United States District Court, D. Columbia.
JAMES E. BOASBERG, United States District Judge.
This case continues to provide a cautionary tale for investors. At the center of the story is pro se Defendant Mary Grace, the CEO of e-Smart Technologies, Inc., a public company that was in the business of developing and marketing purported biometric " smart" cards. Over the course of several years, the company touted significant technological advancements in SEC filings and press releases. At the same time, Grace persuaded investors to part with millions of dollars on assurances that the company was about to obtain or had obtained significant funding and contracts. But these great expectations rarely, if ever, were realized, and many investors later felt that Grace had misled them. The Securities and Exchange Commission shared that sentiment and brought this civil-enforcement action against e-Smart, Grace, and several others, alleging numerous violations of federal securities laws. At the heart of the Commission's suit is the allegation that Grace lied about e-Smart's technology and about impending contracts in order to obtain investor funds, which she then diverted to her personal use.
This Court has already granted the agency summary judgment on two of its five claims against Grace -- namely, that she made material misrepresentations to the investing public and that she participated in a convertible-loan scheme to sell unregistered securities. Now the Court addresses the Commission's Second Motion for Summary Judgment against Grace, which accuses her of violating certain reporting, recordkeeping, and internal-control provisions. As it finds that summary judgment is warranted in favor of the SEC on two of these three counts, the Court will grant the Motion in part and deny it in part.
This Court has already described much of the relevant background in previous opinions. See SEC v. e-Smart Technologies, Inc. (E-Smart I), 31 F.Supp.3d 69, 74-78 (D.D.C. 2014); SEC v. e-Smart Technologies, Inc. (E-Smart II), No. 11-895, 2014 WL 6612422 (D.D.C. Nov. 21, 2014). It therefore only briefly summarizes the key facts here, drawing heavily from the latter Opinion, which granted partial summary judgment to the SEC.
Grace was the President, CEO, Chief Financial Officer, and a Director of e-Smart Technologies, Inc., see Defs.' Ans., ¶ 17, a publicly traded company that was " engaged in the business of creating, marketing, manufacturing, installing, operating and maintaining biometric identification verification systems." Mot., Att. 1 (2006 10-KSB) at 3 . Its key technology was a " smart card" that used fingerprint matching to verify card users and protect against unauthorized use. See E-Smart II, 2014 WL 6612422, at *1. The company reported significant technological achievements in its SEC filings, press releases, and other communications with investors. See id. For instance, it reported in its 2006 10-KSB, 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." See id.
Notwithstanding these reported achievements, the company struggled to stay afloat. It had little revenue, and Grace was continually turning to e-Smart's investors to seek more funds. She frequently assured them that significant contracts and investments were in the bag, and company press releases echoed this theme. Lured in by these promises, investors turned over millions of dollars. But the purported contracts and investments almost never seemed to materialize, and many investors later felt that they had been deceived. See Id. at *2-3.
Agreeing, the SEC brought this civil-enforcement action on May 13, 2011, against Defendants e-Smart, Intermarket Ventures, Inc., IVI Smart Technologies, Inc., Grace, and e-Smart's Chief Technology Officer, Tamio Saito, as well as brokers Robert Rowen, George Sobol, and Kenneth Wolkoff. The thrust of its Complaint is that e-Smart was a sham company with a bogus product. While the company claimed to have a commercially available and advanced smart card, it, in fact, had only a prototype that did not work as promised. The reported contracts and investments, according to the Commission, were complete fabrications intended to persuade investors to fork over their money. The agency believes that e-Smart's " illegitimacy" is further underscored by the facts that the company frequently did not file required reports, that its books and records were in a constant state of disarray, and that it lacked virtually any system of internal controls. Id. It lays the blame for these problems chiefly on Grace, asserting that she exhibited a total disregard for her fiduciary duties and legal obligations as the head of a public company, and that she violated numerous securities laws as a result.
In particular, the SEC's Amended Complaint accused her of: (1) making material misrepresentations in public filings, press releases, and communications with investors, in violation of Section 10(b) of the Exchange Act and Rule 10b-5 (Count I); (2) selling unregistered securities, in violation of Sections 5(a) and (c) of the Securities Act (Count II); (3) failing to file required ownership statements, in violation of Section 16(a) of the Exchange Act and Rule 16a-3 (Count V); (4) certifying SEC filings that she knew were misleading or contained material omissions, in violation of Rule 13a-14 (Count VI); and (5) aiding and abetting the company's failure to file required reports, maintain accurate books and records, and implement a system of internal controls over financial reporting, in violation of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B), as well as Rules 12b-20, 13a-1, 13a-11, and 13a-13 (Count VII). On the basis of these alleged violations, the Commission seeks a host of remedies including disgorgement, civil penalties, and an injunction prohibiting Grace from participating in penny-stock offerings, serving as an officer or director of issuers of securities, and engaging in further violations of federal securities laws.
