Wall Street

The Blood Unicorn Theranos Was Just a Fairy Tale

Founder Elizabeth Holmes spun a beautiful fantasy for investors, not so much for patients.

It was fun while it lasted.

Photographer: David Paul Morris/Bloomberg

It has been pretty obvious for a few years now that Theranos Inc. was a huge fraud. Theranos is a blood-testing startup that developed devices, which it called "TSPUs" and "miniLabs," that were supposed to be able to do a wide range of laboratory tests on a finger-prick blood sample. It seems like Theranos founder Elizabeth Holmes really wanted to build devices that would actually do these things, and thought she could, and tried to. But it didn't work, and Theranos ran out of time: It talked Walgreens into offering Theranos tests at its stores, 1 but "it became clear to Holmes that the miniLab would not be ready" in time for the Walgreens rollout. So she went with Plan B: "Theranos never used its miniLab for patient testing in its clinical laboratory," but did a dozen tests on the earlier-generation Theranos TSPU, 50 to 60 more tests on blood-test-analysis devices that it bought from other companies and modified to take finger-prick samples, and "the remaining 100-plus tests it offered" on regular unmodified devices bought from other companies or sent out to third-party laboratories. Meanwhile Theranos and Holmes were going around giving interviews about how revolutionary their technology was, without ever mentioning that it didn't work and they didn't use it. This got them a lot of favorable press and a $9 billion valuation, which went on for a while until the Wall Street Journal's John Carreyrou reported in 2015 that the product didn't work and that Theranos was lying about using it, after which Theranos fairly quickly collapsed.

But the fact that Theranos was a gigantic fraud doesn't quite mean that it committed fraud. It isn't exactly fraud to go around lying to journalists. 2 People do it all the time! If you decide that you want to be a celebrity, and that the easiest path to fame is by convincing people that you've found a magical new blood test, you can lie about that to your heart's content, and if you fool people then that's their problem, not yours. Undeserved celebrity is a central fact of American life; if it was illegal to lie your way to fame then our politics, for one thing, would be very different.

It becomes fraud in the legal sense if you use those lies to get money. 3  Theranos, in parallel with being a massive fraud, was also raising a lot of money. I used to refer to it pretty regularly as the Blood Unicorn, Elasmotherium haimatos, because it was a Silicon Valley unicorn with a peak valuation of $9 billion that managed to raise $700 million from investors. If you are going around lying publicly about your technology while also raising hundreds of millions of dollars from investors, that certainly suggests that you were defrauding those investors. But it's not a certainty. Theranos wasn't a public company; it raised all that money in negotiated private fundraising rounds where investors received disclosure documents and had the opportunity to conduct due diligence. Perhaps while it was going around talking up its fake product to the press, it was simultaneously giving investors thorough disclosure documents that made clear exactly where its technology stood and exactly what were the risks to its business. Perhaps the investors knew that the technology wasn't ready yet, but invested in the company anyway because they believed that it would be ready one day, and they were kept sufficiently informed of the actual progress for that to be a reasonable belief. This would be a bit of a strange way to roll -- telling self-flattering lies to the press while giving your investors the unvarnished truth 4 -- but it is not impossible, and it would give Theranos a defense against fraud charges.


But no, no, that's not what happened at all. Instead the Securities and Exchange Commission today brought fraud charges against Holmes, Theranos and its former president, Sunny Balwani, and its complaint alleges pretty strongly that the investors were just as bamboozled as everybody else. In fact, Theranos made direct use of its positive press to raise money: It "sent investors a binder of background materials," which included "articles and profiles about Theranos, including the 2013 and 2014 articles from The Wall Street Journal, Wired, and Fortune that were written after Holmes provided them with interviews" and that included her misleading claims about the state of Theranos's technology. She also repeated those claims to investors directly: "For instance, Holmes and Balwani told one investor that Theranos' proprietary analyzer could process over 1,000 Current Procedural Terminology ('CPT') codes and that Theranos had developed a technological solution for an additional 300 CPT codes," even though "Theranos' analyzers never performed comprehensive testing or processed 1,000 CPT codes in its clinical lab," and in fact never processed more than 12 tests on its TSPU. 5 And Theranos would even do a little pantomime blood-draw demonstration directly on the investors:

