Generative AI Startup Stability AI Faces Lawsuit Alleging Fraud and Embezzlement by Second Cofounder

An artist’s illustration of artificial intelligence (AI). This image is a positive imagining of humanities future with AI enabled fusion as the primary energy source. It was created by artist Khyati Trehan as part of the Visualising AI project launched by Google DeepMind.

A second individual claiming to be a co-founder of generative AI startup Stability AI has filed a lawsuit against the company and its CEO, Emad Mostaque. The lawsuit, filed by artificial intelligence entrepreneur Cyrus Hodes, alleges fraud and embezzlement and was submitted to the U.S. District Court for the Northern District of California.

Hodes claims that he was misled by Mostaque into believing his 15% stake in the business was worthless just months before Stability AI secured over $100 million in funding in August 2022. This funding round valued the company at $1 billion and involved investments from venture capital firms Coatue and Lightspeed. Stability AI gained recognition through its viral text-to-image generation system Stable Diffusion and became a prominent figure in the generative AI sector.

According to Hodes’ lawsuit, he sold his stake to Mostaque for $100 across two transactions in October 2021 and May 2022. The suit alleges that Mostaque withheld crucial information about ongoing fundraising efforts and plans to pivot the company’s focus to AI text-to-image generation. Hodes claims that this fraudulent activity resulted in him being cheated out of equity that would have been worth $150 million within months.

The lawsuit also accuses Mostaque of intentionally destroying evidence after being notified of potential legal action. Hodes’ counsel informed Mostaque of their intentions in December 2022, and Mostaque later claimed on Twitter in March 2023 that his WhatsApp had been deleted. Hodes’ complaint suggests that this deletion was deliberate.

Representing Hodes, Avi Weitzman from law firm Paul Hastings described these actions as “shocking swindling” driven by corporate greed. Weitzman expressed anticipation for a thorough examination of the defendants’ misconduct in court.

The lawsuit goes on to claim that Mostaque embezzled funds from external investors to cover personal expenses such as rent for his family’s London apartment and his children’s schooling. It cites an anonymous former investor who disclosed that Mostaque had a history of deceiving investors and misappropriating company assets for personal use. The suit further asserts that Mostaque admitted to improperly using company funds obtained from the Trinity Challenge, an organization that provides health-related grants.

Prior to this lawsuit, Stability AI faced allegations of financial impropriety involving Mostaque’s wife, Zehra Qureshi, who was the former head of PR for the company. Stability AI employees raised concerns about large sums of money being transferred from corporate accounts to Qureshi’s personal bank account. However, a spokesperson for the company stated that these transactions were loans made by the couple and were settled by the end of 2022.

Hodes was initially involved with Mostaque in a business venture aimed at leveraging artificial intelligence to aid governmental agencies in addressing the Covid-19 pandemic. However, this project failed to materialize and was abandoned in subsequent years. Hodes’ lawsuit alleges that one significant reason for its failure was Mostaque’s diversion of attention and company resources toward Stability AI’s AI image generation efforts.

This lawsuit bears similarities to another filed against Stability AI by Tayab Waseem in May. Waseem claimed that Mostaque reneged on an agreement to grant him a 10% co-founder stake in the company but voluntarily dismissed his suit on the same day it was reported. Hodes is depicted as a co-founder of Stability AI in Waseem’s complaint, supported by a slide from the company’s investment pitch deck.

At present, Stability AI has not provided any comments regarding these legal matters.