Flagrant Fraud

Read more about the convictions and sentences of Berkeley Pharmaceutical executives here.

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A lurid corruption saga came to a conclusion in late August when Steven E. Warshak, president and owner of Cincinnati-based Berkeley Premium Nutraceuticals, was sentenced to 25 years in prison. Several other employees and executives received jail time as well, including General Counsel Paul J. Kellogg and Harriet Warshak, the company founder's 75-year-old mother, who held various positions in the company.

In February, a federal jury in the Southern District of Ohio convicted Steven E. Warshak on 93 criminal counts, including conspiracy, obstruction, mail fraud, bank fraud and money laundering. Harriet Warshak was convicted on eight counts and sentenced to two years (although her sentence has been stayed due to poor health). Kellogg got a year and a day for six counts of conspiracy and money laundering.

The jury also convicted the company on 15 counts, including conspiracy, mail fraud and misbranding. TCI Media Inc., a Warshak-owned business used to mislead banks and credit card companies, was found guilty of 21 counts of money laundering.

All told, more than $500 million in fines and forfeitures were levied against Warshak's companies. Berkeley filed for bankruptcy in September--illustrating the way risk and consequences can escalate in the face of bad decision-making.

Pravin B. Rao, former assistant U.S. attorney and SEC enforcement branch chief, puts it as succinctly as one can: "Almost all the things companies can do wrong, this company did."

Scam with a Smile

Most of the misdeeds surrounded the company's flagship brand, Enzyte. The ubiquitous, campy TV ads for the product featured "Smilin' Bob," a goofy-looking guy whose broad grin was a result of Enzyte's promised "natural male enhancement."

Smilin' Bob

It's tempting to look at the Berkeley convictions as a simple matter of comeuppance for a snake oil salesman and his cohorts. But this was no small operation.

"The government could throw the kitchen sink here, and it would be legitimate," says Rao, a partner at Perkins Coie. "The interesting thing is, it's stuff that legitimate companies could run into problems with. One of the most interesting things is [GC] Paul Kellogg. For an inside counsel to get so embroiled in this is amazing. He was completely intertwined with the process."

The 91-page criminal indictment outlines how Berkeley relied on false or misleading advertising to lure clients, used abusive billing practices to keep them and then deliberately misled investigators, laundering money and hiding assets while purporting to cooperate.

At each step of the process, the venture ran afoul of a different federal agency and the scope of the fraud scheme expanded.


False Claims

Although the Smilin' Bob ads used not-so-subtle innuendo to get the point across, other advertising for Berkeley products contained blatantly false claims about the supplements' effectiveness, cited nonexistent research and used endorsements from fictitious doctors. Ads also included money-back guarantees that the company, by policy, would not honor.

"Companies are required, in their advertising and marketing materials, not to be false or misleading," explains Ron R. Urbach, who leads the advertising law group at Davis & Gilbert. "If you make a claim, you have to have actual substantiation and support for that claim."

Urbach adds that law departments often fail to properly vet ads and marketing materials and fail to understand the broad spectrum of potential claimants.

"You could have a regulatory action, federal or state," he says. "You could have a competitor action. You could have an individual consumer action or a consumer class action."

Some states have particularly low thresholds for violation--a lowest common denominator presumption geared to protect the least sophisticated customers. Other states, due to political considerations, have more aggressive attorneys general.

That Berkeley was in the area of personal health made matters worse.

"The Federal Trade Commission is very aggressive about going after any company that makes outrageous health claims, whether it be regarding diet, sexual performance or general health," cautions J. Forrest Hinton, a shareholder at Baker Donelson. "And the bigger you are, the bigger target you are."

Once Berkeley snared customers, it used its "continuity program" to keep them. Customers who requested free samples found their credit cards charged for monthly shipments. If they protested or tried to cancel, they were directed to a nonexistent customer care specialist.

Moreover, the company played games with credit card companies, resubmitting declined charges with fabricated expiration dates or splitting transactions into multiple charges to manipulate statistics that might trigger a card company investigation.

Taken individually, the company's advertising and billing practices may not have risen to the level of criminal charges. But the more the pattern of wrongdoing emerged, the more egregious and willful the company's behavior appeared.

"Once you start doing things like creating this fictitious director of customer care, it's hard to say this is just a glitch in your accounting system," Rao says.

As he reviewed the case, Judge S. Arthur Spiegel reportedly stated that a key aspect of Warshak's strategy depended on the belief that most customers would not come forward out of embarrassment. That belief proved false. The trial featured testimony from customers across the country, in addition to that of investigators from several federal agencies.


Out of Control

The actions Berkeley's management took between 2002 and 2004, before federal investigations expanded into criminal prosecution, sealed their fate.

In one particularly damning example, Kellogg directed employees to hide a truck full of supplements under suspicion of misbranding from Food and Drug Administration investigators.

"When the regulator comes knocking, that's when you can stop things from mushrooming out of control," Rao says. "I think the way they dealt with the FDA and the FTC ramped it up to the criminal side."

Regulators meet regularly with criminal authorities to discuss their current cases. As prosecutors consider the cases they might pick up, any suspicion that the company is hiding information is a red flag.

As a practical matter, it's much easier to prosecute an obstruction case than something like securities fraud, so prosecutors always have an eye out for situations where someone may have lied to investigators. Better to fess up early and pay a fine than risk an indictment that could put the company out of business. But don't attempt half measures.

"If you ma ke t he decision to cooperate with regulators, you better do it fully," Rao advises. "Anything less will be construed as obstruction and will instantly turn it into a criminal case. Here it looks like they were making a surface effort to cooperate with the FTC, but at the same time they were setting up trusts on the side to funnel money out and make it look like they had fewer assets."

The final twist of the knife was Kellogg's involvement. Once the general counsel's role in fraud is proved, the floodgates are opened.

"The crime fraud exception trumps attorney-client privilege," Rao says. "That's how a lot of the documents got in. It's a huge danger in general, once you have in-house counsel involved."

Contributing Author

Steven Andersen

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