The investors duped by the Theranos fraud never asked for one important thing

Supported By:

Net Patrol International Inc.  Data Investigation and Forensic Services
Bankruptcy and Insolvency Trustees

March 20, 2018 (Courtesy of and founder Elizabeth Holmes raised $700 million from mostly wealthy investors without ever having to provide financial statements audited by an independent public accounting firm.

That’s what the Securities and Exchange Commission complaint against former Theranos president Ramesh “Sunny” Balwani suggests — and what a representative of one group of investors confirmed to MarketWatch.

On March 14, Holmes and Theranos, the blood-testing startup that was once valued by investors at $9 billion, settled what the SEC characterized as “massive” fraud charges. Balwani was charged by the SEC in the scheme but is fighting the allegations. Balwani became the company’s president in 2009, after guaranteeing a line of credit for Holmes, who had run the startup for five years but was on the verge of running out of cash, according to the SEC’s complaint against Balwani.

An attorney for Theranos from Wilmer Hale did not return a call requesting comment. An attorney for Elizabeth Holmes from Cooley LLP declined comment.

Balwani’s attorney, Jeffrey B. Coopersmith of Davis Wright Tremaine, provided this statement: “We believe the enforcement action by the SEC is unwarranted. Sunny Balwani accurately represented Theranos to investors to the best of his ability.”

All of the money Theranos raised came from private placements, fundraising that’s restricted to wealthy investors and disclosed to the SEC via an exemption from registration under securities laws called Form D. Companies can use a Form D to tell the SEC about their fundraising from investors, usually without further scrutiny, as long as the money only comes from “accredited investors.” Accredited investors are either individuals whose net worth exceeds $1 million or who consistently have made over $200,000 per year in income; companies that have more than $5 million in assets also qualify.

See: Here’s the blueprint for how ICOs are getting off the ground without SEC vetting

The SEC’s complaint against Balwani describes the binder provided to potential investors. The package included a cover letter drafted and signed by Holmes, a company overview slide-deck presentation, reports of clinical trials Theranos performed with pharmaceutical companies, and financial projections on spreadsheets created from scratch by Balwani.

There were also lots of copies of articles and profiles about Theranos, including glowing profiles of Holmes from 2013 and 2014 by the Wall Street Journal, Wired and Fortune.

Materials within the binders stated that Theranos would generate over $100 million in revenues in 2014 and break even, according to the SEC complaint against Balwani. The unaudited financial statements that the SEC said Balwani created also projected Theranos would reach approximately $1 billion in revenue in 2015.

Conspicuously absent from the package that went to investors are income statements, balance sheets and cash-flow statements audited and signed by a qualified public accounting firm.

Private companies are generally not required to pay for an outside audit until they’ve made a registration with the Securities and Exchange Commission to offer debt or equity to retail investors. However, a company planning to eventually go public starts working toward the requirement of having at least two years’ worth of audited financial statements by the time it files for an IPO.

If a company will have more than $1 billion in revenue by the time it files its S-1 with the SEC to go public, as Theranos claimed it would by 2015, then it is required to provide potential investors with three prior years’ financial statements audited by a firm registered with the Public Company Accounting Oversight Board, the audit-industry regulator, when it files for the IPO.

One veteran Silicon Valley venture capitalist, who did not want to be identified because of the ongoing criminal investigation, told MarketWatch that his firm expects to see auditors hired and audited financial statements when revenues and expenses are in the “tens of millions,” although it depends on the amount of the investment.

Some investors saw the light in October 2015 when the Wall Street Journal’s John Carreyrou wrote a Theranos exposé. The Partner Fund sued Theranos, Holmes and Balwani in 2016 after investing more than $96 million in 2014. The hedge fund accused Theranos of securities fraud, alleging that Holmes and Balwani had raised the funds “[t]hrough a series of lies, material misstatements and omissions.” These investors settled their lawsuit in 2017 for an undisclosed amount that was reportedly approximately half of their investment.

“The SEC’s allegations are serious and are thankfully bringing more attention to what can fairly be described as atrocious misconduct,” said Reed Brodsky, the attorney with law firm Gibson Dunn who represented the Partner Fund.

Going back to 2003, when Holmes founded the company, Theranos raised money primarily from family and friends. An all-star board that at one time included David Boies, the well-known attorney; Richard Kovacevich, the ex-CEO of Wells Fargo; two former secretaries of state, Henry Kissinger and George Shultz; and current Secretary of Defense James Mattis helped recruit investors.The Theranos investor list is a who’s-who of Stanford University alumni and distinguished military veterans. Tim Draper, Larry Ellison and Rupert Murdoch were among the high-profile investors.

Representatives of Draper, Ellison and Murdoch didn’t return messages. Murdoch is the chairman of News Corp, which owns MarketWatch, the publisher of this report.

Some well-known venture-capital firms did take a pass on investing in Theranos, because of Holmes’s unwillingness to share information about the blood-test technology and results and the lack of established scientific support for it via peer-reviewed research. The company and its board also lacked medical and scientific experience.

Bill Maris, founder of Google Ventures, told Business Insider in October of 2015 that he had decided not to invest in Theranos because he had questions about the company’s technology.