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Nonpublic companies can commit securities fraud too

In a case that serves as an important warning for nonpublic startup companies that may think their status insulates them from regulatory oversight, the government brought charges against the CEO of Frank, a now shuttered college financial planning company. Last week, the U.S. attorney’s office for the Southern District of New York, the New York Regional Office of the Federal Deposit Insurance Corporation’s Office of the Inspector General (“FDIC-OIG”), and the Securities and Exchange Commission (SEC) charged Charlie Javice, the start-up’s founder, with criminal charges and securities fraud for lying to J.P. Morgan Chase (JPMC) as it prepared to acquire her company, Frank. The government charged Javice with wire, bank, and securities fraud.  JPMC also filed a lawsuit in December accusing Javice of lying to the company.

According to the government, in a scheme to “fraudulently induce J.P. Morgan Chase to acquire” the start-up for $175 million, Frank greatly exaggerated the number of customers the company had. The plot, according to the government’s claims, included hiring a professor to create fake accounts in an attempt to fool JPMorgan into thinking that there were over four million users or customers in Frank’s database. The company had closer to only 300,000 users. Javice stood to gain over $45 million from the sale of her company.

U.S. Attorney Damian Williams said, “As alleged, Javice engaged in a brazen scheme to defraud JPMC in the course of a $175 million acquisition deal. She lied directly to JPMC and fabricated data to support those lies — all in order to make over $45 million from the sale of her company. This arrest should warn entrepreneurs who lie to advance their businesses that their lies will catch up to them, and this Office will hold them accountable for putting their greed above the law.”

FDIC-OIG Special Agent in Charge Patricia Tarasca said, “The allegations described in today’s criminal complaint exemplify the many ways banks can be defrauded. The FDIC-OIG remains committed to holding individuals accountable who threaten the integrity of financial institutions….”

According to the government’s allegations, Frank’s director of engineering questioned the legality of one of Javice’s data manipulation requests. Her response was that no one would end up in an “orange jumpsuit” over it. The director refused to comply with the request. Javice, a Miami Beach resident, was arrested at Newark Airport in New Jersey. Three of the charges Javice faces each carry a maximum sentence of 30 years in prison.

“Even nonpublic, early-stage companies must be truthful in their representations,” said Gurbir S. Grewal, director of the SEC’s division of enforcement. “And when they fall short we will hold them accountable as in this case.”  The SEC’s complaint alleges Javice violated the antifraud provisions of the Securities Act of 1933 and Securities Exchange Act of 1934. The SEC is seeking to force her to forfeit “all ill-gotten gains,” including interest, and also pay penalties.

There is no indication there was a whistleblower involved in the claims against Javice.  But whistleblowers, especially those with insider knowledge of financial deception and manipulation, are an important tool to bring information about financial fraud forward.

An SEC whistleblower may receive a reward for reporting securities law violations if the SEC orders more than $1 million in sanctions as a result of the whistleblower’s information. SEC whistleblowers also are entitled to confidentiality and protection from job retaliation.

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