Theranos Charges Provide Perspective for Medical Device Companies, Biotechnology Companies, and Investors

On March 14, 2018, the Securities and Exchange Commission (SEC) announced it filed charges against the founder and CEO of Theranos Inc., Elizabeth Holmes, and its former president, Ramesh Balwani.

Theranos describes itself as a privately held technology company based in Palo Alto focused on developing lab-on-a-chip technology for blood testing.  By 2014, Theranos raised more than $400 million and had an estimated value of $9 billion.

As reported by CNN, Theranos’ investors included high profile individuals such as Larry Ellison (Oracle), current Secretary of Education Betsy DeVos, and Rupert Murdoch.  Additionally, Theranos’ Board of Directors has included at one point: Secretary of State Henry Kissinger, Secretary of State George Schultz, Senator Bill Frist, Senator Sam Nunn, and current Secretary of Defense James Mattis.

According to the SEC’s complaint, Elizabeth Holmes and Ramesh Balwani “raised more than $700 million from late 2013 to 2015 while deceiving investors by making it appear as if Theranos had successfully developed a commercially-ready portable blood analyzer that could perform a full range of laboratory tests from a small sample of blood.”  The complaint further alleges that Theranos “modif[ied]
commercially-available analyzers and [ran] misleading demonstrations” and made false or misleading statements to the Department of Defense.

Theranos and Holmes have neither admitted nor denied the allegations.   According to an SEC press release, Theranos and Holmes have agreed to settle the fraud charges levied against them.  Reportedly, the settlement includes Holmes paying a $500,000 penalty and being barred from serving as an officer or director of a public company for the next 10 years.

While Theranos was not a publicly traded company, Steven Peikin, the Co-Director of the SEC’s enforcement division stated the actions make “clear that there is no exemption from the anti-fraud provisions of the federal securities laws simply because a company is non-public, development-stage, or the subject of exuberant media attention.”

As reported by the Silicon Valley Business Journal: “In depositions filed as part of a lawsuit by an investor last year, former Secretary of State George Schultz and retired U.S. Navy Admiral Gary Roughead said they didn’t feel qualified to question the technology. They said they were unaware that Theranos’ equipment could not run all the tests being touted by Holmes — even as news reports started appearing that suggested its capabilities were exaggerated.”

A fundamental principle of corporate law is the role of the Board of Directors.  Under Delaware General Corporation Law §141(a), “The business and affairs of every corporation organized under this chapter “shall be managed by or under the direction of a board of directors….”  While the Directors do not directly manage the day-to-day responsibilities of running a corporation, they are ultimately responsible for the management of the corporation.

A Board of Directors may rely on the Business Judgment Rule, which is a presumption that, in making business decisions, the directors of a corporation acted on an informed basis and in good faith that the actions taken were in the best interest of the company and its shareholders.  However, a Board of Directors must operate with a Duty of Care, wherein the Board of Directors should make informed decisions by assuming an active role throughout the entire decision-making process.

While the culpability of the Board of Directors may be debated, news articles have discussed the merits of choosing Board members with expertise in the technology field of interest and utilizing experts with experience in that technology field to conduct due diligence before making investments.

 

Raj Pai
Raj D. Pai's practice focuses on patent prosecution and litigation in the pharmaceutical, biotechnology, and the medical device sectors. Prior to joining the firm, Raj worked as a post-doctoral fellow at the University of Southern California and the University of California-Los Angeles. His work included analyzing signaling pathways in leukemic cells, parasitology studies, and biofuel production. He holds a Ph.D. from the University of California Berkeley, where he carried out biochemical and structural studies on the bacterial ribosome. Raj attended the University of California Davis School of law. While in law school he served as an articles selection editor for the Business Law Journal and served as President of the King Hall Intellectual Property Law Association. Raj worked as a summer associate at the firm in 2016 and joined the firm in 2017.
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