Startup Litigation Digest #2
UC Center for Business Law San Francisco | Fall 2023
*This post was originally published on Nov 23, 2023, on iContact.
About this Edition
The Startup Litigation Digest attempts to shed light on the opaque world of private company litigation. Though startups may not face as many lawsuits as their public company counterparts, litigation by private parties and regulators is still a key feature of the regulatory environment in which startups operate. In fact, we suspect that both regulators and private litigants will increasingly focus on private markets given their explosive growth in recent years. Yet, little is known about startup litigation because these matters often hide on obscure dockets and rarely result in published opinions or widely read media accounts.
This is the second issue of the digest, published on a quarterly basis. We hope that it becomes an indispensable source for understanding the litigation environment in the innovation economy.
We would love to hear from you. If you have feedback on this digest or know of litigation matters you would like to see highlighted, please email us at cbl@uclawsf.edu
Sincerely,
UC Center for Business Law San Francisco
Summary of Cases
Softbank v. IRL. SoftBank Vision Fund (SVF) sued former Get Together, Inc. a.k.a. In Real Life (IRL) CEO Abraham Shafi and five siblings and cousins for allegedly misleading the investor about the messaging app’s growth, prompting SVF to invest $150 million in the company in 2021. The dispute asserts a wide range of fraud-related claims, including federal securities fraud, California securities fraud, and unjust enrichment.
Madhu v. Socure. Founder sued company for allegedly breaching contractual obligations and acting in bad faith by preventing founder from exercising stock options.
Leder v. Eaze. The founders of Green Dragon, a company acquired by Eaze Technologies, Inc (Eaze) allegedly discovered (post-acquisition) that Eaze's operations violated California law, and that Eaze misrepresented their finances, among other claims including breach of fiduciary duty, fraudulent inducement and breach of contract in connection with the 2022 acquisition.
Alafi v. Cohen. Stanley Cohen, a prominent genetics professor at Stanford was found guilty of negligent misrepresentation and ordered to pay $29 million in damages to investors in Nuredis – a biotech company that he co-founded with Professor Tzu-Hao Cheng in 2016 and that wound up in 2018. The trial took place in 2022 and was presided by The Hon. Beth McGowen, Judge of the Superior Court of CA, County of Santa Clara.
United States v. Rothenberg. Michael Brent Rothenberg, a former San Francisco venture capitalist was convicted of multiple fraud and money laundering charges on Nov 16, 2023. Rothenberg is currently on pretrial release pursuant to an unsecured bond. The Hon. Jon S. Tigar, U.S. District Judge of the Northern District of California scheduled Rothenberg’s sentencing hearing for March 1, 2024.
Updates on Cases from Issue 1 | Summer 2023
You can revisit the full summary of cases from our Issue #1 in this link.
HeadSpin & Manish Lachwani. The sentencing hearing of defendant Lachwani was reset to Jan. 17, 2024 by Judge Charles R. Breyer of the United States District Court for the Northern District of California.
Bitwise, Jake Soberal and Irma Olguin, Jr. On Nov 9, 2023, the SEC filed charges against Jake Soberal and Irma Olguin, Jr. for misleading investors about the company’s finances. Soberal and Olguin have agreed to resolve the charges against them. The complaint alleges that Soberal and Olguin made material misrepresentations and falsified documents concerning Bitwise’s cash position and historical financial performance while raising approximately $70 million from investors in 2022. Soberal and Olguin have each agreed to the entry of a partial judgment, subject to court approval, imposing permanent and conduct-based injunctions as well as an officer and director bar, and reserving the issues of disgorgement, prejudgment interest, and a civil penalty for further determination by the court. In a parallel action, the DOJ announced criminal charges against Soberal and Olguin for a "$100 million fraud scheme, directly and negatively impacting over 900 families from the Fresno and Bakersfield communities." The complaint alleges that Olguin and Soberal agreed to lie to board members, investors, lenders, and others about Bitwise’s finances to obtain investments, loans, and other funding. If convicted, Olguin and Soberal each face a maximum statutory penalty of 20 years in prison and a $250,000 fine.
FTX & Samuel Bankman-Fried. On Nov. 2, 2023, a jury in Manhattan federal court found Bankman Fried guilty on all seven counts of fraud and conspiracy after a monthlong trial. U.S. District Judge Lewis Kaplan set Bankman Fried's sentencing for March 28, 2024. Bankman Fried is set to go on trial again next March on a second set of charges, including for alleged foreign bribery and bank fraud conspiracies.
1. Softbank v. IRL
On July 31, 2023, Softbank Vision Fund (“SVF”) and its affiliates sued Abraham Shafi, founder of social media company Get Together, Inc. a.k.a. In Real Life (“IRL”). The suit relates to a $150 million investment in IRL by SVF and asserts a wide range of fraud-related claims, including federal securities fraud, California securities fraud, and unjust enrichment.
According to the complaint (first reported by The Information), Shafi and his co-defendants (various family members affiliated with IRL) induced SVF to invest at a $1 billion valuation based on eye-popping user metrics. For example, the complaint alleges that Shafi claimed 400% year-over-year user growth and that 25% of U.S. teens under 18 had downloaded the app. SVF would later discover, according to the complaint, that the vast majority of users were in fact bots posing as users so that Shafi could claim outsized growth and network effects.
SVF claims that the fraud began unraveling when an article posted by The Information doubted IRL’s stated metrics. The negative press coverage apparently prompted an investigation by the Securities and Exchange Commission and by a special committee of the IRL board. In addition, IRL’s user count suddenly plunged once Shafi was suspended from his role as CEO for unrelated reasons, according to the complaint. The facts alleged in the complaint suggest a number of governance failures at IRL, including unusual concealment of user data in the course of ordinary operations, nepotism, excessive compensation and travel expenses, and disguised payments to related entities. IRL’s board of directors and a majority of IRL shareholders dissolved the business and transferred IRL’s assets into a trust.
