Theranos, Part 2-2: The fallout

Category: Surrendering to FOMO, one of the Seven Deadly Stupidities.

When it comes to an evaluation of the bad decisions around Theranos, there is much to discuss. Let’s start with the decision to invest. Many investors thoroughly research a company’s industry, management team, customers, etc. But many simply follow each other into deals. Something like this:

If we look closely at the list of Theranos investors, we can detect a pattern:  Other than Tim Draper, none of the investors were traditional venture-capital investors. All the others were wealthy individuals, who invest through “family offices,” which are small business that manage the money of wealthy families and did not have the discerning eye and structured insistence on scrutiny that venture capital has.

In other words, their investments were somewhat impulsive, like chasing after the shiniest object in the room. It should be noted that while Draper is a hugely successful and admired venture investor, his firm did not invest. As a friend of the Holmes family, Draper personally invested……..one million dollars.

Without the audit, an investor is relying on the company’s unverified representations. For example, the company may claim it sold 100 units of its product last year. In reality, those 100 units may be more like 50 units sold and paid for, 25 units being evaluated by customers, and 25 more units based on a handshake the CEO made with a customer. In the opinion of management, 100 units have been sold.  But an auditor would verify the 50 sold units and that would be it. 

The job of the auditor is to apply accounting standards (like defining what an actual sale is) across companies and across industries so investors and others can rely on the consistency of these definitions.

If a company does not have an audit, it is common for venture capital and other professional investors to send in a team of smart MBA types to scrub the numbers and verify management’s claims (eg, 100 units sold). Many companies say that the detailed evaluation by professional investors is more rigorous than an audit.

In the case of Theranos, there was no audit and there was no scrubbing of the numbers by experienced financial professionals. Investors took the word of the company and Holmes about how great everything was and how incredible the future would be. You don’t need this book to tell that taking a person’s word for it is a perfect recipe for stupidity, especially one that involves large sums of money.

In fact, it was worse than not having an audit. Here is a summary from The Dig of the testimony from the Holmes trial by Danise Yam, financial controller at Theranos:

So, it wasn’t like Theranos ignored the whole audit thing, it tried to get an audit, but it could not agree with the auditors on the numbers. So, no audit and Walgreens still invested? FOMO.

The media also fell for the story and fell hard.  One of the most respected business journalists around is Ken Auletta. Auletta has published books on Google, Microsoft, Harvey Weinstein, Lehman Brothers, and many more. He has written dozens of articles in the New Yorker, The New York Times, and other media outlets.  The thing about Auletta’s writing is that people actually read his stuff and talk about it. (I have read most everything Auletta has written over the last several decades.)

Auletta did a full-length story on Holmes and Theranos in the New Yorker. Auletta wrote a balanced story that extolled the virtues of Theranos – if it matured into a full-sized company – while at the same time pointing out the troubling secrecy and the lack of external industry or regulatory oversight. Upon a closer examination of the story, Auletta was careful to attribute all the “change the world” statements to direct quotes from Holmes that were not supported by research. He also referenced competitors and medical experts that expressed deep skepticism regarding the company’s claims.

Wall Street Journal reporter John Carreyrou read the Auletta piece on Holmes and, despite the generally positive tone of the story, sensed the hesitation by Auletta to go all-in on Theranos. Carryrou, mainly working with whistleblower and a hero of the story, Tyler Schultz, went on to break the story of the Theranos fraud.

For the 22-year old Schultz in his first job, it was huge risk. The situation was complicated by the fact that George Schultz, former Secretary of State and Tyler’s grandfather, sat on the Theranos board. Tyler provided information to Carryou about the “open secret” inside the company that nothing really worked. When Tyler was exposed as a source for Carryrou, he felt the full force of Holmes and her army of lawyers and nearly exhausted his family’s resources to fund his own defense.

Yet, Shultz did not waver and, in large part, is responsible for potentially saving countless lives that could have been affected by flawed Theranos testing.

“John Carreyrou did a brilliant job of exposing Elizabeth Holmes — I did not.” Auletta reflected. “So, when I look back on that, yeah, I did a profile of her, but I did not produce the goods that he did.” Yahoo

Writers across the business and social world fawned over the young entrepreneur. Fortune Magazine, Time, Inc., and all the rest of them believed Holmes at her word.

Once Carreyrou broke the story, the media praise shifted from Holmes to Carreyrou and Shultz. From John Naughton in The Guardian:

This goes back to the question of a biased media (more on this in a later chapter). Objectivity and balance do not get page views. As described by Naughton above, the Holmes story was a great story, why screw it up with messy details like checking to see if the product actually worked?

Jean-Louis Gassee, former senior executive at Apple did just that. (Medium) He had his blood tested at a Stanford University lab then walked down the street to Walgreens and had the Theranos tests done. By now, you can guess the outcome:  Two rounds of tests (after all the guy is an engineer) and two rounds of results from Theranos that were not close to the values from Stanford. As he said, “Which should I believe?” Gassee, like most of us, would say that the Stanford results were based on billions of samples running through a lab process that has been around for dozens of years is the choice over a startup that uses a black box to spit out results.

Gassee was no genius. Well, in fact he was, but he was not a medical expert or a journalist. He was somebody who stayed with his rigorous decision-making process and did not buy into the hype. We could say that Gassee has excellent FOMO radar.