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Next Steps When Charged with Wire and Securities Fraud
It’s difficult to know what to do when faced with criminal charges. “Who do I go to? Where do I turn?” The experience can be overwhelming. In August 2021, the co-founder and former CEO of HeadSpin, Manhish Lachwani, found himself in just such a position. He was charged with one count each of wire and securities fraud. According to the U.S. Department of Justice, investors were defrauded of over $80 million.
Founded in 2015, Headspin generates revenue by selling subscriptions to a remote service, allowing customers to use mobile devices worldwide to test their applications remotely. The company has been cooperating with the government investigation and has not been charged.
How did the CEO get into this much trouble? According to the complaint, Manish Lachwani lied and overstated the Silicon Valley startup’s revenue and other key financial metrics for his gain. For some people, like Elon Musk, they somehow get away with it as being “entrepreneurial.” For most people, however, it can lead to serious consequences, even when the person touting his or her company never intended to defraud anyone.
One of the key financial metrics reported to be inflated by Lachwani is called “annual recurring revenue” or “ARR.” ARR measures the total expected revenue per year from customers who have committed and signed contracts. As ARR grows, this indicates the number of new customers or expanded deals with existing customers. The valuation of Headspin depended in large part on this key metric.
In fact, many companies who offer “Software As A Service”, or “SAAS” offer trials of their service. The trial period usually ranges from 7 to 30 days. However, reporting a trial customer as an actual customer without also reporting conversion metrics would seemingly inflate the value of the company, despite reporting actual results.
Allegedly, the founder did just this. He asked his employees to report usage from prospective customers who had not purchased anything and former customers who left and took their business elsewhere. Lachwani instructed his employees to report results this way and kept strict control over all operations, sales, and record-keeping.
In a December 2017 email, Lachwani admitted he intended to “super micro manage” the company’s financials. HeadSpin’s board repeatedly requested Lachwani hire a CFO to manage HeadSpin’s daily finances. However, this did not happen, and Lachwani continued micromanaging the company’s financial records that he provided to investors.
When an investor asked Lachwani to explain why HeadSpin was not billing all its customers, he said HeadSpin often allowed customers to use the product several months before billing clients. This contributed to the inflated results effectively, according to the US government, misrepresenting the company’s valuation.
Authorities in the case say inaccurate reporting allowed HeadSpin to sell shares of their stock at inflated prices. This occurred for several rounds of funding and gave an overvaluation of $1.1 billion. Startup companies with valuations over $1 billion are considered “unicorns.”
While it is not wrong for a CEO to sell their company shares, when the company is overvalued, and the CEO knows, it can lead down a tricky road. Lachwani allegedly sold $2.5 million of his personal shares in one of the fundraising rounds, making a significant amount of money on the false valuation of HeadSpin’s stock.
In any large company, a system of balance and checks is critical, even for the founder and CEO. In Lachwani’s case, nobody else checked the accuracy of the financial statements he was managing. After questioning the financial records, HeadSpin’s board of directors conducted an internal audit and discovered just how inflated the numbers were. They adjusted the valuation of the company from 1.1 billion down to $300 million, which means the company was overvalued by almost 75%! HeadSpin returned 70% of the principal investors’ shares, with some deciding to keep their shares.
Investors deserve to know an accurate financial picture at any given time. According to Monique Winkler, associate regional director in the SEC’s San Francisco office, “Companies and their executives must tell the truth when speaking about financial metrics that are material to the value of the business.”
If found guilty, Lachwani faces up to 20 years in prison on each count and likely court-ordered restitution. To get a conviction, the U.S. Department of Justice must prove Lachwani planned to use a false statement, promise, or misrepresentation to obtain money from the investors. In addition, Lachwani faces civil charges from the SEC for violating the antifraud provisions of the federal securities laws.
White Collar Advice has helped many people charged with financial crimes prepare for their court dates and appearances before a judge. When someone is accused of a crime, they should seek the counsel of an attorney and prepare for a plea of guilty or not guilty. If the government feels they have a strong case, they may offer the defendant a plea deal to avoid going to trial. Once a defendant pleads guilty and takes a plea deal, there is no trial, and they must prepare for a sentencing hearing.
At the sentencing hearing, it is crucial to provide the judge with character reference letters and a statement admitting fault in preparation for sentencing. Writing the narrative to the judge should include a life story and several opportunities to show the judge how remorseful the defendant is. White Collar Crime recently helped a client facing charges for conspiracy to commit securities fraud to write his narrative for the judge. At several points throughout the letter, he was able to show remorse for the crime he committed. He said this, “I realize I made many false statements and misrepresentations to the investors. I promoted a lie, and innocent people got hurt.” In Lachwani’s case, should the prosecution offer a plea deal to avoid going to trial, he likely will be in a similar position as the client above. Lachwani would do well to hire someone like White Collar Advice to help him create a pre-sentencing strategy that could possibly lower the sentence the prosecution recommends. For more information, schedule a call and ask about one-on-one consulting.