Not so long ago, Rishi Shah and Shradha Agarwal were the shining hope of Chicago’s startup scene.
Next week, the 37-year-old co-founders of Outcome Health will be tried in federal court on criminal fraud charges stemming from one of the most spectacular business flameouts in Chicago history. They pleaded not guilty, as did former Chief Operating Officer Brad Purdy, 33, who is also charged with fraud.
Shah, Agarwal and Purdy face up to 30 years in prison each if they’re convicted on charges of mail, wire and bank fraud in a scheme that prosecutors allege duped big drug companies and enabled Outcome to raise nearly $1 billion from lenders and investors, including Goldman Sachs, Google parent company Alphabet, Steve Jobs’ widow, and Illinois Gov. J.B. Pritzker’s former venture-capital fund.
The high-stakes, high-profile case centers on allegations that Outcome Health defrauded its pharmaceutical customers by routinely billing them for ads on more TV screens and tablet computers than the company had installed in doctors’ offices, and falsifying the amount of prescriptions that resulted from those ads.
The trial, which is expected to last about three months, takes place against a backdrop of increased scrutiny of founders of failed startups who are accused of lying to investors and customers. It’s the latest in a series of cases in which the “fake it till you make it” ethos of startup culture is on trial at a time when a massive tech bubble has popped.
Two months ago, Theranos founder Elizabeth Holmes was sentenced to more than 11 years in prison for fraud. Sam Bankman-Fried was charged last month with fraud, conspiracy and money laundering in connection with the multibillion-dollar implosion of cryptocurrency trading platform FTX. Bankman-Fried pleaded not guilty.
Shah and Agarwal left town after they were indicted. Outcome, once valued at $5 billion, merged nearly two years ago with Cincinnati-based rival Patient Point and largely faded away. Former executives, some of whom are expected to be called to testify at the trial, left for other companies, like most of the more than 600 people who used to work for Outcome.
But the trial will serve as a painful reminder of the success that so far has eluded Chicago in a tech and startup sector dominated by coastal giants. Outcome put its name on a downtown office tower and touted plans to hire thousands and go public, raising hopes that Chicago had finally found its long-sought tech champion. In the end, however, it became another ballyhooed Chicago startup that failed to live up to its hype, a list tracing back through Groupon to Divine Interventures.
“Nobody wants to relive this, but we’ll have to relive it while the case is going on,” says Ira Weiss, a longtime local startup investor and professor at University of Chicago’s Booth School of Business. “People will want to know about and follow it. People in the investment community will care. Founders will care.”
Historically, CEOs of failed startups rarely have been charged with crimes. But now they’re being charged more often, and prosecutors appear determined to see those who are convicted go to prison.
“I do think the prosecution will seek prison time, and I think it’s warranted,” says Renato Mariotti, a former federal prosecutor who now is a partner at Bryan Cave Leighton Paisner. “Defrauding people out of millions of dollars is something that should be prosecuted and punished significantly.”
Shadow of Theranos over Outcome trial
There are plenty of parallels between Theranos and Outcome: young, charismatic founders who dropped out of prestigious private universities and won the confidence of high-profile investors.
But there also are key differences. Theranos tried to create a blood-testing technology that would be used directly by consumers. Its technology was never proven, and Theranos never became a moneymaking business.
Outcome, however, was a real business with most major pharmaceutical companies advertising on screens the company had installed in thousands of doctors’ offices. At its peak, Outcome said it was generating more than $100 million in annual revenue.
Prosecutors claim the company billed customers for more advertising than they received, inflating its revenue by 20% to 25%. Those financials were used to obtain two loans totaling $485 million and to raise $488 million from investors.
Unlike Theranos, Outcome’s founders cashed out along the way. Shah and Agarwal received payouts of more than $260 million from the loans and investment, according to court documents, although they were forced to return some of it in a settlement with investors. Shah retained an 80% stake in the company, which prosecutors say was once worth more than $4 billion.
That’s what led to Outcome’s downfall. After reading about the big fundraising round, a company employee contacted a Wall Street Journal reporter “to tell him the truth of how business operated at Outcome,” according to court documents. The Journal’s story in October 2017 triggered an investor lawsuit and investigations by the Securities & Exchange Commission and the Deptartment of Justice.
The money Shah and Agarwal pocketed will make it harder for the defense, says Kevin O’Brien, a former federal prosecutor and partner at Ford O’Brien Landy, a New York-based firm that does white-collar defense. “If the money comes in at trial, it’s pretty devastating because it goes to motive.”
The case involves more than 10 million documents, including email and voice messages. The government expects more than 1,000 exhibits and more than three dozen witnesses.
Among the witnesses are three former employees who have pleaded guilty and are cooperating with prosecutors, including Ashik Desai, once a rising young star and protege of Shah.
The case could turn on the testimony of Desai, who oversaw the matching of lists of doctors’ offices where Outcome had installed screens with those requested by pharma advertisers, as well as measuring the effectiveness of ads in increasing prescriptions written by those doctors.
The defense will paint Desai as a rogue employee and “master con man” who lied to his bosses and “directly and actively oversaw each facet of the operations of the company in which the fraudulent conduct occurred,” according to pretrial court filings.
Defense attorneys will portray their clients as inexperienced managers who got in over their heads. They plan to introduce the concept of “blitz-scaling,” or the growth-at-all-costs mentality of hypergrowth startups.
As with Theranos, the Outcome Health trial will examine the line where entrepreneurial bluster becomes fraud, as well as whether investors did enough to check out the company’s claims before investing.
“When does fake it till you make it become fraud? The answer is it’s always fraud,” Mariotti says. “The hard part is proving it beyond a reasonable doubt.”
