Analyzing the Indictment of Martin Shkreli

You might think if your nickname already was “the most hated man in America,” things couldn’t get a whole lot worse for you. The Martin Shkreli criminal demonstrates you’d be wrong.

Martin Shkreli, a/k/a the "Pharma Bro" Pharmaceutical executive and former hedge fund manager Martin Shkreli recently earned the "most hated" moniker when his company, Turing Pharmaceuticals, bought the rights to a drug called Daraprim and promptly raised the price of a single tablet by more than 5,000%, from about $13.50 to $750. Daraprim is primarily used to treat or prevent toxoplasmosis, a serious parasitic infection often suffered by HIV and cancer patients and others with compromised immune systems. The public and political outcry over the dramatic price hike threatened to break the Internet. Shkreli was defiant and unrepentant, saying his job was to make money for his shareholders. He remarked at one point that his only regret was he didn't raise the price even higher. But although the incident may have qualified him for a starring role in American Greed, it didn't appear to be illegal. Then yesterday, in an unrelated case, the 32-year-old man who social media loves to hate was arrested.  Shkreli stands charged with securities fraud and conspiracy in a seven count federal indictment in Brooklyn. A lawyer who worked as his outside counsel, Evan Greebel, is charged as a co-defendant in one of the conspiracy counts. The charges against Shkreli have nothing to do with Daraprim or jacking up drug prices; they are based on his earlier activities as a hedge fund manager and CEO of a different company. But the near-universal reaction to his arrest seems to be, “Couldn’t happen to a nicer guy.” A new hashtag quickly popped up on Twitter to describe the satisfaction that people felt upon seeing Shkreli being “perp walked” in handcuffs: #Shkrelifreude.

Charles Ponzi: The Classics Never Get Old

Unpacking the Martin Shkreli Criminal Case

The indictment lays out three different fraudulent schemes allegedly carried out by Shkreli. As U.S. Attorney Robert Capers noted during the press conference announcing the indictment, the frauds were basically a Ponzi scheme, but with a twist. (You can find the press release and a link to the indictment here.) In a typical investment Ponzi scheme (a la Bernie Madoff), the defendant lies to investors about the spectacular returns they are allegedly earning, when in fact the defendant is simply stealing their money. As word of the supposedly stellar results spreads, more money and investors pour in. If anyone wants to take their money out, the defendant uses money from new investors to pay for the withdrawal, further adding to the illusion that the supposed returns are real. Typically the scheme collapses at some point when the defendant is no longer able to meet the demands of investors who are seeking to cash out. In classic Ponzi fashion, Shkreli allegedly lied to his hedge fund investors about the money he was earning for them and other issues related to their investment. The twist is that Shkreli created kind of a Ponzi stepladder; he had a series of hedge funds and companies, and when one went belly up he fraudulently used money from the subsequent ones to pay off his earlier obligations. And although he was allegedly misappropriating some of the money, he was actually making investments as well -- albeit spectacularly bad ones. The picture that emerges is of someone who was very good at fraud but really, really bad at investing. MSMB Capital Management Scheme – the first alleged scheme involved MSMB Capital Management, a hedge fund focused on health care companies that Shkreli created and ran from September 2009 to December 2012. Shkreli allegedly lied to investors and potential investors about the returns he was earning, whether the fund had an independent auditor, and how much money the fund was managing. For example, the indictment alleges he told one potential investor MSMB Capital had $35 million under management; in fact, at that point investors had given him only $700,000, and he had already lost it all in a series of disastrous trades. Shkreli allegedly received a total of about $3 million from eight different investors in MSMB Capital and lost it all – all the while telling those investors they were earning returns of up to 40%. When he ultimately sent an e-mail to the investors telling them he was going to wind down the fund, Shkreli told them he had “just about doubled their money net of fees,” when in truth all the money had been lost. The indictment also alleges that Shkreli and the co-founder of the fund, identified only as “Co-Conspirator 1,” misappropriated funds from MSMB Capital by taking out money well in excess of the fees to which the fund managers were entitled. MSMB Healthcare Scheme – MSMB Healthcare LP was another hedge fund created by Shkreli after MSMB Capital. Once again, he allegedly solicited funds from investors by lying to them about things such as his past performance as a portfolio manager, the returns he was earning, and the amount of money he had under management. The indictment alleges that thirteen investors ultimately invested a total of about $5 million in MSMB Healthcare. Shkreli allegedly misappropriated funds from MSMB Healthcare by taking out money for personal use well in excess of the disclosed fees. In addition, in the first rung of the Ponzi ladder, Shkreli allegedly defrauded his investors by using funds from MSMB Healthcare to pay off some of the debts he had incurred through bad trades and fraud at MSMB Capital, even though MSMB Healthcare was not responsible for those debts. Retrophin Misappropriation Scheme – Retrophin Inc. is a publicly-traded pharmaceutical company where Shkreli served as CEO from February 2012 to September 2014. In the next rung of the Ponzi ladder, the indictment alleges that Shkreli and his co-defendant, Retrophin’s outside counsel Evan Greebel, defrauded Retrophin by using millions in company assets to pay off Shkreili's debts and obligations related to MSMB Capital and MSMB Healthcare. The indictment charges that Shkreli, with Greebel’s help, fraudulently transferred Retrophin shares to MSMB Capital, fraudulently used Retrophin shares to settle liabilities owed to investors in MSMB Capital and MSMB Healthcare, and entered into sham “consulting agreements” between Retrophin and defrauded MSMB Capital and MSMB Healthcare investors as a way to pay off the debts owed to those investors.

