SEC Goes After “Fake It Till You Make It” Fraudsters

In 2022, a jury convicted Theranos Inc. founder Elizabeth Holmes of perpetrating an audacious fraud against investors in her blood-testing company that turned the Stanford University dropout into a billionaire in her early 20s. Her story has become a symbol of the ethos to “fake it till you make it” in big business, but her scheme was destined to unravel when Theranos’ technology made the transition from an exciting idea to an actual product.

How many other entrepreneurs out there are fudging their data in hopes of securing a windfall of venture capital? A new campaign by the Securities and Exchange Commission, which has jurisdiction over venture capital funding, suggests the number of imposters in the universe of cutting-edge startups may be higher than you’d expect.

Last month, the SEC charged the co-founder and ex-CEO of business-automation startup Skael, Baba Nadimpalli, with a variety of offenses tied to allegations he lied to investors about the company’s revenues and business prospects. According to the agency, the now-defunct Skael raked in more than $30 million between January 2021 and February 2022 while Nadimpalli touted upwards of $7 million in annual recurring revenues. In fact, the true figure was closer to $170,000, the SEC said. The commission also claims Nadimpalli made up stories that Skael had notable companies as customers, offering forged bank statements indicating Skael received payments from them.

The SEC said Nadimpalli came clean with some investors in May 2022, precipitating an investigation by Skael’s board of directors. The company eventually folded.

Earlier in September, the SEC announced it had settled charges against biotechnology company Zymergen Inc. related to misleading investors during the runup to its initial public offering in 2021. The agency took issue with claims the company made about its “overall market potential, revenue prospects, and customer pipeline for its only commercially available product, an electronics film named Hyaline.” Zymergen, which filed for bankruptcy last year, raised $530 million from the IPO.

Among Zymergen’s offenses, the SEC said the startup courted investors with “unsupported hype” about the size of the market for Hyaline and other unreasonable metrics estimates. “Pre-revenue and early-stage companies that seek to tap the capital markets must do so with reasonable estimates of their market potential,” said Monique C. Winkler, the director of the SEC’s San Francisco Regional Office.

The SEC also announced last month it is going after executives of the now-defunct digital pharmacy Medly Health Inc. over charges it defrauded investors during a round of fundraising that netted the startup in excess of $170 million. The SEC is alleging that Medly’s former CEO, CFO and head of prescription operations perpetrated a scheme to present existing and prospective investors with inflated revenue figures that reflected millions of dollars in bogus prescriptions entered in the company’s computer systems. Moreover, executives disregarded reports from employees that the revenue figure included in financial statements provided by Medly to investors was faulty, according to the commission.

All three of these startups had backing from venture capital firms – a sign that even sophisticated investors can be duped by Silicon Valley fraudsters. Notably, though, these firms may need to consider the possibility that they could also be implicated as perpetrators of fraud. A federal court is allowing investors in Zymergen to pursue claims against a handful of VC firms that the investors claim had control of the company prior to its IPO.

File that one under “faked out until they make it.”