Valley Scribe

OK, I’m still figuring out this whole blogging thing—moving a WordPress blog to my own domain name has proved a little more difficult than I’d hoped—so apologies, readers, that this site is still under construction. But my journalistic instincts are prodding me to post!

There are some big new developments in the curious case of Canopy Financial. This is the now-infamous financial-software company that sucked up around $100 million in venture cash, got some customers and hired 123 employees—before melting down last week amid an alleged fraud. It filed for Chapter 11 bankruptcy protection the day before Thanksgiving. This is no Madoff debacle. But it still looks like a black eye for Silicon Valley and the investors who backed Canopy, a five-year old startup that makes back-end technology to support health-savings accounts.

Now, details of the malfeasance finally are coming to light. I just got hold of a civil lawsuit filed by the SEC Monday against Canopy and its COO, Jeremy J. Blackburn. And boy, is it juicy!

Lawyers in the SEC’s crack Chicago office allege that the $75 million private-placement offering engineered by Canopy this past summer was a scheme to defraud investors—namely Spectrum Equity Investors, a well-respected private-equity firm that ponied up much of the cash.

The main actor in all this, according to the SEC’s complaint, was Blackburn, though CEO Vik Kashyap doesn’t come off looking great, either. (Kashyap isn’t named in the lawsuit and has professed his innocence in the matter.) Blackburn allegedly skimmed off about $2.8 million for himself through the scam, the SEC says.

The narrative goes like this: As Spectrum was conducting its due diligence on the private-placement deal, Blackburn and Canopy passed the firm forged financial statements detailing Canopy’s operations for 2007 and 2008, the SEC says. Blackburn said they had been audited by KPMG, but they had not. He also knew they contained false information, according to the SEC. TechCrunch previously reported the forged KPMG audit reports.

On June 30, the complaint recounts, Blackburn sent CEO Kashyap an email containing the KPMG audit report and the financial statements. The subject of the message was “Audit Finally Complete”. Inside the email, Blackburn wrote to Kashyap, “I never wanna go through this again!” The SEC says that in two earlier, April emails, Blackburn also reminded his friend Tony Banas, Canopy’s chief technology officer “to lie about the existence of the KPMG audit”.

Canopy also gave Spectrum false monthly operating reports, the complaint says, falsely representing how many customer accounts the company had. With some of those reports, Canopy enclosed a cover letter signed by Blackburn and Kashyap summarizing the company’s business. (Kashyap, who stepped down as Canopy’s CEO last month but remains chairman, has maintained he was ignorant of the fraud. His lawyer declined to return my call today.)

Canopy raised the round from Spectrum and other investors; it’s unclear who else participated in that specific round, though Foundation Capital and GGV Capital (formerly Granite Global Ventures) are backers of the company. John Powers, the head of Stanford University’s high-profile, multi-billion dollar endowment, also was an angel investor and board member. Neither Powers nor any of the VC firms wanted to talk to me about Canopy. Canopy raised money in at least two rounds prior to the $75 million offering.

A good chunk of the $75 million went to repurchase some shares, according to documents related to Canopy’s bankruptcy filing: The SEC says Blackburn made more than $1.6 million by redeeming 25,000 shares. He also misappropriated at least $1.17 million in investor funds into his personal bank accounts, according to the lawsuit.

How Blackburn got busted for this scheme is pretty amazing. According to the SEC, it happened when Canopy’s new general counsel started looking for a new CFO for the company in November. The lawyer contacted someone he knew at KPMG to ask about possible candidates, sending along what he thought were Canopy’s KPMG-audited financial reports.

Uh-oh. KPMG wrote back that it had never done audit work for Canopy and never reviewed its financial reports, the SEC complaint says. KPMG thoughtfully included a cease-and-desist letter demanding that Canopy stop using its name on the forged reports.

As it stands now, the SEC wants Canopy and Blackburn to pay a fine and return their ill-gotten gains from the scheme. The SEC also wants to freeze Blackburn’s assets to prevent the “dissipation of remaining investor assets.”

What a mess. It’s unclear if better due diligence by Spectrum and Canopy’s other backers could have prevented this fraud; it certainly makes one wonder. We’ll keep on top of further developments!