The Structure of the Indictment

The indictment contains seven counts; Shkreli is charged in all seven, while Greebel is charged only in the seventh and final count. Counts One, Two, and Three are based on the MSMB Capital scheme, and charge Shkreli with conspiracy to commit securities fraud, conspiracy to commit wire fraud, and securities fraud. These are just different legal theories for charging essentially the same acts: the alleged defrauding of the MSMB Capital investors, as described above. Counts Four, Five, and Six are based on the MSMB Healthcare scheme, and again charge Shkreli with conspiracy to commit securities fraud, conspiracy to commit wire fraud, and securities fraud, based on his alleged defrauding of the investors in that fund. Count Seven charges both Shkreli and Greebel with conspiracy to commit wire fraud, based on their alleged actions that defrauded Retrophin by using its assets to help Shkreli pay off his investors and try to resolve his other legal and financial problems related to his hedge funds. Conspiracy to commit securities fraud has a maximum penalty of five years in prison; all the other charges carry a maximum penalty of twenty years each. Shkreli also faces millions of dollars in potential criminal fines and asset forfeiture.

What to Watch Going Forward

The indictment looks pretty grim for Shkreli; there certainly is nothing that leaps out in terms of potential defenses. They are only allegations, of course, but if true they paint a devastating picture. There are likely additional revelations to come concerning others involved in the misconduct. Most of the charges are conspiracy, and a conspiracy requires the criminal participation of two or more people. For example, in connection with the MSMB Capital scheme, the indictment alleges that the co-founder of MSMB Capital, identified only as “Co-Conspirator 1, a individual whose identity is known to the Grand Jury,” conspired with Shkreli and engaged in some of the same criminal conduct. MSMB Capital’s co-founder was reportedly another New York hedge fund manager name Marek Biestek (“MSMB” comes from the initials of the two men). That suggests Biestek may be Co-Conspirator 1. But whoever he is, Co-Conspirator 1 would seem to be facing criminal problems of his own. The fact that Co-Conspirator 1 wasn't charged suggests he may be cooperating and may have already pleaded guilty under seal, or he may have been granted immunity. It's also possible that charges against him are still to come. The indictment also refers to additional individuals involved in the schemes, using pseudonyms such as “Corrupt Employee 1” and “Corrupt Employee 2,” as well as unidentified "others" involved in the various conspiracies. Again, look for their identities to be revealed as the case progresses; some may already be cooperating in the investigation. The sham consulting agreements with Retrophin also raise some interesting questions. The indictment alleges the defendants used these agreements as a way to pay off defrauded investors in MSMB Capital and MSMB Healthcare. The phony agreements said those investors would provide consulting services to Retrophin, which allowed the defendants to use Retrophin funds to pay off the defrauded investors. In short, these were really settlement agreements for Shkreli's personal obligations, disguised as consulting agreements in order to make it possible to have Retrophin foot the bill. It will be interesting to see what additional information comes out about these sham consulting agreements and the investors involved. For example: if the agreements were signed by the defrauded investors who were being paid off, presumably they knew they were not in fact providing consulting services to Retrophin. If they knowingly executed the sham agreements, aren't they also implicated in the fraud against the company? Shkreli’s legal woes are not limited to the criminal case (although of course that’s the only proceeding that can land him in jail). The SEC also filed civil securities charges against him, and Retrophin is suing him for civil fraud. He was released on $5 million bail and ordered not to leave New York. And in response to his plight, a leading joke on social media is the suggestion that Shkreli’s lawyers should increase their fees by 5,000%.   Shkrelifreude, indeed. Update: On August 4, 2017, a jury found Shkreli guilty of one count of conspiracy and two counts of securities fraud.

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