United States District Court, D. Columbia.
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For U.S. SECURITIES AND EXCHANGE COMMISSION, Plaintiff: Kenneth John Guido, Jr., LEAD ATTORNEY, U.S. SECURITIES & EXCHANGE COMMISSION, Enforcement, Washington, DC.
MARY A. GRACE, Defendant, Pro se, Boulder, CO.
TAMIO SAITO, Defendant, Pro se, Japan.
ROBERT J. ROWEN, Defendant, Pro se, Sebastapol, CA.
JAMES E. BOASBERG, United States District Judge.
In this civil-enforcement action, the Securities and Exchange Commission alleges that e-Smart Technologies, Inc., a public company, was a sham. While it purported to be at the cutting edge of developing and manufacturing a biometric " smart" card, such claims, according to the Commission, were bogus. Instead, pro se Defendant Mary Grace (the company's CEO) and others repeatedly misrepresented the cards' capabilities and e-Smart's success to induce investors to part with their money. That money, in turn, was used to subsidize Grace's extravagant, globe-trotting lifestyle.
Through three years of contentious litigation, this Court has had occasion to rule on myriad motions. It now addresses the SEC's First Motion for Summary Judgment against Grace. That Motion seeks resolution of two of the five claims against her -- namely, that she violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 by making material misrepresentations in connection with the sale of securities (Count I), and that she violated Sections 5(a) and 5(c) of the Securities Act by selling unregistered securities (Count II). Although the materials submitted are voluminous and Grace's are particularly daunting, the Court believes that the SEC has proved its case. It will therefore grant the Motion and enter judgment against Grace on both counts.
On a motion for summary judgment, the Court must view the facts in the light most favorable to the non-moving party. See Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). As explained more fully below, however, Grace did not submit a proper Statement of Facts. As a result, to summarize the relevant background, the Court draws primarily from the SEC's Statement of Undisputed Material Facts, ECF No. 324-1.
A. E-Smart's Technology
E-Smart was a publicly traded company " engaged in the business of creating, marketing, manufacturing, installing, operating and maintaining biometric identification verification systems." Mot., Att. 165 (2006 10-K) at 3. Its " core technology" was a " smart card" that used fingerprint matching " to positively authenticate" card users. See Mot., Att. 162 (Amended 2005 10-K) at 5. Such technology could be applied in a variety of contexts -- such as banking or security access -- to verify people's identities and protect personal information contained on, or accessed by, the cards. See 2006 10-K at 4.
The company's research and development efforts appeared to be quite successful. In October 2007, for example, e-Smart reported in its 2006 10-K -- a mandatory annual-disclosure form for publicly traded companies -- that it believed it was " the first . . . [and] only company offering a commercially available dual !SO [ sic ] 7816 (contact) and ISO 14443 B (wireless) compatible smart card with a fingerprint sensor onboard, biometric matching engine onboard and a multi-application processor." Id. at 5. In March 2008, when the company filed an amended 2005 10-K, it reported that it still believed it was the only company offering such technology. See Amended 2005 10-K at 6. These filings also described the card's various features, including its " unique" " Match-on-Card" capability, which enabled the card to verify a person's fingerprints without connecting to an external database or network. See 2006 10-K at 4-5; Amended 2005 10-K at 6-7. The company similarly announced major technological advancements
in press releases and communications with investors. See, e.g., Mot., Att. 234 (November 4, 2008, Press Release).
B. E-Smart's Investors
Despite these reported achievements, e-Smart had little to no revenue. See Mot., Att. 63 (Deposition of Mary Grace) at 155:4-156:3; 158:8-16; Att. 68 (Deposition of Charlie Black) at 50:2-4; Att. 67 (Deposition of Stewart Hung) at 37:18-38:8. To keep the company going, its CEO, Mary Grace, was constantly seeking funds from investors and other sources. See, e.g., Mot., Att. 58 (Deposition of William McVey) at 27:13-28:19; Att. 25 (Investigative Testimony of Michael Elek) at 36:10-23; Att. 88 (E-mail from Grace to Henry Mollett & Bill McVey (July 30, 2006, 12:46 PM)); Att. 56 (Deposition of Kenneth Wolkoff) at 30:2-31:6.
In her communications with investors, she often explained that money was urgently needed to secure other opportunities or to protect their prior investments in the face of a funding emergency. See E-mail from Grace to Henry Mollett & Bill McVey (July 30, 2006, 12:46 PM); Mot., Att. 101 at 5 (E-mail from Grace to " Michael and Francesca" (Oct. 22, 2008, 3:08 PM)). She also frequently divulged that e-Smart had just obtained, or was about to obtain, significant contracts and investments. See, e.g., E-mail from Grace to Henry Mollett & Bill McVey (July 30, 2006, 12:46 PM); E-mail from Grace to " Michael and Francesca" (Oct. 22, 2008, 3:08 PM); Mot., Att. 105 (E-mail from Grace to " Ron" (Feb. 22, 2008, 1:01 PM)).
