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.
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.
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.