Groupthink is something we very familiar with in Ireland. It was a major factor in creating the financial bubble that led to the banking crisis in 2008
The criminal conviction of Theranos founder Elizabeth Holmes by a jury in California this week, is being seen as a cautionary tale for all of Silicon Valley. But don’t expect much to change after the company founder is sentenced.
Theranos was once a golden child of Silicon Valley after it claimed its technology could run blood tests with just a prick of a finger. However, it was later revealed that the company used conventional blood testing machines for most of its tests and its own tech was sometimes inaccurate.
None of that stopped Holmes from raising over $700m (€620m) in equity and a further $300m in debt and building up a business with a peak valuation of $9bn before it all came crashing down.
The Theranos story isn’t only about lies and deception by its founder, it is about groupthink on the part of investors, directors and partners. It is also about an investment system in the US which facilitates this kind of thing on the basis that it only goes wrong some of the time.
Groupthink is something we very familiar with in Ireland. It was a major factor in creating the financial bubble that led to the banking crisis in 2008. It sucked in bank shareholders, senior management, directors, regulators and the media.
What has been happening in Silicon Valley isn’t all that different when it comes to investment bubbles, exaggerated revenue projections and software products that aren’t fully understood by investors, bankers or journalists.
Groupthink is defined as “a psychological phenomenon that occurs within a group of people in which the desire for harmony or conformity in the group results in an irrational or dysfunctional decision-making outcome”.
What is different here is the profit imperative. In a bull market, is it irrational or dysfunctional to back something that you don’t understand or are suspicious about, if you fundamentally believe its value is going to rise anyway?
Is every cryptocurrency investor a true believer in the intrinsic potential of this “revolutionary” new investment or do they simply believe it is going to rise in value for another month or week or day?
With Theranos it took a Wall Street Journal expose about deficiencies with its technology to prompt an SEC investigation. The expose first appeared asking questions about its tech in 2015. Yet, Theranos was able to borrow a further $100m in December 2017. An SEC probe ended with a settlement just three months after raising that finance.
When it comes to technology companies, there is a line between bullish assessments or assumptions and downright misleading lies.
In the case of Theranos, Holmes admitted in court to adding logos on documentation of leading pharma companies in an attempt to convince potential investors that she had their backing.
She admitted Theranos equipment could only perform 12 tests, despite her public claims of more than 200. This is not optimism or exuberance but fraud.
Surely investors would have questioned a lot of this stuff before parting with their cash? Not necessarily. Sometimes the drive not to miss out on a hot investment far outweighs the risk of actually backing a turkey or even a scam.
The SEC investigation into Theranos looked into a binder provided to potential investors. According US site MarketWatch, the package included a cover letter drafted and signed by Holmes, a company overview slide-deck presentation, reports of clinical trials and gushing media articles and profiles of Holmes, including from the Wall St Journal.
But there weren’t any independently audited accounts or financial statements. This is because private companies don’t have to provide that information unless they are offering debt or equity to small retail investors.
There is an exemption called a Form D which allows companies to provide minimal information to the SEC as long as the money only comes from accredited investors.
In other words, if you are raising money from Joe Bloggs, you would have to present more information than if you were raising money from professionals.
Theranos was able to raise hundreds of millions of dollars from professional investors without being obliged to provide independently audited accounts.
In a way the system is asking for it. The system ends up being an enabler of deception.
Another parallel with the Irish banking crisis was the board. In the case of Anglo Irish Bank, where deception and fraud by the former chief executive David Drumm did take place, the board was stuffed with some of the most experienced businesspeople in the country, who didn’t see it.
Some non-executives later said that while they had huge experience in business they didn’t know enough about banking.
The Theranos board was packed with incredibly experienced people including Henry Kissinger (former US secretary of state), Jim Mattis (retired Marine Corps four-star general), William Perry (former US secretary of defence) and William Perry (former CEO of Wells Fargo).
Not a huge amount of medical expertise there. Not the best equipped group of people to probe the veracity of blood testing results.
The other big parallel with our own crash and groupthink is the media. Just as elements of the media here blindly lauded the property and banking bubble, the same happened with Theranos.
In our defence journalists don’t often have access to the resources to probe the claims made by companies and don’t get to see investor presentations of private companies.
Wake up call or not, Silicon Valley will be business-as-usual after Holmes is sentenced.