The recent resurgence of Elizabeth Holmes in popular culture, fueled by the critically acclaimed and surprisingly successful film You Can See Everything, reignites a crucial conversation beyond the sensationalism of her downfall. While the film delves into Holmes’s enigmatic persona, it inadvertently leaves a significant question lingering: how did so many seasoned investors and prominent public figures overlook mounting evidence of her deception, thereby enabling and perpetuating the devastating Theranos fraud? This pivotal question, Professor of Law Renée M. Jones argues, points not to individual pathology but to systemic flaws within the startup ecosystem, flaws that have paved the way for a disturbing pattern of founder-led fraud.
Professor Jones, the Dr. Thomas F. Carney Distinguished Scholar at Boston College Law School, explores these complex issues in her new book, Untamed Unicorns: Why Startup Finance is Broken and How to Fix It (Harvard University Press). Her work shifts the focus from the captivating personalities that often dominate these narratives to the decades of deregulation in securities markets, which she contends have created the fertile ground for scandals like Theranos and its ilk.
The Rise and Fall of Theranos: A Cautionary Tale
Theranos, once a Silicon Valley darling, captivated the investment world, amassing nearly a billion dollars from luminaries such as Larry Ellison and Rupert Murdoch. At its zenith, the company boasted an astounding valuation of $9 billion, propelling Elizabeth Holmes to the status of the youngest self-made female billionaire in history, according to Forbes. Holmes’s audacious claim was the development of revolutionary technology capable of performing a wide array of medical tests using a single drop of blood.
However, behind the veneer of innovation lay a foundation of deceit. Insider accounts, rigorous investigative journalism, and ultimately, a federal criminal trial, unequivocally established that Holmes had misled investors and the public about the true capabilities of Theranos’s technology. This deception had grave consequences, exposing patients who relied on Theranos’s blood tests to unwarranted anxiety and potentially serious health risks. The company officially dissolved in 2018, marking the end of a once-promising, yet ultimately fraudulent, enterprise.
FTX and the Evolving Landscape of Startup Scandals
The Theranos saga is far from an isolated incident. It represents a growing number of colossal startup failures that cast a shadow of doubt over the venture capital (VC) financing model, long lauded for fostering innovation. Another stark example is FTX Trading Ltd., which filed for bankruptcy protection in November 2022. The cryptocurrency exchange, once the second-largest in the world, had secured nearly two billion dollars in funding from some of the most respected VC investors. Its founder, the then thirty-year-old Sam Bankman-Fried, was widely portrayed in the media as an altruistic wunderkind with a reported net worth of $16 billion.
The success of FTX, much like Theranos, proved to be largely illusory. Shortly after its bankruptcy filing, prosecutors indicted Bankman-Fried on multiple charges of conspiracy and fraud. Evidence presented at trial revealed that Bankman-Fried had allegedly siphoned billions of dollars in customer funds from FTX to Alameda Research, a crypto trading hedge fund he also controlled. These funds were reportedly used to bolster Alameda’s failing business and to provide substantial loans to FTX executives, who then allegedly spent them on luxury real estate, charitable contributions, and illicit campaign donations. In November 2023, Sam Bankman-Fried was convicted on seven counts and subsequently sentenced to 25 years in prison for his orchestration of multiple fraudulent schemes.
A Pattern of Deception: Beyond the Headlines
The high-profile misdeeds of Holmes and Bankman-Fried, dissected in books, television series, and now films, have captured public attention. However, these debacles are merely the most visible manifestations of a more pervasive and troubling trend: founder-led fraud. This trend is significantly enabled by fundamental shifts in the Silicon Valley investment model over recent decades. Other founders convicted of securities fraud in recent years include Travis Milton of Nikola, Carlos Watson of Ozy Media, and Charlie Jarvice of Frank. These cases collectively highlight a systemic vulnerability within the startup ecosystem.
The Root Cause: Decades of Deregulation
Professor Jones’s book, Untamed Unicorns, directly confronts the question of "Why does this keep happening?" The answer, she posits, lies in a careful examination of decades of deregulatory reforms enacted by Congress and the Securities and Exchange Commission (SEC). These reforms have fundamentally reshaped the startup landscape, creating a system where private companies can achieve enormous scale while circumventing the transparency and accountability mechanisms essential for well-functioning securities markets.
Two key legislative actions, in particular, have significantly altered the power dynamic between startup founders and their investors.
The National Securities Markets Improvement Act of 1996 (NSMIA)
In 1996, Congress passed the National Securities Markets Improvement Act (NSMIA). A critical provision of this act eliminated the cap on the number of investors permissible in private funds, including hedge funds, private equity, and venture capital funds. Prior to NSMIA, regulatory restrictions limited the number of non-accredited investors a private fund could solicit, thereby creating a barrier to entry for smaller or less sophisticated investors and implicitly encouraging greater oversight. The removal of this cap led to a dramatic surge in assets under management within private funds. This influx of capital enabled startups to raise substantial funding primarily through private markets, bypassing the more stringent disclosure requirements associated with public offerings.
