What does the Theranos debacle teach about whether or not investors really value the opinions of independent auditors?
The question is timely, as criticism swirls around the globe about both the performance of the auditors (see the dialog I joined last week in the Financial Times, here) and the efficacy of their regulators (see here for a British MP’s call for scrutiny of the Financial Reporting Council).
On March 19, 2018, the Securities and Exchange Commission charged that Theranos, the micro-stick blood testing enterprise started by Stanford dropout Elizabeth Holmes in 2003, was “an elaborate years-long fraud.” Law enforcement finally caught up with exposures reported back to 2015, that the entire promise of low-cost, sophisticated patient-friendly testing and analysis was built out of lies and fantasy.
As described by MarketWatch’s Francine McKenna on March 20, the erstwhile unicorn that made Holmes a Silicon Valley superstar, business media darling and temporary multi-billionaire was able to seduce $ 700 million from wealthy investors, the likes of Rupert Murdoch and Larry Ellison, “accredited investors” under the SEC rules that, instead of requiring years of audited financial statements, permitted no more information than a binder of publicity releases and unaudited spreadsheet projections, supported by a board of marquee names including Henry Kissinger, George Shultz, James Mattis and David Boies.
The entangled symbolism is positively cringe-inducing: A winsome young blonde enticed credulous, cross-generational “smart money” with a high-tech Edenic temptation. There was even an apple, invoked by her costuming in Steve Jobs’s black turtleneck. As for the sanguinary path to fall and expulsion … enough is enough.
Meanwhile the feckless “no audit – no problem” attitude of the cast of veteran investors was Shakespearean. The Bard’s own “old Adam” takes the stage in “As You Like It” just after Jaques’s reminder that in the seven ages of man, the “last scene of all, that ends their strange eventful history, is second childishness and mere oblivion.”
Should lesser investors follow Murdoch and Ellison in their indifference to diligence? Should the regulators let them? There are reasons to resist a cynical, laissez-faire conclusion. To start, the $ 100 million said to be Murdoch’s loss on Theranos is measurable against his reported personal wealth somewhere north of $ 15 billion. Among the playthings that quantify Ellison’s readily open purse, his latest yachting adventure, the 88-meter “Mushali,” occupies a hole in the ocean reportedly valued at $ 130 million.
The funding of Theranos, privately placed and speedily lost in “childishness and oblivion,” in chunks of a size on which the vast majority of investors would happily live forever after, was relative lunch money – a small-change bagatelle -- to the cohort of those succumbing to the Holmsean blandishments.
It could be tempting to invert the old cliché – “If you’re so smart, why aren’t you rich?” – to ask, “If that’s how smart you are, how have you stayed so rich?” Except that schadenfreude is pointless. The Theranos investors will survive untouched and unmarked by the public’s lack of sympathy.
The SEC’s metrics for “accredited investor” set minimum thresholds based on income and net worth, rather than requiring demonstrable acuity of judgment or the ability to resist a compelling sales pitch. And a good thing too, herd behavior being what it is. Consider the likelihood that the roster of luminaries marshaled at Theranos by Holmes would – if allowed by more generous regulation – have passed out offering binders to the faithful, acting as bell-goats leading flocks of eager lambs to their shearing if not all the way to slaughter.
For investors aspiring to achieve reasonable and legitimate growth and safety in their Keogh plans, investment accounts and retirement funds, and also for the gate-keepers and enforcers charged to look after the public interest in the capital markets, Ronald Reagan’s old maxim still holds:
“Trust – but verify.”
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