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Theranos Take-Aways: The ‘Perfect Storm’ for Health Care Startup Fraud

COO of Blood lab Convicted of Fraud

Drop of blood on finger on white background

There has been substantial coverage in the press of the criminal conviction of Elizabeth Holmes, the founder and CEO of Theranos, the much-hyped Silicon Valley blood testing startup.  Holmes was convicted after a three-month trial of three counts of wire fraud and one count of conspiracy to defraud investors of over $700 million. The health care start up fraud was prosecuted in a federal court in California.

In a separate proceeding, Holmes and the company were sued by the Securities and Exchange Commission for offering stock in the company on a fraudulent basis.  The civil claims were settled with Holmes relinquishing all of her stock.  Once worth $10 billion, Theranos has now ceased operations.  Once worth $4.5 billion, Holmes is now headed to federal prison with her fortune wiped out.  Her story is now an HBO documentary called “Inventor: Out for Blood.”

Once worth $4.5 billion, Holmes is now headed to federal prison with her fortune wiped out.

The case came to symbolize the “Go, go, go!” culture of Silicon Valley, with “fake it ‘til you make it” being perceived, at least sometimes, as a legitimate way of doing business.  Some viewed the jury’s verdict as a referendum on the technology startup culture.  Others questioned whether a double standard was applied to female leadership of a company; asking whether a man would have been prosecuted as vigorously.

Health Care is Different

Leaving those questions aside for now, there is an important core lesson in the Theranos story that has not been as closely covered: the fact that health care is different.  In other words, you cannot fully understand the Holmes prosecution and the Theranos collapse without fully appreciating how different the health care industry is from many other sectors of the economy. And why health care startup fraud will be something we will be hearing about for years to come.

There are some important lessons in this perfect storm of a story.

Lesson Number One:  Misrepresentations about a product’s efficacy in the health care sector are far more likely to land the speaker in hot water. 

One need not look far to find examples of exaggeration, falsehoods, bogus conspiracy theories, and misleading pronouncements in our culture.  They are ubiquitous and travel at the breakneck speed of social media.  Many people find it difficult to sort through the noise to find reliable sources of information.  But the law makes distinctions in types of falsehoods:  some are legally actionable, and some are not.  Lying to a federal agent, for example, is a crime – but only if the statement is “material” in some way. 

Likewise, “mere puffery” is a term used to describe exaggerated claims that the consumer should have understood as not grounded in fact, usually in a sales context.  “This is the best car ever made and will last you forever” is not an actionable falsehood when you try to sue the salesman after the car breaks down.  You knew or should have known that he was “just puffing.”

Puffery abounds in the world of startups, but entrepreneurs must be more careful as they approach investors because the claims are subject to greater scrutiny by regulators (e.g., the Securities and Exchange Commission) and law enforcement. Systemically misleading statements that cause actual harm go beyond puffery and can be prosecuted as schemes to defraud.

False statements and deceptive behaviors in health care settings are subject to even more scrutiny because of the nature of potential harm to patients.  Take the Theranos case, for example.  Approximately seventy percent of medical decisions are based in some way on test results.  Testing equipment that doesn’t work can cause immediate harm to patients. Moreover, it causes long-term damage to the medical community’s ability to maintain trust with the patients they are trying to help.  The very reason the Food and Drug Administration came into existence in the early 1900s was the epidemic of snake-oil products and phony cures being peddled.

Accordingly, health care is (and should be) different.  It is regulated closely and has a substantial number of unique laws in place to protect the public and to discourage doctors and others from cutting corners or engaging in self-dealing.  Notably, one of the things Holmes and Theranos were charged with was her claim to investors that Theranos was not required to seek FDA approval for its analyzers and tests.  This was a lie, and doing an end run around the FDA approval process is a sure-fire way to sink a health care startup.  Even mature health care companies pay heavy prices for attempting this tactic.

Lesson Number Two:  Vast fortunes can be made in health care, but almost never quickly and without business fundamentals. 

When we think of Silicon Valley startups and the vast fortunes that have been made, we tend to think of (in the first generation) Intel, Cisco, Microsoft, and in the second-generation Amazon, Google, Tesla, Facebook, Netflix, and so forth.  Note the absence of health care names.  In the dot com boom of the new millennium, some of these companies saw their stock shoot up far earlier than the business fundamentals would have suggested. This is because the internet was such a transformative technology.  Being the first into a business niche was as important or more important than ensuring the traditional building blocks of a company were in place.

While there are countless investors in the health care sector and many who have made fortunes, it is more typical in this space for investments to take time to pay off.  This is because health care is different, as we’ve said.  It requires data. It requires negotiation with regulatory agencies. It requires hard proof that the product is effective.  And it requires the development of trust with consumers who need to believe that the product works and is safe.  All of these things take time.  There is a well-established regulatory infrastructure in place, and those bodies move at their own pace, not at the company’s desired pace.

The founders of Theranos seemed to have been unaware that the health care field is not a great choice for “get-rich-quick” schemes.

Lesson Number Three:  Trust and transparency still matter, particularly in health care.

One can make the argument that fraud is fraud and that violating rules and moving too fast will usually get the perpetrator in trouble.  Perhaps.  But there is a profound difference between driving 70 mph on the highway (where the limit might be 65 mph) and in a school zone (where the limit might be 25 mph).

Just as it is true that not all lies are equally actionable, not all deceptions are equally nefarious.  We hold people who consciously harm others in their bodies and in their health in particular contempt.  Dr. Fata, who gave oncology patients chemotherapy unnecessarily purely for his own greed, is serving a 45-year sentence in federal prison, effectively a life sentence.  Had he “merely” stolen his patients’ money, he would have faced a sentence far less severe.

We simply don’t excuse behavior in the health care sector when it is likely to cause substantial harm to the health of unsuspecting patients.  Patient harm, even the risk of patient harm, is a key aggravating factor as prosecutors decide whether to bring the heavy hand of the criminal law to bear.  Elizabeth Holmes learned this lesson the hard way.  It might be okay to “fake it ‘til you make it” in other sectors, but not in health care.

 

 

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