The long-running financial fraud investigation and subsequent criminal cases involving Theranos Inc. offer a cautionary tale on how easily investors and stakeholders can be deceived by company insiders.
Theranos founder Elizabeth Holmes raised more than $700 million from investors, including from a bevy of Silicon Valley power players. At its height, the company was valued at $9 billion as Holmes spun a tale that her brainchild was about to revolutionize medicine with groundbreaking blood-testing technology. The technology, of course, didn’t work, and a financial fraud investigation, criminal charges and a company meltdown followed.
In the case of Theranos, a slick-talking executive was able to fool some of the world’s most sophisticated tech investors. Yet, Holmes and fraudsters of her ilk are not wizards. They routinely leave a trail of signs that investors and stakeholders can spot—provided they are vigilant and know what to look for.
Let’s consider several fraud prevention techniques investors and stakeholders can learn by examining the Theranos scandal. By implementing these tips, investors and stakeholders can reduce their risk of being misled, even by the cleverest of fraudsters.
1. Do Your Due Diligence. It’s common sense: Know the business, review the financial results, ask questions, and don’t just accept company-generated financial results at face value. With Theranos, a review of financial statements by investors and other stakeholders might have revealed that revenue did not align with the company’s claims about having a revolutionary technology.
Due diligence means thoroughly researching and verifying a company’s operations and fiscal health. Investors and stakeholders who conduct due diligence are better equipped to make informed decisions about whether to invest in or partner with a company.
2. Be Wary of Secrecy. Theranos was known for its culture of secrecy and for operating for many years in what Holmes called “stealth mode.” This meant doling out claims about the effectiveness and potential of the company’s products and financial performance, but revealing little in the way of verifiable facts. For instance, Theranos routinely rejected scientific peer review of its technology, even though blood testing technology is medical in nature.
As we have learned in conducting myriad financial fraud investigations, concealment is the modus operandi of fraudsters. Alarm bells should sound when a company or employee is not forthcoming with financial information or about the products or technology on offer, or when the information appears long after it should.
3. Trust—but Verify. The old axiom applies: When something appears too good to be true, it probably is. Theranos claimed it could extract as many as 240 separate tests from a single drop of blood. It couldn’t. Don’t be afraid to investigate whether a product or claims being made by insiders are actually true. Independent verification can help ensure that the company’s claims are accurate and that its technology and products are viable.
Look for independent experts and peer-reviewed research that can help you verify a company’s technology or products. Experts can help you ask the right questions, challenge assumptions, and help you spot anomalies that may not be evident to someone outside the industry.
Inside a company, owners and managers can help prevent and detect fraud by ensuring that employees are never in a position to check their own work. They should ensure that duties are segregated so financial and product claims can be checked and verified.
4. Invest in an Ethical Corporate Culture. Investors and stakeholders should ask:
• Does the company have a fraud hotline to allow whistleblowers to report on suspicious activity?
• Does the company have a clear ethics policy and are employees trained on it?
• Does the company have an anti-fraud policy in place that clearly defines the actions that constitute fraud and that encompasses all employees, including management and executives?
Whistleblowers were responsible for exposing the false claims made by Theranos executives. And tips from whistleblowers are the most common fraud detection method, according to data from the Association of Certified Fraud Examiners.
Building a culture of transparency and making it easier for employees to report unethical behavior can be a critical fraud deterrent. Investors and stakeholders should look for companies that have a strong culture of transparency and that encourage employees to speak up when they see potential fraud.
5. Pay Attention to Red Flags. Theranos raised a number of red flags over the years that investors and stakeholders should have seen and addressed. The company’s rejection of scientific peer review of its technology is just one example. Additionally, the company had a history of legal disputes and regulatory violations. Warning signs like these should give investors and stakeholders pause about whether a company is operating in good faith.
For business owners and managers, spotting red flags among employees can come down to behavioral issues. A few key questions business leaders might consider: Are employees living beyond their means, or are they known to have financial, legal or ongoing personal problems? Do they have gambling or substance abuse habits? Are they refusing to take vacations, hoarding information, or taking other actions that might prevent their work from being reviewed by others? Are they known to engage in unethical behavior outside the workplace?
The Theranos fraud serves as a reminder that investors and stakeholders must remain proactive where fraud is concerned. They should do their homework about a company’s finances and products, demand transparency, seek independent verification of claims, and investigate if they see red flags. Doing so may help them prevent fraud and detect wrongdoing when it occurs.
To learn more about how Forensic Strategic Solutions helps clients in a financial fraud investigation, contact us for a consultation or visit our Fraud Examinations practice page for more information.