Being a criminal doesn’t pay. Neither does being smug. Martin Shkreli was both. The son of immigrant janitors rose from humble beginnings in Coney Island to land a job on Wall Street at 17, start a hedge fund, a biopharmaceutical company and become arguably the ‘Most Hated Man in America’.1 Oh yeah- and inmate #87850-053, as a result of an incredibly spectacular fraud case.2

Martin Shkreli is considered brilliant by many. So much so that he launched his first hedge fund at age 23. That makes for a story in itself, but that’s not what made him so unusual.

We’ve profiled lots of flawed geniuses in our Masters of Fraud series. Except for maybe the Wolf of Wall Street, few displayed Shkreli’s level of arrogance. His immature antics, especially in front of a congressional hearing, won’t soon be forgotten.

Shkreli also created a social media firestorm with his videos (until Twitter suspended his account), often accompanied by his trusty cat, Trashy. The rants ranged from big pharma to Hillary Clinton’s hair to rap music. In fact, Shkreli even bought a one-of-a-kind Wu-Tang Clan album for a reported $2 million and claimed he would never listen to it.

MSMB’s Fraud

Shkreli’s fund, MSMB Capital, was marketed to investors as a true ‘hedge’ fund, using both long and short positions to mitigate market risk. Still, this strategy isn’t foolproof. The losses on a short side can be, theoretically, unlimited which can overwhelm profits on the long side. Unfortunately for investors, MSMB Capital suffered such an outcome.

Shkreli executed a massive short sale on drug company, Orexigen. Through his executing broker, Merrill Lynch, Shkreli sold short 11 million shares, betting heavily against the small biopharma company.4 With an 11 million share trade, a move against him of just a couple points in the stock could essentially wipe out a fund of MSMB Capital’s size.

But it turned out Shkreli didn’t actually have the money to pay for the trade in the first place, so Merrill was forced to buy back (‘cover’) the shares. The illiquid stock subsequently rose, imploding MSMB and costing Merrill roughly $7 million, which Shkreli was on the hook for.5 Shkreli hid the loss from investors and even employees.

The SEC alleges Shkreli overstated past performance record and assets under management to investors of MSMB Capital.6 And when fund redemptions were requested by MSMB Capital investors, Shkreli would move money between funds to cover claims.7

The Retrophin Chapter

Shkreli had yet another idea-taking a biopharmaceutical company public. Retrophin took a back-door approach to an exchange listing known as a reverse merger.8 In such a transaction, the company typically merges with an existing, yet dormant shell company that’s already listed on a lower-level exchange, like the NASDAQ ‘Bulletin Board’ or “pink sheets”. It’s a way to avoid the lengthy and costly IPO process but is usually reserved for more speculative names.

Once public, Shkreli allegedly began using some of Retrophin’s equity to again pay off MSMB Capital investors. Retrophin payments were inappropriately labeled as ‘consulting’ fees paid to the MSMB investors.9 Eventually, Retrophin’s Board of Directors fired Shkreli (even though he founded the company and was CEO).

Financial Crime and Punishment

For his offenses, prosecutors at the Department of Justice eventually charged him on 8 separate counts. Shkreli was found guilty on three of the eight charges, 2 counts of securities fraud and 1 count of conspiracy to commit securities fraud.10 These had to do with his dealings with investors and his hedge funds.

Ever defiant, the Shkreli camp considered the verdict a moral victory, being found not guilty of the majority of the charges. Regardless, Shkreli was sentenced to seven years and is currently serving time at FCI Fort Dix in New Jersey.

Despite being located on an active military base, the prison has a reputation as being less restrictive than many others. The judge did reportedly deny Shkreli even more freedoms, probably as a result of Shkreli boasting he’d serve time in a cushy “Club Fed’, not uncommon for white collar criminals.

The Most Hated Man in America

No one wants to be referred to as the Most Hated Man in America, but the BBC questioned if Martin Skreli was just that.11 Here’s why-following the Retrophin fiasco and before he was imprisoned, Shkreli started yet another biopharma company, Turin Pharmaceuticals with a similar strategy to Retrophin, licensing out-of-favor or abandoned drugs for commercialization.

One such drug was Daraprim, used to boost the immune systems in AIDS patients, babies and pregnant women. Shkreli’s swung for the fences and decided to raise the price of one pill of Daraprim from $13.50 to $750, an increase of around 5,000%.12

When Shkreli brashly defended the move publicly, he drew the ire of many, including Hillary Clinton, who railed against such practices by drug companies in her 2016 presidential campaign. It should be noted that in an interview with Vice Media before his sentencing, Shkreli offered that if anyone could not afford Daraprim, he’d provide it to them for free, if they reached out to him.13

Turin Pharmaceuticals is hardly the only drug company to try and maximize profits. ‘Orphan’ drugs (defined as having a serviceable market of under 200,000 patients) have seen similar outrageous price tags. Daraprim is a little more complicated- it’s only taken by around 2000 U.S. patients but is taken for about six weeks which is much shorter than traditional orphan drugs.14 Ironically, what made Shkreli so infamous, the price hike, was legal under the law, although it was later allegedly investigated for price gouging.

Lessons to be Learned from the Shkreli Story

With the benefit of hindsight, here are some safeguards that investors and financial institutions should have implemented:

Safeguarding Individual Investors

Shkreli’s assets were relatively small for a hedge fund, with an equally small number of investors. This is presumably how the funds were able to evade proper due diligence. Still, the investors should have done their homework by checking up on the plan administrator and verifying independently audited performance records and financial statements (preferably by a Big 4 accounting firm). This is especially true if a financial advisor introduced the investor to MSMB.

The funds investors, ‘accredited’ high net worth individuals, should have known better. Of course, just because you have over a million in liquid assets doesn’t mean you’re immune to poor asset management.

Safeguarding Financial Institutions

On the institutional side, executing brokers must have more awareness of their customers when taking on such a major order. Verbally verifying that the customer properly ‘located’ (had proof the shares were prearranged to borrow) isn’t always enough. There is often a locate number or code that is entered into a trading platform when short selling. This is something that should exist even with phoned orders.

If uncovering illegal activity and financial crimes exciting, consider pursuing a career in financial crimes. Increasing demand for fraud investigators, forensic accountants and compliance officers could mean job security and well-paying careers with upward mobility.

1,2,3https://www.bloomberg.com/news/articles/2018-03-08/martin-shkreli-s-journey-from-pharma-exec-to-inmate-87850-053

4,5https://www.cnbc.com/2017/07/05/merrill-lynch-salesman-describes-shock-anger-after-shkreli-lost-7-million-for-merrill-on-short-trade-and-then-threatens-firm-if-it-tries-to-collect.html

6,7https://www.sec.gov/litigation/complaints/2015/comp-pr2015-282.pdf

8,9https://www.nytimes.com/2017/07/30/business/dealbook/jurors-to-decide-in-shkreli-trial-were-desperate-gambits-criminal.html

10,12https://www.npr.org/sections/thetwo-way/2017/08/04/541658697/pharma-bro-martin-shkreli-convicted-of-securities-fraud

11https://www.bbc.com/news/world-us-canada-34331761

13https://www.vice.com/en_us/article/vdx8vx/drinking-wine-and-playing-chess-at-martin-shkrelis-midtown-apartment

14https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5033427/