Theranos – When Corporate Governance Fails

I just finished reading ‘Bad Blood’ by John Carreyrou, the Pulitzer Prize winning Wall Street Journal investigative reporter. As I read through the book, I couldn’t stop thinking about the business leaders I’d had an opportunity to meet in person that served on boards of companies like Suncor Energy, Berkshire Hathaway and Honeywell while I was in business school. These were speakers that were there to talk about corporate governance. The most powerful expression I took from this class was said by Patty Bedient. Patty was a long time executive at Weyerhauser and currently serves on the board of Suncor Energy and Alaska Airlines. She described in a single expression for us the job of a board member as – Nose in, hands out. What she meant is that as a board member of an organization, you represented the investors of the company. You kept your nose in to keep a check on how the company was being run but kept your hands out of it in terms of what needed to happen. Oversight of the leadership was what you did as a board member. Similar attestations were made by Bill Ayer, the ex CEO of Alaska Airlines and a board member at Honeywell as well as Charlotte Guyman, a board member at Brooks Running, The Space Needle and Berkshire Hathaway. Essentially, the board is the CEO’s boss – figuratively at least.

You can imagine then that if you are a new company and in need of legitimacy and capital infusion, having oversight from a board comprised of influential people would be great for your reputation. This was Elizabeth Holmes’ masterstroke. She was the queen of networking and managed to propagate a grandiose vision that started with a single influential connection in Tim Draper and a rich genetic lineage to a fraud valued at $700 million. Once she managed to convince Larry Ellison, the founder of Oracle to become an investor and board member, there was no looking back.

Elizabeth was intelligent but arrogant. After only 2 semesters at Stanford, she decided she knew enough about the chemistry of blood testing and business to drop out and start Theranos. She was a wannabe prodigy and wanted to mimic Steve Jobs. She wore black turtlenecks and was extremely stubborn about her vision. That is about where the similarities ceased. Steve Jobs while demanding and difficult to work with at times, was extremely focused and aware of the needs of his customer. Elizabeth on the other hand, failed to even recognize who her actual customer was. She made the decision to go live with her blood testing devices in Walgreens stores in Northern California and Arizona even though her employees told her that the devices were not quite ready. When an employee asked why, she said it was because when she made a promise to a customer, she intended to keep it. Theranos’ sold a noble vision to its investors and the world. A vision to give normal people the ability to test and access their own health data by making blood tests cheap and accessible. But it failed to acknowledge that this vision made patients their ultimate customer.

When misconceptions like this propagate within a company and its leadership, it is the responsibility of the board of directors to provide necessary oversight. It is the responsibility of the board to identify systemic issues and take the necessary steps to rectify the situation. Usually this means finding a new CEO or voting on the right board member to take over. Steve jobs was fired from Apple because the board agreed that he needed to go. He was brought back to Apple for the same reason. Theranos is the perfect example however of what happens when 1) A board does not do its job, and/or 2) A board is incapable of doing its job. In this particular case, it was both.

The Theranos board was very carefully crafted. It included a lot of politically connected figures. Former US Secretary of States Henry Kissinger and George Schultz, Two US Senators, Army General James Mattis, Navy Admiral Gary Roughead and Former CEOs of Bechtel Corporation and Wells Fargo. It is very easy to notice here how none of these people have any affiliation to medical science. One of the US senators was a heart transplant surgeon but he obviously spent more time on policy than medicine by the time Theranos came along. Furthermore, Theranos maintained extreme secrecy in the name of protecting their proprietary technology. They also had the most prominent law firm in the country on a retainer at their beck and call. While a lot of tech companies maintain secrecy around their products, this was at a different level. Why does a startup need the best law firm in the country representing them? Silicon Valley was most certainly not lacking on legal talent to represent startups. A board acting to prevent further dilution of the existing investors’ stake in the company should likely have asked that question. Boies Schiller Flexner LLP is not your run of the mill law firm. I represents clients like Nike in the recent Michael Avenatti fiasco. You might argue that they are in fact looking out for the investors by protecting the intellectual property but you don’t necessarily need a firm on a retainer for that. You can always hire them if you have that sort of a litigation on your hands I’d assume.

The other red flag was Elizabeth’s security detail. Why does a startup founder need that much security? Private security is not cheap and neither is bulletproof glass which is what was installed in Elizabeth’s office. The board knew this was the investor’s money she was spending right? Why did no-one ask this question? She always flew in private gulf stream jets. Corporate executives are often criticized for doing just that and here we had a company that was burning through cash and spending money on entirely unnecessary expenses.

It was not unusual for employees and executives to be fired from the company. As a matter of fact, any time someone spoke up about their disagreements with the decisions being made, they were fired. Elizabeth’s number 2 and boyfriend Sunny threw them out in a fit of rage. How did the board never know about the changing faces of leadership at every level within the company? Were they just purposefully ignorant or were they just that blind to the charisma of Elizabeth? What is weird is that Elizabeth was publicly making claims of the Theranos system being used in battlefields in Afghanistan to get investments. How does such a politically and militarily connected board not know that these claims are being made to investors?

George Schultz even went as far as straining his relationship with his grandson who worked at Theranos by supporting and believing Elizabeth over his own grandson. Most people put more trust on glassdoor reviews than what a CEO says in a TV interview before they take a job because usually, people that work in the weeds are the ones that know what a place is really like.

What really bothers me about all of this is while there was damage done to the reputation of some of these people they will go on to live their lives. The investors in the company were mostly very wealthy individuals and the lost money is a blip in their financial ecosystem so they might not care. As a matter of fact, after the scandal broke, Rupert Murdoch sold back the shares from his $125 million investment back to the company for $1 just to get the tax write-off. The SEC determined that the board was misled just like the rest of the other people. However, how do they get penalized for not doing their jobs? How do they repay for the betrayal of the investors’ trust in them?

It would not be me if I didn’t talk about Warren Buffet while I was talking about corporate governance and ethics. When Elizabeth pitched the Theranos investment to Rupert Murdoch, she told him that she was looking for a long term investor that didn’t care about immediate returns and that the company was planning to stay private for the longhair. This reminded me of an instance from Warren’s biography – The Snowball by Alice Schroeder. When Warren started out his early investment partnerships, he had established very stringent rules about what the investors were allowed to do. Or rather were not allowed to do. They could not know what Warren was investing their money in but he had built a strong level of credibility in the business and had immensely strong character witnesses. While Warren acknowledged that he learned a lot from his mentor Ben Graham, he also admitted he was different. While diversification of portfolio was an indisputable for Graham, Warren would put most of his money on a single bet if the margin of safety was high enough (More on margin of safety in a future post). He was willing to give credit to his mentor where it was due but had the audacity to be different to become who he is today. Elizabeth on the other hand, emulated Steve Jobs by attempting to look like him, talk like him and be stubborn like him but was unwilling to demonstrate his most important quality – being obsessed with quality.

In conclusion, if you ever want to serve on a board of an organization, you should read this book. It is a lesson in many things you should look out for and all things you should avoid. I really hope that Elizabeth and Sunny Balwani get what they deserve. I hope even more that the board members don’t just get to ‘move on’. For now and for what it is worth, the board members have my strongest stamp of disapproval and I say ‘SHAME ON YOU’ for not doing your job.


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