Initial Decision of an SEC Administrative Law Judge
INITIAL DECISION RELEASE NO. 247
UNITED STATES OF AMERICA
Respondent e-Smart Technologies, Inc., f/k/a Plainview Laboratories, Inc. (e-Smart), repeatedly failed to file annual and quarterly reports while its common stock was registered with the Securities and Exchange Commission (Commission) in violation of the periodic reporting requirements of Section 13(a) of the Securities Exchange Act of 1934 (Exchange Act) and Rules 13a-1 and 13a-13 thereunder. This Initial Decision revokes the registration of e-Smart's common stock.
The Commission initiated this proceeding, pursuant to Section 12(j) of the Exchange Act, with an Order Instituting Proceedings (OIP) on December 16, 2002, and e-Smart filed a timely Answer. Shortly before the hearing, the Division of Enforcement (Division) sought to modify the OIP, withdrawing a claim under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and the Commission granted the modification on December 9, 2003 (Modification Order). See e-Smart, Exchange Act Rel. No. 48895. I held a one-day public hearing on December 8, 2003, in New York, New York, at which e-Smart called two witnesses and the Division called none. Three exhibits from e-Smart and five exhibits from the Division were admitted into evidence. The Division and e-Smart filed Post-Hearing Briefs on January 27 and January 30, 2004, respectively.1 Included with e-Smart's Post-Hearing Brief was an additional post-hearing submission, e-Smart's Form 10-QSB for the period ending September 30, 2003, not previously listed on the parties' joint exhibit list. I nonetheless take official notice of this filing, pursuant to Rule 323 of the Commission's Rules of Practice, 17 C.F.R. § 201.323, as it is publicly available over the Commission's Electronic Data Gathering, Analysis, and Retrieval System (EDGAR).
The OIP, as modified, alleges that at all relevant times, e-Smart's common stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act. While registered, the OIP alleges, e-Smart failed to comply with the reporting requirements of Section 13(a) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1, and 13a-13, by filing materially false and misleading reports with the Commission and failing to file annual and quarterly reports for several fiscal periods. If I conclude that these allegations are true, I must then determine, pursuant to Section 12(j) of the Exchange Act, what remedial sanction, if any, is appropriate.
FINDINGS OF FACT
The findings and conclusions herein are based on the entire record. I applied preponderance of the evidence as the standard of proof. Steadman v. SEC, 450 U.S. 91, 102 (1981). All arguments and proposed findings and conclusions inconsistent with this Initial Decision were rejected.
E-Smart, formerly known as Boppers Holdings, Inc., and Plainvew Laboratories, Inc., is a Nevada corporation headquartered in San Jose, California. (Div. Exs. 1, 3-5; Resp. Ex. 3.) IVI Smart Technologies, Inc., a Delaware corporation (IVI Smart), is e-Smart's parent corporation owning seventy percent of the outstanding shares of e-Smart's common stock. (Tr. 87-88; Div. Ex. 3 at 11.) Mary Grace (Grace) has served as e-Smart's president and chief executive officer (CEO) since 2001 and was company chairman prior to that. (Tr. 23.)
E-Smart's business comprises developing and producing "biometric verification security systems" for government entities to be used in combating identity theft and payment fraud. (Tr. 24; Div. Ex. 1.) Among its products is the "smart card," which is a small identification card capable of storing personal data and confirming the cardholder's identity by a fingerprint sensor embedded in the card. (Tr. 61-67; Div. Ex. 1.) Wayne Drizin (Drizin) and Tamio Saito (Saito) are co-inventors of the smart card. (Tr. 25, 177.) Drizin and Saito have been involved with e-Smart since its inception developing products and are listed on the company's patents. (Tr. 132.) Grace, Drizin, and Saito each own ownership interests in IVI Smart. (Tr. 87-88.)
On May 30, 2000, e-Smart registered its common stock with the Commission pursuant to Section 12(g) of the Exchange Act by filing a Form 10-SB (a registration statement for small business issuers). (Div. Ex. 3 at 6) The stock is quoted on the Pink Sheets and is thinly traded. (Tr. 130; Div. Ex. 3 at 12.) E-Smart's equity is financed by private transactions, and no equity has been received through the public issuance of its shares. (Tr. 123; Div. Ex. 3.) According to a quarterly report dated June 30, 2003, e-Smart owns assets worth $107,080, of which $57,771 is categorized as "furniture, equipment, and leasehold improvements." (Div. Ex. 3 at 3.) As of December 8, 2003, e-Smart "ha[d] no source of income," but the company maintains that it is on the verge of securing several lucrative agreements. (Tr. 72, 103.)
