The Bad Blood at Theranos

Theranos’ Fatal Flaws Were in Plain Sight
With this many red flags, it’s a wonder the collapse didn’t come sooner.
Bloomberg, May 30, 2018.



Last week, I previewed 10 books I want to tackle during the summer reading season. I finished the first one, “Bad Blood: Secrets and Lies in a Silicon Valley Startup” by Pulitzer-Prize winning reporter John Carreyrou, over the holiday weekend. It tells the story of blood-testing startup Theranos Inc., which at one point had a value north of $9 billion — making it one of the biggest so-called unicorns in the world. Today, it is essentially worthless.

The Wall Street Journal in 2015 first raised doubts about the company’s technology, 1  which the company claimed would run a battery of tests on a mere drop of blood from a pinprick instead of the multiple vials now required. The company had by then raised more than $700 million from venture capitalists and private investors. Founder and Chief Executive Officer Elizabeth Holmes, a Stanford University dropout who modeled herself after Apple Inc.’s Steve Jobs, black turtles necks and all, was feted on magazine covers and tech conferences. She has since settled civil securities fraud accusations by the Securities and Exchange Commission and the company has laid off most of its staff, though it somehow managed to obtain a loan from a private-equity fund to stay afloat.

That’s what we know today. Before all the bad news broke, there was a series of red flags that were ignored by many investors and journalists alike. Therein lies the cautionary lesson for today.

Whether someone with no medical training who finished just one year of college should have been pursuing this line of research is a fair question. The book doesn’t suggest the original intent was fraudulent. What began as a noble quest to change how we test blood ran into some immediate setbacks. Rather than deal with these head on, Holmes and her partner, a software engineer named Ramesh “Sunny” Balwani, quickly devolved into lying to their partners, employees and investors. Edison, the Theranos testing device, was rigged to deliver fake test results. They created a dummy machine that spit out fabricated results for potential investors. From there, a series of decisions — some bad, some worse, many fraudulent — sent the company into its inevitable death spiral.

The shocking suspension of skepticism and critical thinking by people who clearly should have known better stands out. A list of corporate governance issues reads like a Harvard Business School case study of bad management practices:

  1. The founder had no medical training, no medical-device experience and no health-care background; nor did the firm’s second-in-command.
  2. None of the (original) directors came from the medical-devices or health-care industries.
  3. No outside investors were allowed to closely examine the company’s machines; there were no peer reviewed papers covering the medical breakthroughs the company claimed.
  4. Secrecy at Theranos was excessive — much more extensive than the usual tech nondisclosure agreements.
  5. Staff turnover was extremely high; the chief financial officer left early in the company’s life.
  6. Venture capitalists with experience in medical devices, health care or biotech all took a pass on investing in Theranos.
  7. Early pilot programs with well-known health-care and medical companies were either not renewed or terminated outright.
  8. Promised reports on the proprietary technology’s performance were never delivered, despite repeated promises from the CEO.
  9. Threats of litigation against former employees and staff were aggressive and rampant.
  10. The board had no control; Holmes held 99 percent of voting shares; the board was stocked with faded stars of yesteryear, many in their 80s and 90s.

Any of these shortcomings warranted closer inspection by investors and regulators. Most of the above were either apparent, or could have been discovered via normal due diligence, even before the fraud was revealed. 2

Not everyone was bamboozled by Holmes. Not only did the health-care venture capitalists stay away, so did the U.S. Army. Lieutenant Colonel David Shoemaker, deputy director in the Army’s division of regulated activities and compliance, immediately recognized that Theranos’ medical devices required Food and Drug Administration approval before being used for testing on troops.

Aside from the founder, now under criminal investigation, two players in the Theranos saga come off particularly badly: former Secretary of State George P. Shultz and lawyer David Boies, “America’s greatest litigator.” Both served as directors.

Shultz is portrayed as a naif, smitten in his dotage by Holmes. Shultz makes one disastrous decision after another while under her spell. In contrast, his grandson, Tyler Shultz, a Theranos employee, is the hero whistle-blower in Carreyrou’s telling.

Boies looks even worse — not merely as a hard-knuckled litigator fighting on behalf of his client, but as a thug. The tactics used by Boies in an effort to intimidate former Theranos employees and silence the Wall Street Journal — private investigators, threats of defamation litigation and aggressive demands to sign NDAs — were later shown by the New Yorker to be the same tactics Boies used on behalf of disgraced film producer Harvey Weinstein to silence women who accused him of sexual assault and harassment. 3  Worse yet, Boies owned 300,000 shares of Theranos, worth almost $4.5 million at one point, making his behavior a form of self-interest. The once-fierce defender of media organizations appears to have forgotten his First Amendment basics, even as the Wall Street Journal’s reporting proved to be accurate.

We all suffer from hindsight bias, but more than a few people recognized this budding fraud in real time. The lessons for investors when capital is at risk are manifest: Admit when you don’t understand something. There’s nothing wrong with staying away from an investment that doesn’t seem to make sense. And the failure of narratives as an investing theme is another error we have focused upon.

Relying on the story and the assumption that others have done the heavy lifting and due diligence turned out to be disastrous for Theranos investors. Smart observers can learn a lot from these mistakes.


1. A recent “60 Minutes” installment is worth viewing, as well.

2. Holmes and Bulwani were also later revealed to be engaged in a romantic relationship. This was both inappropriate and never disclosed to the board.

3. Ronan Farrow reports that not only did he oversee the hiring of private investigators, including ex-Mossad agents, to track actresses and journalists, but “Boies personally signed the contract directing Black Cube to attempt to uncover information that would stop the publication of aTimes story about Weinstein’s abuses, while his firm was also representing theTimes, including in a libel case.”


Originally at Theranos’ Fatal Flaws Were in Plain Sight

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