A Massachusetts federal Bankruptcy judge approved a request by the Department of Justice to appoint an independent trustee over TelexFree, LLC and related entities ("TelexFree"), after the U.S. Trustee argued that "compelling evidence of fraud...[and] criminal conduct" warranted such relief "forthwith." U.S. Bankruptcy Judge Melvin S. Hoffman entered the Order several days after a status hearing marking the first appearance of the parties in a Massachusetts bankruptcy court after the cases were transferred from a Nevada bankruptcy court. With the appointment of the independent trustee (who has yet to be named), TelexFree's vision of emerging from bankruptcy with new products and revenue streams appears dismal at best.
Several days after TelexFree's late-night bankruptcy filing in a Nevada bankruptcy court, U.S. Trustee Tracy Hope Davis filed a motion seeking appointing of a Chapter 11 Trustee pursuant to §1104 (a) (the "Motion"). In the Motion, Ms. Davis argued that appointment of a trustee was warranted based on the "compelling evidence of fraud," as well as for the interests of investors and creditors seeking financial accountability. While appointment of an independent trustee is common in bankruptcy filings under Chapters 7 and 13, an entity's desire to reorganize under Chapter 11 and later emerge as a stronger entity often results in the entity's original management continuing to oversee operations during the entity's time in bankruptcy. However, Section 1104(a) specifically contemplates appointment of an independent trustee in a Chapter 11 case in several situations, including
for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case, or similar cause, but not including the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor.
The Motion specifically cites Section 1104, noting that "the appointment of a Chapter 11 trustee would clearly be in the interests of the creditors of this estate" in light of the pending civil actions by the Securities and Exchange Commission and the Massachusetts Securities Division ("MSD"). The Motion notes that "the pyramid has collapsed," and also recounts the discovery of nearly $38 million in cashier's checks in the possession of TelexFree's interim CFO during a raid of the company's Massachusetts headquarters. The Motion also thoroughly summarizes the pertinent facts alleged in the complaints filed by the Commission and the MSD.
The Motion argues that cause for the appointment of a Chapter 11 trustee is clearly established by the "fraudulent and dishonest acts committed by the principals and the officers of [TelexFree]." Fraud is also evident by the very nature of Ponzi schemes, which are "fraudulent by definition." Donell v. Kowell, 533 F.3d 762, 767 n2 (9th Cir. 2008). Under the definition of a Ponzi scheme as set forth by a recent Ohio Bankruptcy Court, the Motion concludes that:
Given the facts alleged in the SEC case, TelexFree appears to be engaged in a classic Ponzi scheme.
Now that an independent trustee will be appointed, he/she will follow Section 1106, which includes the filing of a statement of investigation, as soon as practicable, that includes "any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor..." Additionally, the trustee may recommend the conversion of the case to another Chapter under the Bankruptcy Code, including a liquidation under Chapter 7.