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Fraud deconstructed: Lessons learned from the Theranos fraud scandal

A series breaking down notable fraud cases and what you can learn from them

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Introduction to the case

American corporation Theranos Inc. claimed to have created a revolutionary technique for extracting and testing blood and perform 30 different medical tests with just one drop. It all came crumbling down when questions were raised on the feasibility of its purported technology.

*All amounts expressed in U.S. dollars unless otherwise stated.

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Details of the fraud

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Theranos claimed to have developed a revolutionary technology that could perform multiple blood tests (such as measuring glucose levels and detecting medical conditions such as high cholesterol and cancer) with a drop of blood, a feat unheard of until that point.

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Its technology, however, remained unproven, leading to speculation and questions about the cutting-edge innovative company.

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Former CEO Elizabeth Holmes founded Theranos in 2003 and went on to raise more than $700 million from venture capitalists and private investors, with a peak valuation of $9 billion in 2013 and 2014.

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In October 2015, the Wall Street Journal (WSJ) contended that Theranos had overstated the capabilities of its product.

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It was later revealed that only a tiny fraction of all tests were conducted using the company's proprietary testing technology.  Instead, most of the tests were performed using conventional equipment.

Despite the emergence of allegations by WSJ, former employees, and medical experts, Theranos continued to defend its reputation and product vigorously. It sought to discredit critics and remove adverse reports from the media through legal and public relations efforts.

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How did the fraudsters commit the crime?

Power of leveraging relationships

The entire appeal of Theranos was its ground-breaking technology that allowed it to perform a wide range of tests using a single drop of blood. Along with COO Sunny Balwani, Holmes was able to convince investors about the viability of its technology by:

  1. Leveraging connections with high-level politicians and prominent venture capitalists, including family friends and neighbours, to create the impression of professional endorsements.
  2. Providing fake trial results and claiming partnerships with major global healthcare companies, which were later revealed to be untrue.
  3. Raising investment capital on the condition that Theranos would not have to reveal how its technology worked.

By securing high-profile investors and cultivating relationships with prominent individuals, Theranos created an appearance of legitimacy. Its aura of credibility allowed it to rebuff both critics and demands for technical details of its product. As a result, the truth of Theranos's business remained hidden for years because of assumptions made by stakeholders about its affiliations with credible individuals and organizations.

False advertising

While Theranos boasted of superior medical technology, a former senior employee admitted that its novel product carried out only a fraction of the battery tests. Instead, most of the tests were performed using conventional equipment.

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What was the outcome?

As a result of market suspicions, regulators investigated the company. They concluded that Theranos' claims on its breakthrough device were false and its product's design had not been validated under actual or simulated use cases. 

A letter released by the Center for Medicare & Medicaid Services (CMS) at the beginning of 2016 stated that a California-based lab used by Theranos posed "immediate jeopardy to patient health and safety."1  It gave the company 10 days to correct the deficiencies or face daily fines and/or loss of CMS approval for Medicare payments. 

In July 2016, Holmes was banned by US regulators from owning and running a medical laboratory for two years. By October, the company closed its labs and testing centers, shuttering operations altogether.

 In March 2018, the US Securities and Exchange Commission (SEC) charged Holmes and Balwani with “an elaborate, years-long fraud”2 that involved exaggerated or false statements about the company's technology and performance. Holmes and Theranos agreed to resolve the SEC complaints, with Holmes giving up financial and voting control of the company, paying a $500,000 fine, and returning 18.9 million shares of company stock. She also agreed to restrictions against holding a leadership position in any publicly traded company for 10 years.

As reported by several media, Balwani decided to fight the SEC's charges, claiming that he "accurately represented Theranos to investors to the best of his ability."

In addition to the SEC's charges, the office of the United States Attorney for the Northern District of California also announced in July 2018 that Holmes and Balwani were indicted on federal wire fraud charges. They were charged with two counts of conspiracy to commit wire fraud and nine counts of wire fraud. 

Following trials held in 2022, Holmes was sentenced to 11 years and three months, while Balwani was sentenced to 12 years and 11 months in prison and three years on probation.

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How could this have been prevented?

The Theranos controversy serves as an eye-opener for all businesses. While the intention of revolutionizing an industry is admirable, aspiration cannot prevail over substance. Holmes’ spectacular fall from grace highlights the role of ethics, governance and compliance within an organization, including the duty to:

A company’s endorsements from high-profile individuals do not exempt it from being subject to due diligence. Before making any investments, a thorough assessment of the value proposition, technology, or investment thesis should be clearly understood.

Several potential investors declined the opportunity to invest in Theranos due to a lack of satisfactory answers. A company promising disruptive innovation can be an exciting choice of investment. However, getting caught up in the hype can create blindspots of significant gaps.

The vagueness surrounding Theranos and its shortcomings were glaringly apparent to several medical and technical experts. Meanwhile, misled billionaires who invested in the company lacked experience in the blood-testing industry and rushed their decisions.

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How BDO can help

BDO’s Forensic Disputes & Investigations team offers comprehensive services that can help you prepare against and respond to fraud. We provide industry-specific fraud prevention strategies designed to help you protect your organization and its investments, including investigative due diligence and regulatory compliance investigations.

Contact our team to learn more about practicing compliance:

Footnotes:


*All amounts expressed in U.S. dollars unless otherwise stated.

1 WSJ public resources

2 U.S. Securities and Exchange Commission

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