UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA
SECURITIES AND EXCHANGE
COMMISSION,
Plaintiff,
v. Civil Action No. 11-895 (JEB)
E-SMART TECHNOLOGIES, INC., et al.,
Defendants.
MEMORANDUM OPINION
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
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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.
I. Background
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.
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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
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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.
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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 (1986); Holcomb v.
Powell, 433 F.3d 889, 895 (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 (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 (D.C. Cir. 2006); Aka v.
Wash. Hosp. Ctr., 156 F.3d 1284, 1288 (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 (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 (1986). The nonmovant is required to provide evidence that would
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permit a reasonable jury to find in its favor. Laningham v. Navy, 813 F.2d 1236, 1242 (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.
III. Analysis
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,
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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
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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 (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 (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” –
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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 78l(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
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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
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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 (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 Brokerage Services, Inc., 608 F. Supp. 2d at 954-57
(same).
B. Count VII: Aiding and Abetting Violations
Section 20(e) of the Exchange Act gives the SEC the power to prosecute those who aid
and abet violations of federal securities laws. See 15 U.S.C. § 78t(e). To establish liability for
this type of violation, the SEC must prove: “(1) that a principal committed a primary violation;
(2) that the aider and abettor provided substantial assistance to the primary violator; and (3) that
the aider and abettor had the necessary ‘scienter’ . . . .” See Graham v. SEC, 222 F.3d 994, 1000
(D.C. Cir. 2000). There has been some debate about the type of scienter required to hold
individuals liable under Section 20(e). For instance, although Graham held that knowing or
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reckless conduct would suffice to establish aiding-and-abetting liability, another court in this
jurisdiction has pointed out that Graham addressed aiding and abetting in an administrative
action and that, prior to 2010, the express statutory language of Section 20(e) stated that those
who “knowingly” provided substantial assistance to securities violations were liable. See SEC v.
Johnson, 530 F. Supp. 2d 325, 332-33 (D.D.C. 2008). That court, accordingly, required proof of
actual knowledge. See id. The Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 amended the statute, making it clear that knowing or reckless conduct now suffices. See
Pub. L. No. 111-203, § 929O. Thankfully, the Court need not resolve whether recklessness was
sufficient prior to Dodd-Frank, as it finds that Grace knowingly assisted e-Smart’s pre-2010
violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B), along with their attendant rules. Each
of these three provisions merits a separate analysis.
1. Section 13(a) and Related Rules
Section 13(a) requires issuers of registered securities to file with the SEC any annual
reports, quarterly reports, or information and documents that the SEC may require. See 15
U.S.C. § 78m(a). Implementing that requirement, Rules 13a-1, 13a-11, and 13a-13 command
issuers of registered securities to file annual (Form 10-K), current (Form 8-K), and quarterly
(Form 10-Q) reports. See 17 C.F.R. §§ 240.13a-1, 240.13a-11, 240.13a-13.
Here, the Commission provides evidence that e-Smart did not file annual (10-K) reports
for 2008, 2009, 2010, 2011, 2012, or 2013, and that it also did not file reports for any quarter
ending after September 30, 2007. See EDGAR Search Results at http://www.sec.gov/cgi-
bin/browse-edgar?company=e-smart&owner=exclude&action=getcompany. As Grace points
out in her Opposition, the Commission revoked e-Smart’s registration under Section 12(g) on
January 23, 2012. See Opp. at 38; Order Revoking Registration, available at
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http://www.sec.gov/Archives/edgar/data/1112999/999999999712006081/filename1.pdf. This
would seem to have ended e-Smart’s reporting obligations as an issuer of securities registered
pursuant to Section 12, see 15 U.S.C. § 78m(a), although the company may still have been
subject to Section 13(a)’s reporting requirements pursuant to Section 15(d) of the Exchange Act.
See 15 U.S.C. § 78o(d). The Court need not dwell on this issue without the aid of briefing,
however, because it is clear that, in any event, the company failed to file numerous required
reports for the years and quarters preceding its registration revocation. These failures
unquestionably violated Section 13(a), as well as Rules 13a-1 and 13a-13.
As if that were not enough, the Commission also provides evidence that the reports e-
Smart did file were often submitted long after the applicable deadlines. For instance, the
company’s 10-Ks, which it filed as a smaller reporting company, see 2006 10-KSB; 2007 10-K
at 2, were due within 90 days after the close of each fiscal year. See, e.g., Form 10-K, General
Instructions, available at https://www.sec.gov/about/forms/form10-k.pdf; Revisions to
Accelerated Filer Definition and Accelerated Deadlines for Filing Periodic Reports, Release No.
