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View from Washington: Theranos 2 - Fake it... and then what?

“Well, this is what happens when you work to change things. And first, they think you're crazy. Then they fight you. And then all of a sudden you change the world." (Elizabeth Holmes, 'Mad Money', CNBC, October 2015)

The story of collapsed healthcare start-up Theranos and its founder Elizabeth Holmes fits into a popular Silicon Valley genre: ‘Fake it till you make it’. The fact that it does is set to form a major – and, for other tech companies and investors, discomforting – part of the disgraced CEO’s defence over the coming weeks.

FITYMI does have a more positive side where it describes an approach to personal empowerment and optimistic positivity: behave like the person you want to be, and gradually you will turn into that person. Holmes herself leveraged the concept, most notably adopting a Steve Jobs polo neck-led uniform to look like a tech mover-and-shaker some time before she was declared a billionaire and, according to former fellow students at Stanford University, lowering her voice so that it had a more powerful register.

But the trial – and the alleged $700m fraud over which Holmes and former Theranos president Ramesh ‘Sunny’ Balwani have been charged – will be mostly about how the capability and reliability of the company’s blood-test technology were faked to unreasonable and grossly deceptive levels to secure funds from investors.

On the face of it, there seems little doubt about that. Setting aside the company’s decade-long ‘stealth’ period until 2013, Holmes continued to raise money even though the company’s public debut came when there were still huge shortcomings when it came to the 200 or so tests its Edison machine aimed to run. In fact, the number was only 15 and, after all that time in development, the device was still prone to malfunction. Another 60 or so tests were offered by Theranos but performed on other companies’ equipment.

Of the $742m in venture capital that Theranos raised, more than half was secured after the company had begun general marketing and started to strike in-store deals for blood tests with retailers such as Walgreens chemists and Safeway supermarkets. By this time, the company should, you would have thought, have set its path to a commercial product even if it had not yet walked every step.

So why might Holmes’ defence lawyers see FITYMI as a potential weapon for them rather than the prosecution, particularly as Theranos seems to have been not merely a massive but also a lengthy fake?

It’s simple really: Holmes might have exaggerated but, they will argue, she was still only ‘playing the game’.

On one side of this argument, observers have pointed to various companies that have hyped an idea beyond the technology or systems they initially held, or where possible side effects had not been fully researched – and yet have ultimately proved successful. A list of the lucky ones might include Uber, Dropbox and even Facebook.

Then set this against the widely held assumption that most venture capital investments fail to the degree that investors see a return from typically just one-in-four. In short, it’s a world of hype and, going case by case, you should expect to lose your money.

In recent times, several factors have made this culture arguably even more dangerous. There has been a shift to looking for personality-led investment opportunities from, appropriately if you consider Holmes’ ‘uniform’, the hunt for the next Apple to the hunt for the next Steve Jobs. There is also the obsession with finding ‘unicorns’, pushing companies that pitch for VCs to amplify projects so that they show potential to reach the $1bn-valuation the term implies.

So did Holmes set out to deliberately exploit this culture or was she simply responding within it? Establishing the former might well not absolve her of guilt, though you can imagine good US trial lawyers having a right old ding-dong here over what ‘knowingly’ actual means in the context of ‘misled’, but it could mitigate any sentence.

Either way, this strategy will mean that the wider Silicon Valley investment culture will be litigated (and potentially for future reference ruled upon) alongside Holmes’s individual actions. This is one of the grounds for some nerviness over the trial across much of technology because a Mack truck of dirty linen may be about to turn up outside the trial’s Santa Clara courthouse.

There are big differences between companies that make FITYMI claims while still in the stealth stage with an understandably maturing technology and use cases as opposed to ones offered by those that have, as was the case with Theranos, exited stealth and moved towards putting products into service. On balance, if Holmes’s team wanted to make a case for her solely based on the prevailing investment culture, it would be a tough sell (even though, apparently thanks to legal insurance, Holmes has been able to recruit a clutch of elite trial lawyers).

However, FITYMI is not all that can be found in Holmes’ playbook. ‘Me too’ is also poised to play an important role in the Theranos trials – indeed it already has, with the presiding judge, Edward Davila, having agreed to split the hearings for Holmes and Balwani, her former partner in life and business, as a result.

Here too, current Valley behaviour could also end up in the dock, as we’ll explore in Part Three.

The first part of this series about the Theranos fraud trials can be found here.

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