Notice & Comment

Regulating in the Shadow of Theranos, by Alexander I. Platt

Elizabeth Holmes is back in the spotlight. The Stanford dropout and founder of failed blood diagnostics company Theranos recently took the witness stand in a California courthouse to testify in her own defense.

While Holmes awaits the verdict in her criminal fraud trial, the Securities and Exchange Commission may be gearing up to crack down on “unicorn” startups (like Theranos) that grow very large without going public.

Notwithstanding the mythical moniker, such companies are now common; more than 900 are currently in operation. Many legal experts now worry that these unicorns pose a major social danger and have called for new securities regulations to rein them in. For those seeking a regulatory overhaul, Theranos provides a “smoking gun”– a corporate catastrophe that seems to point to key failures of the current regulatory approach.

Enter the SEC. Last summer, Chair Gary Gensler chose for a senior leadership position a leading unicorn critic who sees the Theranos debacle as illustrating “risks inherent in the unicorn governance model.” More recently, Commissioner Allison Herren Lee gave a speech embracing the unicorn skepticism that has become ascendant in the legal academy, warning that the proliferation of unicorns leaves the public “in the dark when it comes to ever-expanding segments of the economy,” and calling for bold reforms.

But, before overhauling securities regulation in the name of preventing the next Theranos, one might wonder: would these regulatory changes really have made any difference?

Not likely. For one thing, Holmes stands accused of lying to doctors, patients, regulators, investors, the media, major business partners, and her own board of directors, so it seems odd to assume that she somehow would have felt compelled to tell the truth if only Theranos had been subject to mandatory securities disclosures. It’s similarly doubtful that Holmes, who faces up to 20 years in prison if convicted, would have been deterred by a heightened risk of an SEC-imposed sanction.

And, while it’s true that, because of regulatory restrictions on tradability of private company securities, unicorns today are generally immune from the discipline imposed by public market actors who have high-powered incentives to uncover corporate fraud, in Theranos’ case, these actors already had incentives to do this – and simply failed to do so. Investors who learned the truth about Theranos before others might have profited by selling short the company’s publicly-traded business partner Walgreens, or going long on its publicly-traded rivals, LabCorp and Qwest Diagnostics.

Thus, a unicorn crackdown just doesn’t seem like it would have been helpful in preventing or detecting the Theranos fraud. It would also likely prove enormously costly – undermining the many advantages successful unicorns now provide.

Consider Moderna, Inc. – a company surely included in many Americans’ “most thankful for” lists this past Thanksgiving. Before going public in December 2018, Moderna was a secretive, over-hyped biotech unicorn without a single product on the market, an alarming record of turnover among high-level personnel, a CEO with a penchant for over-the-top claims, and a reputedly toxic work culture. More than one observer worried the company was the “next Theranos.”

Thankfully, that didn’t happen. Instead, Moderna endured growing pains as a private company, outside the scrutiny of public investors, SEC enforcers, and the other trappings of public company status. The company was well positioned in early 2020 to develop a highly effective Covid-19 vaccine in record time precisely because of its lengthy gestation period. Expanded disclosure, heightened SEC enforcement scrutiny, or mandated tradability of shares applied at an earlier stage could easily have thrown it off course and prevented it from doing so.

Moderna’s President put it best in 2016 when he remarked: “You don’t want to go through your adolescence publicly.” Coming from the leadership of a company that went on to radically improve the lives of hundreds of millions of people – and stands ready to do so again, if necessary – the statement is worth taking seriously.

In her recent unicorn speech, Commissioner Lee also warned that the “opacity” surrounding these unicorn companies might “obscure systemic risks such as those posed by climate change.” But opacity may be precisely what is needed to enable innovation that can help society combat or otherwise deal with climate disruption. Dozens of unicorns are now operating in “climate tech,” developing products and services designed to mitigate or adapt to global climate change. These companies are risky. Their technologies may fail; most probably will. But one or more of them may represent an important resource for mitigating the fallout from climate change.

Preventing the next Theranos is undoubtedly an important goal for policymakers. But cracking down on unicorns is not the right way to achieve it.

Alex Platt is Associate Professor at the University of Kansas School of Law and the author of “Unicorniphobia,” forthcoming in the Harvard Business Law Review, available here.

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