After a lengthy and contentious discovery period, the SEC filed two separate Motions for Summary Judgment against Grace. See ECF Nos. 324, 386. The initial one addressed the first two counts against her -- i.e., that she violated Section 10(b) and Sections 5(a) and (c), along with their attendant rules. This Court has already resolved that Motion in favor of the Commission. See E-Smart II, 2014 WL 6612422. With respect to the Section 10(b) claim, the Court found that Grace had clearly violated the law by making material misrepresentations in a February 2008 press release about an e-Smart contract with Samsung. See Id. at *7-12. As to Sections 5(a) and (c), the Court concluded that Grace had participated in a convertible-loan scheme designed to sell millions of unregistered shares of e-Smart stock. See Id. at *12-16. It therefore entered judgment against her on Counts I and II.
The Court now turns to the SEC's Second Motion, which covers the three remaining counts.
II. Legal Standard
Summary judgment may be granted if " the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(a); see also Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-48, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986); Holcomb v. Powell, 433 F.3d 889, 895, 369 U.S.App.D.C. 122 (D.C. Cir. 2006). A fact is " material" if it is capable of affecting the substantive outcome of the litigation. See Liberty Lobby, 477 U.S. at 248; Holcomb, 433 F.3d at 895. A dispute is " genuine" if the evidence is such that a reasonable jury could return a verdict for the nonmoving party. See Scott v. Harris, 550 U.S. 372, 380, 127 S.Ct. 1769, 167 L.Ed.2d 686 (2007); Liberty Lobby, 477 U.S. at 248; Holcomb, 433 F.3d at 895. " A party asserting that a fact cannot be or is genuinely disputed must support the assertion" by " citing to particular parts of materials in the record" or " showing that the materials cited do not establish the absence or presence of a genuine dispute, or that an adverse party cannot produce admissible evidence to support the fact." Fed.R.Civ.P. 56(c)(1).
When a motion for summary judgment is under consideration, " [t]he evidence of the non-movant is to be believed, and all justifiable inferences are to be drawn in [her] favor."
Liberty Lobby, 477 U.S. at 255; see also Mastro v. PEPCO, 447 F.3d 843, 850, 371 U.S.App.D.C. 68 (D.C. Cir. 2006); Aka v. Wash. Hosp. Ctr., 156 F.3d 1284, 1288, 332 U.S.App.D.C. 256 (D.C. Cir. 1998) ( en banc ). On a motion for summary judgment, the Court must " eschew making credibility determinations or weighing the evidence." Czekalski v. Peters, 475 F.3d 360, 363, 374 U.S.App.D.C. 351 (D.C. Cir. 2007). The nonmoving party's opposition, however, must consist of more than mere unsupported allegations or denials and must be supported by affidavits, declarations, or other competent evidence, setting forth specific facts showing that there is a genuine issue for trial. See Fed.R.Civ.P. 56(e); Celotex Corp. v. Catrett, 477 U.S. 317, 324, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). The nonmovant is required to provide evidence that would permit a reasonable jury to find in its favor. Laningham v. Navy, 813 F.2d 1236, 1242, 259 U.S.App.D.C. 115 (D.C. Cir. 1987). If the nonmovant's evidence is " merely colorable" or " not significantly probative," summary judgment may be granted.
Liberty Lobby, 477 U.S. at 249-50.
This Court has previously discussed, at considerable length, the various shortcomings of Grace's pleadings in this case. See E-Smart II, 2014 WL 6612422, at *5-6. Unfortunately, it once again finds itself trudging through her jumbled and confusing submissions. That is no small task. It does so largely unaided by briefing, as Grace here essentially re-filed her Opposition to the SEC's First Motion for Summary Judgment, save for a few minor changes. Significant portions of it are, accordingly, irrelevant to the Second Motion, which deals with different counts from the First Motion. Indeed, in 46 pages, she devotes no more than a few sentences to several of the key claims involved in the SEC's Second Motion. The brief, additionally, does not provide citations to her Statements of Fact.
Those Statements -- there are multiple -- also prove particularly opaque. Over the course of two weeks, she submitted 12 different documents labeled " Statement of Facts," totaling 579 pages. See ECF Nos. 435-1; 437-1; 440-1; 440-2; 440-3; 440-4; 440-5; 440-6; 452-1; 458-1; 464-2; 464-3. There is no discernible organization to these Statements, and they contain almost no record citations to the over 6,000 pages of other material that she filed. Instead, her Statements consist largely of copied-and-pasted materials and unsupported assertions, the relevance of which is often unclear.
