Over the last several months, Citizens for Responsibility and Ethics in Washington’s (CREW) old foe Martin Shkreli has become a household name after he acquired the rights to an obscure drug, jacked up the price more than 5,000 percent, defiantly called it a legitimate business move and Twitter-trolled the entire world. After a lot of public heat, he finally agreed to lower the price of the drug. But then he didn’t. Last week he announced he would keep the drug at its new price – a whopping $750.
Way back in 2012, CREW filed complaints with the Securities and Exchange Commission and Department of Justice after it appeared Mr. Shkreli deliberately tried to persuade the Food & Drug Administration to deny approval of drugs produced by pharma companies he had shorted. Unlike traditional long investing in which investors buy low and sell high, short sellers do the reverse: first they sell high and then they buy low. If a short seller believes a stock is overvalued and trading at an artificially inflated price, he or she will borrow shares from a hedge fund or brokerage firm and sell them on the open market. If and when the price drops, the short seller then buys the stock, returns the shares to the original owner and pockets the difference.
Even though Mr. Shkreli had no scientific or medical background, he made highly scientific but suspect arguments about the efficacy of certain drugs, and then took those arguments public to the investing community. Soon afterwards, the stock prices for those companies experienced significant decreases, which resulted in a windfall profit for Mr. Shkreli. CREW asked federal authorities to investigate what seemed to be blatant market manipulation.
Mr. Shkreli’s latest shenanigans are a throwback to his days as a hedge fund manager. Last month, KaloBios (KBIO), a failing pharmaceutical manufacturer based in California, announced it would start winding down and close its doors for good next year. Just three days later on November 16, however, Mr. Shkreli, along with an investment group and a former hedge fund partner, quietly began buying up a boatload of shares, making them the majority shareholders in KBIO. The company then announced Mr. Shkreli was named CEO and the company acquired new financing.
In the days following the acquisition, KBIO shot up from $2.07 on November 18 to an incredible $45.82 just five days later.
So, the simple question is: why would KBIO’s stock shoot up so drastically after the announcement of Mr. Shkreli’s takeover? The answer: it didn’t. While bull rallies thrive on big news of a new CEO or large stock positions taken by big market honchos, the acquisition of KBIO by the infamous Martin Shkreli likely did not drive the action. Investors were not buying KBIO to hold for the long term because they thought it will develop groundbreaking pharmaceutical products in the future. No, they were most likely buying KBIO because they had shorted it prior to Mr. Shkreli’s acquisition and were facing the dreaded “short squeeze” as the stock climbed.
The news that KBIO would not be closing and the massive purchase of shares by Shkreli drove KBIO upwards. Additionally, there were nearly 250,000 shares sold short. Many on the short side scrambled to buy up the stock before it went up further, which also had the effect of increasing KBIO’s share price.
This is a surge known as the “short squeeze”, when short sellers have to frantically re-buy their shares of a rising stock and return them to their original owner. Otherwise, they stand to lose an infinite amount of money if the price keeps going up and up and up. One investor who had short sold KBIO stock lost more than $100,000 in one day during the KBIO spike.
KBIO’s resurgence is all an illusion, based entirely on stock market shenanigans. As Gawker noted, Mr. Shkreli has successfully leveraged his newfound notoriety to play the stock market like a “pan flute”. This looks like market manipulation at its most cunning, but also at its most corrupt.
The curious case of KBIO however may be the final hurrah for Mr. Shkreli as authorities are reportedly finally taking note. If the SEC had heeded CREW’s call years ago, Mr. Shkreli might already be out of business, meaning that patients would have affordable access to an important drug, and the stock market would be just a little more fair and stable.