Since registering its securities, e-Smart has failed to file annual reports with the Commission on Form 10-KSB (an annual report for small business issuers) for the fiscal years ending December 31, 2000, 2001, and 2002. (Tr. 7; Div. Exs. 4-5.) E-Smart also failed to file any quarterly reports on Form 10-QSB (a quarterly report for small business issuers) for the quarterly periods between September 30, 2000, and June 30, 2003. (Tr. 7; Div. Exs. 4-5.) Between May 30, 2000, through the hearing date, e-Smart filed three unaudited quarterly reports: June 30, 2000, September 30, 2000, and June 30, 2003, the last of which was received late by the Commission on November 14, 2003. (Tr. 7, 112-13; Div. Exs. 4-5.) E-Smart also subsequently filed a Form 10-QSB for the period ending September 30, 2003. (Resp. Post-Hear. Brief at Ex. 1.) At the hearing, e-Smart admitted to failing to file its periodic reports. (Tr. 7.)
False and Misleading Reporting
In or about December 2001, certain members of e-Smart's management began to experience legal problems. (Tr. 34-35.) Grace and Drizin were both arrested and charged in actions brought by the U.S. Attorney's Office for the Southern District of New York. (Tr. 132; Div. Ex. 3 at 11.) Although the proceedings were eventually dismissed against both individuals, Drizin was later convicted in 2003 of wire fraud in a U.S. district court in Arizona. (Tr. 132-33, 138.) The conduct underlying the conviction occurred in 1994, was unrelated to e-Smart's business operations, and did not involve securities fraud. (Tr. 133.)
Grace's hearing testimony regarding Drizin's arrest and conviction conflicts with prior testimony taken in Drizin's criminal trial in Arizona. In a declaration filed in that proceeding, Grace described Drizin's availability with respect to e-Smart's operations as "indispensable" to the company. (Tr. 139-40) At the hearing, however, Grace characterized Drizin's current role as not vital to e-Smart's business. (Tr. 134.) E-Smart did not disclose Drizin's arrest or 2003 conviction in its Form 10-QSB, filed for the period ending June 30, 2003. (Tr. 134-36; Div. Ex. 3.) The filing does disclose the dismissals in the Southern District of New York. (Tr. 134-36; Div. Ex. 3 at 11.)
In mitigation of the alleged filing violations, e-Smart claims that it is presently engaged in substantial good faith efforts to update its filings and cites the recent filings of two unaudited quarterly reports as evidence. (Answer; Tr. 73-83, 111, 117, 146-47; Resp. Post-Hear. Brief 1-2.) At the hearing, Grace testified, in substance, that as a start-up company, with little or no capital, the company's failure to file periodic reports is due primarily to minimal financial resources, loss of key persons overseeing the company's financial reporting, and most notably, distractions relating to criminal proceedings brought against both her and Drizin in federal court beginning in December 2001. (Tr. 34, 74-75, 79-82, 103, 117.) Grace claimed that these distractions would no longer interfere with the company's reporting obligations. (Tr. 80-82.)
Certified Public Accountant Anthony Russo (Russo), recently retained by e-Smart to provide financial oversight and business development, corroborated Grace's testimony on compliance and estimated the cost of auditing the company for purposes of filing annual reports would range from $25,000 to $35,000. (Tr. 169-70; Resp. Ex. 3.) Russo also claimed that e-Smart would file an audited annual report for the 2003 fiscal year by the end of March 2004. (Tr. 160-61.) As for e-Smart's past filing failures, Russo opined, however, that "someone with experience could have done those 10-Qs and 10-Ks with little effort" and attributed noncompliance to "economics." (Tr. 180-81.)
CONCLUSIONS OF LAW
At the outset, it is unclear what timeframe the OIP covers. The OIP, issued on December 16, 2002, alleges that e-Smart filed materially false and misleading reports and failed to file periodic reports for "several fiscal periods" and that e-Smart was registered with the Commission at all "relevant times." Many actions the Division deems violative of the securities laws, however, occur well after the OIP was issued. Generally, arguments and factual matters falling outside the scope of the order instituting proceedings are considered only for limited purposes, such as background. Int'l S'holders Servs. Corp. , 46 S.E.C. 378, 386 n.19 (1976) ("The range of inquiry is broad. But it is not limitless."); see also Russell W. Stein, 79 SEC Docket 3098, 3114 n.34 (Mar. 14, 2003) (rejecting argument outside scope of order instituting proceedings). Conduct falling outside the scope of the order instituting proceedings may also be relevant for purposes of assessing sanctions. Robert Bruce Lohmann, 80 SEC Docket 1790, 1798 n.20 (June 26, 2003); J. Stephen Stout, 73 SEC Docket 1441, 1467 n.64 (Oct. 4, 2000); Joseph J. Barbato, 53 S.E.C. 1259, 1282 (1999).
