Learn the consequences that follow for companies and individuals that improperly hide and do not disclose critical information when entering into contracts and raising investor funds.
Case Study: Violating Disclosure Laws
Theranos, a fast-growing private company intent on trailblazing a new technology, set out to attain ambitious goals. That dream garnered buy-in from numerous leaders in both the business and political fields. As a result, the company quickly and rather easily raised hundreds of millions of dollars in pursuit of that vision. Obstacles arose along the way but the company ignored them, plowing forward with business deals and public use of its product despite the fact that the product failed to perform as advertised.
Readers will be able to:
- Understand and identify the need for proper corporate disclosure.
- Explain why corporate leaders should quickly address unexpected roadblocks or failures.
- Describe the importance of checks and balances within and organization.
- Understand and explain how employees might play a role in ensuring corporate compliance.
- Identify and understand how decision making or actions taken within a division or department of a company given too much autonomy, or even by an inadequately supervised employee, can have a cascading effect on fellow employees and the entire organization.
US Food and Drug Administration, blood test, raising capital, disclosure.
Employees given autonomy at work have huge leeway in the performance of their jobs. That leeway creates opportunities for greater efficiency and productivity but also poses the potential for abuse. Most employees honor the position of trust given to them by the company and feel free to admit a need for assistance or to delay the rollout of a product. Others, however, crumple under pressure, trying to cover up their failure, hoping to solve the issue before it becomes apparent. In most instances that strategy is doomed, as a last-minute reprieve fails to materialize.
Failure to timely and properly disclose business issues can lead to material civil and criminal consequences because others such as government agencies, investors, patients, and even fellow employees act in reliance on information being true and accurate.
Many great corporate leaders earn fame and receive great rewards for their eccentric, swash-buckling ways. Steve Jobs, Elon Musk, and many others offer a vision and a pathway to get there. Some achieve their goals while others fail because, all too often, the vision is ahead of the technology. Or, perhaps, their management prowess fell short. Then again, it may only involve a division, department or individual unable to meet expectations. How and when such failures are handled can make all the difference in how a company or individual will be treated by the US justice system.
Theranos was a high-flying unicorn company with an astronomical valuation. It touted a prospective revolutionary technology with a vision of democratizing personal diagnostics in the blood testing field. It also serves as a critical lesson on how quickly and easily it can be to go from the executive boardroom to the courtroom for white-collar crime. Elizabeth Holmes founded and served as CEO of Theranos, a company created to materially advance antiquated blood testing procedures by developing a method using a surprisingly small volume of blood, such as from a fingerprick. Holmes described her fear of needles as motivation, a common fear many people could relate to, which helped fuel the start-up growth of her company.
The company first began as an idea while Holmes attended Stanford University. After the end of her freshman year, Holmes worked in a laboratory at the Genome Institute of Singapore and tested for severe acute respiratory syndrome through the collection of blood samples with syringes. She then filed her first patent application on a wearable drug-delivery patch in 2003, earning a reputation as a brilliant go-getter. Her father, moreover, held positions as a senior executive and then went to work at government agencies such as USAID, the Environmental Protection Agency and USTDA. Her mother worked as a Congressional committee staffer. All of this helped seal Holmes reputation and lent credibility to her bold new idea. In March 2004, she dropped out of Stanford’s School of Engineering and used her tuition money as seed funding for Theranos, bringing on her college advisor and dean at the School of Engineering, Channing Robertson, as the company’s first board member. Mr. Channing instrumentally then introduced Holmes to noted venture capitalists.
By December 2004, Holmes had raised $6 million to fund the firm. At the end of 2010, Theranos had garnered more than $92 million in venture capital. In July 2011, Holmes was introduced to former secretary of state George Shultz. After a two-hour meeting, he joined the Theranos board of directors. Theranos was well on its way.
Holmes went on to form what was widely recognized as “the most illustrious board in U.S. corporate history” over the next three years, including such members as Henry Kissinger (former Secretary of State), James Mattis (a retired US Marine Corps general who went on to serve as President Donald Trump’s secretary of defense),Gary Roughead, (a retired US Navy admiral), William Perry (former US secretary of defense), Sam Nunn (a former US Senator), Richard Kovacevich (the former CEO of Wells Fargo), William Frist (a heart and lung transplant surgeon and former US Senator), William H. Foege (former director of the Centers for Disease Control and Prevention) and Riley P. Bechtel (chairman of the board of the Bechtel Group Inc.).
Holmes notably impressed these individuals who chose to join the Board because of her “competence…both technical and scientific but also focused on human rights in the most classical sense of what human rights are about,” and she was viewed as “…really a revolutionary in the truest sense,” as revealed in subsequent interviews. They also noted the promise of the technology to save lives and Holmes’ vision of democratizing healthcare as additional key factors.
Theranos raised more than $700 million from venture capitalists and private investors by 2014, claiming advanced research and technological development requiring only 1/100 to 1/1,000 of the amount of blood for tests than would ordinarily be needed and costs far below that of existing exams. Behind the scenes, though, the technology did not evolve as hoped and anticipated. Theranos asserted it was conducting patient tests using Theranos-manufactured analyzers; when, in truth, Holmes knew that Theranos purchased and used third party, commercially available analyzers to conduct most of its work.
