SEC Charges Theranos with ‘Massive Fraud’

CEO Elizabeth Holmes settles with SEC, COO Sunny Balwani chooses to fight charges

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CEO SUMMARY: In an action against Theranos and two of its executives, the SEC said in a federal court filing this month that the company, CEO Elizabeth Holmes, and former COO Ramesh “Sunny” Balwani deceived investors into believing that the company’s portable blood analyzer could conduct comprehensive blood tests from drops of blood collected via a fingerstick. Theranos and Holmes agreed to a settlement while Balwani will fight the charges.

EARLIER THIS MONTH, officials at the Securities and Exchange Commission (SEC) announced what it called a massive fraud settlement involving Theranos and its top executive.

The SEC said Theranos, its CEO and its former COO raised more than $700 million from investors through an elaborate, years-long scheme that involved exaggerating or making false statements about the company’s technology, business, and financial performance. The two executives are the company’s founder, Chairman, and CEO Elizabeth Holmes and former COO Ramesh “Sunny” Balwani, who left the company in 2016.

Theranos and Holmes, age 34, settled with the SEC while not admitting nor denying the charges. Balwani, age 52, will contest the charges.

In documents filed March 14 in U.S. District Court for the Northern District of California, the SEC said Theranos, Holmes, and Balwani deceived investors into believing that the company’s portable blood analyzer could do comprehensive laboratory blood tests from drops of blood collected via a fingerstick.

In truth, Theranos’ proprietary analyzer could complete only a small number of tests, and the company conducted the vast majority of patient tests on modified, industry-standard commercial analyzers, the SEC said.

To settle the charges, Holmes agreed to pay a $500,000 fine and give up almost 19 million shares of Theranos stock, the SEC said. Also, she will lose voting control of the company and be barred from running a public company for 10 years.

Given that the SEC regulates public companies, Holmes could still run a private company. Either way, the fraud charges reflect a substantial drop in the company’s value and in the stake Holmes held in the company.

After dropping out of Stanford University at age 19, Holmes founded Theranos in 2003. By the end of 2014, the company was valued at $9 billion and Forbes listed Holmes as one of America’s richest people with an estimated net worth of $4.5 billion, based on her 50% stake in Theranos stock.

No Jail Time for SEC Charges

The SEC charges are civil and so would not involve jail time. But the Department of Justice could bring criminal charges and, if successful, Holmes could face a prison sentence, reported Ellie Kincaid and Michela Tindera for Forbes. Of Holmes, one lawyer said, “She is subject to criminal charges because she outright lied,” they reported. In a criminal case, prosecutors would need to prove that Holmes acted recklessly or that she had intent to deceive investors, Kincaid and Tindera added.

In its court filing, the SEC also charged that Theranos, Holmes, and Balwani claimed that the Department of Defense (DOD) used the company’s products on the battlefield in Afghanistan and on medevac helicopters and that, as a result of its work with the DOD, the company would generate more than $100 million in revenue in 2014.

“In truth, Theranos’ technology was never deployed by the U.S. Department of Defense and generated a little more than $100,000 in revenue from operations in 2014,” the SEC said.

In coverage of the case, Forbes’ Matthew Herper reported that the fraud “appears to be even worse than previously thought.” As an example, he cited how the SEC filing identified a company it called Pharmacy A.

The SEC said in its court filing that Theranos had spent at least five years trying to develop its proprietary analyzer, the Theranos Sample Processing Unit (TSPU) to analyze blood taken from a fingerstick. “The earlier-generation TSPU was designed to perform only one method of testing—immunochemistries—and could process only one sample at a time,” the SEC said. In 2009, Holmes and Balwani wanted to develop a new version of the TSPU, which they called the miniLab, and that could run a wider range of tests.

In 2010, its miniLab analyzer was not ready for commercial use but Theranos wanted to offer it in retail settings with chain drug and grocery store companies, which the SEC identified as Pharmacy A and Grocery A. Pharmacy A is believed to be Walgreens, Herper wrote.

