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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“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?
I think VCs can take whatever risks they want, no matter how improbable the reward. But shareholders of publicly traded companies should have tough questions for their C Suite about their investment and innovation strategy.
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.
No, in fact I hate it more because it’s wishy-washy. If you’re going to say something controversial, then own it.
Completely agree. The FDA cannot approve a “secret ingredient” to administer as treatment and you can’t put a “secret device” in people either.
I don’t think Kip is very far off. To the extent that a well intentioned idea like the PCMH or ACO continues to promote itself on the same premises that have been disproven over and over, it does start becoming fraud like. The effect is compounded when the costs are socialized and cannot be disrupted as they would in a natural marketplace where a bad idea can be recognized and abandoned. These bad ideas are embedded into legislation. The taxpayer has no recourse to walk away from the bad deal. That is at least racketeering.
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.
Ok, Michael, I’ll return the favor: Cute, Michael, arguing with a straw man.
I didn’t discuss the proponents of bad ideas or their motives. I didn’t accuse Holmes of bad motive because, as I said near the end of my comment, I feel I should withhold judgement on her character till I know more.
What I actually discussed was not Holmes and the proponents of bad ideas, but the people who fell for the bad ideas. Therefore, your remark that there is a difference between fraud and wishful thinking is irrelevant. For the record, I agree with you — there is a big difference between fraud and wishful thinking.
You may have inside information on how smug and avaricious the board members were. I don’t know that. I have a different hypothesis that is not inconsistent with yours: I suspect they were vulnerable to hype about technology.
Agree with Michael, too….very different things: Managed care (a broad term, BTW) failed to live up to some hopes and expectations. Insinuating that it was/is fraud is not accurate.
Theranos and ilk like it are another potent reminder that we too easily fall for, use and reward hyped technologies in health care—dx and rx. As Kip says, technology worship…also worship of “the new.” And lust for the buzz. All that ends up accounting for a not insignificant share of what we call waste in health care. Of course there’ll always be ideas and new tools and treatments that sound great and test well at first….and prove to be duds.
Steve
Here’s my comment, also posted on Twitter.
Does starting a tweet with the words “Don’t hate me” grant the author blanket immunity to say whatever they want without owning it? I’m not sure it does.
Kip-
As usual an eloquent discussion of truth. Technology worship is silly in a profession better suited to laying hands directly on human beings. My answer to your question about the “smart people” is that smart does not necessarily mean “disagreeable.” Many smart people are too agreeable.
Those “smart people” who are mucking around with unproven things, are more in love with the constructs of their mind than with the reality of a system they are destroying. I am watching access to healthcare erode before my eyes and it is utterly terrifying.
It will get much worse before it gets better.
Thanks Kip for your insightful comments, as usual.
Spot on, Michael
The ultimate disgrace, a Ponzi scheme up-ended, again.
“The 1980s were filled with junk bonds. In the 2010s, I think we’re dealing with junk innovation.”
That seems to make some sense and for the past thirty plus years the government has sold “junk bonds” in the form of Obamacare, Managed Care, ACO’s etc. without any proof that these schemes would work and the taxpayer and patients have paid big time. I don’t see much difference between what the government did and what Theranos did except Theranos sold its goods to investors that are supposed to have superior knowledge while the government sold their “product” to people that might not even have been able to read.
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.
The 1980s were filled with junk bonds. In the 2010s, I think we’re dealing with junk innovation.
During an interview I conducted with Brennan Spiegel for THCB (https://thehealthcareblog.com/blog/2018/01/26/abstats-vr-the-future-of-digital-health-a-conversation-with-brennan-spiegel/), we talked about the need for research-backed evidence before making medical claims.
I’d like to see more healthcare companies exercise such a higher standard, especially when dealing with startups. And also, when you can’t tell the difference between puffery and fraud, maybe the people in charge need to be re-evaluated as well.
My response to Christina Farr via my Twitter @ChungSports:
“Sure. It’s my responsibility to lock the car when I get out. But I still the guy who actually stole my car is more responsible for grand theft auto.”
For me, the Theranos fiasco has to do with the superhuman powers we assume digital technologies inevitably possess. A chip is magic in and of itself. Add some blood, and we’ve got double magic. Golly, I should have sold them eye of newt. 3X better: predict diabetes, cancer and the future of the kingdom.
Via TweetBot:
https://twitter.com/chrissyfarr/status/973975706769137664
Cited this on my KHIT.org blog. Holmes has been a burr under my saddle for a long time.
