• Oakland – (510) 344-6601
  • San Francisco – (415) 252-9600
California Business Attorneys | Oakland CA
  • Professionals
    • Lonnie Finkel
    • Ruth Auerbach
  • Practices
    • Federal Practice
    • Litigation
    • Transactions
      • Intellectual Property
      • Mergers and Acquisitions
      • Bankruptcy & Restructuring
      • Corporate
      • Tech Start-Ups
      • Real Estate & Environmental
      • Securities & Corporate Finance
  • Insights
    • Blog
    • Resources
      • Copyright Law Fundamentals
      • Protect Your Company’s Software Assets
      • Protect Your Company’s Trade Secrets
      • Crowdfunding White Paper
      • Video Tips
    • Speaking
  • Contact Us
    • 510.344.6601
    • 415.252.9600

Fiduciary Duties of Directors of Biotech Companies in the Age of the Theranos Fraud

May 15, 2019 by Lonnie_Finkel

Theranos, Inc. was a high-flying former biotech company headquartered in Silicon Valley that claimed to have developed a point-of-care blood test that would allow health care professionals to assess the risks many diseases posed to a patient based on a few drops of that patient’s blood. The company’s valuation, before delivering a single product to market, soared into the several billions of dollars, and its founders graced the covers of numerous business publications lauding their genius. Until it all came crashing down for the fraud that it was from the outset.

The collapse of Theranos presents a unique case study for boards of directors of corporations in the medical technology industry, and really in any American industry that relies on its intellectual property to create value for its customers and shareholders.

What Happened at Theranos

According to allegations filed by the Securities and Exchange Commission (“SEC”) and the Department of Justice (“DOJ”) Theranos’ founder and CEO, Elizabeth Holmes, and one of its senior executives, Ramesh “Sunny” Balwani, defrauded investors and patients by leading them to believe that Theranos’ key product could conduct comprehensive blood tests from small drops of blood, and made false statements about Theranos’ business and financial performance to investors and customers.

What was Theranos’ board of directors doing while the company’s senior executives were perpetrating a massive fraud on the public for a period of several years?

Did those directors adequately fulfill their fiduciary duties to the company and its shareholders?

Did the company’s attorneys ever raise any red flags for the directors to consider during the entirety of the company’s existence?

Really?

The risks confronted by directors of companies in the medical technology industry, and frankly in all high technology industries, are particularly high. This is true for a variety of reasons, including:

  • the importance of preserving the secrecy of the intellectual property underlying a company’s goods and services
  • the complex scientific and clinical expertise required to understand and assess medical technologies and the intellectual property on which they’re based
  • and the potential for harm to patients as a result of false or misleading statements disseminated to the public.

While state laws vary, generally, members of a corporation’s board of directors owe two core fiduciary duties to the corporation and its shareholders: The duty of care, and the duty of loyalty.

Board Fiduciary Duties – Duty of Care

The duty of care generally requires that directors use the care that an ordinarily careful and prudent person would use in similar circumstances when making decisions on the corporation’s behalf. This could include, for example, taking reasonable efforts to review all relevant information available and understand the related material facts.

In most jurisdictions, the duty of care will only be breached if the directors or officers are found to have acted in a grossly negligent way when discharging their management responsibilities to the company. In California, however, there is case law that strongly suggests that such liability will be imposed for mere negligence. Think of this duty as the obligation to manage the company’s business affairs competently.

Board Fiduciary Duties – Duty of Loyalty

The duty of loyalty, on the other hand, generally requires that directors act in good faith for the benefit of the corporation and its shareholders. For example, directors and officers must refrain from self-dealing and usurping corporate business opportunities. Think of this duty as the obligation to refrain from enriching yourself at the expense of the company and its shareholders.

Directors who breach their fiduciary duties can potentially face personal liability in many jurisdictions around the United States, and certainly in California and Delaware.

Lessons for Directors

So what lessons can directors in the medical and high technology industries take away from the Theranos’ debacle.

First, it’s imperative to put in place and maintain governance structures and internal controls to facilitate accuracy in financial statements and marketing claims. According to several publications, Theranos’ board of directors – which included former Secretaries of State, Defense Secretaries, senators and other high level military officers – did not have the proper regulatory and financial expertise to appropriately make decisions on behalf of Theranos’ shareholders. They also lacked the relevant expertise in the particular industry to bring different viewpoints to bear to identify and resolve critical issues confronting the company.

Second, having a scientific advisory board – or otherwise engaging independent people that possess that expertise – with knowledge in the relevant industry should be a priority for the board. Companies in the medical and high technology industries are encouraged to form scientific advisory boards or engage independent parties so that directors may consult with these experts when appropriate. It is important, and frequently useful, to have members of the advisory board available to inspect relevant business records and contracts.

Per the award winning investigative journalism undertaken by reporters at the Wall Street Journal, Theranos’ board of directors rarely questioned Holmes’ or Balwani’s management. Even worse, any member of the board that expressed a dissenting viewpoint or asked challenging questions was reportedly asked to resign. That should have been a huge red flag that fraud was afoot.

In the course of investing in corporations in the medical and high technology industries, entrepreneurs, venture capitalists, private equity investors, and their respective advisers, should take action to ensure the corporation is being run and governed for the benefit of all its investors.

Creating a system of transparency that promotes dissenting viewpoints and encourages challenging questions by board members to officers – who incidentally report to the board – allows the directors to thoroughly and properly oversee the people charged with managing the corporation. If you fail to do so, you run the risk of overseeing another Theranos and suffering the consequences of that failure, which could include personal liability for your ignorance or neglect.

Finkel Law Group, with offices in San Francisco and Oakland, has over 20 years of serving as corporate counsel to private technology and biotechnology companies across the San Francisco Bay Area and throughout California. When you need intelligent, insightful, conscientious and cost-effective legal counsel, please contact us at (415) 252-9600, (510) 344-6601, or info@finkellawgroup.com to speak with one of our attorneys about your matter.

Filed Under: Corporate Law Tagged With: fiduciary duties, fraud protection, technology counsel

   

Corporate Law Posts

  • Navigating Federal Securities Laws and Regulations to Avoid Common Pitfalls for Companies Raising Money in the U.S.
  • Defining the Founders’ Roles and Responsibilities in Your Technology Startup
  • California’s SB 113 May Offer Valuable Tax Planning Opportunities for Family Businesses
  • Productive Uses of ADR to Resolve Disputes in Family Business
  • Starting Your New Business on the Right Foot

Connect with social media

  • linkedin
  • yelp
  • academia
  • mail

© 2009-2025 Finkel Law Group, P.C. - All rights reserved.

Contact Information

Oakland Office 1999 Harrison St, Ste 1800 Oakland, CA 94612 (510) 344-6601

San Francisco Office One Sansome Street, Suite 3500 San Francisco, CA 94104 (415) 252-9600

info@finkellawgroup.com

Disclaimer: Please be aware that you do not become a client of Finkel Law Group, P.C. nor have we established an attorney client relationship simply by your visiting the Finkel Law Group, P.C. website or by communicating to this office through this website. In addition, you understand and agree that Finkel Law Group, P.C. will have no duty to keep confidential the information you are now transmitting to this office. The content on this website is only for educational purposes and does not constitute legal advice.