DISRUPTION DISRUPTED

Zenefits is learning the lesson of skirting the law to “disrupt” an industry

It starts with the seemingly impossible: a claim to “disrupt” a tightly regulated industry with a new model of doing things, typically centered around software. But under closer inspection, their businesses start to fall apart.

Such was the case with tech darlings like blood-testing startup Theranos, daily fantasy sports companies DraftKings and FanDuel, and most recently human-resources software startup Zenefits, whose cofounder and CEO resigned Feb. 8 for running a company that flouted state laws. These startups all touted valuations of a billion dollars or more, but have recently run into legal troubles in their attempts to operate in or change highly regulated industries.

Zenefits is just the latest startup in hot water for failing to follow proper protocol. In November, BuzzFeed revealed the company, which investors value at $4.5 billion, was using unlicensed brokers to sell health insurance in at least seven states.

As a result, cofounder Parker Conrad stepped down as CEO and was removed from the board. His replacement, David Sacks—formerly the chief operating officer of Zenefits, CEO of Yammer, and COO of Paypal—didn’t mince words about what happened. In a memo to employees, he said:

The fact is that many of our internal processes, controls, and actions around compliance have been inadequate, and some decisions have just been plain wrong. As a result, Parker has resigned. In order for us to move forward as a company, we cannot seek to hide or downplay the problem.

Given the nature of operating in a highly regulated industry, Sacks stresses the importance of compliance. He revealed that in December, Zenefits tapped a Big Four firm to audit its licensing procedures, a report it “will turn over to regulators as soon as possible.” The company also appointed Josh Stein to chief compliance officer.

Previously, Theranos—a $9 billion company that purported to run lab tests using a single drop of blood—has come under scrutiny and lost business after an investigation published by the Wall Street Journal (paywall) in October revealed allegations of mismanagement, exaggerated claims of how widely its proprietary technology was used in lab tests, and questions of efficacy of its testing device. As a result, US regulators inspected its California lab and found that it violated clinical standards and said problems with Theranos’s tests “pose immediate jeopardy to patient health and safety.”

DraftKings and FanDuel, which attempted to skirt legal troubles by arguing that fantasy sports is a game of skill and not gambling, have faced a number of setbacks as states start cracking down on their operations. New York state’s attorney general, who is suing both companies and attempting to shut down their sites, called daily fantasy sports “a massive, multibillion-dollar scheme intended to evade the law and fleece sports fans across the country.”

So often the tech industry prides itself on asking for forgiveness and not permission, as evidenced by companies like Uber and Airbnb. While Zenefits had gone down this route, it’s learning that it’s safer to to abide by existing laws—and frankly just easier to replace a CEO than to wage a legal battle in every state it operates in.

“For us, compliance is like oxygen,” Sacks said. “Without it, we die.”

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