Seattle angel investor and philanthropist Robert Arnold is investigating the financial activities of MOD Systems, a heavily-funded Seattle startup that reeled in $35 million from NCR, Toshiba and others last September.

Arnold, an early backer of the company and a well known investor whose past investments include Starbucks, has not been satisfied with MOD's response to numerous requests for financial and business records, said Jeff Smyth, an attorney who is representing the former banking executive.

"Most of the disagreement relates to the use of investment funds," said Smyth, who has yet to file any legal action and is hopeful that a resolution can be achieved. MOD's technology helps retailers sell digital versions of movies and TV shows through in-store kiosks.

Ron Braley, an attorney who represents MOD Systems co-founder and Chief Executive Mark Phillips, said that his client has not been engaged in any wrongdoing. He added that there is a "misunderstanding" on the part of Arnold.

"Anytime that you have an early-stage startup company that is about to launch a successful product, people tend to come out of the woodwork and turn over rocks," Braley said. "They are asking questions and we are giving answers. I don't believe there is anything untoward here."

Braley said they are cooperating with Smyth's investigation, turning over financial records and other documents. But Smyth said the records provided to date have been "extremely incomplete."

Both attorneys are hopeful that the parties will be able to settle.

"We will do whatever it takes to get it resolved," Braley said.

MOD Systems' attorney Thomas Grohman declined to comment early last week, saying that he wanted to first discuss the matter with his client. He did not return repeated phone calls and emails throughout the week. Anthony Bay, chairman of MOD Systems, did not want to talk about Arnold's investigation when reached via phone at the Consumer Electronics Show in Las Vegas earlier this month. He said the company has done nothing wrong, and declined further comment.

Adrienne Lenhart, director of marketing at MOD, did not return calls Thursday, Friday or Sunday.

MOD Systems faces other legal issues. In August, Warren Lieberfarb -- a former Warner Home Video executive who was described in a 2006 MOD Systems' press release as the "father of the DVD" -- filed a lawsuit against the company in U.S. District Court in Seattle. Lieberfarb, who held the title of vice chairman at MOD, alleges that the company failed to pay him more than $700,000. 

A consultant with the company who joined in November 2006, Lieberfarb was to be paid in fees, stock options and other compensation for making introductions to investors, according to the August complaint. As part of the agreement, MOD agreed to pay Lieberfarb 5 percent of any funds received from an investor within 15 days of closing a deal, the complaint says.

An amended complaint [PDF] filed in September by Lieberfarb claims that Toshiba -- a current investor in MOD -- made a $4 million investment in the company in September 2007, from which Lieberfarb received a $200,000 fee. But when Toshiba later invested another $3 million, Lieberfarb claims the company classified the investment as a "non-recurring engineering fee." As part of his consulting agreement, the California resident claims he is owed $150,000 related to that investment.

Toshiba also participated in the company's $35 million venture round that was announced last September. Lieberfarb alleges he has not been personally notified of the deal and has not been paid. Lieberfarb -- who says in the amended complaint that he resigned from the board in March 2008 and ceased consulting arrangements with the company at that time -- also claims that he is owed $79,560 in business expenses. And he alleges in the complaint that the company will not provide the number of his stock options that have vested nor financial statements or board minutes, something he claims to have rights to as a shareholder.

In a counterclaim [PDF], lawyers for MOD Systems assert that the charges are void because Lieberfarb made "misrepresentations"  with the purpose of "defrauding" the company.

Filed earlier this month, the counterclaim alleges that the company relied on Lieberfarb's representations of having  "sufficient knowledge, experience, relationships, training, reputation, and resources in the relevant industry to perform under the alleged agreements."

"These representations were in fact false and Mr. Lieberfarb knew they were false when he made the representations," the counterclaim says.

Attorneys for MOD further allege that Lieberfarb did not perform his duties as part of the consulting agreement. They write in the counterclaim that any award to him should be offset due to his "fraud, unjust enrichment, breach of contract, and breach of the implied covenant of good faith and fair dealing."

MOD's counterclaim alleges that Lieberfarb "violated his duties" to the company by trying to obtain control of the business. Furthermore, it alleges that the former board member "developed a strategy to compete" with the company by using and disclosing trade secrets "for his own profit."

As part of that effort, the company alleges that Lieberfarb took action to form a company that competes with MOD and its digital-media kiosk technology. And they allege that Lieberfarb charged unnecessary expenses to the company, including more than $1,000 on luxury car service, air travel and hotels. Lieberfarb's attorneys could not be reached for comment.

Around the time of Lieberfarb's lawsuit, Smyth said his investigation intensified on behalf of Arnold. Last month, the attorney called about 10 technology professionals in town who were familiar with MOD's digital kiosk business.

"There are a lot of disaffected people out there who were more than willing to share information," said Smyth. He declined to elaborate on his discoveries, saying that the matter remains under investigation.  But two people who were contacted by Smyth said they were asked about company finances, business entities associated with Phillips, and other questions about the CEO.

Arnold is a former Seafirst executive and early backer of Starbucks who invested in MOD Systems in 2006, said Smyth. A former U.S. Navy aviator who is now in his early 80s, Arnold is respected in the business community, Smyth said.

In 2005, Arnold donated $15 million to the Fred Hutchinson Cancer Research Center, at the time the largest single gift to the Seattle cancer facility. The following year, the Seattle native was awarded with the National Association of Secretaries of State Medallion, the first Washington resident to receive the honor. Secretary of State Sam Reed said at the time that Arnold -- in addition to his support of non-profits -- has "made extraordinary monetary and personal contributions to our state’s growing technology field.”

MOD Systems is developing a new digital media kiosk technology which allows retailers to sell movies and television shows on SD cards rather than in the pre-packaged formats typically found in the aisles of retail stores. Phillips, who previously worked at Fullplay Media Systems, co-founded the company in 2005. Bay, who also is listed as a co-founder, previously served as the executive chairman of Loudeye and as an executive in Microsoft's digital media division.