The Wrong Takeaway from Theranos
The next step in the Theranos saga is for everyone to call for justice against the board members.
To have a balanced dialogue, you can’t conflate a popular misconception about boards with what they realistically could have done.
Boardroom fraud prevention
If someone tells you a great board can prevent any fraud, you know one thing about that person immediately: they’ve never actually been on a board of directors.
No board can prevent every fraud, and even great boards can’t prevent a lot of them.
As Warren Buffett says at the 8:00 minute mark of?this video interview, at any given moment in any organization, there are people doing things they are not supposed to be doing. In my experience, if employees really want to subvert internal controls, they have a pretty good chance of doing so.
So what can great boards actually do regarding fraud?
Simply put, they erect and monitor thoughtful guardrails.
The Theranos board
Though it never stops most commentators, we, of course, don’t know a lot about what the board actually did and didn’t do. Also, I don’t think anyone has offered detailed evidence about what, if any, internal controls the company had.
But one thing is clear, it’s pretty hard to effectively oversee a microfluidics company, when you know nothing about microfluidics.
During the time of the fraud, none of the board members were microfluidics experts. So even if they tried to discern fact from fiction, their lack of expertise could have made that very challenging. Remember also the company was signing up Fortune 100 partners and successfully raising gobs of money at stratospheric valuations during the period of the criminal conduct. It’s fair to ask whether a reasonable board, particularly one that knew nothing about microfluidics, would have thought something was askew.
What the Theranos board could have done, even without any microfluidics expertise, was to oversee the culture of the company more effectively. This is a popular boardroom blind spot in many highly touted Unicorns – see Uber, and WeWork. Theranos had a 2.8/5 Glassdoor rating, and the reviews of Holmes and the company were apparently quite bleak. Accordingly, an attentive board might have had ample grounds to be concerned about company operations.
The good thing about monitoring company culture is that it’s very cost effective and mostly takes listening and common sense. One of their directors, Henry Kissinger, for example, could have spent the day having lunch with a random sampling of employees onsite in Palo Alto once or twice a year, and reported what he saw/heard to the full board. BTW, if Holmes wouldn’t permit that, a big red flag would have been raised right away.
And had they done that, Dr. Kissinger might have discerned that the entire company was siloed, that many employees operated in fear, and that many former employees were followed and intimidated. Armed with that knowledge, the full board could have brought in some outside expertise to help them ferret out other more technical issues (i.e., where there is smoke, there is fire).
Again, the board might have done some or all these things – we just don’t know. (And, no, I’m not suggesting Dr. Kissinger actually had brown bag lunches with random employees. Don’t get me started on celebrity boards…). If they did none of them, then, yes, they certainly could have violated their fiduciary obligations.
But the drumbeat of, “No frauds take place in companies overseen by competent boards,” is only a refrain for those who… don’t know a lot about corporate governance.
[This was adapted from a recent email I sent to my firm's private community of 1000s of global executives who are interested in capital markets, finance, storytelling, and corporate governance. You can join here for free bi-weekly emails.]
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The author,?Adam J. Epstein, is a former institutional investor, and now an advisor to CEOs and boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC.?He speaks monthly at private corporate events, and corporate governance and investor conferences, and has appeared internationally more than 150 times since 2012.?Mr. Epstein is a key contributor to Nasdaq’s?Amplify?small-cap content initiative, a mentor at the Nasdaq Entrepreneurial Center, and he is chair of?Small-Cap Institute's?editorial advisory board.?He is the author of?The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies?(New York: McGraw-Hill, 2012). In June 2017,?The Perfect Corporate Board?was the #1 ranked corporate governance book on Amazon.com.
Ex-Big4 Principal - Management Consulting | Certified - FP&A + International M&A Expert + M&A Professional | Adjunct Professor - Engineering, Business School(s) | Project Finance | Athlete: Distance Runner & Swimmer
1 年Let’s talk about how Boards are elected in this day and age. First and foremost, during the startup phase, you really want a Board (atleast a small portion) that has experience in the industry. In the case of Theranos, from what I read, none of the Board members had any relevant experience. It seems as though they were a rubber stamp to the whims and wishes of incompetent people (HS graduate with no scientific training - sure!) and if true - is a recipe for disaster. When the Board has no credibility we allow the wolf to watch the hen house. Ignorance-is-bliss is not an excuse. Whether or not this Board tried to do the right thing can’t be judged in social media; however, lack of common sense is a good place to start. As most accredited investors or investors in general know - there is always risk; however, the Board should be held liable in cases of gross negligence - if they did not have the expertise to ask the obvious questions - why not? For starters, anyone with a pinch of brains should ask - y’all how come we don’t have studies and/or FDA approvals backing up our initial trials? It’s unfortunate many organizations have Board members who follow the - you scratch my back and I scratch yours mentality (hint: $$$$$)
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3 年Great stuff but I wonder two things: 1. How many directors periodically meet with random employees at their companies for a significant period of time (like lunch)? I know of a few companies that disclose they have a policy that requires it - but beyond that, I imagine it’s fairly rare. 2. How many employees would truly feel comfortable ‘blowing the whistle’ with a stranger over lunch? Human nature is to not trust someone with something like that, which could endanger their employment in theory.
President, Soundboard Governance LLC
3 年Right on, Adam. In this case, a particularly sad part is that there actually was a whistleblower who went to a board member, and ended up being relaliated against, even though the board member was his own grandfather!
COO, Fractional General Counsel, Board Member & Advisor | Author | Recognized Business/Securities/Non-Profit/Consumer Product Expert | Qualified Financial Expert |
3 年Absolutely correct! Recent Delaware case law underscores the obligation of Board members to follow up on "red flags," of which many were present. Among others mentioned in the press: incomplete answers regarding the technology, lack of audited financials (given the entity's size, etc.), absence of peer reviewed validation of the science, etc.