Pharma Bro's trial a test for fraud prosecution

Martin Shkreli (aka Pharma Bro) is best known as the Turing Pharmaceuticals CEO who overnight raised the price of Darprim — an essential drug for AIDS patients — by 5,000 percent, which led the BBC to ask whether he is “the most hated man in America.” (See Shkreli, Drug Price Gouger, Denies Fraud and Posts Bail, by Christie Smythe and Keri Geiger, Bloomberg, Dec. 17, 2015 and Who is Martin Shkreli - ‘the most hated man in America’? by Zoe Thomas and Tim Swift, BBC, August 4.)

However, Shkreli’s unrelated fraudulent activity as a hedge fund manager led to his arrest, trial and conviction on securities fraud. This is the first fraud trial since Bernie Madoff’s to garner such media attention, public interest and academic discussion. But that wasn’t just because of Shkreli’s reputation for frequently and outlandishly using social media or his lawyer quoting Lady Gaga in his opening statement. (See Defending Martin Shkreli: How His Lawyer Aims To Win, by Jacob Frenkel, Forbes, July 5.)

This fraud was also notable because it apparently didn’t leave its investors at a financial loss. In fact, Shkreli eventually repaid all investors with sizeable profits, which led him to denounce the government’s prosecution as a “witch hunt of epic proportions.” (See Why ‘Pharma Bro’ Martin Shkreli Is Swaggering Into Jail, by Misyrlena Egkolfopoulou, Patricia Hurtado and Chris Dolmetsch, Bloomberg, Aug. 4.)

A high-stakes shell game

The government charged Shkreli of running two now-defunct hedge funds like a Ponzi scheme. Prosecutors alleged that he misappropriated investors’ money to start a drug company, Retrophin, and then eventually stole $11 million of assets from that company, in the form of restricted stock, to repay them. They also alleged that Shkreli repeatedly lied to his clients about the size and performance of their investments that MSMB Capital Management and MSMB Healthcare managed. (See Why Martin Shkreli Is Guilty When Investors Didn’t Lose, Fortune, Aug. 5 and the Shkreli indictment.)

According to the Fortune article, federal prosecutors said Shkreli claimed to be a successful Wall Street money manager overseeing as much as $100 million. “But bank records showed that one fund fell to minus 33 cents and never contained more than $3 million,” according to the Bloomberg article.

According to the Bloomberg article, prosecutors said Shkreli also claimed that his fund outperformed the S&P 500 Index while it was actually posting disastrous losses.

It was an insider-turned-whistleblower who brought all of this to the government’s attention. According to court testimony, Jackson Su, the former COO for Shkreli’s hedge fund firm, said he was spurred to make a complaint on the U.S. Securities and Exchange Commission’s (SEC) website because he believed “there was no transparency in the amount of assets” that Shkreli’s MSMB hedge funds had nor in how the company was describing those assets to investors.

“There was variation in the assets under management that were verbally thrown around without any consistency, and that was a red flag for me,” Su testified. His testimony came after several investors in Shkreli’s MSMB Capital fund testified that only after many months of pestering did Shkreli redeem their investments. According to CNBC, those investors said that Shkreli settled their claims by giving them shares of the company, Retrophin. He founded Retrophin after MSMB Capital effectively went broke in 2011 after a massive trading loss.

So, prosecutors claimed Shkreli defrauded multiple hedge fund investors by misleading them about the fund’s performance and then sought to make them whole on their investments by looting Retrophin stock, which he gave them. (See Former officer of Martin Shkreli hedge fund filed SEC complaint against Shkreli while working for fund, by Dan Mangan, CNBC, July 7.)

The circus begins

Shkreli didn’t shy away from using his estimated $60 million in personal wealth to secure a top defense team, led by Benjamin Brafman who heads the list of go-to New York white-collar defense lawyers, according to Forbes. The question many had after his announcement was whether Brafman would be able to control his flamboyant client. The drama started in court with Brafman’s opening statement.

Brafman told the jurors that “[y]ou may not like Martin Shkreli, and you may have reasons to hate Martin Shkreli, but that is not a basis on which to convict.” He described his client as an eccentric genius and then, in a softer, almost harmless negative descriptor, as an “odd duck.”

Brafman also quoted a Lady Gaga song in describing Shkreli as “born this way.” According to Forbes, Brafman strategically set the stage to spin and ultimately argue that his client’s conduct, even if the jurors found it offensive, is the behavior of a brilliant weirdo. Brafman argued that Shkreli made his investors whole again after a failed risky investment, despite being under no obligation to reimburse them. (See Defending Martin Shkreli: How His Lawyer Aims To Win, by Jacob Frenkel, Forbes, July 5.)

Brafman also quoted a Lady Gaga song in describing Shkreli as 'born this way.'

He asked why Shkreli bothered to repay the MSMB investors when he could’ve just walked away. Brafman argued that Shkreli didn’t really profit from the scheme at all and said this was a victimless case because every investor earned a profit. (See Jury in Martin Shkreli Fraud Trial Has Questions for the Judge, by Stephanie Clifford, the New York Times, August 1.)

According to Rolling Stone, Brafman told jurors that the charges were “ ‘rich people B.S.’ and explained that he felt like ‘a lifeguard on a beach’ who feared ‘not to be able to rescue someone.’ He said Shkreli was ‘floating in his own little world’ and told jurors he needed their help ‘to try and save’ him from drowning.” (See Martin Shkreli: 5 WTF Moments From Pharma Bro Trial, by Eric Killelea, Rolling Stone, July 28.)