The company likewise publicized that it had secured profitable contracts and investments in press releases and investor updates. See, e.g., Mot., Att. 79 (February 2005 " News from the Chairman" ). In a May 2007 release, for instance, it stated that it had a " guaranty" of $50 million in funding from the Growth Enterprise Fund. See Mot., Att. 230 (May 18, 2007, Press Release) at 1. In a February 2008 release, similarly, it announced that it had a contract with Samsung under which e-Smart would deliver 20 million smart cards over two years. See Mot., Att. 108 (February 26, 2008, Press Release) (" Samsung Release" ).
As a result of Grace's pleas and these reported successes, investors ponied up millions of dollars to the company. See, e.g., McVey Depo. at 13:2-15; Mot., Att. 59 (Deposition of Henry Mollett) at 11:14-15:4; Att. 87 at 232-234 (E-mail from William Sandler to Grace (July 31, 2009, 10:11 AM)). Unfortunately, the promised funding and contracts never materialized, see, e.g., Mot., Att. 117 (Letter from Charles Black, et al., to Grace, Dec. 30, 2008) at 1-2, and many investors later felt that Grace had lied to them about the supposedly imminent deals. See, e.g., Mot., Att. 85 at 64 (E-mail from Tom Howard to Richard Dick, et al. (Sept. 14, 2009)); Att. 115 at 1-2 (E-mail from Douglas Borwick to Grace (Apr. 3, 2007, 8:04 PM)); Att. 116 (E-mail from Ken Wolkoff to Grace (Oct. 24, 2006, 9:03 PM)); Mollett Depo. at 22:5-14; Att. 78 at 4 (E-mail from Bill McVey to Grace (Oct. 21, 2011, 8:53 PM)). They communicated their anger and frustration to her over a number of years. For instance, one investor informed her in April 2007:
I believe that millions of dollars were raised over the last two years by telling investors that funding was about to take place, as you did with the loans you
solicited from me and Ralph. . . . There are many investors that believe they were told a lie regarding imminent funding, just to get their money.
E-mail from Douglas Borwick to Grace (Apr. 3, 2007, 8:04 PM); see also Att. 85 at 23 (E-mail from Bill McVey to Grace, et al. (Oct. 22, 2011, 9:19 AM)) (expressing frustration that he had invested $1.5 million over nine years, and none of the deals Grace promised ever happened). Grace, nevertheless, continued to promise investors that contracts and big investments were just around the corner.
C. E-Smart's Finances
In addition to its ceaseless search for revenue, the company struggled to keep its books and accounting in order. See, e.g., Mot., Att. 134 (E-mail from Stewart Hung, CPA, Horowitz & Ullmann to Tony Russo (Nov. 16, 2007, 6:08 PM)); Att. 135 (E-mail from Hung to Russo (Mar. 7, 2008, 5:44 PM)) (listing problems); Att. 70 (Deposition of Anthony Russo) at 42:4-16; Att. 85 at 57-58 (Letter from Henry Mollett to " Investors/ Shareholders," Mar. 9, 2010); Hung Depo. at 39:17-40:17; 112:11-113:15. In fact, one accountant for the company did not even realize Grace had raised millions of dollars for e-Smart because he never saw these sums deposited into the company's accounts. See Russo Depo. at 42:4-16, 48:10-49:25; 55:5-56:4.
One source of confusion may have been the way in which funds were moved among accounts at e-Smart, Intermarket Ventures, Inc., and IVI Smart Technologies, Inc. The latter two companies were corporations that Grace controlled. See Def. Am. Ans., ¶ ¶ 19, 20. Their only employees were Grace and e-Smart's Chief Technology Officer, Tamio Saito, and they had no business operations other than licensing certain technology to e-Smart. See id. Over the years, transactions involving the three companies were " commingled" on the books. Mot., Att. 66 (Deposition of Joseph Leshkowitz, CPA) at 18:1-20:18; Russo Depo. at 42:4-16; 48:10-49:25; 55:5-56:4. Grace also frequently directed significant numbers of e-Smart shares and investor funds to IVI and Intermarket, saying that those funds and shares were supposed to go to those companies. See, e.g., Mot., Att. 94 (E-mail from Grace to Emile Merzoug (May 20, 2007, 10:27 PM)); Att. 8 (Account Opening Document); Att. 2 (April 2007 Bank Record); Att. 86 at 88 (Letter from Grace to William Sandler, Jan. 26, 2009); Russo Depo. at 59:16-61:8; 92:5-94:5; Hung Depo. at 109:20-111:19; Att. 123 (Letter from Maranda Fritz, Hinshaw & Culbertson LLP, to David B. Deitch, Aug. 7, 2008) at 2. E-Smart's accountants, however, did not have access to the IVI or Intermarket accounts. See, e.g., Russo Depo. at 23:2-5; 41:18-23; 55:11-56:4; Leshkowitz Depo. at 58:2-9.
