Startup Founder Charged with Fraud by SEC and DOJ

Fraud Charges Filed Against HeadSpin Co-Founder

Manish Lachwani, the co-founder of mobile app testing firm HeadSpin, is facing legal repercussions as both the U.S. Department of Justice and the Securities and Exchange Commission have brought charges of fraud against him.

SEC Allegations and Penalties

The SEC asserts that Lachwani violated antifraud provisions. They are seeking civil penalties which include a permanent injunction, a conduct-based injunction, and a prohibition from serving in corporate leadership roles or on boards.

DOJ Charges and Potential Sentences

Following his arrest, the DOJ has accused Lachwani of one count each of wire fraud and securities fraud. Conviction for wire fraud carries a potential maximum sentence of 20 years imprisonment and a $250,000 fine. A guilty verdict on securities fraud could result in a 20-year prison sentence and a $5,000,000 fine.

Allegations of Investor Deception

Both the SEC and DOJ contend that Lachwani misled investors out of $80 million while leading HeadSpin as CEO until May of the previous year. He allegedly made false claims regarding the company’s growth in customer acquisition and revenue generation during pitches for its Series C funding round.

The Pursuit of a Unicorn Valuation

According to the SEC, these misrepresentations were intentionally crafted to secure funding at a “unicorn” valuation – exceeding $1 billion. This strategy proved successful, as HeadSpin garnered attention from Forbes in February of last year after receiving $60 million in Series C funding from Dell Technologies Capital, Iconiq Capital, and Tiger Global, achieving a $1.16 billion valuation.

Personal Enrichment Through Misleading Sales

The SEC further alleges that Lachwani sought personal financial gain by selling $2.5 million worth of his HeadSpin shares during a fundraising round where he provided inaccurate information to an existing investor. The specific fundraising round isn’t clarified in the SEC’s complaint.

Timeline of Alleged Fraudulent Activity

Federal complaints indicate that Lachwani’s alleged scheme to inflate HeadSpin’s valuation began “at least in 2018,” with increased activity during fundraising efforts in late 2019.

Control Over Financial Reporting

The DOJ complaint details that Lachwani exerted control over the company’s operations, sales, and financial record-keeping. He held the final authority on revenue recognition and inclusion in the company’s financial statements.

Inflated Revenue Reporting

An FBI investigation revealed instances of Lachwani directing employees to include revenue from sources that had not engaged HeadSpin, from former clients, and from existing clients with significantly lower business volume than reported.

Magnitude of the Overstatement

The cumulative effect of these actions resulted in an overstatement of HeadSpin’s annual recurring revenue by approximately $51 million to $55 million, according to the complaint.

Valuation Correction and Leadership Change

The alleged fraud was uncovered following an internal investigation by HeadSpin’s board of directors, which led to a revised valuation from $1.1 billion to $300 million. Reports surfaced in August of last year indicating plans to reduce the value of Series C stock by nearly 80%.

New Leadership Appointed

Lachwani had already been replaced by Rajeev Butani, who joined HeadSpin as its chief sales officer earlier in the year, according to LinkedIn.

Board Involvement in the Review

Nikesh Arora, former SoftBank president and current CEO and chairman of Palo Alto Networks, played a key role in the internal review as a director on HeadSpin’s board, as reported by The Information.

Ongoing Investigations

The SEC has stated that its investigation remains active. The DOJ also emphasizes that a complaint represents allegations, and all defendants are presumed innocent until proven guilty.

Lachwani’s Background

Prior to HeadSpin, Lachwani sold a mobile cloud business to Google and subsequently co-founded HeadSpin after being introduced to Brien Colwell, a former Palantir and Quora engineer, by Yahoo co-founder Jerry Yang.

Colwell’s Status and Company Cooperation

Colwell continues to serve as HeadSpin’s CTO and has not been implicated in either the SEC or DOJ complaints. The company itself has stated it is fully cooperating with the government’s investigation and has not been charged.