SEC vs Theranos & what it means for Silicon Valley

Securities and Exchange Commission (SEC) filed a lawsuit against Theranos, CEO Elizabeth Holmes and company President Ramesh Balwani accusing them of massive fraud. Holmes has settled the lawsuit and has been stripped of her position as the CEO. As part of the settlement, she will pay $500,000 in penalties and won’t be allowed to serve as an officer or director of a private company. It is quite a comedown for an entrepreneur who often graced the covers of business magazines and was a constant presence at the posh conferences. She also convinced investors to invest $700 million in the company at vertigo-inducing valuations. And even though SEC’s actions are a mere slap on the wrist with no admission of guilt on part of Holmes, the nuanced message of SEC actions is clear enough for rest of the unicorn club.

“Investors are entitled to nothing less than complete truth and candor from companies and their executives,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division. “The charges against Theranos, Holmes, and Balwani 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.”

“The Theranos story is an important lesson for Silicon Valley,” said Jina Choi, director of the SEC’s San Francisco Regional Office, in a statement. “Innovators who seek to revolutionize and disrupt an industry must tell investors the truth about what their technology can do today, not just what they hope it might do someday.”

Ousting of Holmes is an unprecedented step taken by the SEC against a private (and not public) technology company, and is a watershed moment in the history of Silicon Valley. It does not come as a surprise to me that the grim reaper of regulation is walking around in Silicon Valley. The notional values of startups are exceeding those of their public market peers, and a lot of those valuations are based on financial foundations weaker than those of a dollhouse. And what SEC seems to be saying — if you are going to play with the big boys, then you will be monitored like big boys. All those who have been wearing the “unicorn” badge need to make sure that their numbers are right — the I’s dotted and T’s crossed.

While on paper it might seem like a Theranos-specific action, the implications of this will be far reaching. We are starting to see too much bad behavior in the startup ecosystem. A few months ago, we learned about, Chicago-based Outcome Health came under fire for making wild claims. An advertising network that focused on beaming pharmaceutical advertising to patients in doctor’s officers, its founder Rishi Shah were accused of misrepresenting the company’s achievements and getting investors to pump in as much as $500 million into the company. The founder settled the lawsuit with the investors, paid off the debt and left the company.

While it was easy to focus on the founders, I for one, wouldn’t mind SEC holding the board members accountable for such shenanigans, especially if it wants private companies to clean up their act. In case of Yahoo, everyone blamed a succession of chiefs, but I thought the board and its actions were equally damaging for Yahoo! This is not the first example of a derelict board. When covering Enron as a reporter, it was quite evident to me that the company went down the path of moral and real bankruptcy, because it had an ineffective board packed with those who always agreed with the main protagonist.

It has been a good lesson, one that I have carried with me into my life as a professional. Chief executives and founders misbehave because those who sit on the boards turn a blind eye to those actions. They enable, by inactivity in other instances.

In 2002, Yale School of Management professor Jefferey Sonnenfeld wrote:

The key isn’t structural, it’s social. The most involved, diligent, value-adding boards may or may not follow every recommendation in the good-governance handbook. What distinguishes exemplary boards is that they are robust, effective social systems….

…Directors are, almost without exception, intelligent, accomplished, and comfortable with power. But if you put them into a group that discourages dissent, they nearly always start to conform. The ones that don’t often self-select out.

It is why I always encourage founders to get independent and more importantly independent-minded board members. It is just good corporate hygiene. If Theranos had a good, efficient and strong board, SEC wouldn’t be taking the action it did.

Photo by Dave Redfern on Unsplash.

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