33-8644 (Dec. 21, 2005). But e-Smart did not file its 10-KSB for the fiscal year ending
December 31, 2006, until many months after the deadline, on October 24, 2007. See 2006 10-
KSB at 47. E-Smart was even more delinquent in filing its 10-K for the fiscal year ending
December 31, 2007 – it did not file it until May 27, 2009, fourteen months after it was due. See
2007 10-K at 51. These late filings thus also violated Section 13(a) and Rule 13a-1. See 17
C.F.R. § 240.13a-1 (“Annual reports shall be filed within the period specified in the appropriate
form.”); see also Savoy Indus., 587 F.2d at 1165 (reporting requirements “are satisfied only by
the filing of complete, accurate, and timely reports”) (citation omitted and emphasis added); SEC
v. IMC Intern., Inc., 384 F. Supp. 889, 893 (N.D. Tex. 1974) (company violated reporting
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requirements of § 13(a) by not filing timely annual and quarterly reports); SEC v. Beisinger
Indus. Corp., 421 F. Supp. 691, 695 (D. Mass. 1976) (“The failures to provide timely reports . . .
are offensive to the central purpose of the periodic reporting system Congress established
through the Exchange Act. For the system to work properly the information reported must be
both current and adequate.”).
The evidence further shows that Grace provided substantial assistance with respect to e-
Smart’s violations. As CEO, she bore significant responsibility for the company’s SEC filings.
See, e.g., 17 C.F.R. § 240.13a-14(a) (requiring issuers’ principal executives to review and certify
reports); id., § 240.13a-14(c) (prohibiting principal executives from having certifications signed
on their behalf). Yet she did not provide the resources or oversight to ensure that e-Smart
prepared and submitted reports on time.
Grace was also clearly aware of the company’s duty to file annual reports. E-Smart had
previously filed yearly reports that she reviewed and certified. See, e.g., 2006 10-KSB. Other
events also alerted her to this duty. For instance, e-Smart’s Board of Directors wrote to Grace in
January 2009, warning her of its members’ intention to resign because of her failures to
adequately oversee the company. See Mot., Att. 34 (Letter from Charles R. Black, et al. to
Grace, Jan. 12, 2009). Among other things, the Board noted:
[W]e have repeatedly cautioned you that the Company must devote
all of the resources necessary to address . . . important issues faced
by the Company, including the need to cooperate fully with the
Securities and Exchange Commission (“SEC”) in connection with
its investigation of e-Smart, and to bring all of the Company’s SEC
filings current and to ensure that they remain current.
Id. at 1. The letter again urged that “[a]dequate resources must be devoted to the assurance that
the Company’s SEC filings are brought into full compliance.” Id. at 2. Despite this strongly
worded admonition, e-Smart, with Grace at the helm, continued to neglect these reporting
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requirements. Indeed, aside from the 2007 10-K that was filed in May 2009, e-Smart did not file
another report after this letter.
The Commission is, therefore, entitled to summary judgment against Grace on the ground
that she knowingly aided and abetted e-Smart’s violations of Section 13(a), along with Rules
13a-1 and 13a-13.
2. Section 13(b)(2)(A)
Section 13(b)(2)(A) requires every issuer of registered securities to “make and keep
books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the issuer.” 15 U.S.C. § 78m(b)(2)(A).
“Reasonable detail” is defined as the “level of detail . . . [that] would satisfy prudent officials in
the conduct of their own affairs.” 15 U.S.C. § 78m(b)(7). The provision “has three basic
objectives: (1) books and records should reflect transactions in conformity with accepted
methods of reporting economic events, (2) misrepresentations, concealment, falsification,
circumvention, and other deliberate acts resulting in inaccurate financial books and records are
unlawful, and (3) transactions should be properly reflected on books and records in such a
manner as to permit the preparation of financial statements in conformity with [generally
accepted accounting principles] and other criteria applicable to such statements.” SEC v. World-
Wide Coin Investments, Ltd., 567 F. Supp. 724, 748 (N.D. Ga. 1983) (citation omitted). Its
purpose “is to strengthen the accuracy of records and the reliability of audits.” Id. at 749.
