MOD Fraud? Investor’s Lawsuit Alleges Blatant Misuse of Funds by CEO

2/23/09Follow @gthuang

Seattle-based MOD Systems and three of its top executives are being sued by investor Robert Arnold for fraud, embezzlement, misrepresentation, and breach of fiduciary duty, among other complaints. That’s according to a lawsuit filed in King County superior court last Wednesday. Arnold’s investigation into the company was first reported by TechFlash.

In the suit, MOD Systems’ co-founder and CEO Mark Phillips is accused of using corporate funds for his personal benefit—including the purchase of a vehicle, travel and entertainment, and rent for his personal residence. Phillips is also accused of misrepresenting the digital-media-delivery company’s intellectual property to Arnold, who reportedly invested $3 million in the company. Arnold is a prominent philanthropist who donated $15 million to the Fred Hutchinson Cancer Research Center in 2005, and previously invested in Starbucks and other companies.

The lawsuit also names MOD’s co-founder and vice chairman, Anthony Bay, and chief operating officer Kenneth Gordon as defendants. In response, MOD’s chief financial officer Richard Barber said in a statement, “The company believes that the claims Mr. Arnold is asserting against MOD Systems itself are unfounded and without merit.”

Last September, the company received a $35 million strategic investment from Toshiba, NCR, and others. That deal figures prominently in some of the suit’s specific allegations. For instance, Arnold claims the deal gave Toshiba the power to use MOD’s intellectual property for its own interests, and that Phillips and Bay were given special treatment, such as the right of first refusal to buy preferred shares—and because of these “conflicts,” the suit says, Arnold’s approval was required by law for the transaction to proceed. Arnold owned 7.8 percent of MOD, and was the largest shareholder entitled to vote on the transaction. (He did not give approval.)

MOD Systems, which was founded in 2005, makes music and video downloading technology for touch-screen kiosks. Just last month, MOD signed deals with Warner Bros. and Paramount Digital Entertainment to allow retail stores to distribute videos by having customers download content to secure digital cards. MOD is also involved in another lawsuit with the former head of Warner Home Video, Warren Lieberfarb, who claims MOD owes him unpaid consulting fees.

Gregory T. Huang is Xconomy's Deputy Editor, National IT Editor, and the Editor of Xconomy Boston. You can e-mail him at gthuang@xconomy.com or call him at 617-252-7323. Follow @gthuang

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