Court: TelexFree Was a Ponzi And Pyramid Scheme

A court has ruled for the first time that TelexFree, a consortium of companies that peddled interests in voice-over-internet-protocol ("VoIP") services to millions worldwide, was operated as a Ponzi and pyramid scheme. U.S. Bankruptcy Judge Melvin S. Hoffman entered an order granting a motion by Trustee Stephen B. Darr requesting a finding that TelexFree, LLC, TelexFree, Inc., and TelexFree Financial, Inc. (collectively, "TelexFree") "were engaged in a Ponzi/pyramid scheme and that such finding be applicable to all matters in this proceeding."  The ruling, which comes as Mr. Darr seeks court approval to implement an electronic claims process to begin returning funds to over 1,000,000 estimated victims, will have lasting implications beyond the claims process - including paving the way to initiate adversary actions against parties that received transfers from TelexFree.  

The Scheme

As is well known by now, TelexFree raised billions of dollars from hundreds of thousands of investors through the sale of a 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.  After an unsuccessful attempt to quickly usher the companies through bankruptcy, state and federal agencies initiated enforcement actions accusing the company of operating a massive Ponzi and pyramid scheme that defrauded hundreds of thousands, if not millions, of victims worldwide. Mr. Darr was subsequently appointed as trustee, and the company's founders, James Merrill and Carlos Wanzeler, were later indicted on criminal fraud charges.

Mr. Darr has been working through the Herculean task of sifting through the daunting amount of records present in a scheme of such massive proportions.  He recently disclosed that he had identified more than 900,000 unique email accounts associated with investors had registered with the scheme - with each suffering an average loss of approximately $2,000.  Mr. Darr initially delayed the creation of a typical claims process, citing the complexity of the scheme.  Indeed, if each participant submitted a hard copy of a 5-page proof of claim form, the stack alone would be nearly half a mile high, and would stretch nearly 800 miles end to end.

Claims Process

In early October, Darr filed motions seeking (1) establishment of a claims process, proof of claim form, and bar date, and (2) entry of an order finding that TelexFree had been operated as a Ponzi and pyramid scheme.  Darr argued that TelexFree's scheme "had elements of both a Ponzi and pyramid scheme," and as such any "accumulated credits" by scheme participants were simply fictitious profits and thus should not be recoverable by participants.  As the trustee explained,

The accumulated credits based on the posting of meaningless advertisements are equivalent to the fictitious profits promised in Ponzi schemes. The Participants were guaranteed an astronomical return by merely purchasing a membership plan and posting internet advertisements reportedly supplied by the Debtors. Participants were not required to sell a product to receive payment. Accordingly, claims based on the accumulated credits for the posting of advertisements should be disallowed. 

Darr's position is not a novel one, as recognizing investors' accumulation of profits would not only honor the schemer's wishes but would also serve to favor those earlier scheme investors who had more time to accumulate fictitious profits at the expense of new investors.  By finding that TelexFree operated a Ponzi and pyramid scheme, Darr will seek to utilize a "net equity" analysis to determine investor claims by reducing any investment amount by any amounts an investor received from the scheme.  

The court ultimately continued its hearing on the trustee's motion to approve the form and procedure of the proposed claims process, ordering the trustee to serve notice on all affected parties that "allowance of the motion will cause all prior claims filed by any persons against the debtors or governmental authorities to be disqualified."

Ramifications of Ponzi/Pyramid Finding

While the trustee ostensibly sought the Ponzi/pyramid finding as part of his proposed claims procedure, the reality is that the ramifications of such a finding will be much farther reaching.  Indeed, former TelexFree principals Wanzeler and Merrill filed a limited objection opposing "the Trustee's request that the Court's findings made pursuant to the Motion 'shall be applicable throughout these proceedings, for all purposes.'"  Both Wanzeler and Merrill have been criminally charged for their role in the scheme, and at least Merrill will face trial in the near future while Wanzeler remains a fugitive in Brazil.  Wanzeler and Merrill argued that the issue should be decided on a case-by-case basis by the courts in which the issue is pending, and demanded a jury trial and expanded discovery to explore the allegations.

In addition to the potential ramifications in the criminal proceeding involving Merrill, the finding will also simplify the process by which Mr. Darr may seek to recover transfers made by TelexFree to insiders and other parties.  Under both state law and the Bankruptcy code, a trustee may seek to recover transfers made during the course of a Ponzi or pyramid scheme that were made with actual fraudulent intent.  Numerous courts around the country have been nearly uniform in holding that a transfer was made in the course of a Ponzi scheme satisfies the requisite fraudulent intent required by statute.  Thus, in gaining a finding that TelexFree was engaged in a Ponzi scheme, Darr may not only target the nearly-70,000 unique accounts which profited from TelexFree by an average of $20,000, but also those individuals or entities which provided services to TelexFree.