The Court need not address all of the claimed deficiencies in e-Smart’s books and records
because it finds that the company’s concealment of a convertible-loan scheme to sell
unregistered securities resulted in inaccurate financial books and records. As explained in this
Court’s Opinion on the SEC’s First Motion for Summary Judgment, Grace and others operated
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such a scheme from 2005 to 2007 to sell unregistered shares of e-Smart stock. See 2014 WL
6612422, at *13-16. Under the scheme, “lenders” provided short-term loans to Intermarket and
IVI, which in turn offered restricted shares of e-Smart stock as collateral. When the loans went
into default – the inevitable and intended outcome – the lenders could convert the notes to e-
Smart stock at below-market rates. Grace would then authorize e-Smart’s transfer agent to issue
unrestricted shares to the lenders on the basis of opinion letters from Maranda Fritz, e-Smart’s
outside counsel. Later, e-Smart would issue IVI and Intermarket enough restricted shares to
maintain the companies’ respective ownership percentages. As a result of this scheme, e-Smart
distributed millions of unregistered, free-trading shares. See id. at *13.
This scheme necessarily distorted e-Smart’s books. For instance, in its 2007 10-K, the
company reported that it had issued 113,102,557 shares to IVI and Intermarket’s creditors for the
loans, the proceeds of which were used as “working capital” for e-Smart and IVI. See 2007 10-
K at 31. According to the 10-K, IVI and e-Smart had agreed to count the value of the shares it
distributed on behalf of those companies ($6,740,157) as payments for license fees that e-Smart
owed to IVI. See id. But as discussed above and in this Court’s prior Opinion, these
transactions were, in fact, disguised sales of e-Smart stock. Its books and records, therefore, in
no way “accurately and fairly” reflected the nature of e-Smart’s transactions or the disposition of
its assets. See SEC v. Black, No. 04-7377, 2008 WL 4394891, at *15 (N.D. Ill. 2008) (finding
on summary judgment that § 13(b)(2)(A) was violated where payments were incorrectly
characterized in company’s 10-K).
Grace also knowingly provided substantial assistance to this falsification of e-Smart’s
books. She was heavily involved in the loan scheme, see E-Smart II, 2014 WL 6612422, at *15-
16, and knew that this depiction of the transactions and their accounting on e-Smart’s books did
16
not reflect reality. See id. at *14. Indeed, in a June 2006 e-mail to e-Smart’s Board of Directors
about fundraising, Grace had explained, in an apparent reference to the $0.10-share conversion
rate under the loan scheme, that “there [wa]s not a shortage of shareholders who would buy stock
at $.10,” because “[t]he market [wa]s at $0.12.” Id. (citation omitted and emphasis added). As
CEO and CFO of e-Smart, she knowingly allowed this improper accounting to stand.
Her only response to the SEC’s allegations about the company’s books and records is to
maintain that outside auditors prepared and confirmed the company’s financial statements. See
Opp. at 38. She does not, however, provide any evidence regarding the representations that were
made to outside auditors about the loan transactions. She has therefore failed to show that the
auditors certified the accounting of the loans with an accurate understanding of the transactions.
The Court thus finds that e-Smart violated Section 13(b)(2)(A) and that Grace aided and
abetted these violations with scienter. See SEC v. Monterosso, 768 F. Supp. 2d 1244, 1270
(S.D. Fla. 2011) (granting summary judgment to SEC on claim that defendants aided and abetted
§ 13(b)(2)(A) violation where defendants falsified invoices).
3. Section 13(b)(2)(B)
Section 13(b)(2)(B) requires issuers to develop and maintain adequate internal controls
over financial reporting. More specifically, issuers must have internal accounting controls that
provide “reasonable assurances” that (1) “transactions are executed in accordance with
management’s general or specific authorization; (2) transactions are recorded “as necessary . . .
to permit the preparation of financial statements in conformity with generally accepted
accounting principles” and “to maintain accountability for assets”; (3) “access to assets is
permitted only in accordance with management’s general or specific authorization”; and (4) “the
recorded accountability for assets is compared with existing assets at reasonable intervals and
17
appropriate action is taken with respect to any differences.” 15 U.S.C. § 78m(b)(2)(B)(i)-(iv). A
“reasonable” degree of assurance is one that “would satisfy prudent officials in the conduct of
their own affairs.” 15 U.S.C. § 78m(b)(7). “Examples of internal controls include manual or
automated review of records to check for completeness, accuracy and authenticity; a method to
record transactions completely and accurately; and reconciliation of accounting entries to detect
errors.” McConville v. SEC, 465 F.3d 780, 790 (7th Cir. 2006). Here, the Commission argues
that the company lacked virtually any internal accounting controls to ensure that its financial
records and reports were accurate and to ensure that corporate assets were not misappropriated.
