What’s Next for Elizabeth Holmes in the Theranos Fraud Case?

Posted June 18, 2018 7:33 p.m. EDT

Once celebrated as a Silicon Valley unicorn, Theranos has become the latest tale of corporate hubris and investor myopia. The indictment of Elizabeth Holmes, the company’s founder, and Ramesh Balwani, its former president and her erstwhile boyfriend, on charges of conspiracy and wire fraud can be viewed as evidence that the company was built on little more than a pack of lies.

But proving a criminal case, despite the current narrative, is not always as easy as it first appears.

Like most white-collar cases, this prosecution will revolve around the intent of Holmes and Balwani to deceive investors, doctors and patients about the efficacy of Theranos’ blood-testing device. Balwani’s attorney issued a statement asserting that Balwani is “innocent and looks forward to clearing his name at trial,” an indication at this point that he will fight the charges.

If Holmes and Balwani do not plead guilty, the question at a trial will be whether the two defendants were brazen liars, as the government will argue, or whether they were just as deluded as everyone else by Holmes’ vision of disrupting the health care industry.

The charges outline two schemes to defraud. The first is a traditional one, in which Holmes or Balwani deceived Theranos’ investors about the company’s prospects. As first outlined in the civil fraud charges filed in March by the Securities and Exchange Commission, Holmes and Balwani are accused of raising millions of dollars by making misleading statements about how well the blood-testing device worked and the existence of a contract with the Department of Defense. Holmes settled the SEC case, while Balwani chose to fight.

The second scheme is a bit novel. It involves the company’s advertising campaign to induce doctors and patients to have blood tests conducted through a partnership between Theranos and the pharmacy chain Walgreens. Typically, prosecutors pursue charges in which there is a direct connection. Here the deception that is alleged was much less direct. The payments for the tests were funneled through pharmacies rather than taken straight from the claimed victims.

Holmes and Balwani can offer two potentially viable defenses if they go to trial.

The first is to claim that their statements were made in good faith, and that they did not intend to defraud. If they truly believed what they told investors and the public about Theranos’ device, the Justice Department would have difficulty making the case that they set out to fraudulently obtain money.

This defense is risky. It requires the jury to believe the defendants did not intentionally make misstatements and were instead victims of the hype surrounding Theranos like everyone else. To explain what they said and did, one or both of them might have to testify. That would allow prosecutors to cross-examine Holmes about her many hyperbolic public statements.

Such comments could make it difficult for jurors to find that the two top officers were simply in the dark about what was happening. The prosecutors are sure to emphasize how Holmes and Balwani were hands-on managers, belying any claim that they did not know what was going on.

A second defense is based on the materiality of the statements, arguing that even if the statements were misleading, investors did not rely on them in deciding to invest. Among those who put money into Theranos were Walmart’s Walton family, Rupert Murdoch and Betsy DeVos, the secretary of education. Those who invest in Silicon Valley unicorns are not your typical mom-and-pop investors. The defense could raise questions about whether such sophisticated backers were misled by statements hyping the company.

A materiality defense would be much more difficult to offer for the charges involving doctors and patients because the company’s claims about the efficacy of its device and promise of lower costs were one basis for choosing its blood testing. Misstatements to the general public are much more likely to be considered material.

There is one more defense that can be used in any criminal case: Prove it. The prosecution bears the burden of proof beyond a reasonable doubt to show intent and materiality. The defense could challenge the government’s claims without offering its own evidence, and instead argue that there is not enough for a jury to convict. The danger here is that if prosecutors put on a good enough case, there is little the defense can do to challenge a conviction on appeal.

An interesting question is whether Holmes or Balwani will eventually plead guilty. In white-collar prosecutions, a plea agreement is often offered before charges are filed. It is likely then that both refused to resolve the case this way. But that does not prevent them from changing their minds later, especially once they see the government’s case and reckon with the prospect of a substantial prison term if they go to trial.

But if Holmes or Balwani pleaded guilty, that might not reduce the potential prison term each is facing by much. The SEC said investors had put $700 million into Theranos. If most of that money was lost, the recommended punishment under the Federal Sentencing Guidelines would be about 15-20 years in prison. Although the guidelines are only advisory, a prison term as long as 10 years is likely in this case even with cooperation.

Theranos should serve as a warning about how a new technology may be more myth than reality. The question is whether the company’s downfall will teach other Silicon Valley executives and investors to proceed more cautiously. Memories are notoriously short among those looking for the next big thing. Don’t be surprised if Theranos is not the last company to overpromise and vastly underperform.