D. Grace's Spending
Despite the company's lack of revenue, see Mot., Att. 166 (2007 10-K) at 21, Grace lived extravagantly while CEO. One accountant estimated that, over a four- or five-year period, her expenses were in the millions. See Russo Depo. at 39:9-41:12. She spent significant sums on hotels, travel, and personal services and items. For example, in just one month in 2007, she spent $177,000 from an IVI account on hotel accommodations, jewelry, clothing, and restaurants. See Mot., Att. 96 (September 2007 IVI Bank Statement). That same month, she spent tens of thousands of dollars from an e-Smart account on flights and hotels. See Mot., Att. 4 (September 2007 e-Smart Bank Statement).
In a review of a number of e-Smart and IVI bank accounts, the SEC found that, over the course of several years, Grace transferred $1,371,456 to personal accounts and $311,319 to family members, withdrew $397,501 in cash, and spent
$409,038 on retail purchases, $1,114,243 on hotel charges, $59,310 on restaurant charges, and $356,917 on travel expenses. See Mot., Att. 171 (Declaration of Jeffrey Anderson, CPA, SEC), ¶ 6. She also reportedly gave friends and family significant numbers of e-Smart shares " without any contemporaneous documentation or authorization." See Letter from Maranda Fritz, Hinshaw & Culbertson LLP, to David B. Deitch, Aug. 7, 2008 at 2; see also Russo Depo. at 59:16-63:5.
Such spending continued over the years, even though the company frequently had trouble paying employees' salaries and consultants' fees. See, e.g., Black Depo. at 94:5-14; Mot., Att. 72 (Deposition of Thomas Volpe) at 97:11-22; Att. 85. at 49 (E-mail from Beverly Caldwell to Grace, et al. (Dec. 7, 2010, 11:49 AM)); Att. 52 (E-mail from Grace to Tom Volpe, et al. (June 12, 2006, 4:59 AM)). By 2011, the company's financial situation had reached particularly dire straits. See Mot., Att. 98 (E-mail from Grace to Bob Aronowitz, et al. (Oct. 19, 2011, 4:39 PM)). Grace explained in an e-mail to investors that e-Smart urgently needed money because employees had not received salaries in over three months, and they could not " pay their rent, electricity, [or] phone" bills. Id. at 2. She also noted that Marcello Soliven, the company's " fine and critically important wireless inventor, who ha[d] cancer, . . . [could] no longer pay for his chemotherapy treatments." Id. Intriguingly, over the course of that same year, one investor wired over $590,000 directly into Grace's personal accounts. See Anderson Decl., ¶ 7.
In her defense, Grace argues that all of the expenses were legitimate business expenses or were permissible as part of her salary arrangement with e-Smart, Intermarket, and IVI. Regarding charges at designer-clothing and jewelry shops, for instance, she asserts -- although she does not provide any evidence -- that " many if not a majority" of those charges were for " expensive gifts which are always given in Asia as part of their culture as all companies [that] do business in Asia are aware." Opp. at 37. She also points out that e-Smart's 2007 10-K, filed in May 2009, disclosed that she deferred her annual salary of $250,000 as President and CEO of e-Smart, as well as her $250,000 annual salaries as President and CEO of IVI and Intermarket. See 2007 10-K at 47. According to the 10-K, the three companies thus had an arrangement with Grace to pay " all of [her] expenses, including lodgings, food, clothing[,] dental, medical, and preventative and alternative medical, travel, entertainment, public relations marketing, and any and all other expenses, at any time and place where Ms. Grace is conducting company business." Id. Grace therefore argues that because she deferred her salary for 13 years and because she was never repaid the money she allegedly lent e-Smart, " the [c]ompanies owe the CEO -- not the opposite." Opp. at 37.
E. The Lawsuit
On May 13, 2011, the SEC filed this lawsuit against Defendants e-Smart, Intermarket, IVI, Grace, and Saito, as well as brokers Robert Rowen, George Sobol, and Kenneth Wolkoff. The crux of its Complaint against Grace is that for years she duped investors into giving money to e-Smart and then misappropriated those funds for her personal use. More specifically, the Commission asserts that through her various actions as CEO of e-Smart, Grace violated five provisions of federal securities laws, including by making material misrepresentations in connection with the sale of securities and by selling unregistered securities. See Am. Compl., ¶ ¶ 113-19, 127-138. For example, according to the SEC, e-Smart's public filings and press releases misrepresented the state of its technology, and the company
was nowhere close to having a commercially viable card or a card with the reported features. The Commission also claims that Grace incessantly told investors -- through e-mails and press releases -- that e-Smart had finalized or was about to finalize major contracts and investments when none, in fact, existed, and that she ...