It has marshaled substantial evidence in support of these claims.
To begin, the company conceded that it had numerous internal-control failings when it
filed its 2007 10-K in May 2009. See 2007 10-K at 35-38. Those admitted weaknesses included
the following:
• “Many of the stock transactions lacked proper indication of issuance, cancellation, or
redemption.”
• “[T]he Company’s board minutes [we]re not always current.”
• “[S]ignatures were missing on most of the [board] minutes, and the ones that were
signed were frequently signed several months after the date of the appropriate
meeting.”
• The company “d[id] not have a formal policy regarding employee conflicts of
interest,” and having such a policy was “especially important considering the
magnitude of related part [sic] transactions.”
18
• There was poor communication among staff and outside consultants and “[o]ften
times, this included frequent misunderstandings that led to significant inaccurate
information.”
• There were “several instances where loans were made or received without a signed
loan agreement or having a note payable prepared and executed as appropriate
evidence.”
• “Th[e] Company d[id] not have regular board meetings.”
• The accounting staff needed “adequate training to become familiar with the necessary
procedures to complete the year-end accounting.”
• The accounting process “lack[ed] a higher-level supervisory or review function
typically performed by a Chief Financial Officer (CFO) or equivalent.”
• “During [the] audit process, [the company] encountered inconsistencies in the
supporting schedules of the following: fixed assets, inter-company accounts, and
equity transactions.”
2007 10-K at 37-38.
It is also clear that these were not new problems. Indeed, the lack of internal controls at
e-Smart was evident at least as early as the beginning of 2007. At that time, e-Smart’s outside
auditor, Horowitz & Ullmann, provided the company’s officers with a memo containing the
firm’s observations regarding a lack of controls and providing recommendations about policies
and procedures that the company could implement. See Mot., Att. 20 (Auditor Control
Recommendations); see also Att. 7 (Deposition of Stewart Hung) at 52:23-59:5. This memo
highlighted, among other things, that “[m]anagement is dominated by one person, the CEO, who
unilaterally makes the decisions for the Company.” Auditor Control Recommendations at 1.
19
The CEO also “control[led] the bank accounts.” Id. These circumstances created an ability, on
the part of management, “to override controls,” which elevated the risk of fraud, including the
risk that assets would be misappropriated and the risk of fraudulent financial reporting. Id. On a
related note, the memo noted “a significant lack of segregation of duties . . . with respect to the
management of the Company’s funds,” as “[t]he CEO [wa]s the sole signatory on most, if not all,
of the Company’s bank accounts” and “ha[d] the ability to disburse Company funds to any
individual or business without receiving any authorization from other members of management.”
Id. Other observations included “a lack of controls with respect to the accumulation of proper
documentation to support the Company’s disbursements,” “a lack of controls with respect to the
segregation of personal and business expenses,” the lack of an independent audit committee, the
“relatively inactive role” that the Board played in the company, and “a lack of controls . . . with
respect to the recording and reconciling of the issuance of common stock.” Id. at 1-2.
Other evidence that the SEC offers further demonstrates that the company lacked basic
controls, particularly with respect to stock issuances. For instance, the outside auditors found
that the company would issue more shares than were authorized. In November 2007, Stewart
Hung, one of e-Smart’s outside auditors, wrote to Anthony Russo, e-Smart’s accountant, stating:
I see that you have a huge problem with the shares. By the end of
March 2007, you have over 498M shares issued. But you are only
authorized to issue 490M in common shares. To date you have
753M share [sic] issued, but only authorized for 730M in common
shares.
These are seriously [sic] problem that you need to get [Grace] in
the office to discuss face-to-face. I will have a lot of issues with
the numbers as well as the dollar value. Even at the price of $.03,
she has to account for over 7.6M in cash just in the first quarter
alone.
20
Att. 24 (E-mail from Stewart Hung to Tony Russo (Nov. 16, 2007, 6:08 PM)); Hung Dep. at
94:4-95:4. Outside auditors were also frequently forced to seek additional information about
stock issuances because they did not receive adequate supporting documentation and because the
company would report stock issuances as canceled when they had not been. See Mot., Att. 29
(E-mail from Russell Greenblatt to Tony Russo (July 18, 2008, 4:51 PM)) at 1. Those auditors
even wrote to e-Smart’s Board in July 2008 to call its attention to 195,000,000 shares issued to
employees, consultants, directors, and others – amounting to approximately $13,400,000 charged
against the company’s income – that did not appear to have been approved by the Board. See
Mot., Att. 30 (Letter from Stewart Hung, CPA, Horowitz & Ullman, P.C. to “The Board of
Directors,” July 30, 2008) at 1.
