Category: Business Valuation

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SEC Charges Theranos CEO with Massive Fraud – Securities Expert Witnesses

Once considered “The Next Steve Jobs” or the “female Steve Jobs,” Elizabeth Holmes has fallen from grace and landed directly in the cross-hairs of the Securities and Exchange Commission (SEC). Today, the SEC filed a civil complaint against Elizabeth Holmes and her company Theranos, Inc. There was a separate action filed against the Chief Operating Officer, Ramesh “Sunny” Balwani.

The complaint alleges, in part:

“Holmes, Balwani, and Theranos raised more than $700 million from late 2013 to 2015 while deceiving investors by making it appear as if Theranos had successfully developed a commercially-ready portable blood analyzer that could perform a full range of laboratory tests from a small sample of blood. They deceived investors by, among other things, making false and misleading statements to the media, hosting misleading technology demonstrations, and overstating the extent of Theranos’ relationships with commercial partners and government entities, to whom they had also made misrepresentations.”

Oh the good old torts of negligent and intentional fraud and misrepresentation. Takes me right back to the first year of law school, when Nickelback was a hot new band, rather than the sad punchline of Internet memes. I digress.

The complaint goes on to allege that based on representations, investors believed Theranos had developed a proprietary medical device able to conduct comprehensive diagnostic tests from a small amount of blood taken from the patients’ finger. They also made representations that they would collect and transport these samples in order to complete the tests on their proprietary analyzer. All of this would be done more efficiently and economically than traditional blood testing labs.

According to the complaint, Theranos was only able to perform about 12 of the 200 tests they claimed they were capable of performing.

Let’s stop here and give a simple warning: If you are soliciting money from investors, make it very clear what you are able to achieve. Differentiate this from what you hope to achieve in the future. Do not mix the two. Otherwise you get into a bad area called misrepresentation, or in this case, securities fraud.

A wide variety of expert witnesses:

In complex civil litigation such as this, there is room for a wide variety of different experts. I can only imagine the SEC and Theranos are both using consulting experts at this time in preparation for a long drawn out litigation. The complaint has only been filed today, so expert disclosures are a way off. Here are a few types of expert witnesses or consulting experts I expect to see in this matter.

Corporate Governance:

Expert witnesses on corporate governance are highly likely to play a role in this case. Officers of a corporation are fiduciaries of the corporation. Holmes owed a duty of care to the company and to her investors. She is accused of misrepresentation which, if proven, would certainly violate the standard of care owed to shareholders and the company. I expect there will be significant dispute by the parties to prove she either did or did not violate her fiduciary duties.

Securities & Finance:

Several different types of experts who practice in the area of securities fraud may come into play. We are likely to see experienced Wall Street experts with a history in equity trading, proprietary trading, investment research, securities valuation, financial forecasting, venture capital and investment banking.

Some experts will probably have backgrounds in IPO’s, private equity financing, securities financing, and stock options financing.

In this area, I feel as though I can go on ad infinitum. That’s not true and it is probable one or two candidates will have the requisite expertise, described in this section, to address the finance and fraud related matters.

Economics:

Although the SEC is primarily suing for injunctive relief, they do mention the potential for civil monetary penalties. I would expect there will be some need for an economist (by both parties) to establish the value of Theranos and shares owned by Holmes and Balwani.

As I do not practice securities litigation and this is not a law review article, it is possible the civil penalties are predetermined by the Securities Act and there is no need to value the penalties other than by the trier of fact.

UPDATE:

Within hours of writing this blog post, I discovered that Elizabeth Holmes has settled with the SEC. According to Reuters, she will be stripped of her majority control of the company and will have to return millions of shares to Theranos. She will also pay a $500,000 fine and be barred from being an officer or director of a public company for 10 years. As of this update, Mr. Balwani has not settled with the SEC.

 

 

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FORENSIC ACCOUNTING EXPERT WITNESSES & CONSULTANTS

In the fall-out from the past few years’ financial debacle, there has been no shortage of work for Forensic Accountants.  From the Bernie Madoff scheme to Lehman Brothers and all the financial scams in between, Forensic Accountants have been called upon to apply the concept of accounting to help lawyers adjudicate and resolve the resulting legal problems.

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The Accountant’s Handbook of Fraud & Commercial Crime offers a definition which has been informally accepted by many Forensic Accounting Experts.  The definition is as follows:

“Forensic and investigative accounting is the application of financial skills and an investigative mentality to unresolved issues, conducted within the context of the rules of evidence. As a discipline, it encompasses financial expertise, fraud knowledge, and a strong knowledge and understanding of business reality and the working of the legal system. Its development has been primarily achieved through on-the-job training, as well as experience with investigating officers and legal counsel.”

Forensic Accountants apply their knowledge to many different financial transactions such as

  • Bank Fraud & Embezzlement
  • Bank Operations & Practices
  • Check Kiting
  • Electronic Transactions
  • Embezzlement
  • Money Laundering
  • Payment Processing & Fraud Detection/Prevention
  • Royalty Audits
  • Claims Analysis
  • Determination of Compliance

A Forensic Accountant’s area of expertise is not limited to financial crimes and fraud. They apply their knowledge to civil matters as well. Their services are useful for breach of contract, business valuations and marital / family law.

Considering the amount of financial litigation out there today, whether it be civil or criminal, the Forensic Accountant’s docket is most likely as full as the courts in which they testify.