Did China Just Bust A $7.6 Billion Ponzi Scheme?

In what would be the second-largest Ponzi scheme in history and second only to Bernard Madoff's massive scheme, Chinese authorities have arrested nearly two dozen people on accusations that a person-to-person (P2P) lender they operated was nothing more than an elaborate fraud that duped nearly 1 million investors. At least 21 people were arrested for their role in Ezubao, a P2P site that offered the ability to profit from purported online financing opportunities.  At least one Chinese state-run news site is reporting that several suspects have already confessed to the fraud.  If true, the accusations would place Ezubao in notorious company alongside Bernard Madoff's $65 billion scheme and R. Allen Stanford's $7 billion scheme.  

Ezubao (also called Ezubo by several publications) is a subsidiary of Yucheng Group, a Chinese entity that mainly dabbled in finance leasing.  In exchange for providing businesses with equipment, the business agreed to pay Yucheng a series of rental payments.  This form of banking is highly unregulated and appeals to businesses that might be turned down for a conventional loan due to substandard credit.  Armed with this stream of rental payments, Ezubo then solicited investors with the promise of safe and steady annual returns ranging from 9% to 14.6%.  

However, police now believe that the vast majority of purported financing projects presented to potential investors were simply fabricated to induce new investments.  Rather than using new investor funds to finance equipment purchased by businesses, authorities claim that Ezubao used those funds to pay returns to new investors - a classic hallmark of a Ponzi scheme.  In addition to making Ponzi payments, a chairman of Ezubao's parent company is believed to have spent nearly two billion on gifts, including a $20 million diamond ring and over $1 billion in cash payments.   

Police began investigating Ezubao in December, seizing records and freezing assets as part of their probe.  According to the Wall Street Journal, the company sought to hide certain records from authorities by burying over 1,000 accounting books in 80 plastic bags nearly twenty feet underground on the outskirts of town.    

While both the frequency and severity of Ponzi schemes have generally declined in recent years, there have been several recent schemes that parlayed social media into massive growth which ultimately ensnared hundreds of thousands - or even millions - of victims.  One of these examples is TelexFree, a Massachusetts company which attracted more than one million investors through the promise of outsized returns through investments in VOIP software.  That scheme, which incentivized the recruitment of new members though social media and the payment of commissions to existing investors, ultimately took in more than $3 billion from investors.  

Ponzi Promoter's Wife Gets Prison For Cash Withdrawals

A federal judge ordered a Florida woman to spend a year and a day in federal prison for her role in helping her husband withdraw and hide more than $300,000 before a bankruptcy filing.  Lorie Ann Williams, 49, received the sentence after previously pleading guilty to evading bank reporting requirements by structuring more than 30 withdrawals for $9,500 - under the $10,000 currency reporting threshold. Williams could have faced up to two years in prison. 

Williams' husband, Sydney "Jack" Williams, was the top promoter of the massive Ponzi scheme operated by Nevin Shapiro that raised more than $900 million from investors who thought they were profiting from a wholesale grocery business.  Mr. Williams recruited over 60 victims to Shapiro's scheme who collectively invested more than $300 million.  While those investors ultimately suffered losses of nearly $40 million, Mr. Williams profited handsomely by pocketing $18 million in commissions.  He was later indicted on tax fraud charges and received a prison sentence of one year and one day. 

While Sydney Williams never faced criminal charges stemming for any role in Shapiro's fraud, he was the target of lawsuits by those investors who he had convinced to trust their money to Shapiro.  During 2009, Sydney Williams began moving money into his wife's name.  Then, from early March 2010 to late April 2010, his wife began making almost daily withdrawals of $9,500.  In total, Ms. Williams made 35 withdrawals of approximately $332,500, with her husband accompanying her on several occasions.  At the same time, the couple leased a safe deposit bank from a local branch.  Approximately six months later, Sydney Williams filed bankruptcy and failed to list the safe deposit box that he and his wife had opened. 

The couple was subsequently indicted, with both spouses charged with conspiracy to evade transaction reporting requirements and structuring withdrawals.  Sydney Williams was also charged with concealing property belonging to his bankruptcy estate and making a false declaration in connection with his bankruptcy schedules that he signed under oath.  The charge of structuring makes it illegal to make withdrawals of funds in a pattern designed to avoid the filing of currency transaction reports required under the Bank Secrecy Act.  Banks are required to submit currency transaction reports both when a deposit or withdrawal totals $10,000 as well as when there is evidence of intent to avoid a transaction at or above that $10,000 threshold. 