This initial meeting was often followed by a purported demonstration of Theranos' proprietary analyzers, the TSPU, and the miniLab. In several instances, potential investors would be taken by Holmes and Balwani to a different room to view Theranos' desktop computer-like analyzers. A phlebotomist would arrive to draw their blood through fingerstick, using a nanotainer, a Theranos-developed collection device. Then the sample was either inserted into the TSPU or taken away for processing. Based on what they saw, potential investors believed that Theranos had tested their blood on either an earlier-generation TSPU or the miniLab. As Holmes knew, or was reckless in not knowing, however, Theranos often actually tested their blood on third-party analyzers, because Theranos could not conduct all of the tests it offered prospective investors on its proprietary analyzers.

And so the SEC decided that this all did indeed amount to securities fraud. Theranos and Holmes settled with the SEC without admitting or denying the allegations; Balwani will apparently fight the accusations. Holmes agreed to pay a $500,000 penalty to the SEC, "return" 18.9 million Theranos shares to the company and relinquish her super-voting control, and be barred from serving as a public-company director or officer for 10 years. 6  That is a pretty small fine for such a big fraud: Martin Shkreli had to forfeit $7.4 million for what a judge found to be a $10.4 million fraud, while Holmes will pay just $500,000 for a $700 million fraud. But Holmes, unlike Shkreli, does not seem to have a lavish collection of Picassos and Wu-Tang Clan albums to liquidate to pay a fine. Unlike most people who run nine-digit frauds, she never took much money out: The SEC notes that she "was paid a salary of approximately $200,000 to $390,000 per year between 2013 and 2015" and "has never sold any of her Theranos stock." Forbes once estimated Holmes's net worth at $4.5 billion, but essentially all of that was in stock that is now probably worthless. 7  In a very real sense she was the biggest victim of her own fraud.

Two other points. First, when the Theranos story first broke in 2015, you would occasionally see people saying things like "if this were a public company it would clearly be securities fraud." That always struck me as a curious analysis: Securities fraud just means committing fraud in connection with the sale of securities; whether those securities are public or private doesn't have anything to do with it. 8 The SEC's case today doesn't just confirm that Theranos was a fraud; it also confirms that the SEC will pursue securities fraud in private markets:

"Investors are entitled to nothing less than complete truth and candor from companies and their executives," Steven Peikin, the co-director of the SEC's enforcement division, said in a statement. "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."

Second: We talk sometimes around here about how U.S. law seems to classify a lot of random kinds of misbehavior as securities fraud. Intentionally slowing down iPhones or mispricing chickens or denying climate change or lobbying against fiduciary regulation or overprescribing opioids or municipal bribery can all count as securities fraud: If a securities issuer does a bad thing and doesn't tell its shareholders about it, then that's enough to make out a case of securities fraud, and it is often easier to punish the company for that securities fraud than for the underlying bad thing. There is something morally strange about this: "Securities fraud" suggests that the company's shareholders are the victims, while often what actually happened is that the company victimized someone else in order to make more money for its shareholders. 9  

That's not what's going on here: Theranos really did deceive its investors, and they really were victims of its fraud. But they weren't the only victims. The problem with launching a blood-test machine that doesn't work isn't just that you swindle the investors who funded the machine's development. You are also out there performing a lot of fake blood tests. The Wall Street Journal has reported on the "trail of agonized patients" who got blood-test results from Theranos that turned out to be wrong, and Theranos ultimately "voided" two years of results from its machines because they were not sufficiently accurate. Building a fake blood-testing company that raises hundreds of millions of dollars from investors is bad, certainly, but it's not really any worse than any of the other securities fraud that we so often delight in around here. Building a fake blood-testing company that performs fake blood tests on thousands of people is much worse, even if it doesn't count as securities fraud.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
  1. Quotes come from the Securities and Exchange Commission complaint against Holmes and Theranos. The SEC refers to "Pharmacy A," which rolled out Theranos tests and then sued Theranos for breach of contract, as Walgreens did.

