Theranos CEO Elizabeth Holmes Finally Faces Criminal Charges

It's been some time coming, but the CEO of Theranos is finally facing criminal charges for fraud, as the WSJ's Carreyrou reports here. The indictment is a well-written history of the company and distills down to a few pages the scheme to defraud investors, doctors, and patients. The charges focus on Wire Fraud occurring between late 2013 and mid 2015, and of the 11 counts of Wire Fraud, one is for the defrauding of investors, one for defrauding of patients and doctors, six are for monetary transfers from investors, one for payment to advertisers for their products, and two are for wiring of patient blood test results. The pair face up to 20 years in prison, $250,000 in fines, restitution to the defrauded, per count. Holmes, and co-defendant COO Balwani, have both plead not-guilty to all charges.

Holmes settled civil charges with the SEC for "massive fraud" a few months ago, and some were upset that she was allowed to settle for a seemingly small fine ($500,000) and a  10 year ban from being a company director. With the latest charges, Holmes has stepped down as CEO, but somehow remains the board chair at Theranos. I've felt for some time that Holmes was going to jail for what she'd done, and that while the wheels of justice turn slow they grind exceedingly fine. I have the feeling up to 220 years in jail is a pretty smooth paste...

Wire Fraud is a common charge in such cases as it is relatively straightforward to demonstrate as interstate (for federal jurisdiction) and has been upheld by the Supreme Court as quite broad in covering "everything designed to defraud by representations as to the past or present, or suggestions and promises as to the future." Other courts have expanded this to "puts its imprimatur on the accepted moral standards and condemns conduct which fails to match the 'reflection of moral uprightness, of fundamental honesty, fair play and right dealing in the general and business life of members of society'".

Reading that wording, it's surprising and refreshing to see that 'caveat emptor' does not necessarily apply and that there is the expectation of fair dealing and honesty, even about the future. When discussing cases of fraud by startups, I often hear push-back that "everyone exaggerates", "they must have really believed so it was OK to exaggerate", or "well it's within the wording of the law even if they knew it was wrong". While startup and VC mentality may still accept that "fake it 'til you make it" is the norm, as with the SEC charges earlier this year, the law is making it clear that this is not legal, and that exaggeration as well as outright falsehoods are illegal. 

“The Theranos story is an important lesson for Silicon Valley,” said Jina Choi, Director of the SEC’s San Francisco Regional Office.  “Innovators who seek to revolutionize and disrupt an industry must tell investors the truth about what their technology can do today, not just what they hope it might do someday.”

The federal charges against Holmes and Balwani make this even clearer, with wording like "obtaining money... from investors... by means of materially false and fraudulent pretenses... and material omissions with a duty to disclose". If you know it won't work, and fail to disclose, that's going to come back on you too - it's not just what you say, it's what you don't say. Energous, in my opinion, are another example of this type of fraud, where they deliberately create confusion to sell people the hope of at-distance wireless charging, when they know the promised future will never come.

Next standout statement in the indictment, at least to me, was "represented to investors that Theranos did not need the Food and Drug Administration ("FDA") to approve its proprietary analyzer and tests". Given that so many startup companies rely on regulatory arbitrage, that is bypassing existing regulation "because it's tech", and operate in some very grey areas (see Uber's history), companies who have claimed to investors that no regulatory approval would be needed might want to rethink that kind of statement unless they are very, very sure.

One of the last aspects of the "scheme to defraud" that the indictment raises is "represented to members of the media for publication of the false and misleading statements described above, and shared the resulting articles with potential investors both directly and via the Theranos website, knowing their statements to members of the media were false and misleading." So exaggerating/lying to the press then using those articles as part of your fundraising is part of a fraud case? I've repeatedly argued that this behaviour is fraudulent and told that it is not, I'm glad to see the US Attorney agrees. Some startups may want to review their media strategy.

I don't think Silicon Valley have really internalized this yet, and will find ways to make Theranos an exception. How many more Theranos style cases do we need until there's no more denying that they are not the exception? While Holmes' behavior was particularly egregious, to me it was an inevitable outcome of a system that through funding bias regularly selects for the most morally-flexible personalities in their founders. If by funding choices you prefer your CEOs to be liars, don't be surprised when they lie.

I hope that this might be the start of at least some people realizing that if they heavily exaggerate, or try to fake it 'til they make it, regarding investors and customers, that it's not "being an entrepreneur", it's fraud. That being said, until those providing the funding alter their metrics to favor the honest, I don't expect to see any major changes.

For those wanting to read more on Theranos, I can highly recommend John Carreyrou's book "Bad Blood", my review is here.