Those inside the company similarly expressed concerns that e-Smart had significant
problems documenting Grace’s share issuances and that many of those issuances involved
possible conflicts of interest. For instance, Russo testified that Grace issued millions of e-Smart
shares to family members and others, such as a woman who watched her apartment in
Manhattan, without documentation. See Mot., Att. 9 (Deposition of Anthony Russo) at 61:17-
63:5. According to him, “She kept insisting they provided the company with services,” but no
documentation was provided to that effect – it was “just her word.” Id. at 62:17-63:5. E-Smart’s
long-time outside counsel Maranda Fritz also wrote a letter to the company’s Board in August
2008, disclosing a host of concerns about e-Smart’s management and controls, including that:
Grace ha[d] continuously caused the issuance of substantial
quantities of e-Smart stock to companies or entities controlled by
her and to family members. Those hundreds of thousands of
shares ha[d] been issued without any contemporaneous
documentation or authorization and under circumstances which
involve[d] substantial conflicts of interest, appear[ed] to lack
substance or adequate consideration, and generally redound[ed] to
the substantial detriment of the public company.
21
Mot., Att. 33 (Letter from Maranda Fritz to David B. Deitch, Aug. 7, 2008) at 2. 1
To be fair, the 2007 10-K, filed in May 2009, did claim that management was “in the
process of implementing remediation efforts with respect to the material weaknesses.” Id. at 38.
It stated, for instance, that the company had hired “an assistant controller in the New York office
as well as an outside accounting firm to supervise the [accounting] department and to work with
them to improve the quarter-end and year-end accounting procedures.” Id. The executive
secretary in New York had also been assigned the task of maintaining proper Board minutes.
Other planned efforts included making “a concentrated effort . . . to assure the board minutes are
signed timely,” “implementing a policy of monthly board meetings with appropriate minutes
signed in a timely matter [sic],” developing a “formal policy regarding employee conflicts of
interest drafted and implemented in 90 days,” and considering the development of a formal audit
committee. Id. at 38-39.
These remediation efforts, while commendable in theory, only highlight that e-Smart had
significant and longstanding internal-control problems. The Court notes, additionally, that they
did not address many of e-Smart’s shortcomings, including, for example, that Grace solely
controlled e-Smart’s accounts or that transactions frequently lacked documentation. And aside
from submitting evidence that an outside accounting firm was retained to help straighten out e-
Smart’s books, Grace has not shown that the remainder of the proposed efforts were
implemented or that they remedied the deficiencies.
1
Grace submits evidence that Fritz wrote this letter shortly after she was terminated as e-Smart’s counsel,
suggesting the potential that the assertions were biased. See Opp., Statement of Facts, Part 2A, ECF No. 452-1, at
51-55. The concerns expressed in Fritz’s letter, however, are consistent with the SEC’s other evidence, and Grace
does not submit any evidence to contradict the claim that she issued shares without prior authorization or
documentation in situations involving conflicts of interest.
22
Grace’s Opposition, in fact, does not mention the company’s internal controls. Even had
she relied on the outside-auditor certifications here, as she did with respect to the books-and-
records issue, see Opp. at 38, the Court finds that those certifications do not create a material
dispute as to whether the company satisfied its obligations under Section 13(b)(2)(B). For one
thing, e-Smart conceded that it had extensive problems with respect to its internal controls. For
another, the auditors’ certifications were of the company’s financial statements and did not
appear to address the adequacy of e-Smart’s controls. The auditor certification in the 2007 10-K,
for instance, specifically stated that the firm had not been “engaged to perform[] an audit of [e-
Smart’s] internal controls over financial reporting,” and that it expressed no opinion on their
effectiveness. See 2007 10-K at 19. Horowitz & Ullmann’s certifications of the 2005 10-
KSB/A and the 2006 10-K, additionally, made no mention of the company’s controls, and Grace
does not offer any evidence that the firm was retained to evaluate them. See 2005 10-KSB/A at
32; 2006 10-KSB at 21.
In her Statements, Grace disputes that she had “exclusive control” over e-Smart’s
business and financial matters, arguing that she obtained approval from the Board of Directors.
