Holmes, Balwani Indicted by Department of Justice

Each defendant charged with two counts of conspiracy and nine counts of wire fraud

CEO SUMMARY: Federal criminal indictments were unsealed last Friday in San Francisco against Elizabeth Holmes and Ramesh “Sunny” Balwani for their actions as executives at Theranos, Inc., the once high-flying lab test company. Officials at the Department of Justice said the counts against Holmes and Balwani are based on the alleged actions of each to defraud investors and to defraud both the physicians and patients who ordered clinical laboratory tests from their company.

TWO HIGH-PROFILE EXECUTIVES associated with Theranos, Inc. were indicted last week. Elizabeth Holmes and Ramesh “Sunny” Balwani were arraigned before U.S. Magistrate Judge Susan van Keulen on Friday in U.S. District Court for the Northern District of California, San Jose Division. Each one was charged with two counts of conspiracy to commit wire fraud and nine counts of wire fraud.

If convicted, Holmes and Balwani could face prison sentences that would keep them behind bars for the rest of their lives and fines totaling $2.75 million each, the Associated Press reported.

Under a federal grand jury indictment returned June 14 and unsealed Friday, the charges stem from allegations Holmes and Balwani engaged in a multimillion dollar scheme to defraud investors, and separate scheme to defraud doctors and patients. Both schemes involved efforts to promote the lab company Theranos of Palo Alto, Calif., the federal Department of Justice announced.

In the indictment, the DOJ charged that Theranos, Holmes, and Balwani not only defrauded investors, but also defrauded consumers who trusted and relied on Theranos’ blood-testing technology that Holmes and Balwani claimed was revolutionary and would change the clinical lab testing business in significant ways.

“This indictment alleges a corporate conspiracy to defraud financial investors,” said FBI Special Agent in Charge John F. Bennett. “This conspiracy misled doctors and patients about the reliability of medical tests that endangered health and lives.”

The indictment contains at least one new development in the alleged fraud scheme that Holmes and Balwani perpetrated. The indictment states Holmes and Balwani sent to patients and doctors test results that they knew contained—or were likely to contain—data that were inaccurate and unreliable, came from improperly adjusted reference ranges, and were generated from improperly validated assays. Also, the indictment states, the results contained or were likely to contain improperly removed ‘critical’ data.

Prison, Fines, Restitution

If convicted, Holmes, age 34, and Balwani, 53, face a maximum sentence of 20 years in prison, and a fine of $250,000, plus restitution, for each count of wire fraud and for each conspiracy count, the DOJ said.

The DOJ’s indictment follows by three months charges the federal Securities and Exchange Commission filed March 14 in the same court. The SEC charged that Theranos, Holmes, and Balwani 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 SEC’s charges are similar to those in the DOJ’s indictment.

‘Deceived Investors’

In the SEC case, the federal agency 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. (See TDR, March 26, 2018.)

In fact, the company’s proprietary analyzer could complete only a small number of tests while the company conducted most patients’ tests on modified, industry-standard commercial analyzers, the SEC said.

To settle the SEC’s charges, Holmes agreed to pay a $500,000 fine and she agreed to surrender almost 19 million shares of Theranos stock and voting control of the company, the SEC said. Also, she was barred from running a public company for 10 years. At the time, Holmes did not admit to nor deny the charges. Balwani said he would contest the charges.

After dropping out of Stanford University at age 19, Holmes founded Theranos in 2003 with the idea that the company would revolutionize medical laboratory testing through allegedly innovative methods for drawing blood and testing blood and for interpreting the resulting patient data, the DOJ said. At one time, Theranos was valued at more than $9 billion and because Holmes owned almost 50% of the company’s stock, her personal wealth was valued at more than $4 billion, making her the youngest self-made female billionaire, the AP said.

Balwani’s Role at Theranos

From 2009 through 2016, Balwani served the company in several roles, including as president, chief operating officer, and as a member of the board of directors.

The Wall Street Journal’s John Carreyrou reported Friday night that Holmes had stepped down as CEO and that the indictments were the culmination of a 30-month investigation by the U.S. attorney’s office in San Francisco that was sparked by Carreyrou’s reporting on Theranos since October 2015. (See “WSJ Reporter Tells All About Downfall of Troubled Theranos,” TDR, May 29, 2018.)

Sara Ashley O’Brien at CNN reported that minutes before the charges were made public, Theranos announced that Holmes stepped down as CEO and that the general counsel, David Taylor, would assume the role of CEO. Holmes will stay on as chair of the company’s board.

The indictment explained in detail how Holmes and Balwani used advertisements and solicitations to doctors and patients to get them to use Theranos’ blood testing services, even though both Holmes and Balwani knew the technology was incapable of producing accurate and reliable results for certain blood tests consistently and that the tests were likely to contain inaccurate and unreliable results, the DOJ said.

Defrauded Potential Investors

Also, the indictment alleges that Holmes and Balwani defrauded potential investors through direct communications, marketing materials, statements to the media, financial statements, and other means. “Specifically, the defendants claimed that Theranos developed a revolutionary and proprietary analyzer that the defendants referred to by various names, including as the Theranos Sample Processing Unit (TSPU), Edison, or minilab,” the DOJ said. Holmes and Balwani claimed the Theranos analyzer could perform a full range of clinical tests using only small fingerstick samples of blood and that the analyzer could produce results faster, more accurately, and more reliably than conventional testing methods could produce, the DOJ explained.

