On Theranos: It’s Time to Throw the Book at Healthcare Tech Frauds

On Theranos: It’s Time to Throw the Book at Healthcare Tech Frauds

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Huge news hit today as Theranos, its Chairman and CEO Elizabeth Holmes and its former President and COO Ramesh “Sunny” Balwani were charged with “elaborate, years-long fraud” by the Securities and Exchange Commission. The litany of supposed violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 are almost as dizzying as the detailed factual allegations of repeated, willful fraud perpetuated by Holmes and Balwani on investors who likely should have known better.

Reviewing the SEC complaint against Holmes, it’s stunning to see the extent to which Holmes and Balwani were able to pull the wool over investors’ eyes. The highlights of the SEC allegations include:

  • In 2010, even knowing that Theranos’ miniLab product was not commercially ready, Holmes and Balwani pursued partnerships bringing the product to “Patient Service Centers” at a major pharmacy chain (Walgreens) and a national grocery chain (Safeway).
    • Holmes directly told pharmacy executives that Theranos could conducts hundreds blood tests through a fingerstick in under an hour for a much lower cost than other competing project even though the technology had not been finalized.
    • Holmes also told Walgreens that its analyzer was already deployed on military helicopters when no such relationship existed.
  • In 2013, just prior to Theranos’ launch at Walgreens, Theranos realized its miniLab product would not be ready so it substituted an earlier production – one that could only be used to perform immunochemistries, for patient testing. They never told their partners about this issue, in fact denying any such issues, and instead used modified third-party technology.
    • Even though Theranos failed to use its own technology, it presented itself to the media and investors as having achieved a technological breakthrough using its own proprietary technology.
    • In late 2013, Theranos was struggling with only $30 million in cash and short-term securities – which it promised to burn through in a few months.
  • In 2014, Holmes convinced the board to create a new, separate class of shares (“Class B Shares”) which had super-voting power and could only be given to Holmes. Thus, after a stock split and fundraising round, Holmes owned only just over half of the company’s shares but retained over 99 percent of its voting power.
    • Between 2013 and 2015, Holmes, Balwani and Theranos raised over $700 million from two rounds of financing with investors relying on the false and misleading statements by Holmes, Balwani and Theranos.
  • While courting investors, Holmes not only made false or misleading statements about Theranos’ technology and its usage of it but also about:
    • Historical contracts with the U.S. Department of Defense to convince investors of their supposed track record of success.
    • The relationship between Theranos and Walgreens and Safeway, which were presented as thriving when they were actually stalled.
    • Whether or not Theranos required FDA approval of its technology.
    • Theranos’ existing and projected revenues.

The breadth and scope of these lies is stunning. And such fraud would likely bring cries for criminal sanction in other fields, in the Valley, the overwhelming attitude to potential Department of Justice (DOJ) criminal charges accompanying SEC sanctions appears to be one of “who cares”.

In 2016, Thomas Lee, then of the San Francisco Chronicle actually accused federal prosecutors at the DOJ for “grandstanding” when they announced their criminal probe of Theranos’ practices, independent of the SEC.

His argument? That “[f]ederal prosecutors rarely investigate securities fraud at privately held startups, if ever” due to the high bar for putting someone behind bars and that the “supposed victims” should have known better. He distinguished between ordinary people and sophisticated venture capital firms that should have known better.

Some of what Lee says is true. White collar criminals rarely face criminal investigations and charges for defrauding corporate investors. Sympathy is hard to come by for VCs who fail to do the due diligence to see through an amateurish con pulled by a neophyte founder and a President and COO shrouded in mystery. And the DOJ does have limited resources in tackling such a complex and unusual case.

But crucially, Lee is wrong on who is hurt by Theranos’ actions and downfall. Not only were actual consumers defrauded by Theranos’ dubious tests but there is also likely to be downstream costs downloaded onto consumers by Walgreens and Safeway for their failed foray with Theranos.

And that’s the problem.

With healthcare costs running amuck, investments in shiny technology offered by charlatans represent a rapidly cumulating waste of resources and time and less money for other, worthier initiatives. Instead of focusing on how Theranos’ treatment deviates from the U.S. government’s traditional complacency on fraud, perhaps its time to recognize a special responsibility among those companies purporting to operate in the healthcare technology sector should act with a higher ethical standard.

