Theranos Inc. — once the most valuable medical technology start up in America — is now a slow-motion corporate disaster generating waves of bad news.
It’s a corporate disaster that didn’t need to happen. Investors and board members could have insisted on a compliance officer inside the company from the start. Why didn’t they?
First a recap. Theranos claimed its so-called Edison technology could test a drop of blood taken from a finger and achieve the same results as labs that use vials of blood taken by the traditional vein-puncture technique. Theranos said its technology would disrupt the blood testing industry by being faster, cheaper, and better.
At first, investors from Silicon Valley backed the company. Then Theranos attracted big-name investors, including Rupert Murdoch, Cox Enterprises, and Riley Bechtel, the chairman of construction giant Bechtel Group.
The Wall Street Journal said Murdoch and Cox each invested $100 million into the company in a funding round that ended in April 2015 and raised about $632 million.
So far Theranos has raised about $750 million. At the close of the round in April 2015, the company had a valuation of $9 billion.
That made its founder and CEO Elizabeth Holmes, now 32, the richest self-made woman in America. Her 50 percent share of the company was worth $4.5 billion.
Theranos attracted an all-star board of directors. Among them were former Secretary of State George Shultz, Riley Bechtel of the Bechtel Group, former Wells Fargo chairman and CEO Richard Kovacevich, former Senators Sam Nunn and Bill Frist, former Secretary of State Henry Kissinger, and former Secretary of Defense William Perry.
But it wasn’t until July 2016 that the company appointed a chief compliance officer. By then, Theranos and Holmes were accused of making fake claims about the blood testing technology. The corporate disaster was in full swing.
In October 2015 the WSJ had published its first article describing problems at Theranos.
After that, federal regulators banned Holmes from the blood-testing industry for at least two years. The U.S. attorney’s office in San Francisco and the SEC launched criminal and civil investigations to determine if Theranos misled investors and regulators.
Walgreens sued Theranos earlier this month for breach of contract, asking for at least $140 million in damages. The drug store chain said it was forced to end its agreement to host Theranos blood testing centers when it found out the technology didn’t work.
Last month Theranos shut down its blood testing lab and testing centers and fired 340 staff. Holmes said the company would refocus on developing and marketing its “mini lab” hardware.
This week, Robert Colman, cofounder of San Francisco investment bank Robertson Stephens & Co., and another shareholder sued Theranos, Holmes, and Theranos’ former president Ramesh “Sunny” Balwani. The federal suit seeks class action status. It alleges the defendants misled investors.
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Now back to compliance. More than two years ago, a whistleblower from inside the company had come forward.
By April 2014, Tyler Shultz, then 25, the grandson of board member George Shultz, had worked at Theranos for eight months. According to the WSJ, he emailed Elizabeth Holmes “to complain that Theranos had doctored research and ignored failed quality-control checks.”
Holmes forwarded the email to Theranos president Balwani. He “belittled Shultz’s grasp of basic mathematics and his knowledge of laboratory science.”
“The only reason I have taken so much time away from work to address this personally is because you are Mr. Shultz’s grandson,” wrote Mr. Balwani to his employee in an email, a copy of which was reviewed by the Wall Street Journal.
Shultz quit the same day, the WSJ said.
He was one of several Theranos employees, the Wall Street Journal said, “who tried to voice concerns inside the company about what they saw as troubling practices.”
He then contacted New York state regulators, using an alias, and he began talking to the Wall Street Journal.
The WSJ reported what happened next.
Theranos accused him of leaking trade secrets and violating an agreement to not disclose confidential information. Mr. Shultz says lawyers from the law firm founded by David Boies, one of the country’s best-known litigators and who later became a Theranos director, surprised him during a visit to his grandfather’s house.
They unsuccessfully pressured the younger Mr. Shultz to say he had talked to the reporter and to reveal who the Journal’s other sources might be. He says he also was followed by private investigators hired by Theranos.
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The story of Theranos is far from over. But it already shows how things can go wrong early on when there’s no compliance officer to fight for whistleblowers and the truth.
Presumably the first-in financial backers from Silicon Valley could have pushed Theranos and Holmes to appoint a chief compliance officer. Yes, budgets are tight at the start. And top executives might argue that when resources are still stretched during the start-up phase, compliance can wait.
But the later big-name investors — Murdoch, Cox, and Bechtel among them — would have had plenty of leverage to insist on a compliance staff. From a funding round of more than $600 million, a relatively small allocation for the compliance function would have made sense.
The all-star board could have named a compliance officer at any time. They didn’t. Most of the board resigned after the U.S. government banned Holmes from the blood-testing business.
No one seems to have thought of appointing a chief compliance officer until it was too late. Maybe they all thought the early investors’ due diligence was good enough. Or maybe some investors and directors did push for a compliance officer and Holmes resisted. If that happened, it should have been a huge red flag.
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In June Forbes revised its estimate of Elizabeth Holmes’ net worth from $4.5 billion last year to nothing.
Theranos, Forbes said, could be worth around $800 million. There are even some scenarios whereby it could become even more valuable.
But if Theranos were liquidated today, Forbes said, preferred shareholders (those early investors) would be paid before Holmes. Her take would be zero.
Richard L. Cassin is the publisher and editor of the FCPA Blog.