Lawsuit against Theranos reveals extent of alleged deception
Founder and CEO Elizabeth Holmes went to great lengths to mislead investors, says the SEC, which charged the company with fraud.
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Theranos, a once-promising company that set out to revolutionize blood testing, was dealt a massive blow Wednesday when it was charged with fraud by the Securities and Exchange Commission.
The charges, which were also filed against company founder and CEO Elizabeth Holmes and former President Ramesh "Sunny" Balwani, allege false promises surrounding a portable blood analyzer. The SEC says the parties raised more than $700 million from investors between 2013 and 2015 by exaggerating or making false claims about the company's technology, business and financial performance.
According to the lawsuit, Holmes and Balwani deceived investors into believing the company's blood analyzer could provide faster, cheaper and more accurate blood testing using drops of blood. In reality, the SEC says, the analyzer could complete only a small number of tests.
Theranos and Holmes agreed to resolve the charges against them. Holmes will pay a $500,000 penalty, return the 18.9 million remaining shares she obtained and give up majority voting control over the company. She's also be prohibited from serving as an officer or director of a public company for 10 years. In the event Theranos is acquired or liquidated, she won't profit until more than $750 million is returned to defrauded investors and preferred shareholders. The settlements will need court approval.
Theranos and Holmes didn't admit to or deny the SEC's allegations. The SEC will litigate claims against Balwani in federal district court in the Northern District of California.
The suit reveals details about the lengths Holmes and Balwani allegedly went to cover up the company's shortcomings. Here are some of those details, according to the SEC:
Holmes told several investors that Theranos' analyzer had been deployed by the US Department of Defense in Afghanistan and on medevac helicopters, which wasn't true.
After entering partnerships with Walgreens and Safeway, Holmes soon realized the analyzer wouldn't be ready in time for rollout. In July 2013, she and Balwani asked Theranos' engineers to modify third-party commercial analyzers to test blood taken from a finger prick.
When Theranos held tech demonstrations for Walgreens executives in July and August 2013 ahead of the retail launch, Holmes told Theranos employees to put analyzers in a demo room where finger prick samples were collected from the executives. But instead of using the analyzers to process the tests, Theranos secretly used modified third-party machines to process some of them.
Additionally, Holmes told Theranos employees to put several analyzers, which could only be used for research-and-development purposes, in a clinical lab room to make it appear the company used the analyzer for clinical purposes. When Walgreens executives toured the room, they were led to believe their blood samples would be tested on Theranos' analyzers, as opposed to modified third-party analyzers.
Holmes and Balwani pulled the same scheme on potential investors. During meetings with Holmes, investors were taken to a room to look at Theranos' analyzers and had their blood drawn through a finger prick. The samples were either inserted into an earlier model of Theranos analyzer, called the Theranos Sample Processing Unit, or taken away for processing on third-party analyzers. But investors believed their blood had solely been tested on Theranos' machines, the SEC says.
The startup also sent investors a binder of background materials including incorporation documents, shareholder agreements, financial projections and news articles about Theranos. One section included reports of clinical trial work Theranos had supposedly done with pharmaceutical companies. These reports prominently displayed these companies' logos, suggesting they were drafted by them. But only one of the reports was co-written by a pharmaceutical client, the suit states. The other two were drafted by Theranos employees, who simply added the pharmaceutical companies' logos to them. These reports led investors to believe the companies had written endorsements of Theranos' technology, the SEC says.
When potential investors would try Theranos' tech at a Walgreens store, Holmes told her employees to remove tests that Theranos wasn't able to conduct using blood from a finger prick.
Although Holmes told investors in late 2014 that the startup was set to roll out its services to hundreds of Walgreens stores the following year, she knew the launch was stalled, partially due to concerns Walgreens executives had about the low number of finger prick collections being done in its stores. This coincided with Theranos raising the majority of the $700 million, the SEC says.
Even after ending communications with Safeway, where Theranos was once set to roll out its services, Holmes continued to tell investors about the relationship, leading them to believe it was thriving.
Holmes told potential investors that Theranos didn't need FDA approval for its analyzer and tests, but was seeking it voluntarily because it was the "gold standard." Even after FDA representatives told Holmes that clearance or approval was necessary, she continued to tell investors it was strictly voluntary.
Although Theranos claimed it would generate more than $100 million in revenue in 2014, it recorded little more than $100,000.
Theranos representatives didn't respond to requests for comment.
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