What?

While advising an investor in connection with an investment in a start-up company, the question came up whether the famous Theranos (or Elizabeth Holmes) case would also be possible in Switzerland. The answer to the question can be short: Yes, Theranos is possible in Switzerland at any time.

The special thing about the Theranos case was that the company was able to raise money from professional (and famous) investors in the amount of around USD 700 million between 2003 and 2015 and thereby achieve a company valuation of USD 9 billion, without the dizzying claims regarding the technology or the allegedly achieved sales being uncovered.

This gigantic swindle was apparently possible for two main reasons:

– Theranos’ claims about the allegedly developed technology were never independently verified. Allegedly, Theranos prevented this with the argument that there was a risk of violating technical secrets.

– The economic data, in particular the alleged sales and customers, were also never independently verified, in particular Theranos did not have an auditor for a long time after its foundation and despite the allegedly high sales and high company valuation.

In Switzerland, too, a company can issue shares directly to investors without any prior independent verification of the information provided on technology, markets, key figures, etc. The company does not need to be audited before thresholds are reached. There are no regulations that would oblige the company to have such disclosures to investors audited in advance by an independent third party (and there is certainly no audit by a government agency).

Swiss financial market law does not know of any directly effective protective measures for such direct placements of shares by the company:

– The obligation to publish a prospectus (i.e. a binding presentation of the company with financial figures, the business situation as well as the “main prospects, risks and disputes”) under Article 35 of the Federal Financial Services Act is practically never given in the case of private placements by the company, as the exceptions in Article 36 are very broadly defined.

– Even if a prospectus had to be drawn up, it would only have to be checked by an authorised inspection body for “completeness, coherence and comprehensibility” (Article 51). Whether the presentation of the prospects is realistic (for example, whether a technology is already ready for marketing or whether a prospective large order for the product has really been secured in a binding manner) is not the subject of the examination. Experience shows that these prospectuses are standardised documents that contain general information about possible risks and are of little use to investors and do not significantly improve their information situation.

In Switzerland, too, those responsible for a swindling company like Theranos are likely to be convicted under criminal law and also held liable under civil law for the damage they have caused. As a rule, however, this is unlikely to reduce the losses of aggrieved investors, since no money will be recoverable from those responsible.

So What?

Conclusion: There is no alternative whatsoever to carrying out a complete, thorough examination (“due diligence”) of the company offering an investment. It is the own responsibility of anyone considering an investment in a company to obtain the necessary information to make a decision and to examine it critically. It is dangerous to rely on the presumption that other investors have carried out this due diligence. One of the first investors in Theranos was Rupert Murdoch, who obviously had not done any further due diligence …

Do What?

Obvious alarm signs for any investor are for example:

– The company has no auditors at all and claims cost reasons for this. The cost of auditing a company’s annual accounts hardly ever exceeds CHF 10,000 for a start-up. This amount is definitely worthwhile from an investor’s point of view.

– The company refuses to make its technical innovations available to an independent expert for review, claiming the necessary protection of secrecy. However, secrets can be sufficiently protected by means of non-disclosure agreements, so that this argument appears to be a mere pretext.

– The information given in the documents, for example on partners, turnover, etc., cannot be verified or is not independently confirmed.

– Significant parts of the company are located in offshore destinations, or the business is conducted via such destinations. In such cases, there is no sufficient legal certainty for the investor and the clarification of investment fraud is usually extremely difficult if one or even several exotic locations are involved. The reasons usually given for the use of such locations, namely lower taxation and less regulation, must be critically questioned.