E-Smart first filed its registration statement under Section 12(g) of the Exchange Act on May 30, 2000, commencing the company's periodic reporting obligations and the relevant period. The Commission instituted this proceeding on December 16, 2002. The Modification Order of December 9, 2003, simply dropped the allegation that e-Smart violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and did not extend, abridge, or otherwise discuss, the relevant time period for the facts alleged. I conclude, then, that the relevant time period for assessing whether e-Smart committed the charges set forth in the OIP must be fairly limited to the period from May 30, 2000, to December 16, 2002. See Richmark Capital Corp., 77 SEC Docket 621, 650 (Mar. 18, 2002) (limiting timeframe for Division's proof of alleged violative conduct to period set forth in OIP), aff'd, 81 SEC Docket 2205 (Nov. 7, 2003). Those events, cited by both parties, occurring outside the scope of the OIP will be considered only as background or for assessing sanctions.
Section 13(a) of the Exchange Act and the rules promulgated thereunder require issuers of securities, registered pursuant to Section 12 of the Exchange Act, to file periodic and other reports with the Commission. Exchange Act Rules 13a-1 and 13a-13 require the submission of annual and quarterly reports, respectively. Implicit in these regulations is the requirement that the reports accurately reflect the financial condition and operating results of the issuer. See SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975); SEC v. IMC Int'l, Inc. , 384 F. Supp. 889, 893 (N.D. Tex. 1974), aff'd mem., 505 F.2d 733 (5th Cir. 1974), cert. denied sub nom. Evans v. SEC, 420 U.S. 930 (1975). No showing of scienter, that is, mental state embracing intent to deceive, manipulate, or defraud, is necessary to establish a violation of Section 13(a) or the regulations thereunder. SEC v. McNulty, 137 F.3d 732, 740-41 (2d Cir. 1998); SEC v. Wills, 472 F. Supp. 1250, 1268 (D.D.C. 1978).
The importance of the reporting requirements is considerable. By updating information in the issuer's registration statement, periodic reports help ensure that the investing public receives current, accurate information concerning the operation and financial condition of the company. Kalvex, 425 F. Supp. at 315-16; see also WSF Corp. , 77 SEC Docket 1831, 1836 (May 8, 2002), final, 77 SEC Docket 2336 (May 24, 2002). "The reporting requirements of the [Exchange Act are] the primary tool which Congress has fashioned for the protection of investors from negligent, careless, and deliberate misrepresentations in the sale of stock and securities. Congress has extended the reporting requirements even to companies, which are relatively unknown and insubstantial." SEC v. Beisinger Indus. Corp. , 552 F.2d 15, 18 (1st Cir. 1977) (quoting S. Rep. No. 88-379 (1964) (legislative history discussing disclosure requirements for over-the-counter markets)).
E-Smart admits to failing to file annual and quarterly reports during the relevant period. Accordingly, e-Smart violated Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder. During the relevant period, the investing public was deprived of current, accurate financial information on e-Smart.
False and Misleading Reporting
Rule 12b-20 of the Exchange Act requires issuers of registered securities to include in their reports before the Commission all material information necessary to make the required statements, in light of the circumstances in which they are made, not misleading. In practice, "[t]his rule provides that once disclosure has been made, the issuer must be sure to add all other and further material information needed to [e]nsure that the disclosures, which have been made, are not materially misleading." United States v. Yeamen, 987 F. Supp. 373, 380 (E.D. Pa. 1997). A violation of this provision occurs when a filing contains false or misleading information that is material, or omits to state material information necessary so that the statements made are not misleading. Willis, 472 F. Supp. at 1268; Kalvex, 425 F. Supp. at 315-16. As with other corporate reporting provisions, no showing of scienter is necessary to establish a violation. SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1167 (D.C. Cir. 1978); Terex Corp., 69 SEC Docket 1814, 1834 n.11 (Apr. 20, 1999).
The Division contends that e-Smart violated Rule 12b-20 of the Exchange Act because it failed to disclose in its Form 10-QSB for the period ending June 30, 2003, that Drizin, a vital e-Smart employee, was arrested and later convicted of wire fraud. The Division's argument, however, is not persuasive. In order for a violation of 12b-20 to occur, there must be an actual filing. During the relevant period, e-Smart filed its registration statement, no annual reports, and only two quarterly reports in 2000. The Division does not contend that these filings are in violation of the reporting requirements. The quarterly report upon which the Division does rely (for the period ending June 30, 2003) did not exist at the time the instant case was instituted. This filing is beyond the scope of the OIP. Therefore, I conclude that e-Smart did not violate Rule 12b-20 of the Exchange Act. This allegation of the OIP must be dismissed.
