Loyola University Chicago School of Law, JD 2023
The process of the criminal trial of the youngest woman self-made billionaire, has recently started up again after being stalled due to Covid restrictions in the past year. Former CEO and founder of Theranos, Elizabeth Holmes, and her former president and one-time boyfriend, Ramesh Balwani, have been accused of misleading investors and raising hundreds of millions of dollars by making false or exaggerated claims in defiance of the anti-fraud provisions of federal securities laws. While she is currently facing a federal indictment on twelve different charges, including two counts of conspiracy to commit wire fraud and ten counts of wire fraud, Holmes has already settled her civil charges, which were brought forth by the Securities Exchange Commission (SEC). The civil charges brought forth by the SEC have now put Silicon Valley on alert by ensuring that technology companies who claim that they have a new groundbreaking technology that can change the world must be based on factual evidence, not purely myths.
Theranos founder: who is Elizabeth Holmes?
After dropping out of Stanford University as a sophomore in 2003, 19-year-old Elizabeth Holmes founded Theranos to revolutionize technology and change the world. Theranos is a private company, which promised that its technology could efficiently test for conditions like cancer and diabetes with just a few drops of blood taken from a finger. The innovation of this portable blood analyzer gained attention from financiers, media, politicians, and business leaders. Theranos received a nine-billion-dollar valuation while also raising more than $700 million from investors. Forbes estimated Holmes’s net worth to be roughly $4.5 billion. The story that seemed to be too good to be true eventually was too good to be true.
Fraud is the daughter of greed
In 2018, the SEC charged Elizabeth Holmes and Ramesh Balwani with raising more than $700 million from investors through an elaborate, years-long fraud in which they exaggerated or made false statements about the company’s technology, business, and financial performances. These federal charges allege that Holmes knowingly mislead investors, doctors, and patients about her company’s blood-testing capabilities in order to take their money. According to the SEC’s complaint, Theranos blood analyzer could complete only a small number of tests, and the company conducted the vast majority of patient tests on modified and industry-standard commercial analyzers manufactured by others. A major misrepresentation that Holmes and Balwani falsely alleged to investors was that the U.S Department of Defense deployed the company’s products on the battlefield in Afghanistan and on medevac helicopters generating $100 million in revenue for the company. This contract was never executed.
What is fraud?
As companies seek investors to raise capital and grow their business, they must refrain from securities fraud. They can’t intentionally or recklessly make a misrepresentation or omission of material fact. There are many types of security fraud actions, but in the case of Holmes and Theranos, the security fraud at issue was that an officer or director of a corporation did not accurately report the company’s financial information to its shareholders. This can artificially raise the worth of the company’s stock and encourage investors to buy shares of an unhealthy company. The SEC made it very clear that even though Theranos was a privately held company, the anti-fraud provisions of the federal securities laws still apply.
The fairy tale that came to an end
Based on the SEC filing, Holmes agreed to settle with the commission. Holmes decided to give up majority voting control over the company and a reduction of her equity, which, combined with shares previously returned to shareholders, materially reduced her equity stake. Holmes must also return millions of shares to Theranos and is barred from serving as an officer or director of a public company for ten years, incurring a $500,000 penalty. The most shocking and uncharacteristic provision in the settlement against Holmes was that she agreed to give up all control of the company she founded. This provision by the SEC is rarely used as a remedy to combat securities fraud. Still, it seemed that based on the circumstances, the control must be foregone to remedy the investors who were given false information.
What does this mean for Silicon Valley?
The strict sanctions that the SEC placed on Theranos was a clear message to all startups in the technology sector who promise more than they can deliver. Innovators who seek to revolutionize and disrupt the industry must be forthcoming with investors about what their technology can do today, not just what they hope it might do someday. Theranos should serve as a warning about how technology may be more underwhelming than the innovation it alleges. The question raised by the SEC’s sanctions is whether the company’s downfall will teach other Silicon Valley executives and investors to proceed more cautiously. Clearly, it seems that the SEC is making precedent by taking the steps to completely remove the founder of a company from control not likely as a uniform standard to such degrees of security fraud, but more as a severe warning to innovators of technology in the U.S market; he who wins through fraud is no winner. As civil charges have been settled against Holmes, we now tune into the criminal proceedings that will take place this coming year.