Sydney Williams entered a guilty plea in November 2015 and is scheduled to be sentenced in the near future.  He faces up to five years in prison.

TelexFree Trustee Files Clawback Suit Against 78,000 Foreign Net Winners

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.

Background

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.  

Clawback Suits

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:

1 (1)

Appeals Court Revives Charges Against Accused $100 Million Ponzi Schemer

A federal appellate court reversed the dismissal of criminal charges against a Utah man accused of masterminding a $100 million Ponzi scheme, ruling that the trial judge abused his discretion by dismissing the case with prejudice - meaning the charges could not be refiled - after concluding that prosecutors had failed to timely pursue the case.  The Tenth Circuit Court of Appeals issued an opinion last week concluding that U.S. District Judge Clark Waddoup's decision to toss all eighteen charges against Claud "Rick" Koerber with prejudice over violations of the Speedy Trial Act did not adequately address several factors, including Koerber's own actions that contributed to the delay.  Koerber, who touted himself as a "Latter day capitalist" during the mid-2000's, was indicted in 2009 but had the charges dismissed nearly 18 months ago in August 2014.

Background

Koerber, who called himself a "Latter day capitalist," garnered a growing following for his purported real estate investing prowess and was well known in the community not only for his membership in the Latter Day Saints Church but also for hosting a radio show and frequent real estate seminars.  Through his companies, Founders Capital and Franklin Squires, Koerber touted his "equity milling" program that promised lucrative returns through buying and selling residential real estate.  Investors came in droves, entrusting tens of millions to Koerber's operations.  Even Koerber's radio show changed its opening theme song to, "Money, Money, Money" by Abba.  Koerber also appealed to listeners' religious beliefs, even remarking to one listener who questioned his motives that "God is a capitalist."  In total, Koerber raised approximately $100 million from investors.  

However, the collapse of the real estate bubble in 2007 was catastrophic to Koerber's operations, as the majority of Franklin Squires's assets were in the form of real estate that quickly erased any equity as housing prices declined.  He was indicted in May 2009, and a superseding indictment handed down six months later included twenty-two charges including wire fraud, money laundering, and tax fraud.  

Koerber Obtains Dismissal With Prejudice

In April 2014, nearly five years after the first indictment was handed down, Koerber filed a Motion to Dismiss for Impermissible Delay citing multiple grounds, including the violation of Koerber's right to a speedy trial.  The Speedy Trial Act (the "Act"), codified at 18 U.S.C. § 3161, requires that the trial of a defendant entering a plea of not guilty was to start within 70 days of the later of the filing of the indictment or appearance by the defendant in front of a judicial officer.  While the Act also allows for certain extensions, Koerber's motion argued that at least 125 non-exempt days had passed without a trial or other resolution.  

At a hearing, the Government conceded that while a "technical" violation of the Act had occurred, the Court should "cure" the violation by entering an Order pursuant to the Act essentially making a finding that the "ends of justice" warranted a retroactive continuance and outweighed the best interests of the public and Koerber.  However, the Court cited precedent standing for the proposition that such a retroactive mechanism was prohibited and that a violation of the Act would have occurred even of such actions were taken.  

In deciding whether or not to grant dismissal with prejudice, which would prevent prosecutors from re-filing the charges, the Court referenced the seriousness of the offenses and also the "Government's problematic conduct in prosecuting this case," including a "pattern of neglect," tactical delays, an inappropriate use of attorney-client privileged information, and ex parte interviews with Koerber that violated his due process rights.  Noting that prejudice to Koerber was presumed, the Court opined that re-prosecuting Koerber would be impossible and ordered that the case be dismissed with prejudice.

The Appeal

The Tenth Circuit's opinion painstakingly recites the procedural history of the case beginning with the government's 2007 investigation, noting various missteps along the way including the government's failure to provide timely and sufficient proposed orders extending the time under the Act.  These and other missteps eventually prompted Koerber to move to dismiss the case for violations under the Act, which the Tenth Circuit noted subsequently resulted in the government's decision to turn over nearly 1,500 pages of additional discovery.  The district court's analysis resulted in a dismissal with prejudice.