In September 2013, Walgreens and Theranos announced an agreement in which Theranos would provide lab testing services in Walgreens’ pharmacies. Theranos also had a partnership with Safeway supermarkets, according to John Carreyrou who reported for The Wall Street Journal that the Theranos-Safeway partnership began at least in 2011 but unraveled in 2015.

Analyzer in Grocery Stores

“Safeway Inc. spent about $350 million to build clinics in more than 800 of its supermarkets to offer blood tests by startup Theranos Inc.,” wrote Carreyrou. When the tests never started, the companies ended the partnership, he said.

“In connection with discussions about a potential partnership with Pharmacy A, Holmes approved and provided presentations and other written materials to Pharmacy A executives representing that Theranos had the ability to conduct a broad range of tests on its proprietary analyzer, including general chemistry tests, wellness tests, and some predictive and diagnostic health tests (which involved methods beyond immuno-chemistries),” the SEC said. “These materials stated that Theranos would be ready to begin blood testing on its proprietary analyzer at Pharmacy A stores by the fourth quarter of 2010.”

Hundreds of Tests

In addition, Holmes also told the executives of Pharmacy A that Theranos could do hundreds of blood tests via a fingerstick, that its testing could be done in less than an hour, and that the testing would cost less than what competitors charge, SEC documents show. Holmes also told Pharmacy A that its analyzer was already deployed on military helicopters.

By 2013, however, the miniLab was unable to do what Theranos promised it could do. Instead, Holmes and Balwani asked Theranos’ engineers to modify analyzers from commercial manufacturers so they could analyze fingerstick samples. “Holmes and Theranos never told Pharmacy A and Grocery A about Theranos’ technological challenges,” the SEC said.

“At all times, however, Holmes, Balwani, and Theranos were aware that, in its clinical laboratory, Theranos’ proprietary analyzer performed only approximately 12 tests of the over 200 tests on Theranos’ published patient testing menu, and Theranos used third-party commercially-available analyzers, some of which Theranos had modified to analyze fingerstick samples, to process the remainder of its patient tests,” the SEC said.

Criminal Investigation

News reports say that the Department of Justice continues to investigate Theranos and its executives. It is possible that federal prosecutors may bring criminal charges against Theranos, its executives, as well as consultants and advisors who provided advice to the company and acted on its behalf.

It is ironic that the same news outlets that trumpeted the innovations of Theranos and the genius of its founder and CEO, Elizabeth Holmes without much skepticism now devote extensive news coverage to the SEC charges and Theranos’ ongoing struggles to survive.

Theranos Is Subject of Book, Movie, and Documentary

FOR YEARS, clinical laboratory professionals and pathologists questioned the legitimacy of claims Theranos made about its secretive diagnostic technology, its lab analyzers, and its ability to use fingerstick blood specimens for hundreds of medical laboratory tests.

That skepticism was well-founded. In the past two years, federal agencies have disclosed failures to comply with federal regulations. First was the federal Centers for Medicare and Medicaid Services, which inspected the clinical laboratories operated by Theranos and issued letters to the company describing CLIA deficiencies and failures in its laboratories.

Second was the SEC’s court filing earlier this month that describes the allegations of fraud in how Theranos and its executives misled investors and the public.

This spring, new details will emerge about Theranos. Publisher Alfred A. Knopf will release a book on May 21, “Bad Blood: Secrets and Lies in a Silicon Valley Startup.” For this book, author John Carreyrou interviewed more than 150 people, including dozens of former Theranos employees, the New York Times reported.

Carreyrou’s book will be the basis for a movie. The working title is “Bad Blood,” and news accounts say that Jennifer Lawrence will star as Elizabeth Holmes. Adam McKay is slated to be writer-director. He is known for his film “The Big Short.”

Also in production is a documentary about Theranos and Holmes by documentarian Alex Gibney. There have been no announcements of public release dates for the movie or the documentary.


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