2. Madhu v. Socure
On Jan 3, 2022, Sunil Madhu, the founder of Socure, a fraud prevention and identity verification venture-backed unicorn, filed a complaint against the company in the Supreme Court of the State of New York (since amended and filed in the U.S. District Court for the SDNY), alleging that Socure breached contractual obligations and acted in bad faith by preventing Madhu from exercising stock options.
Madhu alleged that, after separating from the company, he attempted to exercise vested stock options in May and October 2021 through communications with Socure executives and through the exercise feature of cap table software from Carta. Madhu claimed that the company’s executives delayed his attempted exercise by providing incorrect information about his agreements with the company and the tax consequences of exercising the options. He also claimed that the company disabled the exercise feature of the Carta software after Madhu had lined up over $8 million in funding for the exercise price and resulting tax obligations.
According to the complaint, company executives incorrectly asserted that the common stock value for purposes of calculating tax obligations on Carta was uncertain due to a potential new financing transaction that would affect the company’s future 409A valuation. Because the value of Socure stock allegedly increased since the attempted valuation, Madhu is claiming millions in damages due to adverse tax consequences.
3. Lisa Leder et al v. Eaze
On July 18, 2023, the founders of Green Dragon, a multistate cannabis company that merged with Eaze Technologies, Inc ("Eaze"), a medical marijuana delivery company, filed a complaint against Eaze and a number of its investors and executives for breach of fiduciary duty, fraudulent inducement, breach of contract, and other claims in connection with a 2022 acquisition.
According to the complaint, Eaze acquired Green Dragon through an all-stock merger in January 2022 under false pretenses. The complaint alleges that Green Dragon was valued at $200 million at the time of the merger agreement and that the Eaze board misrepresented the financial condition of Eaze in order to induce the plaintiffs to close the deal. The complaint also alleges that Eaze “made numerous false representations and warranties to... Green Dragon in the Merger Agreement.”
The complaint also alleges that Eaze had represented itself as a mere delivery service when in fact it asserted an improper degree of control over cannabis license holders. Eaze also allegedly terminated the three Green Dragon co-founders without basis, failed to follow basic board and governance procedures, and entered into conflict-of-interest transactions with investor Jim Clark (a Silicon Valley legend, founder of Netscape, Silicon Graphics, MyCFO and Healtheon, and the subject of Michael Lewis' 1999 book "The New New Thing") among other shareholders.
On October 13, 2023, Eaze moved to dismiss the case based on a forum selection clause in the company’s articles that required the litigation to be brought in Delaware. On November 3, 2023, this motion was granted by Judge Curtis E.A. Karnow from the Superior Court of California, County of San Francisco, and the case was dismissed in California.
4. Alafi et al v. Cohen et al
On June 8, 2023, a California court affirmed an order requiring Stan Cohen, a Stanford Professor and founder of now-defunct biotechnology company Nuredis, to pay investors $20 million plus interest for negligent misrepresentation.
As first reported by pharmaphorum, the suit was filed by Christopher Alafi, a biotech investor and longtime family friend of Cohen, in August 2018. The complaint asserted a number of claims, including fraudulent inducement and concealment, securities fraud (federal , state, and common law), breach of fiduciary duty, and negligent misrepresentation.
According to the complaint, Cohen claimed to have found a cure for Huntington’s Disease using a compound that had already been approved by the FDA for other conditions, but Cohen did not adequately inform Alafi that the FDA had withdrawn the drug in 1976 for potentially deadly side effects. The complaint further alleged that Cohen spent investor money at a ”burn rate” of $465,000 per month, including excessive compensation and travel.
On July 5, 2022, the court found for Alafi on the claim of negligent misrepresentation and awarded him damages of the original investment of $20 million, plus $9 million in interest. Although the court concluded that Cohen had started the business with good intentions and had disclosed some information about the history of the treatment at the FDA, the court found Cohen’s testimony to be “inconsistent, confusing, and unreliable.”
5. United States v. Rothenberg
On Nov 16, 2023, Michael Brent Rothenberg, a former San Francisco venture capitalist was convicted of wire fraud, money laundering, bank fraud, and making false statements to a bank by a federal jury in Oakland, California. The guilty verdicts followed a seven-week jury trial before the Hon. Jon S. Tigar, U.S. District Judge. All told, the evidence introduced at trial established that Rothenberg’s schemes resulted in approximately $18.8 million in missing money.
The jury found that Rothenberg, 39, committed wire fraud with respect to a number of investments from investors in two of the VC funds that he managed in 2015 and 2016. In addition, the jury found that Rothenberg committed wire fraud in February 2016 with respect to a $2 million investment made in a company he owned named Bend Reality LLC (which did business as River Studios), and that he thereafter committed money laundering by transferring a large portion of those proceeds through various bank accounts. Finally, the jury found the defendant guilty of committing bank fraud and making false statements to a bank in relation to a line of credit that Rothenberg obtained for his VC management company from Silicon Valley Bank in late 2015.
In June 2020 Rothenberg was charged with bank fraud, making false statements to a bank, wire fraud, and money laundering.
Rothenberg is currently on pretrial release pursuant to an unsecured bond. Judge Tigar scheduled Rothenberg’s sentencing hearing for March 1, 2024.
About the UC Center for Business Law San Francisco
The UC Center for Business Law San Francisco was founded in 2018 with the mission of bringing together leading scholars, business leaders, practitioners, regulators and students to engage in the study, teaching and practice of business law at UC Law SF (formerly UC Hastings).
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