Litigation Draws Theranos Blood as Finger Prick Test Disappoints

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SEC ban, investor suit dull the shine of media darling founder

Theranos once could do no wrong in the eyes of investors who were drawn to the promise of its single-prick blood test, while founder Elizabeth Holmes was the object of fawning media attention. But a succession of lawsuits has knocked the company and Holmes off their pedestal.

On July 23, a class action lawsuit filed by plaintiffs who had invested millions in Theranos was settled under seal and dismissed with prejudice by District Judge Nathanael Cousins. Filed by Robert Colman and Hilary Taubman-Dye, the complaint alleged that private investors purchased shares in 2014 at a price that implied an inflated $9 billion valuation, a figure that had likely risen by 2015.

“Plaintiffs believe that much of the $724 million raised by investors may have been used up, and Theranos has been sued by Walgreens, other investors, and consumers for damages alleged to be in the hundreds of millions of dollars,” wrote the investor’s attorney, Reed R. Kathrein, in the November 2016 complaint filed in California Northern District Court.

The settlement came little more than a month after Theranos’ board announced that Ms. Holmes had stepped down as CEO and been succeeded by General Counsel David Taylor. It also comes four months after the Securities and Exchange Commission won a case that limits Ms. Holmes’ career prospects, among other things. Ms. Holmes remains as founder and chair.

That SEC complaint, filed in the U.S. District Court for the Northern District of California-San Jose Division, cited a similar dollar figure that Ms. Holmes and former President and Chief Operating Officer Ramesh “Sunny” Balwani raised from late 2013 to 2015 while leading investors to believe Theranos had developed a commercially ready portable blood analyzer that could perform a full range of tests from a small blood sample.

In actuality, the analyzer could complete only a small number of tests.

“They deceived investors by among other things, making false and misleading statements to the media, hosting misleading technology demonstrations, and overstating the extent of Theranos’ relationships with commercial partners and government entities, to whom they had also made misrepresentations,” said SEC Attorney Jessica W. Chan in the complaint.

An order issued in the SEC case removed Ms. Holmes from her throne and set aside her crown of entrepreneurial achievements.

“As a result of Holmes’ alleged fraudulent conduct, she is being stripped of control of the company she founded, is returning millions of shares to Theranos, and is barred from serving as an officer or director of a public company for 10 years,” said Stephanie Avakian, co-director of the SEC’s Enforcement Division, in a statement.

The March 27, 2018, final judgment also set a financial penalty of $500,000 for Ms. Holmes.

“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, in a written statement.  “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.”

Investors and regulators aren’t the only ones to have a rude awakening when it comes to Theranos or Ms. Holmes. As cited in the investor complaint, partner Walgreens in November 2016 sued alleging the company didn’t cooperate with its requests for information.

“Theranos resisted Walgreens’ request for information relating to Theranos’ lab leadership,” wrote Walgreens Attorney Kevin R. Shannon. “Eventually, Walgreens was allowed to speak with the director of Theranos’ Newark lab, Dr. Sunil Dhawan, on Nov. 14. Walgreens learned that Dr. Dhawan was a full-time dermatologist, had no experience prior to Theranos with any lab outside of dermatopathology and spent only one day a week at the Newark lab.”

At the time, Theranos defended itself, saying in a statement online, “The clinical lab is just one of Theranos’ many opportunities to provide access to high-integrity, affordable and actionable health care information, and the company will continue to carry out its mission under the leadership of its founder and CEO, Elizabeth Holmes.”

Theranos didn’t reply to PacerMonitor’s requests for comment.

“If it sounds too good to be true, it probably is,” said James Goodnow, an attorney and legal analyst in Phoenix. “So it is with Elizabeth Holmes and Theranos. Vaporware in Silicon Valley is nothing new, and unicorns will continue to appear as the thirst for the next big thing is unquenchable, but discerning when big promises turn into fraud is trickier.”

Theranos was eventually ordered to make certain payments to Walgreens, including $5 million on or before June 30, 2018, as part of a settlement and dismissal without prejudice.

According to court records, Theranos counterclaims that Walgreen’s lawsuit overreached by “demanding, without any justification, accelerated repayment of the principal of a $40 million convertible note that a Walgreen affiliate purchased from Theranos and by improperly asserting an alleged breach of the implied covenant of good faith and fair dealing that also rewrites the parties’ contract.”

By July 2, Theranos had not paid up, so Walgreens sued again.

Bankruptcy is often a method in which an enterprise can avoid payment of a judgment or debt.  However, there are statutory exceptions. Due to the nature of the claim against Theranos, a bankruptcy petition would likely be opposed.

“Walgreens could file an adversary proceeding alleging that same is not dischargeable since the agreement or judgment arose out of fraudulent conduct,” said Vincent Averaimo, an attorney with Milford Law in Connecticut. “I suspect they would claim that there was a duty, like a fiduciary duty, that Theranos owed to Walgreens under their agreement which it breached. This, by definition, and if proven would constitute fraud and prohibit the discharge of said debt. Therefore, despite the Bankruptcy petition they would still have to pay the agreed to monetary amount.”

Holmes is no stranger to raising money, and there’s nothing stopping her from launching another business, not even the SEC settlement.

“If she were to start up a private company and attempt to be CEO that might fall outside of the purview of the SEC agreement, however, based on Ms. Holmes past, I suspect she would only be interested in a public company,” Mr. Averaimo told PacerMonitor.

Last year, Theranos secured a $100 million loan from Fortress Investment Management, and in April Ms. Holmes requested money from shareholders in a letter that was leaked to the press.

“Many potential investors would probably be significantly speculative of her representations based on the allegations made in both the Walgreens action and by the SEC,” said Mr. Averaimo.

In launching a new startup, the challenges Ms. Holmes would likely face include increased regulation, scrutiny and oversight by various governmental agencies. Not to mention scorn and suspicion from her peers.

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