Monday, April 9, 2018

Investors may forego blind faith in Silicon Valley

SEC charges healthcare tech company and CEO with massive fraud

Photo: Canva
Once upon a time, Silicon Valley companies only had to offer 
promises of new technology to wrangle investments. A recent 
fraud case may change the blind faith investors often have in 
Silicon Valley.
By Nicole Lavallee and Victor S. Elias,
Guest Columnists

For as long as “Silicon Valley” has been part of the popular vernacular, investors have always been willing to invest in that sector based on faith and the promise of what a new technology can bring.  As the Security and Exchange Commission’s recent charges against Theranos Inc. and its former CEO, Elizabeth Holmes, show, promises can only get you so far and there is no substitute for healthy skepticism and detailed due diligence. 

In March, the SEC charged Theranos and Holmes with a “massive” fraud that raised $700 million from investors.  The SEC accused the healthcare tech company of making false statements about a finger-prick technology said to be able to run hundreds of blood tests from just a few drops of blood.  To resolve the charges, Holmes agreed to pay $500,000.  She also agreed to give up control over the company, return millions of shares, and not act as an officer of another company for ten years.  

What takes this story outside the rubric of traditional securities fraud is the story of Holmes’ and Theranos’ rise.  Holmes, a Stanford dropout, founded Theranos in 2003 when she was just 19 years old.  She rose quickly among the ranks of Silicon Valley “disruptors.”  
Projected to revolutionize the blood-testing industry, and declared by Forbes as the youngest self-made billionaire, Holmes became the subject of beaming profiles in tech magazines.  Prominent investors jumped on the bandwagon, including media mogul Rupert Murdoch and former Secretary of State Henry Kissinger.  At its height, Theranos reached a valuation of $9 billion. 

The problem is that it appears to have all been a lie.  According to the SEC, Theranos deceived investors about its blood-testing and bottom line. The product performed just 15 types of blood tests, not 240 as touted by the company.  Moreover, the company used commercial analyzers to perform those tests, and not its own technology.  And despite claims to the contrary, military medics did not use the product on battlefields in Afghanistan.
The real question, however, is how investors and the public bought into the company’s hype with so little to back it up.  To attract investors, the company allegedly gave out binders with media articles and financial statements made from whole cloth.  But what those materials lacked were specifics and credibility—they contained neither details about how the technology worked nor audited financial statements. 

The charges against Theranos are not the SEC’s first foray into Silicon Valley’s private sector, to be sure.  But they have to be one of its most prominent.  And while the hard lesson of this failure is a good reminder for investors that nothing takes the place of asking hard questions and performing ample due diligence, it is too soon to tell whether this experience marks a sea-change in the way investors look at the promise of new technology or rather is just a blip in the quest to find the next big thing. 

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Berman Tabacco or TEXPERS.

About the Authors
Nicole Lavallee is the managing partner of Berman Tabacco's San Fransico officer and Victor S. Elias is an associate in the San Francisco Office.
Victor S. Elias
Nicole Lavallee

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