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We're almost starting to feel bad for Theranos. Once a Silicon Valley wunderkind, Theranos rose to fame on the back of its founder Elizabeth Holmes' Steve Jobs-turtle necks and claims that the company could reshape the blood testing industry. Theranos rode that hype to a $9 billion valuation, only to be brought down by skepticism from the medical community, federal investigations, and an eventual ban on Holmes operating a medical laboratory. Once considered the richest self-made woman in the world by Forbes, the magazine recalculated her wealth this summer, declaring her net worth to be, essentially, zero.
A company doesn't crash and burn so spectacularly without attracting lawsuits, of course, and Theranos has had its share. It's been hit with consumer class actions and its former partner, Walgreens, recently filed a $140 million breach of contract suit against the company. Those things are expected. But the company is now facing a much more unusual suit: a rare lawsuit alleging pre-IPO securities fraud.
A Pre-IPO Securities Suit?
If you haven't heard of a pre-IPO securities fraud lawsuit, you're probably not alone. They're pretty rare, given the small amount of investors in non-public companies and the lack of publicly traded stock prices and public securities filings, according to the Recorder's Ben Hancock.
But Theranos might be the perfect example of when a pre-IPO securities suit is appropriate. "Here, I think there's no question that the company has lost value," Washington University law professor Hillary Sale told Hancock. "And certainly from the publicly available information, there's no question that people were misled."
A Look at the Complaint
The suit, a putative class action filed in the Northern District of California, accuses Theranos of violating California's securities law and of engaging in unfair competition, multiple types of fraud, and negligent misrepresentation.
The suit was brought by Robert Colman and Hillary Taubman-Dye on behalf of early Theranos investors. Interestingly, Taubman-Dye purchased her Theranos securities through SharePost, a website that lets investors buy an interest in nonpublic companies. Taubman-Dye made her purchase in August 2015, but the sale did not finalize until that December, after questions about Theranos's technology had already been raised. Taubman-Dye tried to cancel her purchase, the complaint explains, but was unsuccessful.
"Companies owe a duty to potential investors to be open and honest. Even non-public companies are bound by this principle of frankness no matter how sophisticated their potential investors might be," the complaint says.
It goes on to cite over 20 Theranos press releases, plus even more coverage in the press, which it says prove that the company put forward a "false narrative" in order to attract investors, misrepresenting the state of its technology.
The suit seeks class status for all investors in Theranos from July 29, 2013 to October 5, 2016, along with unspecified damages.
The pre-IPO nature of the suit is highlighted by the plaintiffs' reliance exclusively on California law. California's securities fraud laws do not require investors to show that they relied on allegedly false representations, according to Reed Katherein, a partner at Hagens Berman who is representing the plaintiffs. That's especially important in the pre-IPO context, given that Theranos's shares aren't publicly traded, precluding plaintiffs from relying on a "fraud-on-the-market" theory under federal securities law.