The Jumpstart Our Business Startups (JOBS) Act of 2012
Ten years later, in 2012, Congress enacted the Jumpstart Our Business Startups (JOBS) Act. This legislation fundamentally altered the pathway to public markets for growing companies. Notably, the JOBS Act amended Section 12(g) of the Securities Exchange Act, increasing the threshold for mandatory SEC registration from 500 shareholders to 2,000 shareholders. Furthermore, it excluded employee-held shares from this count, effectively allowing startups to remain private for much longer periods.
The impact of these legislative changes has been profound. The median age of a company at its Initial Public Offering (IPO) has steadily increased, rising from approximately nine years in 2012 to thirteen years by 2024. Concurrently, the number of "unicorns"—privately held startups valued at $1 billion or more—has exploded. From just forty in 2013, the number of these highly valued private companies has surged to over 1,500 today, according to Pitchbook data. This proliferation of large, privately held companies represents a significant shift in the financial landscape.
The Erosion of Accountability: Founder-Friendly Terms and Diminished Oversight
The combined effect of NSMIA and the JOBS Act, alongside other incremental SEC reforms, has been a substantial shift in control from investors to founders within the startup ecosystem. The sheer volume of capital flowing into private securities markets, facilitated by NSMIA, created intense competition among venture capitalists. To secure access to the most promising deals, VCs began offering increasingly "founder-friendly" terms.
This founder-friendly model, now pervasive in Silicon Valley, often grants founders supervoting stock rights—typically ten votes per share—at the very early stages of a startup’s lifecycle. This structure empowers founders to exert significant control over their company’s board of directors, essentially allowing them to appoint their own overseers. This arrangement inherently complicates the traditional role of VCs in disciplining or removing ineffective or errant founders, a mechanism that historically provided a crucial layer of accountability.
Furthermore, the JOBS Act’s relaxation of the 500-shareholder rule removed a key incentive for founders to establish robust internal controls designed to prevent unethical conduct and fraud. The previous 500-shareholder rule, in place since 1964, had created a clear imperative for thriving startups to professionalize their operations and prepare for the rigorous scrutiny accompanying an IPO. The looming prospect of public scrutiny compelled founders and their investors to implement strong governance, hire experienced executives, and build out compliance and financial reporting departments.
In the absence of this immediate prospect of public accountability, many founders have resisted adopting the internal structures and controls appropriate for enterprises of their growing scale. The first interim report on control failures at FTX exchanges by John J. Ray III, an independent director, highlighted this deficiency, stating that FTX "lacked independent or experienced finance, accounting, human resources, information security, or cybersecurity personnel or leadership, and lacked any internal audit function whatsoever." This lack of basic operational and financial oversight at a company handling billions of dollars in customer assets is a stark illustration of the problem.
The absence of effective internal controls at these large, private companies has created an environment where illegal conduct, unethical behavior, and outright fraud can take root and flourish. In this new era of founder dominance, investors often find themselves disempowered, struggling to address emerging problems effectively. Consequently, scandals have become almost commonplace, erupting at companies like Uber, WeWork, Theranos, FTX, and numerous other lesser-known startups that have either failed spectacularly or engaged in significant fraudulent activities.
Charting a Course for Reform: Restoring Balance and Accountability
Professor Jones’s Untamed Unicorns proposes a comprehensive roadmap for reform aimed at restoring a more equitable balance between public and private markets. The core objective of these reforms is to ensure that investors, whether in public or private markets, have access to the information necessary to make sound investment decisions, while simultaneously preserving the exemptions that enable small businesses to access capital efficiently.
The proposed reforms include several key initiatives:
- Disclosure for Large Private Offerings: Mandate disclosure requirements for the largest private offerings, ensuring that sophisticated investors have access to critical information.
- Disclosure by Startups in Private Markets: Require ongoing disclosure from startups whose shares are actively trading in private markets, enhancing transparency for secondary market participants.
- Expanded Employee Offering Disclosure: Increase disclosure requirements for startups making offerings to their employees, safeguarding employee investors.
- Restoration of Public Reporting Thresholds: Reinstate the legal requirement for all large companies with a broad shareholder base to become public reporting companies. This would effectively revert to a threshold similar to the pre-JOBS Act era, compelling companies to adhere to public market standards once they reach a certain scale and investor base.
In the event that Congress does not act to restore the original 500-shareholder rule under Section 12(g) of the Exchange Act, Professor Jones urges the SEC to actively close existing loopholes. These loopholes, often exploited through mechanisms like special purpose vehicles (SPVs), allow startups and their investors to circumvent the Exchange Act’s disclosure requirements. Such recommendations are poised to serve as a critical guide for policymakers as they navigate the evolving regulatory landscape, particularly in anticipation of future shifts in SEC leadership and priorities.
The scandals surrounding Theranos, FTX, and others are not merely cautionary tales of individual greed or incompetence. They are symptomatic of a larger structural issue within the startup finance ecosystem, an issue that Professor Jones meticulously deconstructs and offers concrete solutions for. By shifting the focus from individual personalities to the systemic regulatory framework, Untamed Unicorns provides a vital intellectual toolkit for understanding and ultimately rectifying the broken aspects of startup finance, ensuring a more accountable and sustainable future for innovation.
