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Theranos on the Ropes as Scathing Regulatory Report Is Made Public

Apr 01, 2016

Another punishing article in the Wall Street Journal Thursday evening, revealing the depths of the problems that led federal regulators to cite a Theranos lab for multiple "serious deficiencies" in January, raises the question of how many more setbacks the young blood analytics company can survive.

According to the article, regulators at the Centers for Medicare and Medicaid Services have so far found the company's plan to fix deficiencies at its Newark, Calif. lab last January "inadequate" and they plan to impose sanctions against Theranos that could range from fines to suspension of their right to test human samples.

In a statement, Theranos says: "Quality and patient safety is our top priority. Theranos submitted a Plan of Correction to CMS and related evidence that addressed how the company has actively ensured that our lab operates at the highest standard. We’ve made mistakes in the past in the Newark, CA lab, but when the company was made aware of the deficiencies we have dedicated every resource to remedy those failures."

The Journal story, by John Carreyrou and Christopher Weaver, comes just three days after researchers at the Icahn School of Medicine at Mt. Sinai published a peer-reviewed study comparing Theranos's results to those of Quest Diagnostics and LabCorp and finding that, among other worrying issues, Theranos produced 1.6 times as many "abnormal results" as the other labs.

Though the Journal story was sourced to people "familiar with the matter"—sometimes too vague a description to give confidence—it's clear from the context of the article that the Journal's sources must include either CMS officials or disaffected high-level Theranos officials, or both.

The 1,400-word Journal article provides a close analysis of a nonpublic, unredacted version of the highly technical, 121-page CMS inspection report. A redacted version of that report was publicly released only minutes before the Journal article came out. To me, the ongoing boldness of the leaks to the Journal suggest a level of outrage about Theranos's conduct on the part of either CMS officials or among Theranos's own high-level employees or, again, both.

In any case, even if the CMS gives Theranos another chance, it's highly unclear whether Walgreens—which hosts 43 of Theranos's 45 blood collection centers—will be as charitable. (It already suspended the operations of its Theranos's wellness center in Palo Alto, which had depended on the Newark lab.)

"Walgreens is in the process of assessing this latest development," a source close to the company told Fortune Thursday evening. The company itself declined comment.

But it has already been reported—originally in Journal stories, again, though subsequently confirmed by Fortune—that, if not for contractual issues, Walgreens would have already put an end to the relationship.

Theranos, founded by CEO Elizabeth Holmes, originally aimed to provide a full range of lab tests from small quantities of blood drawn by fingerstick, rather than by venipuncture (a needle in the crook of the arm). Last fall, it stopped using fingerstick draws for all but one test after an inspector with a different federal regulatory agency—the U.S. Food and Drug Administration—opined that the company's hallmark "nanotainer," a small test-tube used to collect fingerstick draws, was an "uncleared medical device."

The newly revealed January CMS inspection report, based on an inspection last November, concerns the company's Newark, Calif. lab. Though the company also has a lab in Scottsdale, Ariz., only the Newark lab has the proprietary machines the company uses to analyze fingerstick blood. The Scottsdale lab only analyzes tests performed by venipuncture, and only uses conventional machines purchased from outside parties, like Siemens.

According to the Journal, the CMS inspection report found, among a great many other problems, that the company's Newark lab often failed to follow its own guidelines for ensuring that its equipment was rendering reliable results.

It showed, for instance, that "29% of the quality-control checks performed on the company's proprietary blood-testing devices in October 2014 produced results outside the range considered acceptable by Theranos," according to the paper. Theranos had nevertheless continued to use the machines.

An outside expert consulted by the Journal, Stephan Master, an associate professor of pathology at the Weill Cornell Medical College, told the paper: “This is the first time that we’ve actually seen data from the Theranos instrument, and it’s as bad as one would have worried it would be. . . . Based on this data, it’s hard for me to believe that they went live with this instrument and tested patient specimens on it.”

In Theranos's statement responding to publication of the CMS report, it outlined some of the specific steps the company said it had taken to ameliorate the situation. Among these it said it "made personnel changes in our Newark, California lab, including hiring a new full time lab director who is an M.D. and board certified pathologist, and two co-lab directors who are also M.D. and board certified pathologists, to run the lab."

The statement also said that the company had "proactively suspended testing associated with any affected areas last year after learning of the issues."

"Theranos shares the same goal as CMS," the statement concludes, "which is to provide best quality care to our patients. This has only made the company stronger and we are better for it today."

There are two main issues for Theranos that are not fully put to rest by its statement, however.

First, part of the problem the CMS seemed to find—the use of proprietary equipment that was not producing results within acceptable levels of precision during proficiency testing—suggests that its proprietary methods may simply not work well enough for certain kinds of tests, or at least that they are still not yet ready for prime time more than two years after the company started offering tests to the public.

Second, the notion that problems of this gravity resulted solely from certain failings of the previous lab crew at Newark is not credible. The lab was also the responsibility of the chief operating officer, Sunny Balwani, who is president of the company. A former Microsoft official and entrepreneur, he comes from a software background, not a lab background, which may be part of the problem.

But Balwani has been a close associate and confidante of Theranos founder and CEO Elizabeth Holmes since before she launched the company. He's not going anywhere. She and he are the CEO and president, and she and he constitute the entire executive committee of the board.

Nor is it meaningful to hope for change that will come from greater outside board supervision. This is a private company which is run by its founder, who still owns more than 50% of the stock. What's a board going to do—oust her in favor of John Sculley?

The fate of this company rides on who Elizabeth Holmes turns out to be. Can she make her inventions work and how quickly can she do it?

In the meantime, she can't be practicing on human beings. And if that's what she's been doing, neither the CMS nor the FDA nor Walgreens are going to put up with it much longer.

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