Prosecuting Ponzi Schemes: What We Can Learn From Martin Shkreli’s Trial

Remember Martin Shkreli? I wrote about him some months ago. Shkreli’s securities fraud trial started last week. He became the poster child for all that is wrong with the pharmaceutical industry when he raised the price of a common drug used to treat newborns and HIV patients from $13.50 to $750 per pill.

Among other things, Shkreli created two hedge funds and Retrophin, a biopharmaceutical company.  Shkreli told investors he had a successful track record as a hedge fund manager. That was probably true. Shkreli had been on Wall Street since he turned 17 years old and was, for a time, a highly sought-after trader.

Shkreli is accused of effectively running a Ponzi scheme. In this case, Shkreli personally lost millions of dollars trading. He drained money from one company to cover his trading losses, formed Retrophin, and sought investors to raise money to replace the money he drained from another company. Whether or not that is true remains to be seen. There is no doubt, however, that Shkreli’s investors, the people who invested in Retrophin, made lots of money.

Securities violations are one way of prosecuting Ponzi schemes. Another way, and arguably simpler from the perspective of a prosecutor, is mail and wire fraud. There are some wire fraud counts in Shkreli’s case. Either way, the fact that Shkreli’s investors made money doesn’t help him. What matters in a prosecution of this kind is whether or not Shkreli told investors the truth when he was trying to get them to invest with him. If he lied, or omitted certain relevant facts, no amount of profit is going to help him. Maybe.

Shkreli’s investors weren’t ordinary people. They were extremely rich, highly experienced investors.  They had prior involvements with in hedge funds. Some of the investors have been described as “fabulously wealthy.”  Long story short, the disclosure obligations someone seeking investors has to experienced investors is different than the duties to the average investor. It’s never permissible to lie to get someone to invest money, but qualified investors, also called accredited investors, is a statutorily defined term. Accredited/qualified investors can deal in securities that are exempt from various SEC rules.

Sarah Hassan was one of Shkreli’s investors. Last week, she testified that she invested $300,000 with Shkreli. Hassan’s father, Fred Hassan, is a former chairman of Bausch & Lomb, former chief executive of Schering-Plough, and a partner at Warburg Pincus. Schering-Plough is a pharmaceutical company. Warburg Pincus is a private equity firm. In other words, in certain circles, Sarah Hassan’s and Fred Hassan’s names carry influence. Lots of influence.

Shkreli pitched Sarah Hassan to invest additional funds into his new business Retrophin. Retrophin was supposed to sell “orphan drugs,” drugs that treat rare conditions. Shklreli allegedly told Hassan she could make a lot of money because the price per patient of orphan drugs was really high.

One problem, according to Sarah Hassan, was that Shkreli kept cc’ing her father on emails. And listed Fred Hassan among Shkreli’s investors. Fred Hassan was reportedly listed as an investor on tax documents. It took Sarah Hassan quite some time to get her money out of Retrophin, but when she did, she more than tripled her money.

Here’s an example of where this case gets challenging for both sides. If Shkreli lied and used Fred Hassan’s name to impress perspective investors and Shkreli was trying to get non-qualified investors to invest with him, such conduct would almost certainly be an easy conviction for the prosecution. The representation that Fred Hassan invested would likely be material to a decision made by a non-qualified investor. On the other hand, even if Shkreli lied about Fred Hassan’s involvement with the company and he was pitching qualified investors, the question of whether the lie was material becomes a much closer call.

Experienced hedge fund investors and others who are “fabulously wealthy” are so financially sophisticated they can make risky investments without the protections of the Securities and Exchange Commission. In other words, the law will assume qualified investors aren’t going to make an investment just because there are big names involved. But under the right set of circumstances, such a lie could be material. And there is no doubt that the investors in Retrophin made money. Lots and lots of money.

Shkreli’s lawyer, in his opening statement, acknowledged Shkreli sometimes played fast and loose with the facts but that the documents and arrangements the government is relying on were blessed by lawyers or Retrophin board members. Playing fast and loose with the facts can be a problem when it comes to talking with investors. But again, it really depends on which facts were fast and loose,  when those conversations happened, why, and so on.

One thing is sure: Shkreli’s lawyer told the jury in his opening statement to “Hang on. It’s going to be a wild ride.” That it is.