More Ponzitracker coverage of TelexFree is here.

ABA Journal Selects Ponzitracker For 2015 "Blawg 100"

For the third year in a row, Ponzitracker is honored to announce it has been selected for inclusion in ABA Journal's "Blawg 100," a collection of the top 100 legal blogs.  The 9th Annual ABA Journal Blawg 100, compiled by staff and reader submissions, was selected from more than 4,000 "blawgs" maintained in the site's "blawg directory."  The list is available online here, and will also be featured in ABA Journal's December 2015 magazine issue.

Ponzitracker is honored to be included in the Blawg 100.  The blog was originally started with the simple goal of serving as a resource for those interested in Ponzi schemes, whetheboth nationally and internationally.  While focusing solely on news articles at its inception in 2011, the blog has since expanded to include maps of current and previous Ponzi schemes, rankings of top schemes, and a comprehensive (and free!) database of legal pleadings gathered from dozens of Ponzi receiverships and bankruptcy proceedings nationwide.  

The site has recently added sections on top investor recoveries in Ponzi schemes as well as the Ponzi Database - an extensive and exhaustive compilation of all Ponzi schemes reported during the last six years.  The resource, which is free, not only includes relevant information about each scheme but has also enabled the analysis of various underlying trends which provide a previously-unavailable insight into the proliferation and scale of these financial frauds.  The blog also reached its 1,000 blog post earlier this fall.

In short, thank you to all who have made Ponzitracker a regular on your blog list.  

Feds Allege Family Insurance Business Was $40 Million Ponzi Scheme

Two Michigan brothers, along with one man's two daughters, were indicted on charges that their family-owned insurance business was a Ponzi scheme that defrauded hundreds of victims out of ten of millions of dollars.  Michael Holcomb and Gary Holcomb, along with Michael Holcomb's daughters Kristen Van Breemen and Jennifer Chalmers, were charged with one count of conspiracy to commit mail and wire fraud, nine counts of mail fraud, six counts of wire fraud, one count of conspiracy to commit money laundering, and six counts of money laundering.  In addition, Michael and Gary Holcomb were charged with one count of bank fraud and one additional count of money laundering.  If convicted of the charges, each of the defendants faces decades in prison.  

The Scheme

The Holcomb brothers operated Berjac of Portland and Berjac of Oregon (collectively, "Berjac"), which were family-owned insurance businesses originally established in the 1960s.  Berjac purported to operate an insurance premium financing business, which provided loans to small businesses for the purpose of paying those businesses' insurance premiums.  Those loans are considered low risk, as Berjac would retain an interest in the unused portion of the insurance premium if the business defaulted on its loan to finance the premium.  

Berjac solicited prospective investors with representations that they could earn safe and above-average returns through an investment in Berjac.  Investors were assured that Berjac was a safe and financially stable investment, and Berjac touted that it has never missed or otherwise defaulted on an interest payment or investor obligation.  Berjac provided investors with quarterly statements showing consistent appreciation on their investment, and investors were also told that they could add or withdraw funds from their investment at any time, and that they could do so without the inconvenience of filling new forms out.  Based on these representations, Berjac raised at least $43 million from investors.

The Scheme Collapses

However, authorities allege that Berjac operated a classic Ponzi scheme by commingling investor funds, using those funds to make "interest" payments and also diverting some funds for their own use, and failing to disclose that the operation was suffering significant losses.  Additionally, Berjac and its principals had been the subject of multiple regulatory actions.  One of the Berjac entities' previous managers, Peter Snook, previously served a 3.5-year sentence for operating one of the Berjac entities as a Ponzi scheme from 1987 to 1991.   And in 1996, the Oregon Division of Finance and Corporate Securities sanctioned Michael and Gary Holcomb for Berjac's unlawful sale of securities and the failure to disclose that investor funds were being used for unrelated real estate speculation projects.  

Another former Berjac entity, Berjac of Colorado, was sold in 2004 to Michael Turnock.  Turnock and another principal, William Sullivan, were arrested in 2012 and charged with operating that entity - then known as Bridge Premium Financing - as a Ponzi scheme masquerading as an insurance premium financing business.  Turnock is currently serving a 77-month prison sentence after pleading guilty to money laundering and mail fraud charges.

