Elizabeth Holmes lawsuit reveals investor lack of due diligence

SAN JOSE, Calif .– In 2014, Dan Mosley, lawyer and power broker among wealthy families, asked entrepreneur Elizabeth Holmes for the audited financial statements of Theranos, his blood testing start-up. Theranos never produced one, but Mr Mosley still invested $ 6 million in the company – and wrote Mrs Holmes a gushing thank you email for the opportunity.

Bryan Tolbert, an investor at Hall Group, said his company invested $ 5 million in Theranos in 2013, although he did not have detailed knowledge of the startup’s technologies or its work with pharmaceutical companies. and the army.

And Lisa Peterson, who manages investments for Michigan’s wealthy DeVos family, said she hadn’t visited any of Theranos’ test centers at Walgreens stores, called any Walgreens executives, or hired. no external expert in science, regulations or legal issues to verify the start-up’s claims. . In 2014, the DeVos family invested $ 100 million in the business.

The humiliating details of bad investments like Theranos are rarely displayed so clearly to the public. But they have been laid bare in recent weeks during the trial of Ms Holmes, 37, who faces a dozen counts of wire fraud and conspiracy to commit wire fraud; she pleaded not guilty. She and Theranos fell out of favor – with investor money evaporating and the company shutting down in 2018 – after claims about its blood testing technology turned out to be false.

Now in its ninth week, Ms Holmes’ lawsuit has offered a particularly clear picture of the many ways sophisticated investors can be drawn into the hype of a hot start-up, ignoring the red flags that seem obvious with hindsight. This behavior still resonates today, as investors compete to pour money into start-ups in Silicon Valley, which have been in a frenzied state of record fundraising.

With so many new investors flocking to start-ups, the due diligence is sometimes so minimal that it is used as a punchline, the investors said. An overheated market “definitely creates an environment for people to make more exaggerated statements” and may even make them lie, said Shirish Nadkarni, longtime entrepreneur, investor and author.

During his life, Theranos exemplified this dynamic. The company has raised $ 945 million from well-known venture capitalists, including Tim Draper, Donald Lucas and Dixon Doll; wealthy heirs to the founders of Amway, Walmart and Cox Communications; and powerful tech and media moguls such as Larry Ellison and Rupert Murdoch.

And as investors testified during Ms. Holmes’ trial, a central tension has arisen around due diligence. Could these investors have avoided disaster if they had simply done better research on Theranos? Or were they doomed because their research was based on lies?

Prosecutors have presented a growing list of examples to support the latter argument. For example, Theranos added logos of drug companies to validation reports indicating that drug companies had approved its technology when they had not, according to evidence and testimony. Theranos also claimed in late 2014 that she would bring in $ 140 million in revenue that year when she had none, according to evidence and testimony. The startup has also rigged demos of its blood testing machines to investors, witnesses said.

In response, Ms Holmes ‘attorneys goaded Theranos investors for their oversights, in an effort to convince the jury that the investors were responsible for not digging into Ms Holmes’ claims.

His lawyers recently pushed Wade Miquelon, the former chief financial officer of Walgreens, to admit that he was unsure if his company had ever had any of Theranos’ devices tested in its offices before entering into a partnership. Lawyers also got Mr Mosley to admit that he never asked Ms Holmes directly whether a pharmaceutical company wrote the validation report.

The strategy has sometimes turned into condescension. This was evident last week when Lance Wade, an attorney for Ms Holmes, asked Ms Peterson, an investment professional, if she was familiar with the concept of due diligence.

“Do you understand this is a typical thing to do when it comes to investing? ” he said.

Investors pushed back, saying they were acting on false information provided by Ms Holmes.

“You are trying to measure our sophistication as an investor when we have not received complete information,” Ms. Peterson said. Mr. Wade asked the judge to strike the commentary off the record.

Yet testimonials from executives of pharmaceutical companies who have interacted with Theranos have shown that it is possible to see through at least some of Ms.Holmes’ grandiose claims.

Constance Cullen, former director of Schering Plow, said this week that she was responsible for evaluating Theranos technology in 2009. She said she was “unsatisfied” with Ms. Holmes’ responses to her technical questions, calling them “wise” and indirect. She said she had stopped responding to emails from Ms Holmes.

Shane Weber, chief executive of Pfizer, looked into Theranos in 2008 and concluded that the company’s responses to its technical questions were “oblique, roundabout or evasive,” according to a memo used as evidence. He recommended that Pfizer stop working with Theranos.

But investors were less inquisitive, especially when Ms. Holmes tapped their egos. His visionary persona, reinforced by magazine covers and personal eccentricities, created the feeling that supporting Theranos was an exclusive and elitist opportunity.

In testimony and evidence, it was shown that Ms Holmes had withheld information about the company, calling it a trade secret. She told investors she was looking for wealthy families who wouldn’t want to see a return on their investment anytime soon, making those she chose feel special with formal invitations. And she tightly controlled the company with “voting” stocks worth 100 times the power of other stocks.

“She has a good understanding of the business, make no mistake about it,” said Christopher Lucas, an investor in Theranos, during a call with other investors which was recorded and performed in front of the court. “She would have the right to kick investors out.”

Mr. Lucas’ company, Black Diamond Ventures, has invested around $ 7 million in Theranos, although it has not had access to its financial information or reviewed all of its business records. It was unusual, Mr Lucas said Thursday, but Ms Holmes told him the information was sensitive because a leak could “give competitors a chance to crush the business.”

This secrecy extended to due diligence. Ms Peterson testified that she was concerned Ms Holmes would take her business out of the deal if they delved into the details of Theranos’ business.

“We were very careful not to get around it and upset Elizabeth,” she said. “If we did too much, we wouldn’t be invited to invest again. “

Longtime investor Nadkarni said such behavior seemed familiar. He said he had observed a relaxation of diligence in the transactions he has been involved with over the past year.

It didn’t cause a lot of problems when times were good, he said, but “if something happens to the economy then everyone will be toast.”