Pivotal TelexFree Bankruptcy Hearing Set For Friday

Lawyers for a telecommunications consortium accused of operating a $1.1 billion pyramid and Ponzi scheme are set to square off against government lawyers in a Nevada bankruptcy courtroom on Friday morning over the future of the three-week old bankruptcy case. TelexFree, LLC, which declared bankruptcy along with two related entities on April 13, 2014, is seeking to forge ahead with a bankruptcy proceeding to strengthen a legitimate voice-over-internet-protocol (VoIP) business that was hampered by overwhelming payment obligations to "promoters" that marketed its business. The Securities and Exchange Commission and other agencies dispute this characterization, instead alleging that the bankruptcy proceeding is a sham and that, in reality, TelexFree was a massive fraudulent scheme that may have raised over $1 billion from victims based on the guise of a nearly non-existent VoIP business. A pivotal hearing scheduled for tomorrow will likely set the tone for proceedings going forward and offer a glimpse into how well-received TelexFree's efforts will be.

Background

Late in the evening on April 13, 2014, a trio of nearly identical bankruptcy petitions were filed in the Nevada bankruptcy court. Blaming the company's financial woes on an ill-fated change in compensation plan to promoters, TelexFree vowed to use bankruptcy to restructure company debts and emerge as a stronger company. However, 36 hours later, both the Massachusetts Securities Division ("MSD") and the Securities and Exchange Commission ("SEC") filed actions in Massachusetts accusing the company of operating as a massive Ponzi and pyramid scheme. While the MSD filed an administrative proceeding, the SEC's civil enforcement action sought and was granted a temporary asset freeze against TelexFree's assets. During a raid on TelexFree's Massachusetts headquarters that same day, federal agents discovered more than $38 million in the possession of TelexFree's acting CFO, Joe Craft.

In the ensuing two weeks, a flurry of activity took place on the Nevada bankruptcy court docket. The first significant filings were by TelexFree. In a flurry of "first day" motions, TelexFree asked the court for authority to, among other things, reject the compensation obligations it had incurred to what it estimated were over 700,000 "promoters" involved in the multilevel marketing aspect of its business. Several days later, TelexFree sought a six-week delay to file financial disclosures that were customarily required within two weeks of a bankruptcy filing, citing in support the significant resources devoted to addressing the MSD and SEC actions as well as the fact that the search warrant executed on its Massachusetts headquarters had deprived it of access to its files.

While TelexFree had perhaps envisioned a subdued response to their bankruptcy filing, the ensuing MSD and SEC actions brought intense scrutiny to the Nevada proceedings. A week after the filings, the U.S. Trustee made waves when she petitioned the court for the appointment of an independent bankruptcy trustee, arguing that "compelling evidence of fraud...[and] reasonable grounds to suspect...criminal conduct" warranted the immediate appointment of an independent fiduciary. This motion was followed by the SEC's Motion to Change Venue, which argued that the bankruptcy proceeding was nothing more than a "coordinated effort to avoid the Massachusetts courts" and that a weighing of pertinent factors warranted a transfer of the bankruptcy proceedings to a Massachusetts bankruptcy court where they could proceed alongside the SEC's civil enforcement proceedings in Massachusetts district court. Unsurprisingly, TelexFree has filed objections to each of these motions, and has sought to void certain parts of the SEC's temporary restraining order based on conflicts with the bankruptcy court's authority.

At least ten motions are set to be heard tomorrow in a hearing scheduled for 9:30 A.M. MST. From the parties' respective filings, the tone likely to be taken by each side is fairly evident. In each of its filings, TelexFree has included the same verbatim narrative touting the future of the company and paying little heed to the allegations that the company made numerous material misrepresentations to investors in raising at least hundreds of millions of dollars. The company's filings have increasingly sought to focus on the present-day change in management and future business while distancing itself from the company's tumultuous past.  In contrast, the SEC and the U.S. Trustee have consistently opposed TelexFree's efforts to seemingly erase nearly two years of allegedly rampant fraud in favor of focusing on an aspect of its business that grossed approximately $1 million since November 2012.  As the SEC stated in a recent brief, TelexFree is "in reality, a fraudulent enterprise not capable of reoganization."

The company seeks a "do-over" that totally excuses the alleged rampant violations of securities laws through the U.S. Bankruptcy Code under the guise that the company is now (and can be going forward) a legitimate business. Perhaps adding insult to injury, the many millions of dollars that will be - and have already been - paid to the professionals hired to assist the company's path through bankruptcy will inevitably come from investor funds; the SEC has charged that the company took in only $1.2 million in revenue from November 2012 to March 2014 despite incurring $1.1 billion in obligations to "promoters." The SEC and U.S. Trustee have come out strongly against TelexFree's efforts, with the SEC urging the court to either transfer the case to a Massachusetts bankruptcy court or to abstain from further proceedings.