In support, she offers a series of unsigned minutes from Board meetings, see Statement of Facts,
Part 2A, ECF No. 452-1, at 6-22, and a handful of e-mails and snippets of testimony indicating
that the Board reviewed the 2006 10-K and ratified stock issuances. See id. at 37, 61. Whether
the Board subsequently ratified some of her decisions, however, is immaterial. As noted
previously, the company conceded in its 2007 10-K that it had numerous control problems
(including the relative inactivity of its Board). The fact that the Board may have subsequently
approved the issuance of stock does not speak to many of the control problems that were
identified, such as the lack of documentation for loans and stock issuances, the lack of training
23
and supervision for the “accounting department,” and the lack of systems to identify
inconsistencies in the company’s financial records prior to the outside auditing process. It is
highly ironic that Grace submits unsigned Board minutes as evidence of internal controls when
e-Smart listed as one of its weaknesses the fact that Board minutes were often not current and
that most lacked signatures. In sum, it is clear that e-Smart violated Section 13(b)(2)(B)’s
mandate to develop, implement, and maintain a system of internal controls.
It is likewise clear that Grace substantially assisted these violations. She was e-Smart’s
CEO and CFO and, consequently, bore special responsibilities with respect to the company’s
internal controls. See, e.g., 15 U.S.C. § 7241; 17 C.F.R. § 240.13a-14. Yet she failed to adopt
policies and procedures to ensure that transactions were appropriate and that improper or poorly
documented transactions were quickly remedied. Many of the shortcomings in the company’s
internal controls, furthermore, related specifically to Grace’s conduct. As an example, she was
largely, if not solely, responsible for the stock issuances that lacked supporting documentation.
See, e.g., Hung Dep. at 94:23-95:4 (Grace was the only person who authorized the issuance of
shares); Russo Dep. at 81:22-82:3; 88:10-93:2 (the stock-transfer agent only took direction from
Grace, and she was responsible for the issuance of shares without documentation).
Grace also clearly knew that the company lacked essentially all forms of internal
controls. She was, after all, the source of the problems: she regularly issued stock without
adequate supporting documentation, see, e.g., Russo Dep. at 61:17-63:5; she served on the
Board, which rarely met and rarely signed off on the minutes; she was the Chief Financial
Officer and could see that the accounting department was not adequately supervised; and she
knew that outside auditors frequently had trouble reconciling e-Smart’s transactions. See, e.g.,
24
E-mail from Russell Greenblatt to Tony Russo (July 18, 2008, 4:51 PM); Letter from Hung to
“The Board of Directors,” July 30, 2008.
She also signed certifications of the 10-K reports, which stated that she had evaluated the
company’s internal controls over financial reporting, thus indicating that she was aware of the
need to have and maintain internal controls. See, e.g., Certification of 2006 10-KSB. She
repeatedly claims in her Opposition that others affixed her signatures to these documents and that
she never reviewed them. See, e.g., Opp. at 14. The Court finds such assertions troubling
coming from the person whom the securities laws expressly tasked with reviewing and certifying
those documents. See 17 C.F.R. § 240.13a-14(c) (“A person required to provide a certification .
. . may not have the certification signed on his or her behalf pursuant to a power of attorney or
other form of confirming authority.”). But, more importantly, she does not provide any evidence
of this fact.
The Court is mindful that, in general, claims that issuers violated Section 13(b)(2)(B) or
that others aided and abetted such violations are not well suited for summary judgment.
Determinations about what is reasonable will often vary from company to company and require
“a fact-intensive inquiry.” Black, 2008 WL 4394891, at *15 (citations omitted). There can be
no dispute, however, that e-Smart – led by Grace – failed to establish even basic controls to
ensure that the company’s dealings were adequately documented and conducted in accordance
with appropriate authorization. Summary judgment in favor of the SEC is therefore warranted.
See McConville, 465 F.3d at 790 (affirming SEC’s finding that CFO failed to implement internal
accounting controls where company’s finance department was in disarray and company’s records
did not accurately reflect financial transactions).
25
C. Count VI: Rule 13a-14 Violations
Rule 13a-14 requires that certain reports, including 10-K reports, be accompanied by
certifications. See 17 C.F.R. § 240.13a-14. Specifically, “[e]ach principal executive and
principal financial officer of the issuer . . . must sign a certification,” id., that “based on the
officer’s knowledge, the report does not contain any untrue statement of a material fact or omit
to state a material fact.” 15 U.S.C. § 7241(a)(2). They must also state that “based on such
officer’s knowledge, the financial statements, and other financial information included in the
report, fairly present in all material respects the financial condition and results of operations of
the issuer.” Id., § 7241(a)(3).
