On Monday, Elizabeth Holmes was acquitted on charges that she misled doctors and patients as she raised money for her blood testing company, Theranos. The jury found that she did not intend to harm or mislead providers and recipients of care, but she was found guilty on four counts of wire fraud for lying to and deceiving some of the smartest and most sophisticated investors in the world.
The fact that she misled or outright lied to her backers is clear, and the discussion about whether there is a difference between lying and puffery has been exhausted and isn’t getting us anywhere. Frankly, the terminology doesn’t really matter. What does matter is that in order to express outrage at perceived excesses, we are misusing the purposes and sanctions of the criminal law.
The United States has a federal agency charged with the oversight and protection of investors: the Securities and Exchange Commission. The SEC has the power to act — to require such things as audited financial statements in appropriate circumstances, and to require review of offerings.
When a private company decides to go public, the SEC subjects it to very strict disclosure and review requirements. However, there are no similar requirements when a private company raises private funds from wealthy investors. There is no reason why there should not be significant disclosure and review requirements on companies such as Theranos, which at its peak was valued at $9 billion, when they are raising money.
Presumably, the SEC is lax in monitoring these private offerings because it believes that investors at this level have the sophistication and means to assure that they are protected from misstatements. And indeed they do. The mostly super wealthy investors in Theranos made the choice not to protect themselves.
The SEC has made the choice not to require protections that would likely have avoided the Theranos debacle. (The SEC charged Theranos with securities fraud in 2018, but that was years after reporting raised questions about the company’s practices.) Under those circumstances, why is the criminal law, as opposed to the civil law system, being used to sanction the consequences of what was inevitable when oversight is abandoned by those with the means and authority to provide it?
Some say that Holmes was prosecuted to send a message to Silicon Valley, one about truth, overstatement and transparency. But will her conviction really send that message? Not a chance. One or two cases, even with severe criminal sanctions, will not change the culture of lying or overstatement. The potential benefits are too high, and the fact remains that the odds of a criminal case being brought are very slim, with the standard of proof beyond a reasonable doubt exceptionally difficult to meet and prosecutorial resources too stretched to be a credible detriment.
When a contractor lies to a customer, we use the civil system to remedy the situation. Just as the civil law system is used to enforce contract violations, so too should that same system be used to enforce truth and transparency in cases like that of Theranos. Holmes deserved bankruptcy for her misdeeds, but at the same time investors should know that they have the responsibility to protect themselves by doing due diligence.
The U.S. has a tradition of misusing criminal law. In the 1970s and ’80s the mail fraud statute was used for increasingly creative prosecutions, often unrelated to the purpose or meaning of the statute, which outlaws the use of mail in schemes meant to defraud. (Ultimately this misuse of the criminal law was rejected by a unanimous Supreme Court opinion that essentially limited the scope of mail fraud to bribes and kickbacks, but only after lives and careers were destroyed.) In the famous Drexel Burnham investment bank case, Michael Milken was prosecuted and convicted — though ultimately pardoned — for violating a hyper-technical provision of the securities law for which no one had ever been prosecuted.
Elizabeth Holmes lied. That was not a good thing. But it’s important to think of her case in context. She never cashed out, and plenty of other CEOs have left failing companies without facing criminal charges.
Criminal law is being misused in cases like this and it’s a shame. When we allow criminal law to lead the charge in campaigns to change social norms — and to supplant the role that civil agencies like the SEC should perform to protect even sloppy investors — we risk the legitimacy of criminal sanctions. And that risks hurting our nation much more than what has been done to the few rich and sophisticated investors who foolishly invest in charming founders with big dreams and brazen lies.
David Mills is a professor of practice of law at Stanford Law School.