Verdict in Fraud Case of Theranos Founder Elizabeth Holmes Offers Lessons for Investors

• Elizabeth Holmes was found guilty of four charges in her criminal fraud trial.
• Theranos isn’t the only bad apple out there; it’s just the most recent example of one.
• There are lessons that investors can learn from this latest case.

Sometimes an investment is too good to be true.

Take Elizabeth Holmes' health-care start-up, for example. On Monday, the founder and former CEO of Theranos was found guilty of four charges in her criminal fraud trial.

Nearly a decade ago, Holmes raised $945 million from high-profile investors including the family of former Education Secretary Betsy DeVos, Rupert Murdoch and the Walton family of Walmart fame.

To lure investors, witnesses testified that Holmes' claims about the company's blood-testing technology were either exaggerated or false. In the end, jurors convicted Holmes of wire fraud and conspiracy to commit wire fraud. She faces up to 20 years in prison.

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"The Theranos story is an important lesson for Silicon Valley," Jina Choi, director of the SEC's San Francisco regional office, said at the time charges were filed. 

"Innovators who seek to revolutionize and disrupt an industry must tell investors the truth about what their technology can do today, not just what they hope it might do someday."

Because Theranos never went public, it wasn't under the same government and public scrutiny as other more established companies. That gave investors an opportunity to get in while it was on the rise, but also put the burden on them to vet the blood-testing startup largely independently.

Theranos isn't the only bad apple out there; it's just the most recent example of one.

Other black eyes for the industry have included uBiome, which was investigated by the FBI for fraudulent billing, and Outcome Health, a health-care advertising company that provided misleading information to drugmakers on where their ads were showing up and how they performed.

Of course, fraud extends far beyond health care.

Corporate malfeasance comes in waves, said Len Sherman, professor of business at Columbia Business School. From Enron and WorldCom to Bernie Madoff and now Theranos, "we are in another era that has conditions that are conducive to promoting fraud." 

How to spot a problem

"It's important that we don't assume that every company is like a Theranos; we just need to ask the right questions," said Ruby Gadelrab, founder and CEO of MDisrupt, a medical due diligence company for the health-tech industry, which aims to avoid making similar mistakes in the future.

"Health care, as a whole, is complex," Gadelrab said. "It's probably the hardest area to invest in."

To help investors vet health technology companies, Gadelrab suggests first establishing if the product is clinically and commercially viable.

"Investors do technical and financial diligence using experts, in health care we need to do medical diligence using health-care experts."

Then, determine if there's evidence to back up the founders' scientific claims.

The technology should be validated, Gadelrab said. "Show me the data." For example, "does it actually pick up a disease or biomarker when it's present and doesn't pick it up when it's not?"

"Not all data is created equal," she added. Good data is done externally with scientists and research labs, great data is published in peer-reviewed journals and excellent data is published and replicated.

Finally, look at the team structure. "Do they have clinical experts in senior positions? On their boards, as their investors, in their C-suite?"

"Make sure health experts have a seat at the table and a voice in the process," Gadelrab said.

The secrecy surrounding the Theranos technology and the intense attention given to its CEO was part of the mystique and also a major red flag, according to Sherman. "I hope the next time that kind of stuff happens, someone says 'wait a sec.'"

Lessons learned

With any investment, whether publicly traded or otherwise, you should do your due diligence, advised Winnie Sun, managing director of Sun Group Wealth Partners in Irvine, California.

For starters, Google the company and read consumer reviews, she said. In addition, check Twitter to see how customers are responding. "That's going to factor in to whether you want to own that company," Sun said.

If you are working with a broker or financial advisor, then you have an additional layer of protection — as long as that person meets a minimum level of credentials and background to work in the industry. (Check that financial advisors are licensed or registered with a firm through the SEC's Investment Adviser Public Disclosure website or that the broker is listed on The Financial Industry Regulatory Authority's resource, BrokerCheck.)

"If you are doing this on your own, you have to do a little more due diligence, especially if it's an investment idea you heard about from a friend or on the internet," Sun added. "Spend as much time looking at what's in your portfolio as you would booking your next vacation."

Otherwise, invest in an exchange-traded fund or mutual fund rather than picking individual stocks.

Most experts say diversifying with these asset classes is the best way to manage risk and improve long-term performance.  

"As investors, it comes back to the core philosophy of diversification," Sun said.