These sorts of pleadings have made addressing the Motions for Summary Judgment in this case extremely taxing. But as with the SEC's First Motion, the Court is mindful of the impact of granting summary judgment when a pro se litigant is involved. It has, consequently, waded through her Statements to determine whether she has presented evidence to establish that there are genuine disputes of material fact. In the end, it finds that undisputed evidence shows that she violated the provisions in Count V and Count VII, but that summary judgment on Count VI would be premature on the present record. The Court will take up the counts in this order.
A. Count V: Section 16(a) Violations
Section 16(a) of the Exchange Act provides that " [e]very person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security (other than an exempted security) which is registered pursuant to section 78l of this title, or who is a director or an officer of the issuer of such security" must file ownership statements with the SEC. See 15 U.S.C. § 78p(a)(1). These include initial ownership statements on Form 3, statements disclosing changes in beneficial ownership on Form 4, and annual statements on Form 5. See id. § 78p(a)(2); 17 C.F.R. § 240.16a-3. To establish a violation of these provisions, the SEC must show that Grace was an officer, director, or 10% beneficial owner and that she did not file Section 16(a) disclosures after an applicable triggering event. See SEC v. Prince, 942 F.Supp.2d 108, 131 (D.D.C. 2013).
As this Court mentioned in its Opinion addressing Grace's Motion to Dismiss, the D.C. Circuit has not addressed whether scienter is an element that the SEC must prove to establish a violation of Section 16(a).
See E-Smart I, 31 F.Supp.3d at 86 (citing Prince, 942 F.Supp.2d at 137 n.14). Because Grace did not raise the issue at that earlier stage, the Court did not have reason to rule on it then. Id. Now, however, because the Commission has not pointed to any evidence of scienter, the Court must decide whether the agency must offer proof of this element.
After surveying the rather limited caselaw on Section 16(a), the Court believes that scienter is not required. First, numerous district courts, including one in this jurisdiction, have consistently held that Section 16(a) does not require a showing of scienter and have treated it as a strict-liability provision. See Prince, 942 F.Supp.2d at 131 (although not reaching decision on § 16(a) violation, noting scienter is not required element); SEC v. Verdiramo, 890 F.Supp.2d 257, 274 n.14 (S.D.N.Y. 2011) (stating that no showing of scienter is required to establish violations of § 16(a)); SEC v. Sierra Brokerage Services, Inc., 608 F.Supp.2d 923, 957 n.32 (S.D. Ohio 2009), aff'd, 712 F.3d 321 (6th Cir. 2013) (same); SEC v. Teo, No. 04-1815, 2010 WL 3184349, at *9-10 (D.N.J. Aug. 10, 2010) (finding § 16(a) violation without addressing scienter ); SEC v. Save the World Air, Inc., No. 01-11586, 2005 WL 3077514, at *14 (S.D.N.Y. Nov. 15, 2005) (same); SEC v. Solucorp Indus., Ltd., 274 F.Supp.2d 379, 420 (S.D.N.Y. 2003) (same); SEC v. Poirier, 140 F.Supp.2d 1033, 1045-46 (D. Ariz. 2001) (same).
Second, the D.C. Circuit has ruled that scienter is unnecessary to establish a violation of Section 13(d)(1), a very similar reporting provision. See SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1167, 190 U.S.App.D.C. 252 (D.C. Cir. 1978). Section 13(d)(1) provides that those who directly or indirectly become beneficial owners of 5% or more of a class of an issuer's equity securities must file disclosure reports with the Commission.
See id. at 1159 n.26; 15 U.S.C. § 78m(d)(1). The Circuit explained that " [t]he language of section 13(d)(1) indicates clearly that it is a reporting, and not an antifraud, provision." Id. at 1167. The Supreme Court's determination in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), that scienter was required to establish violations of the antifraud provisions in Section 10(b) was, therefore, irrelevant. See id. After all, in Ernst, the Supreme Court had " seized upon [Section 10(b)'s] use of the words 'manipulative,' 'deceptive,' 'device,' and 'contrivance'" to determine that it was directed at intentional conduct. Id. (quoting Ernst & Ernst, 425 U.S. at 197) (some internal quotation marks omitted). " [T]he plain language of section 13(d)(1)," by contrast, " gives no hint that intentional conduct need be found" -- instead, it " appears to place a simple and affirmative duty of reporting on certain persons." Id. The same is true of Section 16(a). The Court thus believes that to hold Grace liable for Section 16(a) violations does not require a finding of scienter.
