Journalist John Carreyrou, whose reporting helped expose what the SEC called an “elaborate, years-long fraud” by Theranos founder and CEO Elizabeth Holmes, wrote in his book Bad Blood: “Hyping your product to get funding while concealing your true progress and hoping that reality will eventually catch up to the hype continues to be tolerated in the tech industry.” While reasonable minds could differ as to the tech industry’s toleration for such tactics, it is becoming increasingly clear that the Department of Justice (DOJ) is on high alert for situations when hype turns to fraud at tech startups.
On March 26, 2021, DOJ announced that the former CEO and founder of Trustify, a private investigator platform, was sentenced in the Eastern District of Virginia to more than eight years in prison, ordered to pay $18,131,742.21 in restitution, and ordered to forfeit $3.7 million, for his role in an investment fraud scheme. The defendant had previously pleaded guilty, in December 2020, to one count of securities fraud and one count of wire fraud in connection with the alleged scheme.
Beginning in 2015, the defendant allegedly promoted Trustify as the “Uber” of private investigator services and ultimately raised more than $18 million from over 250 individual and corporate investors, including by falsely overstating the company’s financial performance and fabricating business relationships.
The defendant allegedly created a fake email account to pose as a prominent potential investor, which he used to send a fraudulent email to convince an investment firm to invest nearly $2 million in the company. The defendant also allegedly made false statements to investors about the amount of investor funds that he would personally receive while diverting substantial amounts to his own benefit. The defendant allegedly used at least $3.7 million in proceeds from the fraud to secure a down payment on two houses, to pay for a chauffeur, a house manager, family vacations, private jet trips, and premium seats at sporting events.
According to DOJ, Trustify’s collapse in 2019 ultimately led to over $18 million in losses to investors and over $250,000 in unpaid wages and costs for the company’s employees.
The Trustify case provides a cautionary tale—albeit alleging extreme misconduct—that underscores the importance of ensuring that hype and puffery do not escalate into misrepresentations and fraud. Founders and executives can mitigate risk by ensuring that they maintain documentation and support for any objective factual representations they disclose to potential investors and other third parties, in case an investor or enforcement authority ever calls such representations into question. In a related vein, investors should ensure that they carefully review and verify all documentation and other support for representations made by a startup that are material to an investment decision before investing.