04 July 2019 by Ibi Eso
At its height, Theranos was the darling of Silicon Valley with a valuation of $9 billion, but it is now facing fraud charges and a loss of hundreds of millions. So what went wrong?
The Theranos story started in 2003 when Elizabeth Holmes dropped out of Stanford University to set up a promising health technology business that claimed to be able to accurately diagnose health conditions from a single drop of blood. It is ending with investors losing hundreds of millions, employees out of work and out of pocket, while its founder and COO are facing multiple fraud charges.
In my opinion, put simply, Theranos experienced ongoing governance failures on an epic scale. The science at the heart of the company was allegedly deeply flawed but this crucial fact was allowed to remain hidden by a corporate culture of secrecy and a startling lack of checks and balances.
Pulitzer Prize-winning journalist John Carreyrou of the Wall Street Journal, who uncovered the deception, detailed the company’s downfall in his book Bad Blood. It was also the subject of a five star-rated ABC podcast, ‘The Dropout’. Having listened to this, I had a growing sense of disbelief at what went wrong and, in my mind, the governance shortcomings were clear.
The Theranos board failed to carry out its duties properly and challenge the accepted wisdom. Not one individual, it appears, was courageous enough to confront their fellow directors and ask difficult questions for fear of being branded either stupid or a troublemaker. Non-executive directors (NEDs), being a step removed from the day-to-day running of the business, should feel able individually to challenge what they were being told.
Section 173 of the Companies Act 2006 clearly establishes the duty of directors to exercise independent judgement, with its explaining notes clarifying that:“directors must exercise their powers independently, without subordinating their powers to the will of others.”
This means it is important for directors to make an effort to question the popular opinion, even at the risk of being controversial or being seen as an outlier, as there could be a slim possibility that the majority view is wrong. At Theranos this did not happen.
Let’s not forget that everybody involved desperately wanted the company’s premise to be true and feared missing out on ‘the next big thing’. They were simply unable to be objective. It is fair to say that gender and wishful thinking both played a part. Carreyrou said: “There was a yearning to see a female entrepreneur break out and succeed on the scale that all these men have: Mark Zuckerberg, Larry Page, Sergey Brin, Steve Jobs and Bill Gates before them”.
Holmes seemingly had the ability to charm high-profile older men – including the then US Secretary of State James Mattis – into investing in or endorsing her venture, lending it unwarranted credibility.
It is significant that the story was eventually broken by a sceptical employee, who was able to resist falling under the spell of Holmes and Theranos president, Ramesh ‘Sunny’ Balwani. “One of the first things that struck me as ‘off’ in this story was the notion that she had dropped out of Stanford with just two semesters of chemical engineering classes under her belt and [had] gone on to pioneer a groundbreaking new medical science”. Having attended many board meetings, you do come across people such as Holmes that ‘talk the talk’, but don’t necessarily have the ability to deliver. It is important that people like Holmes, who happen to be in senior managerial positions, are grilled at board meetings. Here, NEDs should fulfil their duty by constructively challenging, using their professional experience to uncover the facts behind the glossy exterior.
None of Theranos’ directors had a scientific background. Best practice dictates board composition should include non-execs with sector-specific knowledge and experience. I can’t remember how many times I’ve advised boards I’m working with to ensure directors have the right combination of skills, experience and independence to deliver on the agreed strategy. This can be tested by carrying out a skills audit of board directors and checking this against an agreed statement of desirable skills. All boards should ensure they have a statement that lists the desired combination of skills and experience to lead their organisation and deliver on its agreed strategy.
As governance professionals, we advocate that businesses strive for a culture of openness and transparency but, according to Carreyrou, “The culture at Theranos was toxic”. This meant would-be whistle-blowers were threatened with legal action and any criticism of leadership or business practices was met with anger. Those who persisted were usually either fired or marginalised and forced out. It appears that the board was out of touch with the business and deaf to the whispers of increasing disquiet around them. So much so that one of the key whistle-blowers, Tyler Schultz, felt the only way his concerns would be addressed was by taking them directly to a newspaper.
In businesses with transparent cultures a concerned employee should feel able to share their doubts directly with business leaders without fear of recrimination. As a governance professional, I always advocate that every organisation has a whistle-blowing policy and that it is promoted throughout the organisation: it’s pointless having such a policy if no one knows it exists or understands that it’s the proper channel to raise concerns.
The culture of any organisation is also crucial. This can be promoted through agreeing to a set of values the organisation should live by. The UK Corporate Governance Code 2018 places a welcome emphasis on organisation culture. Principle B of the Code states: “The board should establish the company’s purpose, values and strategy, and satisfy itself that these and its culture are aligned. All directors must act with integrity, lead by example and promote the desired culture”.
The blind acceptance by the board of Holmes’ narrative created an environment in which she was reportedly able to falsify test results. She claimed the company’s finger-stick tests were performed using Theranos machines, rather than the Siemens machines that it’s alleged were actually used.
According to whistle-blowers, Theranos made active efforts to deceive, cherry-picking data to make test information appear accurate. When lab associates raised issues about equipment failures, data inconsistencies and flawed methodologies, they were repeatedly knocked back. Carreyrou notes, “The gap between what she claimed and what she had really achieved became a massive fraud”.
Readers who remember the TV programme Back to the Floor will recall this was about the most senior person in an company - usually the CEO - going back to the operational heart of the organisation. The benefit of leaders visiting operations and seeing for themselves what is happening on the ‘shop floor’ cannot be over-stated. It is vital that directors, and non-executive directors particularly, make the time to see how things are run and satisfy themselves that operationally the organisation is running well. I doubt any of the Theranos directors actually took the trouble to verify that the machines tasked with performing the pin prick blood test really did work.
The signs at Theranos were there had anyone looked for them. The problems with the Theranos devices would have been apparent even to those with no scientific background. During Tyler Schultz’s deposition, he revealed the devices had everything from mechanical errors to parts breaking off to temperature issues and experiment contamination.
Priorities were constantly changing with deadlines and expectations in constant flux. And unsurprisingly, given the chaotic environment, the majority of Theranos employees were unhappy at work, which resulted in high staff attrition. This fact alone should have raised red flags. Staff turnover and sickness levels can be markers for what’s really going on in a business and exit interviews should always be conducted to delve into the reasons why people are leaving. The UK Corporate Governance Code 2018 recognises this and strives to raise the profile of the employees’ voice in the boardroom. This is a welcome addition to the Code as employees are an organisation’s most valued asset.
Theranos now looks set to join the corporate fraud wall of shame and should act as a cautionary tale to any short-sighted business that still questions the need for, and value of, governance.
Ibi Eso is Managing Director at Bridgehouse Company Secretaries