Possible Scenarios

There are several possible scenarios that could result from tomorrow's hearing. Due to the numerous motions scheduled for hearing, it is possible that Judge August Landis could take many or all of the motions under advisement - that is, not make an immediate ruling. However, due to the time constraints involved in the Massachusetts proceedings, it stands to reason that some rulings may be made. The decisions will depend first on whether the court allows the bankruptcy to proceed. The SEC has urged the court to abstain from hearing the cases or suspend the proceedings while the SEC's enforcement action proceeds in Massachusetts, arguing the bankruptcy is nothing more than a delay tactic. If the court grants that motion, then the remaining motions can likely be tabled until further notice as proceedings would halt while the Commission's enforcement action proceeds. This would most likely be a death knell to TelexFree's hopes of reorganization, and an appeal would likely ensue.

In the event the Court does not abstain from hearing or suspend the proceedings, the SEC has also asked for the transfer of the cases to Massachusetts. TelexFree has opposed this motion as well, as this would also serve to speed up the proceedings. Assuming the bankruptcy does move forward, it appears likely that the U.S. Trustee's motion for appointment of an independent trustee would be granted in the face of the serious allegations made by the MSD and SEC. This, too, would likely be detrimental to Telexfree's plans to control its destiny in bankruptcy.

Of note, the background of the presiding bankruptcy judge likely weighs against TelexFree's efforts. Judge August Landis was appointed to the bankruptcy bench in November 2013, having served in the U.S. Trustee program since 2005 and most recently serving as the acting U.S. Trustee for the Nevada region since 2010. The current U.S. Trustee, Tracy Hope Davis, was the individual that likely replaced Judge Landis and who filed the motion for appointment of an independent trustee over TelexFree. Judge Landis's history as a U.S. Trustee, including his understanding and grasp of bankruptcy law, leave him well-prepared for tomorrow's hearing.

Previous Ponzitracker coverage of TelexFree is here.

New York Fund Manager Pleads Guilty To $96 Million Ponzi Scheme

Authorities announced that a New York investment fund manager has agreed to plead guilty to charges he masterminded a $96 million Ponzi scheme that diverted investor funds to purchase a 117-room Montauk beachfront resort among other things.  Brian R. Callahan, 44, will plead guilty to one count of securities fraud and one count of wire fraud.  In exchange, prosecutors agreed to drop over twenty remaining charges originally brought in an August 2013.  Callahan could face up to a forty-year prison term if he receives the maximum sentence under the charges, 

Authorities indicted Callahan and his brother-in-law, Adam J. Manson in August 2013.  According to the indictment, Callahan managed multiple offshore investment funds organized in Nevis and the British Virgin Islands. Several of these funds operated as "fund-of-funds", meaning that they purportedly used investor funds to invest in other hedge funds.  Callahan told investors that their funds would be invested in various New York hedge funds, and required a $5 million minimum investment.  Another fund, the Fiduciary Select Income Fund, LP ("Fiduciary"), advertised itself as a short-term investment similar to a money market fund, but claimed above-average returns through investments in high-dividend stocks, bonds, and certificates of deposit.  Investors were provided with regular account statements purportedly showing consistent account growth.  In total, the funds raised nearly $120 million from at least 40 investors, including the Montauk, N.Y. volunteer fire department and a Maryland investor that alone lost $11 million.  

However, rather than using investor funds as promised, the men diverted tens of millions of dollars for a variety of unauthorized purposes and used new investor funds to make payments to existing investors in Ponzi-scheme fashion.  Investor funds were used for a myriad of personal expenses, including credit card bills, golfing club dues, down payments on multiple houses, and payments for luxury automobiles including a Range Rover and BMW.  The men also acquired a 10-acre property in Montauk, New York, that consisted of multiple buildings and beach-front cottages.  

A copy of the indictment is below:

Callahanmason Indictment

Tiger Woods Foundation Faces $500,000 Clawback Suit From Stanford Receiver

The court-appointed receiver overseeing recovery of assets for Allen Stanford's massive $7 billion Ponzi scheme has filed a lawsuit seeking the return of more than $500,000 donated by Stanford to charitable organizations headed by golfer Tiger Woods.  Ralph Janvey, the court-appointed receiver, filed suit against the Tiger Woods Foundation and the Tiger Woods Charity Event Corp. (the "Woods Entities") in a Texas federal court, alleging the entities received fraudulent transfers of $502,000.  

The "clawback" suit, as it is known, seeks the return of funds that were transferred to a third party.  Under state-specific fraudulent transfer laws patterned after the Uniform Fraudulent Transfer Act, a creditor can seek to avoid a transfer made by a debtor to a third-party under several theories, including that the transfer was made with the intent to hinder, delay, or defraud creditors, or the debtor did not receive reasonably equivalent value for the transfer.  While a showing of actual fraud is not required and can be demonstrated through other factors, transfers made from a Ponzi scheme are presumptively made with the intent to defraud due to established law that a Ponzi scheme is insolvent from inception as a matter of law.  

