CEO And CFO Fraud Creates Exposures For Boards

June 12, 2018

The U.S. Securities and Exchange Commission accused the founder/CEO and the former president of Theranos, a Silicon Valley blood-testing startup, of "massive fraud." The SEC alleges that the two officers defrauded investors of more than $700 million.

According to the SEC, the two leaders lied about the organization's technology, business, and financial performance for years. The SEC alleges the CEO told investors that Theranos had new technology for testing blood for diseases more inexpensively than any other method and with only a prick, when it in fact sent blood to third-party companies for testing.

The CEO also allegedly told investors that the organization "was on track to make $100 million by the end of 2014," when it was actually making around $100,000. Articles in support of the organization, which the officers told investors were written by pharmaceutical executives. were actually written by the company's own employees.

At its peak, Theranos was valued at nine billion dollars.

The CEO paid $500,000 to settle with regulators. The SEC consent order also prohibits the CEO from being a director or officer of a public company for 10 years, and from profiting from Theranos until it has paid $750 million back to investors.

Theranos disclosed to investors in 2016 that it was under a criminal probe, but no criminal charges have been filed. Kevin Dugan "SEC accuses Theranos CEO Elizabeth Holmes of 'massive fraud'" nypost.com (Mar. 14, 2018). 


Commentary

An organization’s board can be held liable if it knew, or should have known, about a corporate officer’s wrongdoing. Shareholders can sue the board for failing to investigate and stop fraud or other forms of wrongdoing committed by organizational leaders that cause stock prices to drop. In this case, if the board failed to practice due diligence and its negligence allowed the fraud to occur, the company could owe shareholders millions of dollars.

It is essential for boards to create systems of oversight for an organization’s leadership.

First, make certain that statements of value and product development are verifiable. In this case, a simple analysis of cash flow would have shown that the company was overvaluing itself and its product.

Periodically audit the organization’s finances and look for any signs of fraud. Double check information provided by your leaders.

Having written checks and balances that hold leaders accountable will prevent an environment where directors and officers think they can misbehave with impunity.

Create a third-party reporting system so that employees can report suspected director and officer wrongdoing without fear of retaliation.

If the board receives a report—whether it is an official report or even a rumor—of wrongdoing by a director or officer, it should investigate the allegations immediately.

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