Lessons from the Theranos Debacle

Article originally published in the Philadelphia Business Journal on June 18, 2018

What is the responsibility of a CEO to her investors? For public companies, there is a legal responsibility to follow the Securities and Exchange Commission Rules and Regulations pertaining to disclosing material events and providing accurate information about the financial and operational condition of the company.

For private companies, the obligation to disclose is not as well prescribed. However, the CEO still has a responsibility to disclose pertinent information to the company’s shareholders and prospective investors, so they can make informed investment decisions about the company.

The obligation of a CEO to be honest and ethical transcends any prescribed legal reporting responsibilities. It shouldn’t be necessary, but one would hope this is taught in business school.

Privately held startup company Theranos is a case in point. On June 15, the Department of Justice announced that a federal grand jury indicted Theranos CEO Elizabeth Holmes and former president Ramesh Balwani, charging them with wire fraud and conspiracy to commit wire fraud associated with false claims about the performance of the portable blood analyzer manufactured and marketed by the company.

The indictment follows charges by the SEC on March 14 against Theranos, Holmes, and Balwani for deceiving the company’s investors. Quoting the SEC press release, “numerous false and misleading statements [were made] in investor presentations, product demonstrations, and media articles by which they deceived investors into believing that its key product – a portable blood analyzer – could conduct comprehensive blood tests from finger drops of blood, revolutionizing the blood testing industry.”

Steven Peikin, co-director of the SEC’s Enforcement Division, commented, “Investors are entitled to nothing less than complete truth and candor from companies and their executives. 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.”

Many tests purported to have been performed on a Theranos blood testing device were actually tested by the company on other commercially available testing devices. Holmes and Balwani also claimed their products were deployed by the U.S. Department of Defense in Afghanistan, but it was discovered this never happened. They further claimed revenue for their company would reach over $100 million in 2014 but ended up only generating $100,000.

Due to hyped-up claims that were not accurate, Theranos attracted over $700 million from investors. At its peak, the company was valued at $9 billion.

Holmes, a Stanford University drop-out, founded Theranos in 2003. Sure, investing in startups is risky, and investors should understand those risks. However, investors have an expectation that the CEO will not make false and misleading claims. Does Holmes feel any remorse for defrauding these investors? Where was her ethical compass?

What happened at Theranos begs the question, where was the company’s board and why was there a breakdown in the governance process? Were they blind to what was going on? Did they understand their oversight and fiduciary responsibilities to prevent false disclosures by the company?

The board consisted of luminaries such as Henry A. Kissinger and George P. Shultz, both high profile and well-respected elder statesmen who served in the administrations of former presidents in a variety of high-level positions, as well as former senators Bill Frisk and Sam Nunn. Secretary of Defense Jim Mattis once served on the board.

These individuals have excelled during their careers, but one must ask what do they know about corporate governance or enterprise risk management? Why didn’t they hold Holmes accountable for the claims the company was making? It appears as if they were appointed to the board as window dressing to give an aura of credibility to Theranos. They should have done their job and held Holmes to high ethical standards.

Whether a privately held startup or established public company, directors have a duty of care and a duty of loyalty to the company and its investors. Investors should be able to rely on them to do the right thing. Did the directors of Theranos know these duties? Their personal reputations depend on it, but more importantly, it is the right thing to do.

Stan Silverman is founder and CEO of Silverman Leadership. He is a speaker, advisor and nationally syndicated writer on leadership, entrepreneurship and corporate governance. Silverman earned a Bachelor of Science degree in chemical engineering and a MBA degree from Drexel University. He is also an alumnus of the Advanced Management Program at the Harvard Business School.