China's Madoff Moment: The Latest About The Alleged $7.6 Billion Ponzi Scheme

Last week authorities arrested nearly two dozen employees of a shuttered Chinese peer-to-peer lender on accusations that the company was a massive Ponzi scheme that had taken in billions from countless investors.  These mind-blowing figures were soon followed by revelations of lavish purchases by key insiders - including a $12 million diamond ring - as well as some slick policing that uncovered (literally) nearly 100 bags of evidence buried 20 feet underground.  As the rest of the world struggles to get their head around the sheer size of this scheme, which would be the second largest Ponzi scheme in history, more details have started to trickle out which shed further light on the allegations. 

Ezubao (also referred to as Ezubo by several publications) shot to prominence in the past two years as one of many Chinese peer-to-peer lenders operating in China’s “shadow banking” industry.  Ezubao and others catered to smaller or underserved business segments which might not qualify or meet the standards for the extension of credit from established financial institutions.  As a subsidiary of Yucheng International Holdings Group, Ezubao purported to finance equipment purchases for small to medium-sized businesses, who in turn paid rental payments to Ezubao for the use of that equipment.  Ezubao pointed to these profitable lending relationships in soliciting investors with promises of annual returns ranging from 9% to 14%.  These above-average returns, which were up to ten times higher than the official rate offered by Chinese banks on deposits, caused investors to flock to Ezubao.  In total, at least 900,000 investors handed over at least $7.6 billion. 

One of the reasons for Ezubao’s explosive growth may lie in its extensive use of marketing to cultivate a favorable reputation and public image.  Last year, the company reached millions by sponsoring online broadcasts of the National People’s Congress and even having its logo hung in the Great Hall of the People in Beijing.  The broadcasts were carried by a subsidiary of Xinhua, which is a Chinese state-owned news agency.  The company also ran prime-time television advertisements on state-owned television channels and had its logos covering seats on the Shanghai-Beijing high-speed train. In a particular stroke of irony, the company was even the recipient of an award given to the most responsible internet finance companies from state-run news company China Newsweek.  In addition to creating the impression that it was blessed by the Chinese government, Ezubao also used its own employees to project an appearance of success by implementing a formal dress code.  Indeed, more than $100 million was distributed to employees this past November, with a portion of the funds earmarked for the purchase of luxurious clothing and jewelry.  The company also sponsored industry conferences, including one just months ago that featured government officials and other industry leaders extolling Ezubao’s business plan and prospects.  

But authorities now allege that Ezubao’s business was a massive fraud built on lies.  China’s news agency is now reporting that approximately 95% of the investment projects listed on Ezubao’s website were simply made up.  Similarly, of the 207 companies Ezubao claimed to call business partners, only one of those partners had apparently ever done business with Ezubao.  Authorities discovered that the company had shelled out as much as 800 million yuan to buy business plans from corporate brokers and use those details to fabricate investment projects used to solicit potential investors.  In a confession being broadcast by Chinese state-run media, Ezubao founder Ding Ning admits that he embezzled close to 1.5 billion yuan from the company and lavished Yucheng president (and girlfriend) Zhang Min with hundreds of millions of yuan in cash payments and the purchase of luxury items such as a 12-million yuan diamond ring.  

As the scheme began to collapse in December 2015, Ning and Min claimed in their confessions that they began making plans to run away and hide evidence.  Authorities somehow caught wind of the scheme and were able to learn that employees had hidden dozens of bags of documents underground in the outskirts of a Chinese province.  Two excavators and twenty hours of digging later, authorities uncovered the hidden documents.  

It remains unknown as to what charges Ning, Min, and the other Ezubao employees will face, but China differs from the United States in that it allows the imposition of the death penalty for nearly sixty offenses, including fraud and economic crimes.  One Chinese businessman labeled as China's "Madoff" was secretly executed back in 2013 after being convicted of running a $460 million Ponzi scheme.  