The defendants also represented to investors that Theranos would generate over $100 million in revenues and break even in 2014 and that Theranos expected to generate approximately $1 billion in revenues in 2015; when, in truth, the defendants knew Theranos would generate only negligible or modest revues in 2014 and 2015.
Development shortcomings, however, did not stop Theranos from rolling out a deal with the large, national drug store chain Walgreens, enabling Theranos to begin reaching consumers directly. Shortly thereafter, Capital BlueCross, central Pennsylvania’s largest health insurer with over 700,000 consumers, selected Theranos as its lab and bloodwork provider. In July 2015, Theranos’s test for detecting herpes simplex virus 1 is approved by the US Food and Drug Administration (FDA). The company reached a valuation of $10 billion.
Holmes’ personal wealth skyrocketed to over $1 billion as she began living a luxurious lifestyle rivaling that of a movie star, according to an article on CNBC.com. She employed personal assistants to run her luxury shopping sprees, traveled by private jet, stayed at exclusive hotels and drove an expensive SUV. She also enjoyed the high-end friendships and relationships that develop from being constantly in the limelight.
Theranos’ technology was only first questioned when John P.A. Ioannidis, MD, DSc, criticized Theranos in an article published in The Journal of the American Medical Association for having operated in “stealth mode” for years without publishing research in peer-reviewed medical journals in 2015. Things continued to take a turn for the worse for Theranos after The Wall Street Journal (WSJ) published an in-depth exposé on the company. In the piece, the author John Carreyrou interviewed ex-employees who made claims including management incompetence and that the company had exaggerated the capability of the technology, thereby deceiving the public.
Holmes appeared on CNBC’s Mad Money in an attempt to do damage control in the face of growing accusations. During the episode, she claims the statements in the WSJ are false an, that Theranos had supplied over 1,000 pages of documentation that disprove the allegations. “This is what happens when you work to change things. First, they think you’re crazy, then they fight you, and then all of a sudden you change the world,” she remarked in the company’s defense.
All these revelations caused the FDA to re-examine Theranos’s nanocontainer, with the FDA determining Theranos used an “uncleared medical device” whose design was “not validated under actual or simulated use conditions.” This forced Theranos to cease use of its unapproved nanotainer for all of its blood tests, except for one. This cratered Theranos’s $350 million deal with Safeway which would have allowed Theranos to offer tests in more than 800 supermarkets, in which Safeway had already spent money to build out clinics.
The Centers for Medicare and Medicaid Services (CMS) then inspected Theranos’s Newark, California, lab. The investigation found that the facility failed to “comply with certificate requirements and performance standards” and caused “immediate jeopardy to patient health and safety.” In light of the CMS report, Walgreens stops tests at its Theranos Wellness Centers.
In June of 2018, the DOJ indicted Holmes and Theranos’s Chief Operating Officer (Ramesh Balwanion) on two counts of conspiracy and nine counts of wire fraud, finding that the pair had “engaged in a multi-million-dollar scheme to defraud investors, and a separate scheme to defraud doctors and patients.”
Government prosecutors intend on putting Holmes’s luxurious lifestyle on trial as part of their case.
Companies with powerful, visionary leaders often develop a culture of complete deference to those leaders, creating an unhealthy work environment in which instructions are followed without question or consideration. Leaders at every level of an organization must foster a system that empowers rank and file employees to speak up and provide opinions. There were surely a number of people at Theranos who were aware that the product rolled out at Walgreens and planned for Safeway would not perform as advertised, yet they chose to remain silent until questioned by The Wall Street Journal.
A company’s Board of Directors must serve as a check on management by reviewing corporate decision making. Board members need to do more than show up at meetings acting as mere figureheads. Theranos formed a Board of Directors widely recognized as one of the most illustrious in corporate America. Yet, they failed miserably as the company rolled out its signature product. Directors must act independently and ask uncomfortable questions. A company should also create a mechanism for employees to communicate concerns to the Board of Directors without fear of recrimination.
Patience is often the greatest part of valor. Several companies formed following in Theranos’ wake show great promise. Truvian Sciences and Genalyte out of San Diego, Finland’s Nightingale Health, Switzerland’s 1Drop Diagnostics, and Spain’s RheoDx are just a few companies created to pursue the same strategy first envisioned by Holmes. They filed multiple patents, produced numerous scientific articles, and completed hundreds of thousands of successful tests using micro-amounts of blood compared to current testing systems, intending to capitalize on Holmes’s vision.
All seem on the verge of promising breakouts toward marketable technologies we might all soon be utilizing for speedier, safer, and more cost-effective diagnostics. Perhaps Theranos would have succeeded had its leaders been patient enough to allow the technology to catch up to its visions.
Companies engaged in emerging technology are given a certain degree of flexibility, in recognition of the fact that, much like Thomas Edison learned in creating the light bulb, it often takes doing something wrong a thousand times before getting it right. To enjoy that flexibility, however, companies must be transparent in both their successes and failures. Going forward, we can expect additional supervision and government review of companies expanding into newly developed and rapidly evolving technologies.