Option #1: Just quit, and keep your mouth shut. Do you really want to be party to a fraud? And, given it is a fraud, will your equity ever actually be worth anything? This is the easy option.
Option #2: Quit, tell world you think this is fraud. Better talk to a lawyer first, you want to phrase it the right way (and may get sued anyway).
Option #3: Stay on, try to convince them it's bad idea. In this case I'd go for "I think this is fraud, it's too risky", with nice broad paper trail that will be trivially findable by discover if they get sued later, and copies of paper trail kept by you. You may well get fired. And do you really want to keep working for these people?
Thing is, if company's choice is "fraud or bust", it's dead anyway. So you're not losing anything by quitting (and maybe you can get them to pay you a lot of money for transition to replacement CTO.)
If you do quit, leaving behind the nice paper trail for lawsuit discovery might discourage some bad behavior.
(Not a lawyer. Not legal advice. I'm random person on Internet. You probably want to talk to a lawyer.)
Who would work-hours bear,
To grunt and sweat under a startup life,
But that the dread of something after now,
The undiscovered country to whose bourn
No traveler arrives puzzles the will
And makes us rather bear those ills we have
Than fly to others that we know not of?
Thus time does cause operations in us all,
And thus the native hue of indecision
Is painted o'er with the pale cast of change,
And edifices of great inertia
With this regard their currents turn awry,
And gain the name of action.
I was once told of this expression: It doesn't matter whether the rock hits the egg or the egg his the rock. The egg will break.
If you are the egg, either get out or prepare to suffer (#4). It looks like in this case the CTO feels he/she is the egg and a wrong choice has been made.
If "it is definitely happening" then I would suggest #3, find another job and be merry :)
> Option #3: Stay on, try to convince them it's bad idea. In this case I'd go for "I think this is fraud, it's too risky", with nice broad paper trail that will be trivially findable by discover if they get sued later, and copies of paper trail kept by you.
This approach requires great care. You could easily leave a paper trail that makes it look like you (1) knew it was fraud, (2) advised against it because you thought it was risky, not because you thought it was wrong, (3) when the company went ahead with it you went along.
I think you want something more along the lines of "This seems like it could be fraud, or at least appear to be fraud, but I'm not a lawyer...are we sure this is legal?", and the paper trail needs to have someone that you have reason to trust answering that it has been checked out and is OK. If it hits the fan legally, either civilly or criminally, you need to come off as someone who was an inside victim, not an inside accomplice.
An interesting thing too you may experience at discovery is that the other party has documented their own parallel but self-serving version of events via emails to themselves.
e.g. "Today Harry repeated his threats to sue us for fraud. Todd and I are trying to work out how to deal with it, its new territory for us."
Option #3 leaves you open to this unpleasant scenario.
Option #4: Voice your concerns, document, if you can't stop them quit as soon as a lawyer agrees something bad was done, and then sue them. Now you let the world know and maybe you can sue for your equity since you were forced to leave by not wanting to commit fraud.
OT: thank you for your conscientious objection, and for talking honestly about the situation. Would be fascinated to hear the rest of the story; I hope you didn't end up going to prison as many peaceniks seem to.
There's also option#4: just get on-board. Accept it's a fraud, milk it for everything you can, then leave after (hopefully) cashing in and leave the whole mess to everyone else and hope there won't be any (too bad) implications for yourself.
Thus:
Option #1: Just quit, and keep your mouth shut. Do you really want to be party to a fraud? And, given it is a fraud, will your equity ever actually be worth anything? This is the easy option.
Option #2: Quit, tell world you think this is fraud. Better talk to a lawyer first, you want to phrase it the right way (and may get sued anyway).
Option #3: Stay on, try to convince them it's bad idea. In this case I'd go for "I think this is fraud, it's too risky", with nice broad paper trail that will be trivially findable by discover if they get sued later, and copies of paper trail kept by you. You may well get fired. And do you really want to keep working for these people?
Thing is, if company's choice is "fraud or bust", it's dead anyway. So you're not losing anything by quitting (and maybe you can get them to pay you a lot of money for transition to replacement CTO.)
If you do quit, leaving behind the nice paper trail for lawsuit discovery might discourage some bad behavior.
(Not a lawyer. Not legal advice. I'm random person on Internet. You probably want to talk to a lawyer.)