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U.S. Securities & Exchange Commission v. e-Smart Techs., Inc.

United States District Court, D. Columbia.

March 12, 2014

U.S. SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
e-SMART TECHNOLOGIES, INC., et al., Defendants

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For U.S. SECURITIES AND EXCHANGE COMMISSION, Plaintiff: Kenneth John Guido, Jr., LEAD ATTORNEY, U.S. SECURITIES & EXCHANGE COMMISSION, Washington, DC.

MARY A. GRACE, Defendant, Pro se, Boulder, CO.

TAMIO SAITO, Defendant, Pro se.

ROBERT J. ROWEN, Defendant, Pro se, Sebastapol, CA.

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MEMORANDUM OPINION

JAMES E. BOASBERG, United States District Judge.

Defendant e-Smart Technologies, Inc. bills itself as a cutting-edge technology firm dedicated to producing " smart cards," wallet-sized credit or ID cards with a built-in identity-verification system. According to e-Smart, those smart cards can lock and unlock information -- e.g., access to a credit card account or a secure facility -- based on biometric data such as a user's fingerprint. In an era where identity theft is a reality and cyber threats increase in prominence, having a simple means to verify a user's identity could be a true boon -- and e-Smart had the technology. At least, that is what the company's unwitting investors believed.

According to the Securities and Exchange Commission, however, the cards do not work as advertised and have never been anywhere near ready for production, despite e-Smart's promises. Because e-Smart is a publicly traded company, the SEC brought this suit alleging that e-Smart, its officers, and two affiliated companies defrauded investors; neglected to file several required reports, including a registration statement for a massive sale of stock; and failed to keep their accounts in order, all in violation of U.S. securities laws. Three brokers who participated in the sale of unregistered e-Smart stock were also named as Defendants. The Clerk has since entered default against the corporate Defendants, and the Court approved a consent judgment against two of the brokers.

Now, two of the company's executives, Chief Executive Officer Mary Grace and Chief Technology Officer Tamio Saito, who are acting pro se, have separately moved to dismiss the SEC's First Amended Complaint. They contend, in essence, that the Commission gets the facts of the case wrong. Unfortunately for Defendants, at this stage of the litigation, the Court must accept the factual allegations in the SEC's Complaint as true, and it, accordingly, will deny the Motions to Dismiss.

I. Background

The SEC contends here that e-Smart's CEO Grace and its CTO Saito violated a number of U.S. securities laws. The allegations range from not crossing T's and dotting I's in e-Smart's bookkeeping to an elaborate scheme to sell unregistered stock. See Am. Compl., ¶ ¶ 113-41. The accusations at the heart of the case, however, involve Grace, Saito, and e-Smart's lying to investors about the very core of the company's business. See id., ¶ ¶ 113-15. For the purpose of Grace and Saito's Motions to Dismiss, the Court must " treat the complaint's factual allegations as true," Sparrow v. United Air Lines, Inc., 216 F.3d 1111, 1113, 342 U.S.App.D.C. 268 (D.C. Cir. 2000), and must rely solely on matters set forth therein. See Fed.R.Civ.P. 12(d). All facts recounted below are, therefore, drawn from the First Amended Complaint and public filings that the Complaint incorporates by reference.

At the time the fraud allegedly occurred, Grace " operated e-Smart" -- an advanced research and development company -- " from her personal residence in Washington, D.C." Am. Compl., ¶ 19. She " has controlled e-Smart since its inception in 2000" and " is now, and at all relevant times has been, e-Smart's president, CEO, CFO, and Chairman of the Board of Directors." Id. Other than a brief absence in 2006-07,

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Saito has also been with the company since its founding as its resident technology tsar. See id., ¶ 20. Although he is an American citizen, he currently resides in Tokyo. See id.

The fraud perpetrated by e-Smart supposedly occurred in its 2005 and 2006 10-KSB annual reports filed with the SEC. The company filed its 2006 10-KSB in October 2007 and its Amended 2005 10-KSB in March 2008. See id., ¶ 2. In those reports, e-Smart claimed that it had " smart cards" ready " for deployment today," which had certain technical capabilities that made them uniquely secure and yet compatible with existing technologies. Id. According to the SEC, however, e-Smart's claims were inaccurate, as Saito and Grace either knew or should have known. See id., ¶ ¶ 24-25, 133.