Bankruptcy

Berjac filed bankruptcy in 2012, disclosing $17 million in investor liabilities.  The FBI subsequently opened an investigation and an independent bankruptcy trustee was appointed to investigate Berjac's financial condition.  The trustee filed a lawsuit last year against four Oregon banks, accusing them of providing the "lines of credit that were an essential component to the continuation of the Ponzi scheme."  The suit also names an accounting firm that provided services to Berjac.  The suit seeks at least $50 million in damages, as well as $10 million in punitive damages.  

The Indictment is below:

US v Holcomb

California Men Sentenced For $134 Million ATM-Leasing Ponzi Scheme

Two California men received prison sentences for orchestrating a massive Ponzi scheme that caused losses exceeding $100 million in what victims thought was a highly successful ATM leasing venture.  Joel Barry Gillis, 75, and Edward Wishner, 77, were sentenced by U.S. District Judge S. James Otero to prison terms of 10 years and 9 years, respectively.  The men received sentences lower than the recommended federal sentencing guidelines, with Judge Otero indicating that he accounted for their age, early decision to plead guilty, and cooperation with a federal court-appointed receiver to recover assets for victims.  Each was ordered to report to prison on December 28, 2015.

Gillis and Wishner operated Nationwide Automated Solutions ("NAS").  According to authorities, NAS solicited investors since 1999 by promising that their funds would be used to place, operate, and maintain automated teller machines ("ATMs") throughout the country.  Investors were told that they could purchase ATMs for a price ranging from $12,000 to $19,800 from NAS, and could then lease those same ATMs back to NAS for a 10-year term in exchange for a "rent" of $.50 per ATM transaction.  A contract memorializing the investment purportedly contained the serial number and the location of the ATM, and investors were guaranteed an investment return of at least 20% annually.  Notably, each contract also included a "non-interference" clause prohibiting the investor from interfering with the operation of the ATM by contacting the locations where the ATM was installed or any ATM service provider.  An analysis of NAS' bank accounts from 2013 forward showed that more than $123 million was raised from investors in just that short period.

While the company's records showed that it had sold and was leasing back more than 31,000 ATMs to investors as of June 2014, third-party settlement reports provided by NAS's ATM servicers show that only 253 ATMs were serviced.  As the SEC previously alleged,  

Defendants have “sold” and “leased back” tens of thousands of ATMs to NASI investors that they never owned, that they never operated, and that may have never existed. 

For example, while NAS's internal records claimed ownership or operation of nearly 700 ATMs located at "Casey's Convenience Mart" locations in the Midwest, the Commission's investigation showed that neither NAS nor any of its investors owned or serviced any of those ATMs.  Rather, those ATMs were owned by an unrelated company with no affiliation with NAS.  The Commission also alleged that NAS often sold and leased back the same ATM to more than one investor.  Of the ATMs that NAS did service, those revenues were minimal and were dwarfed by the significant amount of new investor funds.  Those investor funds were used to pay returns to existing investors - a classic hallmark of a Ponzi scheme.  

Authorities alleged that NAS bounced over $3 million in checks to investors in August 2014, with investors told that a "glitch" in connection with retention of a new outside firm handling investor payments was to blame.

Authorities began investigating NAS shortly after the bounced checks, with court records in the SEC's case demonstrating that an application for a temporary injunction and other relief was filed on September 17, 2014.  Criminal charges were filed several months later, and the men pleaded guilty earlier this year to one count of conspiracy, two counts of mail fraud, and one count of wire fraud.  

A receiver, William Hoffman, was appointed at the request of the SEC, and a website has been established at http://www.nasi-nationwideatm.com/ for interested parties.  

Oddly enough, multiple Ponzi schemes centered around promised riches from ATM leasing or rentals have popped up in the past few years, including here, here, and here.

Jury Holds Ernst & Young Liable For Madoff Losses

A Washington jury has found accounting firm Ernst & Young ("E&Y") liable for at least $10 million of losses suffered by a Washington investment company that invested in Bernard Madoff's infamous Ponzi scheme through a "feeder fund" audited by the firm.  FutureSelect Portfolio Management ("FutureSelect"), a Washington-based financial firm, obtained a total verdict of $20 million resulting from what it alleged were more than $129 million in losses suffered from its exposure to Madoff's scheme through a Madoff feeder fund, Tremont Partners.  The verdict is significant not only because of the large amount of damages but also because such verdicts have been relatively rare against accounting or auditing firms in Ponzi scheme litigation.  It is expected that E&Y will appeal the verdict.