Ponzi Scheme Discoveries and Sentences Dropped Sharply In 2015

In exclusive data compiled by Ponzitracker.com, both the number of uncovered Ponzi schemes as well as the number of sentences handed out to individuals for their role in Ponzi schemes appear to have decreased sharply in 2015.  The statistics, which come over seven years after the discovery of Bernard Madoff's massive Ponzi scheme, show a significant drop in the number and severity of Ponzi schemes in 2015 - a welcomed trend that will no doubt be trumpeted as a product of increased enforcement efforts.  However, while certainly encouraging, it remains to be seen whether this reversal is simply an anomaly.  

In 2015, at least 61 Ponzi schemes were uncovered with a collective total of more than $800 million in potential losses.  The number of uncovered schemes was down approximately 10% from the number discovered in 2013 and 2014.  Further, the $800 million of estimated losses in 2015 was 50% less than the estimated losses in 2014 and nearly 75% less than the estimated losses in 2013.  Similarly, the average Ponzi scheme size in 2015 of approximately $13.2 million was 40% less than 2014 and 70% less than 2013.  The median Ponzi scheme size also significantly decreased from $6.8 million in 2014 to $4.5 million in 2015 - a 33% decrease.  With 61 schemes discovered, this correlated to a new Ponzi scheme uncovered roughly every six days in 2015.  The average scheme losses also declined compared to previous years, with only one scheme in 2015 having estimated losses of $100,000,000 or more.  At least six uncovered schemes in 2013 had losses of $100 million or more, while 2014 saw at least five schemes with at least that amount of losses.

Similarly, the number and severity of sentences handed down to those convicted for their role in a Ponzi scheme in 2015 also sharply decreased.  In 2015, 79 individuals were sentenced to nearly 700 years in cumulative sentences.  Both the number of individuals sentenced and the cumulative sentences handed down were approximately 50% less than sentences handed down in 2013 and 2014.  Additionally, the average sentence decreased approximately 20% from 2014 to 2015.  Curiously, the percentage of female defendants receiving these sentences declined by more than 50% from 2014 to 2015.  The sentences handed down ranged from mere months to decades in prison, with Joyce Allen's 30-year sentence for a $20 million Ponzi scheme ranking as the highest Ponzi sentence handed down in 2015.  

While the 2015 statistics constitute notable drops compared to 2013 and 2014, the discrepancies are even more apparent when looking back to the 2009, 2010, and 2011 time periods that marked the high-water marks in Ponzi scheme discoveries.  Then, fresh on the heels of the discovery of Madoff's massive scheme and during the middle of an financial crisis that caused the implosion of countless schemes, the number of Ponzi schemes discovered annually averaged over 100 and included the discovery of Madoff's $17 billion scheme in 2008 and Stanford's $7 billion scheme in 2009. 

A chart showing the last four years of statistics shows just how significant this decrease was in 2015:

A search for answers in the data itself does yield some interesting insights.  The immediate takeaway is that Ponzi schemes are declining in all measurable areas - number discovered, average size, and total losses.  Ponzi scheme sentences are also dwindling correspondingly as a result of the declining number of schemes.  At least part of this decrease can feasibly be attributed to a burgeoning economy.  Some can also be attributed to increased and more sophisticated enforcement efforts, with the decreasing average scheme size suggesting that regulators are becoming more adept at shutting down schemes before they can grow exponentially.  Similarly, a decline in both the number of sentences and the cumulative time handed down may well be blamed on the growing gap between present-day and the days where massive mind-blowing schemes were being discovered nearly daily and brewing public outrage.  

The data is presented below.  Analyses of the 2013 and 2014 data are available here and here, respectively.

(As a disclaimer, this database is meant for educational purposes only, and was compiled through articles published on Ponzitracker as well as through reporting available on the internet through various sources, including Kathy Phelps' monthly Ponzi roundups at ThePonziSchemeBlog.com. A special thanks to Alison Jimenezwith Dynamic Securities Analytics for her assistance in visualizing the data.  Individuals accused of Ponzi schemes are presumed innocent until proven guilty. The database generally only included Ponzi schemes of $1 million or more.  Please feel free to direct any comments or inquiries toinquiries@ponzitracker.com.)

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:

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