Theranos CEO Elizabeth Holmes’s fraud trial to test the limits of entrepreneurship

In early 2015, Elizabeth Holmes’s star was rising fast. Theranos, her Silicon Valley startup, was being feted for its remarkable invention: A printer-sized machine capable of running hundreds of different blood tests cheaply and quickly from just a tiny droplet of blood taken from a patient’s finger, rather than vials drawn from a vein in the arm.

The promise was a revolution in health care that could catch illnesses early and save lives. Joe Biden, then U.S. vice-president, visited the Theranos labs that summer and called its technology “inspired.” Harvard Medical School appointed Ms. Holmes to its prestigious Board of Fellows.

With Theranos’s value pegged at US$9-billion, the 31-year-old’s 50-per-cent ownership stake made her the youngest ever self-made female billionaire. Her ascent also won her a slew of magazine cover stories, including Fortune, Forbes and Inc., which hailed her as “the next Steve Jobs.”

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Around the same time, however, Dr. Eleftherios Diamandis’s bosses at Mount Sinai Hospital in Toronto asked him to look into Theranos’s claims – with an eye to possibly adopting the technology at the hospital. Theranos’s much-hyped testing tool was shrouded in secrecy, but Dr. Diamandis, the head of clinical biochemistry at the hospital, saw enough to concern him.

In a journal paper he penned in May, 2015, Dr. Diamandis warned that Theranos’s “claims of superiority over current systems and practices are speculative, at best,” and that “most of the company’s claims are exaggerated.”

As it turned out, Dr. Diamandis was one of the first critics to publicly raise red flags about a company that, within a year, would be embroiled in investigations and lawsuits. The ordeal is set to come to a head on Aug. 31 when, after several delays, Ms. Holmes’s trial on fraud charges finally opens in a San Jose, Calif., courtroom. She faces a maximum sentence of 20 years in prison if found guilty.

Prosecutors allege Ms. Holmes knowingly lied about Theranos’s blood-testing capabilities. At its peak, the company claimed its machines could run more than 200 individual tests for things such as diabetes, HIV, cholesterol, calcium and iron, with up to 30 tests conducted at once from a single droplet of blood. All for as little as one-tenth of what hospitals charged for traditional tests.

But prosecutors say Ms. Holmes knew Theranos’s proprietary analyzer could only run a small handful of tests, and even then its results were wildly inaccurate.

What’s more, many tests weren’t even being done using Theranos’s own so-called Edison machines, but on commercially available, third-party lab equipment instead, contrary to what investors who had sunk US$700-million into the company, and its retail partner, the Walgreens pharmacy chain, were led to believe.

“The whole Silicon Valley ethos is to fake it till you make it, and you can get away with that if you’ve got a piece of consumer technology or software that you need to keep improving,” said Tom Sanko, a Redmond, Wash.-based consultant who works with medical device startups. “But medical devices are intimately related to people’s health, and Theranos chose to put that in the background. Elizabeth Holmes is on trial because she actually endangered people’s lives.”

Ms. Holmes is charged with two counts of conspiracy to commit wire fraud and nine counts of wire fraud. Ramesh “Sunny” Balwani, Theranos’s former chief operating officer, who was also in a secret relationship with Ms. Holmes at the time, faces the same charges. But his trial is not scheduled to open until January.

Both deny any wrongdoing and have pled not guilty to all charges.

But as much as the trial will centre on the accuracy of the company’s blood tests, a larger question will hang over the proceedings: How did a world obsessed with Silicon Valley’s startup culture miss so many obvious clues that something was very wrong at the blood-drawing unicorn?

Before her downfall, Ms. Holmes’s story was undeniably appealing, and checked all the boxes that a rule-breaking, single-minded oddball visionary who said she was out to “change the world” was supposed to.

After dropping out of Stanford University at the age of 19 in 2003, Ms. Holmes launched what would eventually become Theranos. The name is an amalgam of “therapy” and “diagnosis,” and over the next 12 years, she built it into Silicon Valley’s most valuable startup.

She fashioned herself after Apple Inc.’s charismatic and demanding Mr. Jobs, complete with black turtlenecks. And when she spoke in interviews and at conferences, it was in an unexpectedly deep baritone that some former employees say she put on and occasionally let slip, revealing her higher-pitched natural voice.

Magazines clamoured to put her piercing stare on their covers – Ms. Holmes was famous for rarely blinking. Channing Robertson, a professor emeritus of chemical engineering at Stanford University who Ms. Holmes recruited early on, said mentoring her was akin to teaching Beethoven to play piano.

But what really helped bring in the money was her connections. Ms. Holmes stacked the Theranos board with a who’s who of the old, white male establishment, including former U.S. secretaries of state Henry Kissinger and George Shultz, and former secretary of defence James Mattis. (Mr. Shultz’s grandson and former Theranos employee Tyler Shultz would eventually be one of two key internal whistle-blowers who helped expose Theranos’s lies.)

Glaringly absent was anyone capable of asking difficult questions about Theranos’s strategy or its medical technology.

“A board’s primary role is to gather and filter information and provide guidance to management so you need to have people with relevant expertise,” said Chris MacDonald, an associate professor at Ryerson University and a consultant on business ethics. “It was just unimaginable in a highly technical field like this that you would have no one who knows anything about the technology.”