As this Court noted in its Opinion on Grace’s Motion to Dismiss, there is some
disagreement among courts regarding whether the SEC may bring actions for violations of Rule
13a-14. See E-Smart I, 31 F. Supp. 3d at 86 (citing SEC v. Brown, 740 F. Supp. 2d 148, 164
(D.D.C. 2010)). The Court declined to decide the issue at that time, since Grace did not
challenge the SEC’s right to bring such a claim. Id. at 87. Now that the Commission moves for
summary judgment, the Court cannot defer judgment on the issue any longer.
Based upon a review of the applicable statutes, rule, and caselaw, it is ultimately
persuaded that the SEC may bring such actions. As another court in this jurisdiction explained,
the Commission is empowered, under Section 21(d)(1) of the Exchange Act, to bring civil-
enforcement actions to enjoin violations of Title 15 and the rules and regulations promulgated
under it. See Brown, 740 F. Supp. 2d at 165 (citing 15 U.S.C. § 78u(d)(1)). This includes Rule
13a-14. Courts have, accordingly, “routinely permitted” such claims when brought by the SEC.
Id. at 164-65 (collecting cases). The Court therefore considers the Commission’s claim that
26
Grace violated the Rule by knowingly certifying filings that were false or contained material
omissions.
The SEC bases its Rule 13a-14 claim here on Grace’s certifications of the company’s
annual 10-K reports. See Mot. at 8; see also Mot., Att. 17 (Certification of 2005 10-KSB/A);
Att. 15 (Certification of 2006 10-KSB); Att. 16 (Certification of 2007 10-K). According to the
Commission, the Amended 2005 and 2006 10-KSBs materially misrepresented the state of the
company’s technology. See Mot. at 8. Those two reports, the SEC claims, also omitted material
financial information by failing to disclose that the company was paying Grace’s personal
expenses and by failing to disclose the amount of those expenses. See id. Finally, it argues that
she stated in the certifications that she had reviewed the company’s internal controls over
financial reporting and determined that they were effective when she knew full well that the
company lacked meaningful controls. See id. The Court will address these arguments in reverse
order.
1. Effectiveness of Internal Controls
In rather cursory fashion, the Commission argues that Grace certified that the company’s
internal controls were effective when she knew that they were not. Although it is not clear from
the agency’s Motion, this argument clearly pertains only to the 2005 Amended 10-KSB and the
2006 10-KSB since the company disclosed in its 2007 10-K that Grace had found e-Smart’s
internal controls wanting. See 2007 10-K at 35-36. Looking, then, at Grace’s certifications of
the company’s 2005 10-KSB/A and 2006 10-KSB, which stated that e-Smart had effective
internal controls for financial reporting during those fiscal years, see, e.g., 2006 10-KSB at 32,
the Court finds that it cannot conclude, as a matter of law, that she signed the certifications
knowing at the time that they were false.
27
This may seem to be an odd result in light of the Court’s detailed finding above that e-
Smart lacked internal controls and that Grace was aware of those deficiencies. But the evidence
that the SEC has presented on these issues relates almost exclusively to 2007 and onward – that
is, after the time period that the 10-Ks address. At a hearing on this Motion, the SEC argued that
this evidence is relevant to fiscal years 2005 and 2006 because the internal-control issues were
not the types that just happen to arise. The SEC might be right. The Court, however, cannot find
as a matter of law that this is so.
2. Grace’s Personal Expenses
In a similarly perfunctory manner, the SEC contends that Grace violated Rule 13a-14 by
certifying the Amended 2005 10-KSB and the 2006 10-KSB even though those filings omitted
material financial information. The only specific omission noted in the agency’s brief is that the
reports did not “disclose[] that e-Smart was paying Grace’s business and personal expenses,
much less the amount of those expenses.” Mot. at 8. The Commission does not explain its
precise theory for why that information should have been disclosed. The Court assumes that the
agency believes such disclosure was necessary because companies are required to include a
“clear, concise and understandable disclosure” of any compensation “awarded to, earned by, or
paid to” certain executive officers, including the principal executive officer. See 17 C.F.R. §
229.402(a)(2)-(3). If the company was paying Grace’s personal expenses on top of her reported
salary of $250,000, then it would need to disclose the amount of those expenses as additional
compensation.