Specifically, in its 2006 Form 10-KSB, which was submitted to the SEC and is available to the public online, e-Smart claimed:

o The smart card was " multifunctional" -- it could work " as an ID card, debit card, debit/credit card, driver's license and/or physical access card" all at the same time, id., ¶ 26;
o " One card can contain multiple, independent and secure applications. For example, the technology will permit/deny access (physical and logical), identify precise location and/or movement of personnel and/or watch list parties while at the same time operating other secure applications, each completely and securely isolated one from the other," id. (quoting 2006 10-KSB at 5);
o It possessed a " Zero/Zero System," which " internal studies" show " reduces the false reject rate" for thumbprints, id. (quoting 2006 10-KSB at 5);
o The card met international standards, " ensuring that the card was able to work with various card readers," id.;
o e-Smart was " the first, and currently the only company offering a commercially available dual ISO 7816 (contact) and ISO 14443-B (wireless) compatible smart card," id. (quoting 2006 10-KSB at 5); and
o The card was ready " for deployment today." Id. (quoting 2006 10-KSB at 5).

According to the SEC, none of this was true. See id., ¶ ¶ 26-27. Not only did the card lack the technological capabilities that e-Smart outlined, but the company " did not have a fully developed manufacturing process for" the " card and was not close to being able to" produce actual smart cards. Id., ¶ 27.

The company's Chief Operating Officer raised similar concerns with e-Smart's counsel, noting " that certain of the claims in the draft technology section" of the 2006 10-KSB " were untrue." Id., ¶ 35; see id., ¶ ¶ 32-39. Counsel conveyed these concerns to Grace and Saito. See id., ¶ 38. The CEO and CTO nevertheless signed the 10-KSB and allowed it to be filed with the SEC. See id., ¶ ¶ 39-41. Grace later signed an Amended 10-KSB for 2005 that included substantially similar claims about the smart cards. See id., ¶ 43.

In addition, the SEC alleges that e-Smart " failed to disclose certain material events" relating to the " loss of key personnel" in a " timely or adequate fashion." Id., ¶ 47. In 2006, " CTO Saito, the entire research and development staff," and " the company's sole manufacturer[] all cut ties with the company." Id. According to the SEC, this was a material event that e-Smart was required to timely disclose. See id., ¶ ¶ 47-49. Saito even e-mailed Grace to inform her that the departure of the CTO and tech staff were " material

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events." Id., ¶ 50. Still, e-Smart " made no public disclosure about the loss of e-Smart's technology team" until February 2007, over six months after the departures and only a month before Saito ultimately returned to e-Smart. Id., ¶ ¶ 20, 51-52. At that time, e-Smart claimed that research and development would be done by an affiliated company, IVI Smart Technologies, but IVI had no technology team either. See id., ¶ ¶ 53-54.

The SEC contends, moreover, that " Grace repeatedly lied to potential and current investors and to the e-Smart Board of Directors about major funding commitments and lucrative contracts she claimed to have obtained for e-Smart." Id., ¶ 56. As an example, from 2006 through 2009, " Grace told numerous investors, employees and the Board . . . that an organization named 'Louis XVII,' led by an individual named 'John Duff,' was going to inject hundreds of millions of dollars into e-Smart." Id., ¶ 60. Over the years, she also promised that " tens of millions of dollars" would be flowing in from " affiliates of Adnan Khashoggi" in Dubai. Id., ¶ 61. Those claims were false, as Grace either knew or should have known. Id., ¶ ¶ 63, 68.

