In a wild turn of events Friday evening, Bernard Madoff's former lawyer sought to intervene on behalf of two potential clawback targets in the $600 million Zeek Rewards Ponzi scheme, disputing the Securities and Exchange Commission's ("SEC") characterization that the scheme violated federal securities laws and seeking to end the brief tenure of the court-appointed receiver. The motion, filed by famed New York criminal attorney Ira Lee Sorkin on behalf on Trudy Gilmond ("Gilmond") and Kellie King ("King"), takes issue with the SEC's determination that the fraud perpetrated by Zeek and its principals involved the sale of securities - thus bringing the operation under the ambit of federal securities laws. King and Gilmond are currently being pursued by the court-appointed receiver, Kenneth Bell, for over $1.5 million in "false profits" they received from the scheme based on an original investment of $4,597 - thus giving them plenty of incentive to seek the requested relief.
The crux of Sorkin's motion focuses on the contention that the 'investment products' at issue - the various methods by which a Zeek participant could build up 'profit points' that included either selling penny auction bid packages or purchasing "VIP bids" and giving them away - did not fit under the definition of a security as defined under §2(a)(1) of the Securities Act of 1933. Instead, the filing continually makes the case that the Retail Profit Pool and the Matrix, central parts of Zeek, were actually
"contractual rights entitling independent contractors to a share of a company’s profits in return for their efforts in promoting the company."
The definition of a security was established in the seminal case SEC v. Howey, 328 U.S. 293 (1946), and was set forth in a four-part test:
- investment of money due to
- an expectation of profits arising from
- a common enterprise
- which depends solely on the efforts of a promoter or third party
Id. at 298. In disputing that the investment contracts did not satisfy this four-part test, the motion strenuously argues that, rather than simply expect profits from the actions of others, Zeek participants took numerous "time-consuming" actions to "earn" those profits, such as enrolling in a monthly subscription plan, recruiting customers, selling penny auction bid packages, and purchasing VIP bids that were to be given away. Indeed, according to Gilmond's affidavit, she spent "twelve to fourteen hours each day working for ZeekRewards." The motion also argues that the profit points earned by affiliates were not shares of stock, as alleged by the SEC.
Importantly, the motion makes no attempt to address the contention that Zeek ran a Ponzi scheme or explain the discrepancy between the amount of profits actually generated by the scheme and the amount represented to participants that was used to determine their "share" of daily profits. As alleged in paragraph 5 of the SEC complaint,
Approximately 98% ofZeekRewards' total revenues, and correspondingly the purported share of "net profits" paid to current investors, are comprised of funds received from new investors
Instead, the motion seeks to spotlight the "work" involved in recruiting new investors that entitled each participant to a share of the daily profits. Simply, while playing up the roles of the scheme participants, the motion does nothing to dispute the central fact - that the advertised payouts and funds used to make those payouts were made possible through the use of investor funds, rather than legitimate profits.
Courts analyzing whether a scheme fits the parameters of a Ponzi scheme have observed that "the definition of a Ponzi scheme is broad and flexible." In re Bayou Group, LLC, 362 B.R 624, 633 (Bankr. S.D.N.Y. 2007). Under this definition, this involves "any sort of inherently fraudulent arrangement under which the debtor-transferor must utilize after-acquired investment funds to pay off previous investors in order to forestall disclosure of the fraud." Id. Thus, rather than a one-size-fits-all approach, courts have held that "there is no precise definition of a Ponzi scheme, and courts look for a general pattern, rather than specific requirements." In re Manhattan Inv. Fund Ltd., 397 B.R. 1, 12 (S.D.N.Y. 2007).
While the motion faces a difficult probability of success, it will not go unnoticed, as it clearly challenges the authority of the SEC and the legitimacy of the receivership. While the motion takes issue with the characterization that no work was performed, it remains, unless proven otherwise, that Zeek was a massive fraud that promised unrealistic returns payable only by using funds from new investors to pay existing investors - the hallmark of a Ponzi scheme. Proceeding under this assumption, and given the large amount of 'false profits' the Recever is seeking from Gilmond and King, the two likely recruited hundreds, if not thousands, of participants into the scheme. Indeed, according to the receiver, Gilmond and King realized a profit of $1.5 million on an investment of less than $5,000 - a return of 30,000%. According to an unnamed source familiar with King and Gilmond, the two were often present at official Zeek "Red Carpet" events to accept their hefty distribution checks. Meanwhile, according to the receiver, possibly over 1 million participants lost some or all of their investment.
The Receiver and the SEC are expected to file their position shortly with the court.
A copy of the Motion is here.