  2. Two points: First, I am not your lawyer, and this is not legal advice. Second, I am your journalist, and in my capacity as a journalist I advise you not to go around lying to journalists. It may not be illegal but it is certainly rude.

  3. This here is particularly not legal advice. The wire fraud statute refers to "obtaining money or property," and securities fraud cases often involve propping up an existing stock price rather than issuing more; exactly what sort of things of value you can and cannot obtain by lies is a subtle question. But in general lying to strangers for your own amusement is legal and lying to them to get them to give you money is not.

  4. One thing that would be strange about it is: Wouldn't you expect the investors to eventually leak to the press that the private accounts were very different from the public ones?

  5. There was also allegedly some more straightforwardly financial fraud: 

    Holmes also provided historical financial information to one potential investor. In August 2015, Holmes met with a potential investor, during which she provided Theranos’ financial results for fiscal year 2014. These financials showed 2014 net revenues of $108 million, and 2015 and 2016 net revenue projections of $240 million and $750 million, respectively.

    But Theranos’ actual financial performance bore no resemblance to the financial information Holmes shared with investors. Theranos recorded little more than $100,000 in revenue in 2014 and was nowhere near generating $100 million in revenue by the end of 2014.

    Holmes knew, or was reckless in not knowing, that Theranos sent different financial information containing Theranos’ actual revenue numbers (a little over $100,000) to a third-party valuation firm that it had retained to value the company’s common stock. Some of Theranos’ projections, provided to potential investors in October 2014, stated Theranos would earn $40 million from pharmaceutical services, $46 million from lab services provided to hospitals, and $9 million from lab services provided to physicians’ offices, all by the end of 2014. In reality, Theranos had no revenues from any of those lines of business.

  6. "The SEC made no mention in its statement of a penalty imposed on Theranos," notes Bloomberg News, and it makes sense that the SEC wouldn't fine Theranos. After all the fraud consisted of tricking Theranos's investors out of their money. Their money is now invested in Theranos, which may be worthless, but which also may not be. (Maybe the technology will work one day?) Taking money from Theranos to pay a fine would just punish the investors who were defrauded.

  7. The SEC notes that, "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." (She owns common stock, which is behind the preferred in priority.) If Theranos ends up being sold for $9 billion then she will be a billionaire again, but of course if Theranos ends up being sold for $9 billion then it really wasn't much of a fraud. If Theranos turns out to be worthless or near-worthless or even just modestly successful, Holmes won't cash out.

  8. That's an exaggeration. In practice, the public/private distinction does actually matter quite a bit for securities fraud: As noted above, lying to the press while raising money privately may not be securities fraud, if you are scrupulously candid in your communications with private investors (and make sure that they rely on your disclosures rather than the misleading press accounts). But lying to the press as a public company is always risky, because your shares trade constantly, and investors who trade your shares may be relying on your public statements in their trading decisions even if you aren't dealing with them directly. 

    Still, the point is, misleading investors is securities fraud, whether those investors are public or private.

  9. But it all kind of works out, because the SEC fines the company for deceiving the shareholders about the bad thing that it did to someone else, and then the shareholders have less money. As I once wrote about an effort to go after Exxon Mobil for securities fraud for denying climate change:

    For one thing, if you actually think that Exxon Mobil is engaged in a diabolical conspiracy to suppress climate science to wring extra profits out of an earth-destroying business, the last people you should be worried about are Exxon's shareholders. They're the ones profiting from all that destruction! For another thing, if you are concerned about those shareholders, the last thing you should do is fine Exxon a lot of money. They're the ones who will ultimately have to pay that money! 

    So that is doubly stupid, but the stupidities offset, so that if you actually want to punish Exxon shareholders you can go ahead and do it by fining Exxon for deceiving them.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net

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