The court-appointed bankruptcy trustee tasked with recovering assets for victims of the $3 billion TelexFree Ponzi and pyramid scheme has filed a lawsuit seeking to force nearly 80,000 participants to return over $1 billion in collective profits realized from the scheme. Stephen Darr, the bankruptcy trustee, filed an adversary proceeding against thirty-three of the top "net winners" from the TelexFree scheme, who realized more than $26 million in collective profits, as well as a "class" of approximately 78,000 net winners who reside outside the United States. The tactic, which has been used at least once in a similarly complex Ponzi scheme, seeks to efficiently recover the sums from a large number of defendants without the expense and procedural morass of filing separate lawsuits against each of the defendants.
TelexFree raised billions of dollars from hundreds of thousands of investors through the sale of a voice over internet protocol (“VoIP”) program and a separate passive income program. The latter was TelexFree's primary business, offering annual returns exceeding 200% through the purchase of "advertisement kits" and "VoIP programs" for various investment amounts. Not surprisingly, these large returns attracted hundreds of thousands of investors worldwide, and participants were handsomely compensated for recruiting new investors – including as much as $100 per participant and eligibility for revenue sharing bonuses. Ultimately, while the sale of the VoIP program brought in negligible revenue, TelexFree's obligations to its "promoters" quickly skyrocketed to over $1 billion.
In April 2014, after multiple attempts to modify the passive income program both to rectify regulatory deficiencies and to curb increasing obligations, TelexFree quietly filed for bankruptcy in a Nevada bankruptcy court. While it appeared that TelexFree had hoped to use the bankruptcy proceeding to eliminate its obligations to its "promoters" and extinguish any ensuing liabilities, the filing immediately attracted scrutiny and was followed shortly by enforcement actions filed by the Securities and Exchange Commission (the "Commission") and Massachusetts regulators. The Commission then moved to transfer the bankruptcy proceeding to Massachusetts, where the company was headquartered and where the Commission had filed its enforcement proceeding. Despite vehement objections by TelexFree, that effort was ultimately successful, and the appointment of an independent trustee, Mr. Darr, shortly followed.
TelexFree's founders, James Merrill and Carlos Wanzeler, were later indicted on criminal fraud charges, with Wanzeler currently a fugitive and believed to be in Brazil.
In a June 2015 hearing, Mr. Darr disclosed that approximately 70,000 unique member accounts realized a net profit from their involvement in TelexFree, meaning that the profit distributions they received over the course of the scheme were greater than their investment. Mr. Darr further divulged that each "net winner" had realized an average profit of $20,000 - meaning that the universe of potential clawback suits could exceed $1 billion in recoveries.
The initial adversary proceeding is directed at the approximately 78,000 net winners who reside outside the United States, with a footnote in the complaint indicating that the trustee intended to file a separate adversary proceeding to recover from the approximately 15,000 net winners that reside in the United States. A chart from the complaint listing the named defendants and the amount of their profits is below:
While the recovery of profits paid to Ponzi investors is well recognized by courts, the trustee is also wading into new territory in seeking to recover those participants' receipt of any funds from investors they recruited in what the trustee refers to as a "triangular transaction." As TelexFree incentivized its members to recruit new members by paying commissions to the recruiting member, it offered those recruiting members the ability to pay for the new member's membership plan by redeeming accumulated credits in that recruiting member's account. Conceptually, the transaction is akin to a recruiting member redeeming those accumulated credits, which were paid as purported returns on that member's investment, and thus the trustee is taking the position that the transaction effectively represented an additional way for a member to monetize their payable interest credits.
Lawsuit Names "Net Winner Class"
In addition to the thirty-three named defendants, the trustee is also seeking to establish a framework by which he may pursue all net winners through the creation of a Net Winner Class. Rather than filing separate lawsuits against each of the 78,000 net winners, the creation of a Net Winner Class will allow the trustee to establish his claims against each of those net winners in a single adversary proceeding - a hugely efficient method that willnot only greatly reduce the complications and redundancy in bringing the same claims against thousands of individuals, but in doing so will also preserve assets for future distribution to those victims who were not as fortunate. For example, the move will results in savings alone of at least $31 million from not having to file filing fees for 78,000 separate lawsuits.
The use of a Net Winner Class, while rare, is not unprecedented and indeed has been recently approved in a similar context. The court-appointed receiver for the Zeek Rewards Ponzi scheme, which duped tens of thousands of investors out of at least $600 million, sought to use an identical procedure when he asked a North Carolina federal court to approve a class of 9,400 net winners who had each profited by at least $1,000. There, the receiver, Kenneth D. Bell, successfully argued over the objection of the proposed net winner class that his request satisfied the requisite criteria prescribed by Rule 23 of the Federal Rules of Civil Procedure.
Mr. Darr has filed a motion seeking court approval for certification of the Net Winner Class. The certification of the class will not only result in an efficient mechanism to pursue thousands of clawback claims, but also will avoid the nightmare scenario of potentially having inconsistent results if Mr. Darr were forced to pursue each of the net winners individually. Additionally, doing so would have resulted in exponential costs to Mr. Darr that would serve only as a dollar-for-dollar reduction in assets that could potentially be later returned to victims. Finally, allowing the pursuit of clawback claims in a class action also increases the total potential recoveries by allowing Mr. Darr to target net winners with a lower threshold of clawback claims that might not have been a realistic target in the context of a separate action.
A copy of the Complaint is below: