January 12, 2022
Elizabeth Holmes didn’t deliver on her projections. Her defense argued that “failure is not a crime.” But she was a fraud – a medical version of one of the biggest financial scammers of all time.
A ‘Medical Madoff’
As I wrote in May, one of the most successful Ponzi (or pyramid) schemes of all time was run by financier Bernie Madoff. His guise was a preternaturally consistent and successful hedge fund that returned between approximately 10% and 12% every year, regardless of market conditions.
In an investment world where small cryptocurrencies regularly post returns with a handful of zeros, that might not sound like much. But a solid double-digit return with low volatility – that is, minimal swings in performance – over decades is the purple unicorn dancing on a rainbow of the asset-management world. It’s an impossible fantasy beyond achievement.
But using a legitimate brokerage house as a front, Madoff was able to rip off around 40,000 investors who were deceived into thinking they’d accrued $65 billion in profits over a period of more than 40 years.
And Holmes was a kind of “medical Madoff,” according to Erin Arvedlund, an old friend of mine who wrote the definitive book on Bernie Madoff, Too Good to Be True: The Rise and Fall of Bernie Madoff.
Madoff got away with vague explanations of how he was able to generate such strong and consistent returns… and when pushed, hid behind the claim that his ideas were “proprietary,” and too valuable to be shared.
Holmes similarly used jargon and fuzzy language, designed to confuse rather than clarify. And she insisted on secrecy when asked to explain. In other words, both leaned hard into the car-mechanic syndrome to confuse investors.
Like Holmes, Madoff had a long list of influential backers – investors who happily referred their friends and family to Madoff, thinking they were doing them a favor. Like Madoff, Holmes warned investors to not expect much information or frequent updates… and actively discouraged probing questions.
Investing is similar to science, in that a result is valuable only if it’s able to be replicated… that is, if multiple people can arrive at the same conclusion repeatedly. But if no one can derive the same results using the same inputs and process? That’s a fluke.
Madoff’s investment results were simply mathematically impossible… and not replicable. “There were those who suspected Madoff’s magic was just an illusion. Among Wall Street option traders, the conventional wisdom was that Madoff’s strategy could not be replicated by anyone in the marketplace – at least not so it generated the double-digit returns he claimed,” Erin wrote.
The big problem with the Theranos device was that – despite years of experimentation and hundreds of millions of dollars in investment – it simply didn’t work consistently… when it worked at all. The complications of miniaturizing complex processes were just too much. Like Madoff, Theranos couldn’t reliably and repeatedly deliver results without cheating.
Madoff was sentenced to life in prison, where he died this past April.
Did Holmes’ Gender Matter?
Beyond a few sectors – like fashion and personal products – relatively few women have built billion-dollar corporate empires from scratch. Of the CEOs of S&P 500 Index companies, just 30 (or 6%) are female. For all the talk of equality, women in senior management circles face a very different set of circumstances – and far more challenges – than their male counterparts.
There’s another side to this corporate sexism, though… which is the over-the-top glamorization of some women when they (apparently) make it to the top.
If Holmes had been just another male Silicon Valley entrepreneur, would things have turned out differently? Would Holmes even have had the opportunity to defraud her investors? As a (female) columnist wrote in the Financial Times in 2019, while contemplating the collapse of Theranos…
If Holmes had been just another Silicon Valley male geek touting a then-unproven medical innovation, she probably would not have graced the cover of Forbes magazine. Nor might she have pulled so many luminaries on to her board, sucked in so much investment or avoided hard scrutiny for so long.
Given her age and gender, the deck was stacked against Holmes. But she used her apparent weaknesses to her benefit. As the Financial Times concluded…
Female executives need to be scrutinized and challenged like their male colleagues — no more but also no less. If we remember this, we can take a step towards building a more level playing field, and create female entrepreneurs we can applaud.
How Theranos Collapsed
To paraphrase Ernest Hemingway’s thoughts about how bankruptcy transpires – Theranos came apart gradually, then suddenly…
In August 2015, the Food and Drug Administration nosed around the Theranos facilities, and medical regulators found inaccuracies in the company’s blood tests. The first in a series of bombshell articles in the Wall Street Journal in October 2015 put Holmes on the defensive.
The U.S. Securities and Exchange Commission launched an investigation into the company. In late 2016, Theranos closed its lab operations. And in June 2018, Holmes stepped down as CEO, and was charged with conspiracy and wire fraud.
After several delays due to COVID-19 – and then because she was pregnant – Holmes’ trial in San Jose, California finally began in September. She ditched the black turtlenecks to adopt a “softer, ‘everymom’ persona,” the Financial Times said in an article devoted to Holmes’ court attire – to try to win over the jury.
The core of Holmes’ defense – besides asserting that (criminally) “faking it” and failing isn’t fraud – was that none of it was her fault… and instead, the people to blame were her employees, and most notably, the company’s former chief operating officer, who was also Holmes’ boyfriend.
The Lessons of the Elizabeth Holmes Saga
Since it was a private company, the financial fallout of the collapse of Theranos hurt only the likes of high-net-worth and venture capital investors. But there’s still a lot that we can learn from the collapse of Theranos…
- Beware the ‘story stock’
Holmes had a potentially world-changing vision. But a big idea without execution is nothing more than a good story.
In the stock market, that’s called a “story stock” – that is, a company that’s valued based on a promise, a vision, or a cool idea… rather than fundamentals and a solid business plan.
Story stocks often have delusions of grandeur and few revenues. They feed on capital raised from patient investors who buy into (and often ferociously defend) what they think – hope – is the boundless potential of the story.
But the storytellers often underestimate the challenges with converting a great idea into reality. The problem is that when someone like Holmes tries to develop their great concept, everyone winds up losing money.
- Do your due diligence
There’s no substitute for the hard work of research… something that investors in Theranos simply didn’t do. As the New York Times asked while reporting on the Holmes trial…
As investors have testified at Ms. Holmes’s trial, a central tension has emerged around due diligence. Could these investors have avoided disaster if they had simply done better research on Theranos?
That’s about checking in with customers, suppliers, and partners about a company’s product and production… getting expert insight on the sector, and on the strengths and weaknesses of the company… reviewing past forecasts to see if they were met… talking with former executives from the company and managers of competing firms… stress- and reality-testing financial statements and projections.
Though it might seem obvious, all too often investors, including those who should know better – with visions of huge returns and under the spell of the car mechanic – don’t do basic research on prospective investments, even with millions of dollars hanging in the balance.
If iconic technologists like Tim Draper and Larry Ellison can be duped by a good story… and hard-nosed negotiators (and, presumably, accomplished judges of character) like Henry Kissinger and James Mattis can be won over by a smooth talker… what hope do normal people have to be able to see through a fraud?
They’d have had more of a chance if they’d done their homework. There were plenty of red flags… but they were invisible to the investors who weren’t looking.
- Don’t put all your eggs in your company basket
Holmes was – on paper – a multibillionaire. But she never sold any of her shares in Theranos. Perhaps it was a show of her own faith in the enterprise, or she didn’t want to send the wrong signal to Theranos employees and investors.
And it may have also been because Elizabeth Holmes had drunk the Theranos Kool-Aid that she’d brewed herself, and believed that Theranos’ tabletop blood tests were going to change the world.
But Holmes made a rookie mistake: She didn’t diversify her personal financial exposure to Theranos. She was like the company lifer who doesn’t sell some of the shares that his employer awards him in a 401(k) account… who loses it all when that employer turns out to be like Enron or WorldCom, two big publicly traded that famously went bust – taking the retirement funds of their employees that were invested in the companies down with it.
Or Holmes was like the investor who doesn’t balance his portfolio after a big win… or doesn’t follow a stop-loss on a stock that moved up quickly.
In any case, Holmes apparently lost it all when Theranos went bust.
- Watch out for the silver tongue
When was the last time you were wowed – blown away, deeply impressed, thoroughly sold on – by someone who was selling you something… whether it was kitchen cabinets, $200 sneakers, or a stock? Chances are that you bought it, and you didn’t know what was happening until it was over.
If you feel overpowered by charisma… stop. Because that’s a problem, and it may be a symptom of someone who’s “faking it” and hoping to make it.
Investors in Theranos were blinded by Holmes’ channeling of Steve Jobs. They felt her appeal to a higher purpose of Theranos – beyond just making money. They didn’t appreciate her ability to obscure, bulldoze, obfuscate, and bully to get her way.
If you find yourself signing on the dotted line when there’s a heady buzz in your head, heed the signs… take a time out, and take a break from the silver tongue to see what’s really there.
It won’t help investors in Theranos… But it might help you the next time around.
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Executive Editor, American Consequences
With Editorial Staff
January 12, 2022