SGR Holds Due Diligence Roundtable on Lessons Learned from Theranos Case

SGR recently hosted an informal, virtual roundtable to discuss some of the lessons that can be learned from the Theranos saga and the recent trial of its former CEO, Elizabeth Holmes. SGR partners Lori Gelchion and Bob Hussle (Corporate Practice), Michael Riesen (Intellectual Property Practice) and Emily Ward (Litigation and White Collar practices) each approached the case from their unique vantage point and discussed issues ranging from investor due diligence to corporate governance policies to patents. They also shared advice for company directors, investors and other lawyers. Below are some key excerpts and topics covered in their panel.

Theranos was a privately held corporation that claimed to have developed a breakthrough blood-testing technology that only required very small amounts of blood. The company raised nearly $700 million from venture capitalists and private investors, most of whom were ultra-wealthy, in private placements not registered with the Securities and Exchange Commission (SEC). At its peak, Theranos was valued at approximately $10 billion. Eventually it was revealed that many of the claims made by Theranos and Ms. Holmes about its technology and business were false. The SEC brought a civil action against Theranos and Ms. Holmes under the anti-fraud provisions of federal securities laws, which was subsequently settled. The Justice Department then brought an 11-count criminal indictment against Ms. Holmes for wire fraud and conspiracy, among other charges. Based on the same conduct as the SEC’s civil action, in January 2022 a jury convicted Ms. Holmes of three counts of investor-related wire fraud and one count of conspiracy to defraud investors; the jury was unable to reach a unanimous verdict on the remaining charges.

Investor Due Diligence

Emily: Theranos raised its money through private placements to pre-selected investors and institutions, not publicly registered offerings in the open market. At least some of these so-called sophisticated investors did very little due diligence or investigation into the company and its claims. What kind of diligence might have revealed that something was amiss or at least sent up some red flags?

Lori: It’s very typical, almost universal, for investors to review the issuer’s financial statements and corporate records. Some investors asked for these items from Theranos but did not receive them. Receiving pushback on this very basic request is clearly a red flag.

It’s also typical for investors to review material contracts. Given the claims made against Theranos, review of Theranos’s contracts with the military, retailers or pharmaceutical companies may have revealed, for instance, that claims of Theranos products being used by the U.S. Department of Defense in Afghanistan were not supportable.

Investors could have also performed diligence on the Theranos supply chain. This may have revealed that Theranos was purchasing traditional blood-testing equipment from third parties. This should have led investors to ask “why?” As we now know, Theranos was testing blood samples on other companies’ equipment and claiming it as their own.

Investors might have also engaged health care and technology experts to diligence the product. Simply put, does it work? Some investors never asked to see the blood analyzer in action, and those who did ask questions about the technology received answers that were characterized as cagey, indirect, oblique or deflective. Ultimately, even those investors who did conduct some due diligence were still defrauded because their diligence did not uncover the fraud.

Emily: Focusing on start-ups, what kind of due diligence should investors consider taking when considering whether to invest in a start-up company like Theranos?

Lori: Diligence on start-ups typically involves reviewing financial statements, corporate records, material contracts, the product or the technology, the market capitalization, the business model, and projections, among other things. With start-ups in particular, it’s also important to diligence the people – the founder, the senior executives and the key management. Is there sufficient experience and expertise in the C-suite to know that what the company is attempting to achieve is actually possible? Do they have a fundamental understanding of the product or process and how it works? And do they have the leadership and experience necessary to achieve what they envision?

Corporate Governance – Investor Due Diligence

Emily: One of the consequences of Theranos being a private company is that it did not have many of the corporate governance safeguards required for public companies like an independent audit committee or whistleblower protections. What should a prospective investor look for when considering the corporate governance policies of a private company?

Bob: With respect to the board composition, it’s important for potential investors to note not only the qualifications of each of the directors but also what their personal investments are in the entity in which you are about to invest. Ideally, you would like to see a board comprised of individuals with significant personal investments and stakes in the entity.