In their presentations to investors, Holmes and Balwani knew that their statements about the analyzer were false, the indictment alleged. “For example, allegedly, Holmes and Balwani knew that the analyzer, in truth, had accuracy and reliability problems, performed a limited number of tests, was slower than some competing devices, and, in some respects, could not compete with existing, more conventional machines,” the DOJ said.

Doctors, Patients Defrauded

Doctors and patients were defrauded because Holmes and Balwani made false claims about the ability of Theranos’ testing systems to provide accurate, fast, reliable, and low-cost blood tests and test results, the DOJ said. Also, Holmes and Balwani failed to disclose the limits of that technology and the problems they had developing those testing systems, the DOJ explained in its announcement.

“The defendants knew Theranos was not capable of consistently producing accurate and reliable results for certain blood tests, including the tests for calcium, chloride, potassium, bicarbonate, HIV, HbA1C, hCG, and sodium,” the DOJ said. “The defendants nevertheless used interstate electronic wires to purchase advertisements intended to induce individuals to purchase Theranos blood tests at Walgreens stores in California and Arizona.”

In its advertisements, the company explicitly represented that Theranos’ blood tests were cheaper than blood tests from conventional laboratories, the DOJ said. As a result of Holmes and Balwani’s misrepresentations and omissions, many hundreds of patients paid for blood tests and test results or had their health insurers pay for blood tests and results following referrals from their “defrauded doctors,” the DOJ said.

Indictments Are a Warning to Silicon Valley and All Labs

IN ITS PRESS ANNOUNCEMENT about the indictments of Elizabeth Holmes and Ramesh “Sunny” Balwani, the federal Department of Justice outlined how it will pursue cases against those who misrepresent the technology they are developing.

That announcement for the DOJ’s district office in San Francisco serves as a warning to companies in Silicon Valley where Theranos is based, as well as to clinical and genetic testing labs.

In addition, lab directors and pathologists should note that the federal Food and Drug Administration’s Office of Criminal Investigations assisted the FBI and DOJ in its pursuit of fraud charges against Holmes and Balwani.

“This district, led by Silicon Valley, is at the center of modern technological innovation and entrepreneurial spirit; capital investment makes that possible. Investors large and small from around the world are attracted to Silicon Valley by its track record, its talent, and its promise,” the DOJ said. “They are also attracted by the fact that behind the innovation and entrepreneurship are rules of law that require honesty, fair play, and transparency.

“The conduct alleged in these charges erodes public trust in the safety and effectiveness of medical products, including diagnostics,” the DOJ added.

Scheme to Mislead Investors

Holmes and Balwani also used various schemes to mislead investors, the DOJ said. “For example, with respect to investors, defendants performed technology demonstrations during which defendants intended to cause potential investors to believe blood tests were being conducted on Theranos’ proprietary analyzer when, in fact, the analyzer really was running a ‘null protocol’ and was not testing the potential investor’s blood,” the DOJ said.

“Similarly, defendants purchased and used commercially-available analyzers to test patient blood, while representing to investors that Theranos conducted its patients’ tests using Theranos-manufactured analyzers,” the DOJ explained.

‘Negligible’ Revenue

In addition, Holmes and Balwani misrepresented Theranos’ financial condition and its future prospects, the DOJ said. The defendants claimed Theranos would generate over $100 million in revenue and break even in 2014, the DOJ said. Also, the defendants claimed that the company expected to generate $1 billion in revenue in 2015. “In truth, the defendants knew Theranos would generate only negligible or modest revenues in 2014 and 2015,” the DOJ said.

In addition to making false claims about how the DOD was using its technology, Holmes and Balwani also misrepresented to investors its relationship with Walgreens, the DOJ said. “The defendants represented to investors that Theranos would soon dramatically increase the number of Wellness Centers within Walgreens stores when, in truth, Holmes and Balwani knew by late 2014 that Theranos’ retail Walgreens rollout had stalled because of several issues, including that Walgreens’ executives had concerns with Theranos’ performance,” the DOJ explained.

Holmes and Her Mother Both Had Fear of Needles

TWO OFT-TOUTED BENEFITS of the proprietary Theranos lab test technology were that it needed just a tiny amount of blood as a specimen and that blood could be collected with a finger stick, thus avoiding a venipuncture. Nearly all pathologists and clinical laboratory scientists recognized the dubious nature of these claims.

In his book about Theranos—”Bad Blood: Secrets and Lies in a Silicon Valley Startup”—that was published last month, author John Carreyrou, The Wall Street Journal reporter who exposed the fraud at Theranos, wrote about the origin of these two benefits. On page 19, he wrote:

The main difficulty stemmed from Elizabeth’s insistence that they use very little blood. She’d inherited from her mother a phobia of needles; Noel Holmes [Elizabeth’s mother] fainted at the mere sight of a syringe. Elizabeth wanted the Theranos technology to work with just a drop of blood pricked from the tip of a finger. She was so fixated on the idea that she got upset when an employee bought red Hershey’s Kisses and put the Theranos logo on them for a company display at a job fair. The Hershey’s Kisses were meant to represent drops of blood, but Elizabeth felt they were much too big to convey the tiny volumes she had in mind.

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