Seattle angel investor Robert Arnold is suing the top executives at MOD Systems, alleging that CEO Mark Phillips embezzled and misused corporate funds. The suit alleges that Phillips and possibly others "untruthfully represented" that the maker of digital media kiosks owned valuable intellectual property rights, with executives using that information to persuade Arnold to invest. It further claims that Phillips "deliberately engaged in a massive fraud" against the company.

In a statement, MOD Systems said they are taking Arnold's charges "very seriously" and that they have formed an independent committee to investigate the matter. Though the company called Arnold a respected member of the investment community, they said the claims against MOD are unfounded.

The suit, however, alleges that Phillips stole funds from the company and pushed through a financial transaction with Toshiba, NCR and others last September that benefited him personally.

"Between 2006 and the present, Phillips has used and continues to use MOD and/or Banana corporate funds for his personal benefit, including the purchase and/or lease of his personal vehicle, the purchase of electronics for his personal residence and as gifts, extensive non-business related travel and entertainment, the payment of rent for his personal residence....," the suit says.

In June 2008, Phillips -- acting on behalf of MOD -- established a consulting agreement with Meteor Consulting on the order of $15,000 to $25,000 per month. Payments are made to a bank account in the Netherlands controlled by Phillips, the suit says.

"...MOD has not authorized, and is unaware, that Phillips is paying himself these sums," the suit says. "Accordingly, the payments constitute an embezzlement of corporate funds."

Arnold -- a former banker and well-known philanthropist who invested $3 million in MOD -- filed the derivative lawsuit in King County Superior Court on Wednesday on behalf of the company and an entity known as Banana Corp. In addition to Phillips, the suit names  Vice Chairman Anthony Bay and Chief Operating Officer Kenneth Gordon as defendants. It also names MOD and Banana -- an entity incorporated by Phillips in 2006 and operating under the trade name Mettawallet -- as defendants. 

The lawsuit comes to light one month after TechFlash reported on Arnold's initial investigation. In that story, attorneys for both Phillips and Arnold expressed optimism that the matter would be settled without litigation. "We will do whatever it takes to get it resolved," said Ron Braley, the attorney representing Phillips.

Braley could not be reached Thursday, while Smyth declined to comment. MOD and other defendants have 20 days to file a response.

The lawsuit is the latest legal dust up in the Seattle startup community. In the past four months, the top two executives at Seattle-based Entellium pled guilty to wire fraud, while Bellevue-based Count Me In was roundly criticized for failing to remit registration fees to youth sports clubs.

Highly-touted for its retail media kiosks, MOD announced $35 million in venture funding from NCR and Toshiba last summer. That deal is at the heart of Arnold's dispute with MOD's leadership.

In the lawsuit, Arnold alleges that Toshiba, NCR and a third company by the name of Deluxe Entertainment were to be given controlling ownership of MOD Systems. Known as the MTND transaction, Toshiba was to be provided with "very broad latitude to utilize MOD's intellectual property for its own interests, regardless of impact on MOD," the suit says.

It further claims that  Bay and Phillips received special considerations as part of the deal. For example, they were given the right of first refusal to purchase preferred shares. They were also given the ability to register their shares in the case of an initial public offering, something that Arnold claims he was not entitled to.

Arnold -- a founding shareholder who owned a 7.8 percent stake in MOD -- never approved the MTND transaction. He claims that certain information was withheld from him during the negotiations in order to create the illusion that the MTND deal was legitimate. And he alleges that MOD's legal counsel also failed to provide adequate information.

In addition to fraud, corporate waste and negligent misrepresentation, the complaint alleges that Phillips, Bay and Gordon breached their fiduciary responsibilities to the company.

Arnold said he's been denied basic information about MOD's business, so he is asking that financial documents be turned over to him. Furthermore, he is requesting that a receiver be appointed in order to "cease the ongoing waste, looting and destruction of assets."

Before co-founding MOD Systems, Phillips served as chief technology officer and vice president of research and development at Fullplay Systems. That company was liquidated in a 2003 bankruptcy. Bay is a former executive at Loudeye and Microsoft's MSN.

Arnold is a former Seafirst executive and early backer of Starbucks who first invested in MOD Systems in 2006. A former U.S. Navy aviator who is now in his early 80s, Arnold donated $15 million to the Fred Hutchinson Cancer Research Center in 2005.