The problem is that there appear to be disputes of material fact with respect to whether
Grace’s personal expenses were reportable “compensation.” The 2007 10-K, in which the
company first divulged that it covered her personal expenditures, stated that “[e]xpenses deemed
28
to be strictly personal and unrelated to business by the companies’ management are deducted
from the total deferred compensation owed Ms. Grace by the respective companies.” 2007 10-K
at 31. She additionally provides testimony from Anthony Russo, the company’s accountant, that
over two fiscal periods in 2005 and 2006, “detailed tests” were conducted to determine that
approximately 23% of Grace’s expenses were personal, and that the company used that
percentage to calculate the amount of expenses that should be subtracted from her deferred
compensation. See Opp., Statement of Facts Part 1A, ECF No. 435-1, at 41-42; Unnumbered
Att. (Deposition of Anthony Russo), ECF No. 448-1, at 69:3-22. Hung also stated that when the
auditors could not identify some of her expenses as “legitimate business expense[s]” or when
they appeared “personal in nature,” they reclassified them as compensation. See Opp., Statement
of Facts Part 1A, ECF No. 435-1, at 3. Based on this, the Court cannot conclude that the 2005
Amended 10-KSB and 2006 10-KSB materially misrepresented her compensation when they
stated that “the aggregate compensation paid to, accrued by or set aside for” Grace was
$250,000. See 2005 10-KSB/A at 55, available at http://www.sec.gov/Archives/edgar/data/
1112999/000119312507095481/d10ksba.htm; see also 2006 10-KSB at 39.
Assuming, alternatively, that the Commission believes this type of arrangement should
have been disclosed regardless of whether the expenses were additional compensation, the Court
cannot conclude as a matter of law that this omission was material. As noted above, Rule 13a-14
requires officers to certify that a filing does not contain material misrepresentations or omissions.
For information to be material, “there must be a substantial likelihood that the disclosure of the
omitted fact would have been viewed by the reasonable investor as having significantly altered
the total mix of information made available.” Basic Inc. v. Levinson, 485 U.S. 224, 231-32
(1988) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)) (internal
29
quotation marks omitted); see Media General, Inc. v. Tomlin, 387 F.3d 865, 869 (D.C. Cir.
2004). In other words, facts are material if a reasonable investor would find them “important.”
SEC v. Steadman, 967 F.2d 636, 643 (D.C. Cir. 1992) (citing Basic Inc., 485 U.S. at 231-32).
Because materiality is a mixed question of law and fact, it is often difficult to resolve such issues
on summary judgment. See TSC Indus., 426 U.S. at 450 (“Only if the established omissions are
‘so obviously important to an investor, that reasonable minds cannot differ on the question of
materiality’ is the ultimate issue of materiality appropriately resolved ‘as a matter of law’ by
summary judgment.”) (quoting John Hopkins Univ. v. Hutton, 422 F.2d 1124, 1129 (4th Cir.
1970)); Media General, 387 F.3d at 869 (“Whether alleged misrepresentations or omissions are
material under the securities laws is a mixed question of law and fact that is particularly well
suited for jury determination.”). Here, it seems that reasonable minds could disagree as to
whether investors would find it important that a company was paying its executive $250,000 in
cash versus $250,000 through some combination of cash and reimbursements for personal
expenses. The Court, accordingly, finds that it cannot grant summary judgment on this basis.
3. The State of E-Smart’s Technology
Finally, the Commission suggests that Grace violated Rule 13a-14 by certifying e-
Smart’s 10-Ks even though she knew that they contained material misrepresentations about the
company’s technology. See Opp. at 8. On this issue, it relies primarily on the arguments and
facts laid out in its First Motion for Summary Judgment, where it contended that Grace had also
violated Section 10(b) of the Exchange Act and Rule 10b-5 as a result of those
misrepresentations. In resolving that First Motion, the Court did not reach this complex
technical issue because it found that she had violated Section 10(b) and Rule 10b-5 as a result of
her statements in the 2008 Samsung-contract press release.
30
The Court remains loath to enter this thicket now, before ruling on the SEC’s Motion for
Summary Judgment against Saito, which concerns similar and related technological issues. The
Court, accordingly, feels that it is more prudent and efficient to deny summary judgment at this
time on this asserted basis for Rule 13a-14 violations. It does so without prejudice, leaving open
the possibility of revisiting this claim after it rules on the SEC’s Saito Motion.
The Court, consequently, denies summary judgment on Count VI.
IV. Conclusion
For the foregoing reasons, the Court will grant the SEC’s Second Motion for Summary
Judgment against Grace on Counts V and VII of its Amended Complaint, and deny that Motion
as to Count VI. A contemporaneous Order will so state.
/s/ James E. Boasberg
JAMES E. BOASBERG
United States District Judge
Date: February 12, 2015
31