Thanks Kip for adding this smart money / dumb patient perspective. I met today with folks that see Flatiron as worse than Theranos because the Flatiron investors (Google) are privatizing the benefits and socializing the costs to the next dumb patient that has to pay for their tech. The sub-prime mortgage bubble had the same pattern of smart investor privatizes profit and dumb home owner loses their investment in their home – and nobody goes to jail.
OMG! Are you telling me that a company out to make money sold bad technology to Walgreens, a pharmacy that will very soon in charge of making medical diagnoses and prescribing treatments?
This is so utterly shocking. I thought Walgreens and those other pharmacies were going to save consumers millions while being held to the high ethical standard of physicians. Stop the presses.
While I totally agree with Jasons’ eloquent take, there are 100’s of more companies out there like Theranos and they will keep winning until third parties get their grubby paws off of my noble profession. Why can’t doctors just do their jobs without all this junk interference?
I am so glad to hear more new “technology” is so helpful and my stethoscope, light, and ink pen are still so useless to the practice of medicine. Even the ink pen is a better tool than a blood tester thing that doesn’t work, because in a pinch, I can use it for a tracheostomy tube.
Someone will rescue Theranos and save them from books being thrown and criminal charges being filed because that is the American Health System: Doctors suck and every other person in healthcare is amazing even if they kill you. Because if they do kill you, at least they didn’t have 12 years of education so they can’t be held accountable.
Cute, Kip, but there is a difference between wishful thinking and deliberate fraud.
In terms of how “smart people” are sucked in, I would only concentrate on the board and suggest that, for many, they have long traded their fame for money and viewed this as just one more transaction. Cupidity and smugness mitigate against asking tough questions and encourage the groupthink you so correctly identified.
re ” Elizabeth Holmes defined her blood analyzer the way managed care proponents defined HMOs, ACOs, medical homes, and pay-for-performance — according to what she hoped it would do” and our experts bought in “without a shred of evidence”. Yes, and add the benefits of EHRs and the groupthink about the evil of fee for service…ignoring the fact that fee for service works in all other domains of human commerce….yet so many of our smart policy elites agree, lets ditch it.
According to the SEC’s charges, Elizabeth Holmes defined her blood analyzer the way managed care proponents defined HMOs, ACOs, medical homes, and pay-for-performance — according to what she hoped it would do. She hoped it would facilitate multiple tests on a small drop of blood.
Just as managed care proponents never described the mechanisms or interventions that ACOs etc. would use, so Holmes refused to describe the mechanism she had allegedly invented that would cause her analyzer to do what she claimed it would do. And just as managed care buffs never produced a shred of credible evidence supporting claims for HMOs etc. before lobbying Congress and employers to invest in their latest next new thing, so Holmes failed to publish supporting evidence before lobbying investors and Walgreen’s to invest in her new thing.
I’m fascinated by the question, How do smart people get sucked into supporting bad ideas before doing anything resembling due diligence? I’m much less curious about how poorly educated people get sucked into making dumb decisions. It’s the wholesale hoodwinking of large swaths of the educated elite that fascinates me. If the SEC’s charges are correct, this is another example of a critical mass of smart people turning off their brains and letting groupthink dictate their decision-making.
The type of groupthink that leads to stupid decisions varies depending on the dumb idea under investigation. So, for example, the groupthink that led to the housing crash and the Great Recession (housing values would never decline in all part of the country at once, and in any event Moody’s and the other rating agencies with their enormous computers would never label bad mortgages as creditworthy) is different from the groupthink that sustained Theranos, and those forms of groupthink in turn vary from the groupthink that led to the folklore that it’s possible to measure the “merit” or “value” of doctors and punish and reward them accordingly.
But I suspect that all three of those dumb ideas share something in common — technology worship, especially the worship of big computers and big databases. Here’s an essay I wrote about the hype that was published about Flatiron three years ago. http://www.healthcareitnews.com/blog/big-data-latest-fad-health-policy When I first read about Flatiron, I was sure the founders were overestimating what technology could do to accelerate research on a cure for cancer. My formal training is law and economics, and yet I was 99 percent sure that the assumptions the Flatiron founders made about big data (in this case data on cancer patients) and how research in the life sciences works was wrong. My bet is technology worship played a role in the rise and fall of Theranos.
I want to stress here that I don’t know for sure that Holmes is guilty of the SEC charges. I haven’t followed her adventure that closely. If in fact she’s had credible evidence supporting her claims all these years, she better produce it now.
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.