Background

FutureSelect managed several investment funds, and was approached by a representative of Tremont in 1997 regarding an investment in the Rye Funds.  Tremont served as the general partner of the Rye Funds, which was one of the prime feeder funds that funneled investor funds into Bernard L. Madoff Investment Securities ("BLMIS").  During those discussions, FutureSelect was told it was being given a "rare, and potentially fleeting" opportunity to invest with Madoff and was provided with audit opinions from auditing firm Goldstein Golub Kessler.  Based on these opinions and representations from Tremont about its oversight and constant monitoring of Madoff, FutureSelect invested nearly $200 million in the Rye Funds from 1998 to 2007.  E&Y audited several funds comprising the Rye Funds from 2000 to 2003, and also conducted "surprise" audits of Tremont from 2000 to 2008.  In 2008, Madoff's fraud came to light and estimated victim losses were pegged at nearly $20 billion.  FutureSelect's net loss was estimated at nearly $130 million.

Tremont reached a $1 billion settlement with Irving Picard, the bankruptcy trustee appointed to liquidate BLMIS, who had accused the firm of ignoring red flags associated with Madoff.  The settlement allowed claims asserted by several Tremont funds to proceed in the bankruptcy proceeding, providing an avenue for those funds to compensate their investors who were excluded from Picard's claim proceeding due to their status as "indirect" investors.  Claimants with allowed losses in the Madoff bankruptcy have recovered over 50% of their losses to date and are expected to recover most, if not all, of their losses when the bankruptcy proceeding concludes.  However, FutureSelect opted out of the settlement with the intent of pursuing other parties for its losses.  

FutureSelect filed the suit against E&Y, Goldstein, and others in 2010, asserting negligence claims and violations of Washington's State Securities Act.  A trial court dismissed the complaint, but an appeals court subsequently reinstated the suit in 2014.  FutureSelect settled its claims against Goldstein and was compelled to arbitrate its claims against another firm, KPMG, so E&Y was the only defendant left standing to face trial.

The Trial

Trial began in mid-October, with E&Y pinning its defense on the claim that it had done its job and that it was only one of many who failed to detect Madoff's fraud.  E&Y defended its actions, saying it had "scrupulously" followed generally accepted accounting principles in auditing one of the many funds that had used Madoff as its investment adviser.  Lawyers for FutureSelect scoffed at these claims, claiming that E&Y had simply relied and signed off on audits performed by a little-known firm, Friehling & Horowitz ("Friehling").  (editor's note: David Friehling, the principal of that firm, was referred to by Madoff as the "dumb auditor" and was the first to be charged criminally for his role in auditing Madoff's books.  He ultimately received a sentence of probation.)  

FutureSelect argued that E&Y blindly accepted and relied on Friehling's audits of BLMIS and that a simple review would have demonstrated that the firm's purported assets did not exist.  Indeed, if E&Y would have looked into Friehling, it would have discovered that the nondescript firm was not peer reviewed and was in violation of industry standards.  E&Y countered that the accusations were "all based on hindsight" andthat "no audit of a Madoff-advised fund could have detected this Ponzi scheme." 

FutureSelect ultimately sought approximately $200 million from E&Y.  The jury deliberated several days after closing arguments earlier this week and ultimately returned a verdict with mixed findings on the WSSA counts but finding against E&Y on the negligent misrepresentation claims.  The jury awarded damages of $20.3 million, with E&Y liable on half that amount.  Lawyers for FutureSelect estimate that E&Y could be on the hook for nearly $25 million when factoring in prejudgment interest.  

Rare Recovery

While rare, recoveries from  accounting firms for their role in failing to detect Ponzi schemes are on the rise.  Many liken the firms as gatekeepers between investors and fraud-feasors and argue that they should be held accountable along with other gatekeepers such as lawyers.  While the recovery against E&Y is noteworthy because it represents a jury finding against an auditing firm, the recovery is not unprecedented in Ponzi-related litigation against auditors.  A Florida CPA firm paid $3.5 million in 2007 to resolve claims of inadequate auditing relating to its work for a massive insurance Ponzi scheme. Another Florida-based accounting firm, Kaufman Rossin, paid nearly $10 million in 2010 to settle claims (without admitting liability) brought regarding the firm's work surrounding the Thomas Petters Ponzi scheme.  An Indiana firm, DeWitt & Schrader, paid $1.8 million last year over its accounting work for a $9 million Ponzi scheme.  And BDO USA LLP paid $40 million earlier this year to settle claims for its auditing of several entities connected to the massive Ponzi scheme masterminded by Allen Stanford.