The suit against the Woods Entities alleges both actual and constructive fraudulent transfer theories, as well as theories of unjust enrichment and constructive trust.  Janvey has filed hundreds of clawback lawsuits against both investors that profited from the scheme and third parties that received investor funds, including political parties, 

A copy of the lawsuit is below:

Tiger Woods Complaint

Pearlman Victims To Receive Additional 2% Distribution

Victims of former boy band mogul Lou Pearlman's $300 million Ponzi scheme are set to receive a second distribution of approximately 2% of their total losses.  Nearly seven years after Pearlman was arrested in June 2007, the distribution by bankruptcy trustee Soneet Kapila comes after an initial distribution in June 2013, and brings the total recovery to date by Pearlman investors to approximately 6%.  Pearlman is currently serving a 25-year prison sentence in a Texas prison, and is scheduled to be released in 2029.

Pearlman operated a vast array of businesses from airlines to blimp companies to entertainment ventures.  While some of his businesses were legitimate enterprises, he used these profitable businesses to sustain other unprofitable businesses, including TransContinental Airlines ("TCA"). Investors were solicited to invest in TCA, drawn by the promise of above-market interest rates as well as the future possibility of an initial public offering (IPO) that would result in exponential returns for initial investors.  Pearlman also offered investments through TCA in an alleged "Employee Investment Savings Account," which was apparently designed to mimic the Employee Retirement Investment Savings Account (ERISA) established under federal law.  In total, investors contributed nearly $300 million to Pearlman's various ventures.

In addition to his legitimate ventures, Pearlman also used the massive cash horde generated by his creation of two wildly-popular boy bands, 'N Sync and the Backstreet Boys.  While under contract, the groups essentially financed Pearlman's other unprofitable ventures through a stead stream of cash.  However, after the groups successfully sued to escape their contract, Pearlman was faced with mounting investor obligations while cash inflows decreased.  As a last ditch effort, Pearlman even established his own fake accounting firm, Cohen & Siegel, which existed solely to forward phones and generate bogus accounting reports and audits. After an unsuccessful attempt to quickly liquidate assets to support the failing scheme, Pearlman fled to Thailand in 2007.  After he was spotted by a tourist, he was arrested, extradited back to the United States, and pled guilty in February 2008.

Kapila was appointed in early 2007 and  tasked with unraveling Pearlman's fraud and marshaling funds for defrauded investors.  Soon after his appointment, Kapila filed over 700 'clawback' lawsuits targeting investors who had received distributions in excess of their principal investment.  Notably, one of these clawback lawsuits was profiled on Discovery Channel's True Crime with Aphrodite Jones, in which the investor sued by Kapila hired a hitman to kill him in order to allow his family to collect on a generous life insurance policy.  The hired killer was later caught and sentenced to twenty years in prison.

Of the 700-plus clawback cases, Kapila and his team have recovered more than $30 million, and litigation remains ongoing.  However, administrative fees due to Kapila and other professionals reduced the amount of cash on hand to approximately half of this amount.  

According to the Orlando Sentinel, Kapila expects to make a third and final distribution later in 2014 as the remaining adversary proceedings are resolved.  

Report: Six Suicides Linked To TelexFree Collapse

Last week, both state and federal regulators alleged that TelexFree, Inc. and related entities were a massive Ponzi and pyramid scheme that may have raised hundreds of millions of dollars from victims worldwide.  In addition to the financial carnage inflicted on these victims, many of whom invested significant sums, one recent report claims that at least six people have committed suicide in the wake of the scheme's collapse.  According to Dominican Today, one well-known TelexFree promoter has claimed that at least six recent suicides in the town of El Seibo, Dominican Republic, are attributable to TelexFree.

Maria Cordones, originally from the Dominican Republic but currently residing in New York, indicated that she had recruited at least 40 people to invest in TelexFree, which promised exorbitant returns in exchange for several minutes of work daily that purportedly entailed approving computer advertisements.  For example, an investment of $1,375 resulted in a weekly payout of $100 - an annual return of over 200%.  Authorities have estimated that TelexFree raised at least $300 million from United States investors alone.

One reason for TelexFree's popularity was its practice of incentivizing investors to recruit new investors to the scheme.  This incentive-based system rapidly expanded the scheme's reach, and the promised returns were especially well-received in poorer countries such as the Dominican Republic and Brazil.  According to Cordones, the 40 people she recruited in the Dominican Republic - where the average annual wages pales in comparison to larger countries - collectively lost thousands of dollars.

A morbid topic that is not often discussed, suicides attributable to Ponzi schemes do occur.  In one particularly grim example, at least ten suicides were linked to the collapse of of a massive Indian Ponzi scheme last year.  Given that the suicides linked to TelexFree are isolated to one town in Dominican Republic, the possibility certainly exists that this number could increase.