Since I have concluded that e-Smart violated Section 13(a) of the Exchange Act and its Rules 13a-1 and 13a-13, the only remaining issue is the appropriate sanction. Section 12(j) of the Exchange Act authorizes the Commission, "as it deems necessary or appropriate for the protection of investors," to revoke the registration of a security or suspend the registration of a security for a period not exceeding twelve months if it finds, after notice and an opportunity for hearing, that the issuer of such security has failed to comply with any provision of the Exchange Act or the rules and regulations thereunder. The Division argues that revocation of e-Smart's registration of common stock is appropriate. E-Smart, on the other hand, requests a grace period within which to complete and file its audited annual reports for the years 2002 and 2003.
In determining whether a sanction is appropriate under Section 12(j) of the Exchange Act, the public interest factors identified in Steadman v. SEC are instructive. 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981); see also WSF Corp. , 77 SEC Docket at 1836-37 (12(j) case applying Steadman). The relevant factors under Steadman are (1) the egregiousness of the respondent's actions, (2) the isolated or recurrent nature of the infraction, (3) the degree of scienter involved, (4) the sincerity of the respondent's assurances against future violations, (5) the respondent's recognition of the wrongful nature of its conduct, and (6) the likelihood of future violations. 603 F. 2d at 1140. No one factor controls. WHX Corp. , 80 SEC Docket 1318, 1337 (June 4, 2003).
The severity of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. See Berko v. SEC, 316 F.2d 137, 141-42 (2d Cir. 1963). Any failure to cooperate with the Commission to remedy the violations may suggest a propensity to engage in future violations. SEC v. First New Jersey Secs., Inc. , 101 F.3d 1450, 1477 (2d Cir. 1996). Consideration of hardship and equitable factors may also be appropriate, but the public's interest in preventing future violations is paramount. SEC v. Manor Nursing Centers, Inc. , 458 F.2d 1082, 1102 (2d Cir. 1972).
Several factors under Steadman call for a strong sanction. E-Smart's violations were not only recurrent but also egregious, lasting over three years and continuing to the present. E-Smart has never filed audited annual reports and since September 2000, has filed just two unaudited quarterly reports, with those only becoming available near the hearing date. Grace's words may demonstrate that e-Smart recognizes the wrongfulness of its filing failures, but the company's three-year hiatus from complying with the reporting requirements exhibits a very different attitude toward the federal securities laws. Further, although e-Smart represents that it intends to bring itself into full compliance with the periodic reporting requirements no later than March 31, 2004, this endeavor seems doomed. Based on cost estimates for audited reports, a dearth in its operating revenues and available capital, and no clear evidence beyond rosy speculation that funding is forthcoming, I conclude that e-Smart's persistent noncompliance will likely continue beyond March 31, 2004.
In lieu of revocation, e-Smart proposes a grace period as the appropriate sanction. Such a sanction, however, is not available under Section 12(j) of the Exchange Act. A variant of e-Smart's sanction proposal that might be authorized by Section 12(j) is a suspension of e-Smart's registration. If e-Smart fails to bring itself into compliance at the conclusion of the suspension period, the Commission, however, would be required to initiate a new administrative proceeding to revoke e-Smart's registration. The overwhelming evidence convinces me that e-Smart cannot readily remedy its periodic reporting violations, which will likely recur in the future. Accordingly, I conclude that a suspension will not sufficiently protect the investing public.
E-Smart's failure to file required periodic reports has deprived the investing public of current, reliable audited information regarding e-Smart's operations and financial condition. Although private transactions may comprise all of e-Smart's funding, the company's common stock remains publicly available, and there is little or no available information upon which existing and potential investors can rely. In fact, only the insiders know the company's true financial state, while the public is left to guess. Having considered the Steadman factors in their entirety, I conclude that the only appropriate sanction for the protection of investors is revocation of the registration of e-Smart's common stock.
CERTIFICATION OF RECORD
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), I hereby certify that the record includes the items set forth in the record index issued by the Secretary of the Commission on February 18, 2004.
Based on the findings and conclusions set forth above:
IT IS ORDERED that, pursuant to Section 12(j) of the Securities Exchange Act of 1934, the registration of the common stock of e-Smart Technologies, Inc., f/k/a Plainview Laboratories, Inc., be and it hereby is REVOKED, for the company's violations of the periodic reporting requirements of Section 13(a) of the Securities Exchange Act of 1934 and Rules 13a-1 and 13a-13 thereunder; and
IT IS FURTHER ORDERED that the allegation in the OIP that e-Smart Technologies, Inc., f/k/a Plainview Laboratories, Inc., violated Rule 12b-20 of the Securities Exchange Act of 1934, be and it hereby is DISMISSED.
This Initial Decision shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice, 17 C.F.R. § 201.360. Pursuant to that rule, a petition for review of this Initial Decision may be filed within twenty-one days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) of the Commission's Rules of Practice, 17 C.F.R. § 201.360(d)(1), within twenty-one days after service of the Initial Decision upon them, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this Initial Decision as to any party. If a party timely files a petition for review, or the Commission acts to review as to a party, the Initial Decision shall not become final as to that party.
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