With that issue settled, Count V is quickly resolved against Grace. E-Smart was an issuer of securities registered under Section 78 l (g). See 2006 10-KSB at 1; Mot., Att. 2 (2007 10-K) at 1. There is no doubt that she did not file any ownership statements, see Defs.' Am. Ans., ¶ 10, and she was clearly required to file. In fact, she fit the bill for each of the categories of persons obligated to file reports under Section 16(a): she was the President and CEO of e-Smart, see, e.g., Defs.' Am. Answer, ¶ 17, and was, consequently, an " officer" of the company. See, e.g., 17 C.F.R. § 240.16a-1(f) (" The term 'officer' shall mean an issuer's president . . . ." ). She also served as one of the company's directors and was subject to Section 16(a)'s requirements in that role as well. See Defs.' Am. Answer, ¶ 17. Finally, she was a beneficial owner of more than 10% of e-Smart's securities.
Ignoring the first two categories, either of which is sufficient for liability, Grace only challenges the last. Determining who is a " beneficial owner" covered by Section 16(a) is guided by the definition of that term in Section 13(d) of the Act and its attendant rules. See 17 C.F.R. § 240.16a-1(a)(1). There, " a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (1) Voting power which includes the power to vote, or to direct the voting of, such security; and/or, (2) Investment power which includes the power to dispose, or to direct the disposition of, such security." 17 C.F.R. § 240.13d-3(a). Grace wielded voting power over the majority of e-Smart's stock: she was the majority shareholder of IVI, and IVI owned a clear majority of e-Smart's securities at various times. See Defs.' Ans., ¶ 19; 2007 10-K at 11 (" IVI has historically had and will continue to have the ability to control the outcome of all matters requiring stockholder approval." ); see also, e.g., Adoption of Beneficial Ownership Disclosure Requirements, Release No. 13291 (Feb. 24, 1977) (providing as an example of an indirect beneficial owner of an issuer under § 13(d)(1) a person who owns a majority of a corporation that, in turn, holds 5% or more of the issuer's securities).
Grace makes bald assertions in her Statements that she was not IVI's majority shareholder, suggesting that Intermarket held that role instead. See Defs.' Statement of Facts, Part 2A, ECF No. 452-1, at 5-6. Aside from the facts that she already admitted to having been IVI's majority shareholder, see Defs.' Ans., ¶ 19, and that the only evidence she points to is e-Smart's 2006 10-KSB, which actually contradicts her assertion, see 2006 10-KSB at 41 (" Intermarket . . . owns 37.5% of the outstanding shares of IVI." ), her contention would not help her since she has also admitted that she was Intermarket's majority shareholder. See Defs.' Ans., ¶ 20. If she controlled IVI through Intermarket, and IVI in turn controlled e-Smart, she still would have been an indirect beneficial owner of greater than 10% of e-Smart's securities. There is, in sum, no question that Grace was required to file -- at the very least -- an initial ownership statement on Form 3, but she failed to do so.
In her defense, Grace offers only a vague argument that counsel told her the disclosures in the company's 10-K filings were " adequate and accurate." Opp. at 38. Because scienter is not a required element, this assertion appears immaterial. See, e.g., SEC v. Levy, 706 F.Supp. 61, 69 (D.D.C. 1989) (holding in related § 13(d)(1) context that relying on an attorney's advice was irrelevant because scienter was not required element). Even if reliance on counsel were a good defense, however, Grace would still be out of luck as she has failed to establish the elements of such a defense. Specifically, to demonstrate that she relied on counsel, she would need to show that she: " (1) made a complete disclosure to counsel; (2) requested counsel's advice as to the legality of the contemplated action; (3) received advice that it was legal; and (4) relied in good faith on that advice." Zacharias v. SEC, 569 F.3d 458, 467, 386 U.S.App.D.C. 301 (D.C. Cir. 2009) (internal quotation marks and citation omitted). She has offered nothing more than an unsupported assertion in her brief that counsel informed her that the 10-K filings were " adequate." This does not suffice.
The Court also notes that such a defense would seem inapplicable here, given that Grace reviewed and certified the company's 10-Ks, which explicitly acknowledged that its executive officers and directors (among whom Grace was listed) were subject to Section 16(a)'s reporting requirements and that, to the best of the company's knowledge, none of its executive officers and directors had filed the necessary forms. See 2006 10-KSB at 38; 2007 10-K at 41-42.
Because the material facts related to this count are undisputed, summary judgment in favor of the SEC is warranted. See, e.g., Verdiramo, 890 F.Supp.2d at 273 (granting SEC summary judgment on § 16(a) claim); Sierra ...