However, while his top lawyers stuck to their defense strategy, Shkreli couldn’t control himself and repeatedly spoke to reporters and others in the courthouse and on social media. According to the Rolling Stone article, Shkreli went on a surprise lunch-break rant during which he called the prosecution “junior varsity” and said that his critics “blame me for capitalism.”

According to the Rolling Stone article, Brafman reportedly had to enter the lunchroom to wrangle his client out. Because of this, prosecutors filed papers with Judge Matsumoto, writing that Shkreli could influence jurors by “roaming the halls of the courthouse commenting” and that he was “riling up his social media following.” However, Brafman “argued that Shkreli had ‘a demonstrated history of significant anxiety’ because he felt attacked by the media and ran his mouth as ‘defensive measures,’ ” according to Rolling Stone.

According to the Rolling Stone article, prosecutors felt the need to ask Matsumoto to issue a gag order on Shkreli because he’d “embarked on a campaign of disruption” and had made “a spectacle of himself and the trial directly on the courthouse grounds.” The judge issued a modified gag order, but that didn’t prevent Shkreli from sharing his thoughts on Facebook Live and in YouTube videos.

The question of intent

The jury deliberated for two full days before coming back to request instructions from the judge. Following closing arguments, jurors heard a reading of 90 typed pages of instructions. Specifically, they asked the judge to clarify the meaning of “assets under management” and “fraudulent intent.” Legal observers saw this as a good sign for the defense. (See Jurors ask about fraud ‘intent’ at Martin Shkreli trial and then recess for day, as ‘pharma bro’ reads Warren Buffett biography, by Dan Mangan and Rachel Pak, CNBC, August 1.)

It seemed possible that his defense team had been successful in planting doubt among the jurors that Shkreli, with his genius and eccentric behavior, had actually intended to “defraud” his investors. The defense team had argued repeatedly that the investors were sophisticated and understood the risk of investing in “high risk” hedge fund investments.

According to the August 4 Bloomberg article, “Why ‘Pharma Bro’ Martin Shkreli Is Swaggering Into Jail,” investors said they’d nicknamed Shkreli “Rain Main” after actor Dustin Hoffman’s autistic savant character in the 1988 film. “Day and night, Shkreli would focus on a single market. While building Retrophin, witnesses said, Shkreli would work around the clock with a sleeping bag in his office, often at the expense of his health and his hygiene,” according to the article.

Does fraud pay?

Not surprisingly, the jury returned a split verdict. Although the government had sought convictions on a total of eight charges of fraud and conspiracy, the jury found Shkreli guilty on only three of the eight charges. Most importantly for Shkreli, he was found not guilty on the charge that would’ve forced him to forfeit the majority of his personal wealth.

According to the Aug. 4 Bloomberg article, after the trial, Shkreli addressed the press. “This was a witch hunt of epic proportions. … Maybe they found one or two broomsticks but at the end of the day we’ve been acquitted of the most important charges in this case,” Shkreli said.

Because he wasn’t found guilty of actual damages to the victims, Shkreli can expect, even with his brash behavior in and out of the courtroom, to receive a light sentence as prescribed under the Federal Sentencing Guidelines (FSGs).

Although each charge carried a maximum jail time of 20 years, Shkreli has publicly stated that he expects less than a year, if not probation. “It doesn’t seem like life will change very much for Martin Shkreli, basically ever,” said Shkreli on his YouTube channel. “I think I can get probation. I think there’s a decent chance that there’s a complete vacation of the charges for any sentence.” (See ‘I Think I Can Get Probation.’ Martin Shkreli Unshaken After Fraud Conviction, by Mahita Gajanan, Time magazine, Aug. 4.)

Regardless of Shkreli’s bravado, as of press time, a federal judge on Sept. 13 nullified his $5 million bail because in Facebook posts he offered $5,000 to anybody who would “grab a hair” from Hillary Clinton during her recent book tour.

Other organizations carefully lying?

After researching this case at great length, I must admit that even as a fraud examiner, I felt unsure about the outcome of this trial. I’ve never been involved with a case in which the fraudster made the victims whole before even being charged with a crime. Certainly, I haven’t seen one in which the victims actually made a profit.

After researching this case at great length, I must admit that even as a fraud examiner, I felt unsure about the outcome of this trial.

After reading about Shkreli’s activity on social media, I reached out to him to see if he wanted to share his point of view with me for this column. Although he did accept my invitation to connect on LinkedIn, he declined to speak with me about the case. Maybe my openness and honesty about my CFE credential influenced his decision.

Only after his sentencing will we know if Shkreli’s high-stakes game of investment oversight and entrepreneurship will end up costing him the one thing he seems to treasure the most: his freedom to say whatever he wants via social media.

As reported in the Aug. 4 Time magazine article, Shkreli would consider running a hedge fund again, but that would require him first to get all three convictions overturned on appeal. I have a feeling even now he’d find investors willing to take the risk.

Steve C. Morang, CFE, CIA, CRMA, is a senior manager at a Northern California-based CPA firm and president of the ACFE’s San Francisco Chapter. His email address is: steve.morang@yahoo.com.