The Tenth Circuit faulted the district court's analysis in dismissing the charges on two grounds.  First, while the district court correctly embarked on an analysis of the seriousness of the offenses pursuant to 18 U.S.C. § 3162(a)(2), the Tenth Circuit found that this analysis had included several unrelated factors - the presumption of innocence, issues with the "indefiniteness of the information contained in the indictments," and the government's alleged misconduct.  Rather than stopping its analysis at the seriousness of the allegations, the Tenth Circuit found the district court had abused its discretion by considering:

the indictment’s allegations, which are beyond what this factor measures: the seriousness of the charged offenses

...

The strength of the allegations and of the evidence against a defendant is irrelevant to [the seriousness of the offense] factor.

...

The district court strayed off-course by weighing the strength of the government’s allegations instead of the seriousness of the charged offenses themselves.

The Tenth Circuit concluded that the district court abused its discretion in both weighing the seriousness of the offense and applying that finding to whether or not dismissal with prejudice was warranted.

Next, the Tenth Circuit agreed with the government's argument that the district court had failed to "fully consider Koerber's responsibility in the [Act] delay," noting that the "district court was not free to ignore Koerber’s other acts that may have partially contributed to the STA violation."  The government pointed to instances where Koerber "disregarded his STA rights by waiting passively and acquiescing to the postponement of his case," including his waiting months or even years to file motions directed at certain specific events or dates.  The Tenth Circuit agreed, noting that:

One such motion is Koerber’s April 2012 motion to suppress statements from the February 2009 interviews. The district court held a hearing in November 2012 and additional argument in April 2013. Not until August 15, 2013, did the district court grant Koerber’s motion.

The Tenth Circuit ordered the district court to review whether Koerber's actions contributed to delays under the Act, and whether those delays would change the district court's review of the second factor of its analysis given the government's conduct.  

While the Tenth Circuit's ruling is, on paper, a win for the government, the tone of the opinion suggests that this triumph may be more of a pyrrhic victory.  The opinion concludes with an ominous condemnation of the government's handling of the case, including its disagreement with the government's contention that its "role in the admitted STA violation was unintentional."  The opinion cites several instances, including the government's inexplicable loss of 27 discs of information, the delayed production of thousands of pages of documents, and the protracted nature of the case involving the passage of five years of time and a "dozen Assistant United States Attorneys," in concluding that this conduct could justify "the more serious sanction of dismissal with prejudice."

Next steps

The case will now be remanded back to the district court, where Judge Waddoups will be required to address the deficiencies noted in the opinion.  

A copy of the Tenth Circuit's opinion is below.

14-4107

SEC Accuses Utah Company Of Running $28 Million Ponzi Scheme

The Securities and Exchange Commission announced it had obtained an asset freeze and halted an alleged $28 million Utah-based Ponzi scheme that may have duped over 250 investors nationwide.  Marquis Properties, LLC, its President/CEO Chad R. Deucher, and Vice President Richard Clatfelter, were named in a January 19, 2016 complaint alleging multiple violations of federal securities laws.  The Commission is seeking injunctive relief, imposition of civil monetary penalties, prejudgment interest, and disgorgement of ill-gotten gains.

According to the Commission's complaint, Marquis held itself out as an experienced property-management company that specialized in acquiring and managing high-quality cash-flowing properties.   The company solicited potential investors by representing that it would manage various properties located in Indiana, Missouri, and Ohio, collect monthly rental income, and distribute a return ranging from 8% to 12% annually as passive investment income.  Potential investors were told that the various investments offered by Marquis were safe and risk-free because investment returns would be secured by a first deed of trust on property and that investments would be "over-capitalized."  From April 2010 to June 2015, Marquis raised at least $28.2 million from hundreds of investors.

However, the Commission alleged that Marquis operated a classic Ponzi scheme by using new investor funds to pay purported returns to existing investors.  Rather than purchase real estate with investor funds, as had been represented to investors, the Commission charged that Marquis had diverted investor funds to pay returns to existing investors and to pay personal expenses including the transfer of nearly $400,000 to Mr. Deucher's wife.  While Marquis stopped paying returns to investors in June 2015, the Commission's complaint alleges that Mr. Deucher had recently represented to an investor that repayment would begin shortly.  

A copy of the Complaint is below:

Comp 23451