Grace also had a habit of heralding non-existent contracts to purchase e-Smart cards to the Board and would-be investors. See id., ¶ ¶ 56-59, 63. In one instance, she approved a press release stating that e-Smart had signed a contract " to deliver to Samsung 20 million" smart cards. Id., ¶ 71. The release claimed that " [d]eliveries of the first order of 10 million cards are planned to begin in June 2008 and continue through March 1st 2009, with the orders of the second 10 million delivered over the following 12 months." Id. The company estimated that " the Samsung orders may produce profits in excess of $100 million." Id. Grace was specifically quoted as saying, " [W]e believe [it] is the largest order of its kind placed in the world to date for a biometric smart card," and " I anticipate that this is the first of a series of orders for our advanced 'I AM'[TM] card, not only for Samsung and Korea but for many more countries with whom we have been closely working." Id. After the press release was issued, " both the price of e-Smart's shares and the volume of trading in e-Smart shares increased." Id., ¶ 73.

According to the SEC, however, Samsung had not ordered any cards from e-Smart. Rather, the two companies had executed a supply contract, which gave Samsung " the option of purchasing cards from e-Smart" under agreed-upon terms, " but Samsung S1 was also entitled to choose not to place any purchase orders from e-Smart." Id., ¶ 74. The company later " apologiz[ed] to Samsung S1 for the confusion related to e-Smart's press release," but the company never publicly corrected its misstatements. Id., ¶ 79; see id., ¶ 80.

The SEC also accuses e-Smart of selling hundreds of millions of unregistered shares of stock by disguising the stock as payment for sham " loans." The SEC contends that " Grace conceived of and oversaw this unregistered distribution of e-Smart stock," which involved e-Smart and two private companies that Grace controlled and oversaw as President, IVI Smart Technologies and Intermarket Ventures, Inc. Id., ¶ 8; see id., ¶ 7. The allegation is that investors were solicited to provide " bogus 'loans'" to IVI and Intermarket. Id., ¶ 9. IVI and Intermarket, however, never had any intention of repaying the loans, which all defaulted. Id., ¶ ¶ 9, 85, 89. Instead, the investors had been promised (and were then issued) cheap, unrestricted e-Smart stock -- which served as collateral for the loans -- in place of repayment. Id., ¶ ¶ 85-86. Then e-Smart

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gave IVI and Intermarket additional stock to replenish their preexisting store of securities, which had been sold in exchange for the " loans." Id., ¶ 87. The money for this disguised sale of e-Smart stock did not go to e-Smart, but instead went to IVI or to finance Grace's exorbitant lifestyle. See id., ¶ 9. This stock distribution was never registered with the SEC. See id., ¶ 7.

The SEC further alleges that " [d]espite the fact that e-Smart had virtually no revenues," e-Smart -- as well as IVI -- " paid for Defendant Grace's business, personal and living expenses." Id., ¶ 97. This arrangement was not fully disclosed until May of 2009. Id., ¶ 100. Those " payments amounted to millions of dollars, and included such extravagances as huge bills at resort hotels, ultra-high end designer clothes purchased at French boutiques, jewelry, cosmetics, lavish meals and travel, and 'longevity' medicine." Id., ¶ 102. In addition, " e-Smart also paid for gifts to family and friends, including an $18,000 Cartier watch, hundreds of thousands of dollars ostensibly for consultant fees and travel payments, and tens of thousands of dollars in salary and travel payments for Grace's children." Id.

E-Smart's bookkeeping has also purportedly been deficient. During its operations, " e-Smart failed to make and keep books and records which accurately reflected the transactions and disposition of assets of the company." Id., ¶ 106. As a result, " [t]he last periodic report e-Smart filed was its annual report for the period [that] ended December 31, 2007, which it filed on May 28, 2009." Id. Since then, e-Smart failed to file quarterly or annual statements for 2008, 2009, 2010, or 2011. Id. The company's records of stock transactions, board meetings, loans, and inter-company dealings are all incomplete or improperly kept. Id., ¶ 107. When accountants or auditors tried to reconcile the accounts, Grace ensured that they were fired or denied payment. Id., ¶ 105.

Finally, the SEC alleges that Grace and Saito failed to file required statements of ownership. The " Exchange Act requires executive officers, directors, and those who own more than 10% of a registered class of equity securities to file with the Commission initial statements of beneficial ownership (Form 3), reports of changes in ownership (Form 4), and annual reports concerning their ownership (Form 5)." Id., ΒΆ 110. Grace was an officer and director of e-Smart, and Saito ...


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