. Smith and Timothy McGinn, chairman of the board, are also charged with providing falsified documents to Finra.
Finra launched a broad investigation of brokerages' sales of private placements, or Reg D offerings, in 2009, said Shorris. The number of investor complaints to regulators involving private placements rose significantly in 2009, more than doubling since 2008 as deals went sour, said Shorris. The complaint against McGinn Smith, however, was triggered by findings during an examination, he said.
Three investors have won a total of more than $3 million in arbitration awards against McGinn Smith since late December, according to Finra arbitration awards, but none of the investors have collected in the actions. Finra suspended the brokerage in late March for not paying fees assessed in some of cases, according to regulatory filings.