How could big investors have been this gullible?


I have been fascinated by the case of the company Theranos, whose founder Elizabeth Homes is going on trial for fraud.

The trial, delayed earlier this year by Holmes’s pregnancy, is scheduled to begin on Tuesday and last several months.

Jurors will hear allegations that Holmes raised more than $700m from investors on claims Theranos invented a revolutionary machine that could conduct hundreds of laboratory tests from a single finger-prick of blood, but was actually using other companies’ technology for the tests. The company folded in 2018.

Holmes dropped out of Stanford University at 19 and became a star in a startup space dominated by men. She founded Theranos in 2003, with the goal of revolutionizing blood testing. The company’s rise and fall became a cautionary tale about the Silicon Valley hype machine.

Theranos received glowing media coverage and raised more than $700m from investors on
claims it had invented a machine that could conduct hundreds of laboratory tests from a single prick.

The tests were rolled out in Walgreens stores and Theranos reached a $9bn valuation before it became clear that many of the claims about the supposedly revolutionary blood test were bogus.

What intrigues me is how she managed to get wealthy people to invest big sums in her company without seeming to check if her much-touted product could actually do what she claimed it could do. It seemed her real talent was not in producing a revolutionary new blood-testing device but in charming older men to overcome their skepticism.

Early on, she started associating with these older men who could give her more credibility. It started out with Channing Robertson, the well-regarded Stanford engineering professor who would join her board, encouraging her and putting her in touch with people he knew around the Valley.

Then George Schultz was key in terms of being able to put together the last iteration of the board. He introduced her to all those luminaries; many of them were fellows at the Hoover Institution. And so she milked it. She was able to meet Gen Mattis, ex-cabinet members like Kissinger, and on and on.

The [Securities and Exchange Commission] has a term for this, and it’s affinity fraud. It’s associating yourself with people who are credible and well regarded by society to give yourself credibility. And that is a big part of the Theranos story.

She was going to be the first woman who reached billionaire status and join the pantheon of these tech leaders. People were really rooting for her – young girls were writing her letters.

A lot of people wanted to believe this fairytale, because it would have represented real progress in this very male-dominated world of Silicon Valley. Unfortunately, it was a fairytale that wasn’t true.

If she’s convicted and does significant prison time, it’s going to be a shot across the bow to venture capitalists and startup founders in the Valley that there are limits to how much bullshitting you can do, to how much exaggerating and hyping you can do and how many rules you can break.

There has long been a culture of faking it until you make it in Silicon Valley, and she is a product of that culture. To reform that, it is going to take a conviction and people realizing if you cross too many lines, you will end up in prison.

The flip side of that is that if she’s acquitted you’ll have young entrepreneurs running around Silicon Valley saying: “Yeah, I push the envelope but look at what Elizabeth Holmes got away with – she did worse than what I am doing and didn’t do a day in prison.”

There will always be people who are so enamored with the idea of getting in early on the next revolutionary product and reaping massive financial rewards that all it requires is for them to be flattered to drop their defenses.

Comments

  1. beholder says

    If she’s convicted and does significant prison time, it’s going to be a shot across the bow to venture capitalists and startup founders in the Valley that there are limits to how much bullshitting you can do, to how much exaggerating and hyping you can do and how many rules you can break.

    Not going to happen. Charges, if any, will end in a settlement, and she may even be able to hold onto nearly all of her fortune with a creatively structured bankruptcy. Convictions and prison time are for ordinary people.

  2. Who Cares says

    @beholder(#1):
    As long as you stick to robbing ordinary people. See what happened to Madoff and more why/how it happened. Doesn’t mean she won’t get a settlement but I’d expect an implied threat of embarrassing them some more with juicy bits released during a trial to be the reason if she does.

  3. Matt G says

    I’ll have to remember the term “affinity fraud.” It’s used a lot in pseudoscience. I have a flyer from ten years ago advertising the first annual Catholic Geocentrism conference. Lots of Ph.Ds and held near (near!) Norte Dame.

  4. says

    I used to occasionally watch Dragon’s Den (the same show as Shark Tank but with a different name) and the product that showed me how full of BS the Dragons (investors) were was a photo booth for hospitals for taking pictures of newborn babies that proud parents could then share with friends and families. This was at a time when cell phones with cameras were already pretty much ubiquitous, yet two of the Dragons wanted in on it.

    The product didn’t get anywhere as far as I’m aware. Nobody on the show brought up camera phones, but I suspect when they were doing further due diligence after filming someone likely reminded everyone of them.

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