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SEC Charges Theranos CEO, President with "Massive Fraud"

By:
Chris Gaetano
Published Date:
Mar 15, 2018
SECURITIES-AND-EXCHANGE-COMMISSION-facebook

The SEC has charged Elizabeth Holmes, the CEO of blood testing company Theranos, and Ramesh “Sunny” Balwani, its president, with a "massive fraud" involving exaggerations and false statements regarding the firm's technology, business, and financial performance. The SEC complaint said that Theranos said it would revolutionize the diagnostic industry through new technology that, according to a 2013 article in theWall Street Journal, could near instantly perform a full spectrum of blood tests using a microscopic quantity of blood. This claim so impressed investors that the company was able to raise $700 million from them. However, the SEC said the company's claims were untrue, and that leadership knew it. The complaint said that, in fact, the company's proprietary analyzer, on which the success of the entire venture was staked, was only able to perform 12 of the over 200 tests that Theranos claimed it was capable of doing. For the rest, the company simply outsourced to third party commercial analyzers, some of which had been modified to analyze fingerstick samples. 

Despite the device not being commercially ready, the company none the less decided to pursue retail clinical laboratory space, and used misleading product demonstrations to convince buyers of its efficacy. For example, they conducted some demonstrations on modified third party devices while not telling potential buyers that these were not, in fact, the actual products they were developing. It also instructed employees to place labs that could only be used for R&D testing in the same room as the clinical labs and then led pharmacy executives on a tour of that room without telling them of the difference between the machines. It also explicitly denied that there were any technological problems. 

The company also began making touting its new technology in various media, generating a great deal of buzz around the company. The SEC said that the company not only didn't correct false and misleading statements about the technology but made some of their own as well. Like what happened during the product demonstrations, the firm heads made claims of their technology being able to do things that it was not actually capable of doing (else they wouldn't have needed to outsource most of their testing or modify third party devices). 

The SEC said the company continued making these false claims and giving rigged product demonstrations in order to raise additional investment. The complaint said that potential backers were led to believe their own blood was being tested on one of Theranos' proprietary devices when, in fact, they mostly used the modified third party devices because the actual ones weren't able to do the tests the company claimed they could do. Further, Holmes would distribute kits to investors containing what looked to be reports authored by well-known pharmaceutical companies essentially endorsing the company, when in fact only one had done so; the other two reports were drafted by Theranos employees, who then just added the companies' logos to the copy. 

The SEC added that the company also made misleading claims about its relationship with the Department of Defense. The complaint said that Holmes claimed that the firm had a strong relationship with the DoD, and that Theronos products were being used on the battlefield in Afghanistan. This was an exaggeration, according to the SEC: while the military did indeed buy Theranos products, it was part of a burn study that generated revenues of about $300,000 from three DoD contracts. The complaint also said that the company exaggerated its relationship with pharmacy chains, saying they were strong when, in fact, Theranos was working very hard to keep them from walking away (which they did eventually do). Further, the complaint said that Holmes made wild claims about revenue projections, telling investors that the firm made $100 million in 2014 and was on track to make $1 billion in 2015 when she, in fact, had absolutely no basis for the claim. 

“Investors are entitled to nothing less than complete truth and candor from companies and their executives,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division.  “The charges against Theranos, Holmes, and Balwani make clear that there is no exemption from the anti-fraud provisions of the federal securities laws simply because a company is non-public, development-stage, or the subject of exuberant media attention.”

Theranos and Holmes have agreed to settle the fraud charges levied against them.  Holmes agreed to pay a $500,000 penalty, be barred from serving as an officer or director of a public company for 10 years, return the remaining 18.9 million shares that she obtained during the fraud, and relinquish her voting control of Theranos by converting her super-majority Theranos Class B Common shares to Class A Common shares.  Due to the company’s liquidation preference, if Theranos is acquired or is otherwise liquidated, Holmes would not profit from her ownership until – assuming redemption of certain warrants – over $750 million is returned to defrauded investors and other preferred shareholders.  The settlements with Theranos and Holmes are subject to court approval.  Theranos and Holmes neither admitted nor denied the allegations in the SEC’s complaint.  The SEC will litigate its claims against Balwani in federal district court in the Northern District of California.

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