Clearing Up The Shkreli Confusion

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Shortly before lunchtime on Thursday, Turing Pharmaceuticals CEO, the FBI arrested Martin Shkreli at home, on charges of securities fraud. Much of the media is focusing on his Daraprim price rise, and it seems there exists some confusion as to the driving factor behind his arrest. We’ve got access to the official indictment documents, so let’s try and clear up the confusion.

We’ll begin by saying that, officially at least, the arrest has nothing to do with price hikes. What Shkreli did with daraprim, while questionable from a moral perspective, is perfectly legal and happens all the time in biotech. Having said this, bad press on a global scale makes you a hot target for the authorities, so there is always a chance that, indirectly, the Daraprim situation turned the authorities on to Shkreli and spurred the investigation. That, we will probably never know.

So to the case in hand. It’s all rooted in a hedge fund Shkreli started in 2009 called MSMB Capital. He, his lawyer and an unnamed (but known to the authorities) third party referenced in the indictment as Co-conspirator 1, reportedly attracted investor capital through the misrepresentation of performance records, capital under management and the retaining of an independent auditor.

Under the terms of any investment, Shkreli and partner was set to take a 1% management fee, and the general partner would receive 20% of the limited partners’ (the investors’) net profits for the year in question. The start of the case kicks off with Shkreli inducing a $700,000 investment from four unnamed partners, without disclosing that he had already lost all of the funds from his previous hedge fund, and that he had an outstanding $2.3 million default against him from Lehman Brothers that came about as a result of his previous trading activity.

He then went on to elicit a total of approximately $3 million across a period of about three months from an individual capital partner, having convinced this partner that MSMB had $35 million under management, and that the funds auditors were Rothstein, Kass & Company, P.C. Neither of these claims were true. The fund had no independent auditors at the time, and capital under management was less than $700, with Shkreli having lost the already mentioned $700,000 through his trading activities. Through a series of misrepresented shorts (one notable in Orexigen Therapeutics, Inc. (NASDAQ:OREX) for Shkreli’s misrepresentation to Merrill Lynch that he has located shares to borrow), the funds declined from low single digit millions to less than $60,000 in February 2011.

From here, things get messy. Shkreli starts fabricating performance reports, and sending out emails claiming that the new incarnation of MSMB – MSMB healthcare – now had $55 million under management and that its partners (investors) had all made good returns, when in reality their capital had depleted to practically nothing. This is where Retrophin, Inc. (NASDAQ:RTRX) comes in to the picture. Shkreli used a $900,000 equity investment in the biotech (reclassified as an interest bearing loan) to start transferring funds from Retrophin to MSMB, which he then used for a variety of purposes. Specifically, the repaying of the money owed to Merril Lynch, personal debts and a range of other MSMB liabilities.

It doesn’t end here, however. Over the next 12 months, Retrophin received nearly $5 million in investment from MSMB healthcare (according to the books) but when audited by an accounting firm, no such funds had come from either MSMB capital or Healthcare. The SEC started sniffing around, and Shkreli responded by saying he was shutting MSMB operations down and returning funds to its partners.

This is where things start to unravel. Here Shkreli and his lawyer conspire to pay MSMB investors off using Retrophin capital, recording the payoffs as a combination of Retrophin stock and cash payments listed as “consulting agreements”. By listing as consulting, the pair could avoid reporting the payments in the company financials.

And that’s an outline of the whole situation. Of course, a piece of this length far from does the case justice – the details are fascinating (they include email correspondence between the relevant parties). You can read the whole thing here. Hopefully, we’ve cleared up a bit of the confusion surrounding Shkreli’s situation, however. This is not about rising the price of drugs – it’s about misrepresentation.

As a final note, it’s worth mentioning that this is all as yet unproven, and as things stand the allegations are just that – allegation. It makes for great reading however, and finally offers some insight into the ongoing legal battle between Shkreli and Retrophin we’ve heard so much about over the last few months. Let’s see how things play out.

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