Nor did regulators provide much oversight of Theranos’s blood analyzers from 2013, when the company launched its first “Wellness Center” in partnership with Walgreens, to 2015. Theranos exploited a U.S. Food and Drug Administration loophole that allowed a company to develop and conduct diagnostic tests in its own lab without subjecting its testing procedures to FDA scrutiny.

Investors didn’t seem to mind, and by all accounts performed little or no due diligence on Theranos’s finances or technical claims. That was partly because to ask too many questions risked having your investment in the heavily hyped early-stage company turned down. Among the investors who took the plunge were Walmart’s Walton family (US$150-million), media tycoon Rupert Murdoch (US$125-million) and Betsy DeVos, later education secretary in the Trump administration (US$100-million).

In fact, the only traditional Silicon Valley venture capitalist who put money into Theranos and might have been in a position to ask questions was Tim Draper of venture firm Draper Fisher Jurvetson. He was a neighbour of Ms. Holmes when she was growing up and continued to defend her until at least 2018, when he still insisted Theranos had “great technology” and blamed her troubles on “hyena” journalists. Mr. Draper did not respond to a request for comment.

When Dr. Diamandis began to look at Theranos in early 2015, he was well aware of the hype, but also the complete absence of independently verified scientific data to back it up. Another researcher, Dr. John Ioannidis at Stanford, had already raised concerns about the company’s “stealth research.” Theranos enforced a culture of secrecy and paranoia – another trait Ms. Holmes borrowed from Mr. Jobs – by isolating employees from one another and forbidding them from discussing their work, all in the name of protecting “trade secrets.”

“In our business when someone makes a claim, you say show me the data, and Theranos wouldn’t do that,” Dr. Diamandis said. His initial paper picked apart Theranos’s claims about the relative cost and speed benefits of its technology, and raised concerns about the risks of patients self-testing and trying to interpret their own bloodwork, a key Theranos selling point.

In another six papers, Dr. Diamandis and his team also demonstrated that Theranos’s “revolutionary” tests using minuscule amounts of blood were unlikely to be useful for diagnosing illness.

The papers drew protest from an anonymous scientist who unsuccessfully demanded in a letter to the academic journal’s editor that they be taken down. Dr. Diamandis also clashed with some members of the American Association for Clinical Chemistry, a professional organization, after the AACC gave Ms. Holmes a high-profile platform to talk about Theranos at its annual conference in 2016.

“There were a lot of efforts to silence my voice, but they never produced the desired result, because eventually the truth would come out,” said Dr. Diamandis. “I lost a lot of friends but we were vindicated from the scientific point of view.”

For Ms. Holmes and Theranos, the downfall began in October, 2015, when The Wall Street Journal published the results of a year-long investigation uncovering internal dissent at the company, the faulty test results from its machines and its use of commercial lab equipment to conduct tests.

Ms. Holmes clung to her claims about Theranos, telling Jim Cramer, the host of CNBC’s Mad Money, the newspaper’s story was “what happens when you work to change things. First they think you’re crazy, then they fight you.” But the damage was done.

By the following year, the FDA, the Centers for Medicare & Medicaid Services (CMS) and the Securities and Exchange Commission had all launched investigations. The CMS banned Ms. Holmes from the medical lab industry for two years, while the SEC levelled “massive fraud” charges at Theranos, Ms. Holmes and Mr. Balwani.

Theranos and Ms. Holmes settled with the SEC in 2018 without admitting or denying the allegations, and she agreed to a 10-year ban from serving as an executive or director of a public company. That year Theranos was dissolved, and she and Mr. Balwani were indicted by a federal grand jury.

Several factors could come into play as Ms. Holmes’s trial gets under way. In July, she gave birth to her first child with her husband, Billy Evans, heir to a California hotel chain, who she married in 2019. Along with the COVID-19 pandemic, her pregnancy had already delayed the trial. Many observers are watching to see whether it affects the jury’s perception of Ms. Holmes and the judge’s sentence if she is convicted.

While it’s not clear yet how Ms. Holmes’s lawyers plan to defend her, hints of that are also emerging. Court records show her legal team has explored a “mental disease or defect” defence and they plan to call as an expert witness a psychologist who specializes in domestic violence and relationship trauma.

As a result, some legal experts have speculated Ms. Holmes may try to cast herself as having unwittingly acted under the sway of Mr. Balwani, who is nearly 20 years older than her.

A lot is at stake in the outcome. John Carreyrou, the former Wall Street Journal reporter who broke the story about Theranos’s faulty technology and has launched a podcast to cover the trial, recently told CNBC that a guilty verdict will “be a major shot across the bow to entrepreneurs in Silicon Valley … that you can’t do anything you want, you can’t completely ignore rules and regulations.”

On the other hand, Mr. Carreyrou said, an acquittal would have the opposite effect. “Young entrepreneurs all over Silicon Valley will be running around saying, ‘Yeah, maybe I pushed the envelope, but look at what Elizabeth Holmes got away with,’ ” he said. “It would be an extremely dangerous precedent.”

Back in Toronto, Dr. Diamandis hopes justice will be served, given the lies and dangers Ms. Holmes and Theranos created for blood test patients. But even if she evades conviction, he is satisfied with the part he’s played.

“The verdict might say they were innocent,” he said, “but we have documented their scientific sins.”

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