There is also no requirement for private companies to have audited financial statements, but at some point during the life cycle of a private company, you would expect that prior significant investors would demand that the company prepare and distribute audited financial statements. So the fact that they don’t have those should be a clear red flag. Theranos was valued at approximately $10 billion at its peak so it’s almost inconceivable that it could go that long without having audited financials.

Emily: One other corporate governance safeguard lacking at Theranos was for whistleblowers. Internal whistleblowing was not protected by law at Theranos and was reportedly highly discouraged. Is that something prospective investors should consider?

Bob: Absolutely. One thing you might ask a company is what their whistleblower policy is, and whether they have updated their employee nondisclosure forms to make clear that those employees are permitted to talk to the government. Many employees still don’t know that they are permitted by law to disclose to the government without fear of reprisal.

Corporate Governance – Board of Directors Due Diligence

Emily: Are there any additional corporate governance considerations that someone should investigate when considering whether to join the board of a private company like Theranos?

Bob: What they might also wish to examine is whether there are committees of the board, like an audit or a corporate governance committee. Does the board meet in executive sessions without management? Does the company have auditors and does the board have direct access to those auditors? Those are all things that, if I were considering joining a board, I’d want to know about. In addition, I’d want to know if there is insurance in place, how the board operates, and whether it conducts its oversight of the entity in a way that discharges the board’s duties.

Diligence of Patents

Emily: Elizabeth Holmes and Theranos filed for, and were granted, several U.S. patents. This is something that likely made them look like a good investment, both for individual investors and some of the large companies who had contracts with Theranos. Does the fact that Theranos was granted patents for technology mean the technology itself was good and vetted by the U.S. government?

Michael: Patents are meaningful to competitors, to investors and to the patent owners themselves. But does having patents mean that it’s been vetted, that the technology is good? The short answer is no.

With increased public interest in patents comes some general misinformation and misnomers, if you will. For example, someone may read that a widget company has patents on an electric car, and without a full understanding of the scope of those patents, accept the widget company’s representation that it has the exclusive rights to the electric car without further investigation or diligence. In that situation, you may find out that the patent applications were still pending, or maybe they were abandoned, or maybe they were granted and only covered a very specialized particular area – maybe the battery pack and nothing else. That’s why it’s important that we do have diligence in the patent area.

One way to conduct diligence is to look at the patent application. A good patent application should include enough details such that you’re teaching somebody else how to do it or how to make it. If you see hundreds of millions of dollars in investment after the applications were filed, or years and years of trial and error and even third-party equipment being brought in, one may speculate very quickly that what was put in the application was not necessarily enabled because someone couldn’t just go out and make it based upon what was written there.

Emily: What sort of patent-related diligence is accessible to a prospective investor in a company?

Michael: I think it’s important that you understand what the scope of the patent really covers. That could mean just picking up the patent and having someone look at it with that technical and legal eye to determine what is really covered by this patent and whether there are problems with the patent. Just because the Patent Office has put its stamp on it doesn’t necessarily mean that the challenges are over. There are several jurisdictions that allow post-grant challenges. When conducting diligence, you should look to identify whether these patents could be challenged or invalidated.

Key Takeaways:

  • Issuers: Your innovators must tell investors the truth about what their technologies can do today, not just what they hope it might do someday.
  • Investors: Be wary about investing based on relationships without doing sufficient diligence. Even if you have a relationship with and trust the founder, a board member or other investor, you need to verify the claims made about the company before investing.
  • Patents: Investor diligence needs to determine if trade secrets are being protected by the company and if the patent portfolio can stand up to a challenge or enforcement.
  • Government Oversight: We may see increased regulatory scrutiny on large private companies that have chosen to stay private rather than go public and expose themselves to public disclosure obligations. This could result in some rulemaking or legislation at either the federal and or the state level that companies should be aware of.

To listen to the full Leaders Speak podcast, “Episode 37 – Due Diligence: Lessons Learned from Theranos,” visit

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