Make no mistake. While Theranos was particularly brazen in its approach to massive fraud, the truth is that the current lax environment in terms of criminal sanctions may have allowed another Theranos to fester. Fraud costs society and when fraud affects funds earmarked for innovation in healthcare, it specifically hurts the sector. So maybe it’s time to throw the book at Theranos and those trading in fraudulent science – and make sure it hurts.

Jason Chung is the Law & Technology Editor at The Health Care Blog. He also writes on the intersection of health, technology and sports as the senior researcher and attorney at NYU Sports and Society, a think tank dedicated to the study of sports and social issues.

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26 Comments on "On Theranos: It’s Time to Throw the Book at Healthcare Tech Frauds"


Member
William Palmer MD
Mar 16, 2018

There was enough truth in what Theranos was attempting to really draw in those investors with partial knowledge. I thought it was a decent venture at first because there are quite a few clinical needs for very small blood draws. Many folks actually develop anemia while in the hospital from multiple samplings of their blood. And some people have difficult veins which require surgical exposure. E.g. modern chemistry analyses can do an entire metabolic panel on about 50 microliters of plasma. This is approximately a drop of blood–well a little more (which is about 30 microliters.)

You have to be careful with fingerstick specimens, however, because if one squeezes the finger too much it can alter the results, change hematocrits, etc. And some analytes are actually different in capillary blood, e.g. glucose.

She should have used scientist-advisors from the American Association of Clinical Chemistry and they might have succeeded.

Member
pjnelson
Mar 15, 2018

The ultimate disgrace, a Ponzi scheme up-ended, again.

Member
Barry Carol
Mar 15, 2018

The thing that people need to understand about the VC world is that most investments in startups either fail or provide very disappointing returns at best. However, there are also a small number of spectacular successes that can way more than pay for lots of failures. Think Amazon, Facebook, Google, etc. It’s a high risk / high reward business.

The promise of Theranos’ technology had it proved successful was appealing to millions of patients. I, for one, used to feel like I was going to pass out when getting blood drawn. In more recent years, I learned to look away so it doesn’t bother me anymore but in the early days, I needed to lie down while it was drawn. Theranos was unduly secretive though investors could have refused to invest unless they could see the machine work and verify results vs. conventional technology.

As a patient, I’m thankful for all the innovation in medical devices including stents, pacemakers, ICD’s, hip and knee replacements, etc. I’m also thankful for all the new drugs that were developed over the last 40-50 years with lots of failures along the way and I’m thankful for less invasive surgical techniques that shorten operations and recovery times while reducing patient risk.

The Theranos concept had a lot of promise if it worked. VC investors understand that. Investor losses, including those incurred by Safeway and Walgreens, are easily sustained within their business models. They saw sufficient promise to accept Theranos’ culture of secrecy around its technology. Failure comes with the territory.

Member
Mar 17, 2018

Respectfully, I don’t think that’s the issue here.

Of course the VC world is built on tackling big ideas and taking high risks but Theranos is about the conduct of those running the businesses. Theranos was not just unduly secretive, they appear to have flat out lied to multiple rounds of investors about the track record of their technology, the roll-out of their technology, their previous clients and even whether they were leveraging their own technology.

Innovation is great, tolerance of failure is a must, fraud is not okay.

Member
Allan
Mar 18, 2018

“fraud is not okay.”

I think fraud can be civil or criminal. When you are using the term “fraud” are you considering criminal fraud? If so which elements of this case make it criminal? Regarding specific fraud allegations, I don’t think they impacted patients (limiting the question to the ‘new high tech equipment’) did they?

Member
Mar 15, 2018

Cited this on my KHIT.org blog. Holmes has been a burr under my saddle for a long time.

Member
Adrian Gropper, MD
Mar 14, 2018

The problem is secrecy in medicine. As healthcare approaches 20% of GDP and $1 Trillion of that is waste and fraud, we can expect thousands of mini-Theranos every year. Why not take a chance if there’s with no risk of jail time and you are hailed as the future.

The root problem is treating medicine as intellectual property, rewarding secrecy in Theranos or Flatiron Health’s $2 Billion database of patient records as necessary for progress. Medical technology that is open-source and subject to peer review is much less accessible to fraud and respectful of the invaluable and often involuntary contribution of patients at our most vulnerable moments.

The lesson of Theranos is the need to keep medicine and science open and transparent.

Member
LeoHolmMD
Mar 16, 2018

Completely agree. The FDA cannot approve a “secret ingredient” to administer as treatment and you can’t put a “secret device” in people either.