Private Share Litigation Cases are Challenging

In a very high profile private share litigation, Theranos, a privately held health-technology and medical-laboratory-services company worth $9 billion as of 2014, has been sued this Monday by one of its largest and trusted financial backers, San Francisco hedge fund Partner Fund Management, LP (PFM).  It will be a widely watched, difficult case.

In its lawsuit in the Delaware Court of Chancery, PFM has accused Theranos Inc. and its founder Elizabeth Holmes of deceiving their fund to attract a $100 million in investment. PFM has sent a letter to investors accusing Theranos of “a series of lies, material misstatements, and omissions” and also “engaged in securities fraud and other violations by fraudulently inducing PFM to invest and maintain its investment in the company.” Furthermore, PFM makes the claim that Theranos intentionally lied about having developed “proprietary technologies” that would work and also lied about being in the process of receiving regulatory clearance and approval.

The Theranos case highlights the risks of even institutional investors like hedge funds investing in private companies. It is very difficult for investors to do proper due diligence on private companies. If things go poorly as they have here, a securities fraud case in Delaware court is challenging. There are strenuous pleading requirements and dispositive motion practice. Major investors are actually better off in arbitration where there are no pleading requirements and very limited dispositive motion practice. However, Theranos isn’t looking down a clear path to victory because the Securities and Exchange Commission is investigating the allegations that Theranos misled investors. The SEC has subpoenaed PFM in the case and PFM will likely be more than willing to cooperate with authorities.

Theranos is also facing federal civil and criminal investigations. The private company has said they are cooperating with the investigations and are continuing to cooperate with regulators.

Theranos has made it clear that they will fight this lawsuit and also claims that PFM, “is engaging in revisionist history, making claims that are not rooted in facts.” Sounds like the beginning of a very long fight.  Even if PFM wins many years down the road, there is a chance Theranos won’t have the assets to make PFM and other potential litigants whole.

Here are links to the WSJ and NY Times stories on the case:

WSJ – Major Investor Sues Theranos

NY Times – Theranos Sued by Investor Who Accuses It of Securities Fraud