The article below is written by Jordan Maglich, a well know complex-litigation attorney who gives a different perspective on scams and those who run them
Last week was a busy week for TelexFree. After filing for bankruptcy protection on Monday in a Nevada bankruptcy court, state and federal securities regulators filed civil actions accusing the company of operating a massive pyramid and Ponzi scheme that, by one estimate, may have raised $1 billion from investors worldwide. That same day, federal agents from the FBI and the Department of Homeland Security raided the company’s headquarters in Marlborough, Massachusetts, which later drew headlines after authorities discovered TelexFree’s Chief Financial Officer attempting to remove $38 million in cashier’s checks from the offices. (The company later claimed there was no nefarious purpose behind this effort.)
Now, one week after TelexFree’s bankruptcy filing and as reality begins to set in to an estimated 700,000 company “affiliates,” the focus turns to the next steps. This includes not only the various pending court and regulatory proceedings, but also the future of those “affiliates” that made substantial investments based on promises of extravagant returns.
Currently, there are three pending court proceedings that interested parties should consider following. The first is a Chapter 11 bankruptcy proceeding pending in the District of Nevada Bankruptcy Court (the “Bankruptcy Case”). The second and third are civil actions pending in Massachusetts: one, an administrative action filed by the Enforcement Section of the Massachusetts Securities Division (the “Massachusetts Case”), and the other an enforcement action filed by the Securities and Exchange Commission pending in U.S. District Court (the “SEC Case”) (collectively, the “Civil Cases”). There are no current pending criminal cases, although it has been reported that criminal authorities were involved in the search warrant executed on the company;s headquarters last week.
Both the Massachusetts Case and the SEC Case are enforcement actions premised on alleged violations of state and federal securities laws. As civil regulatory actions, the purpose of these proceedings is purely remedial — each seeks injunctive relief prohibiting future violations of securities laws by the TelexFree entities (and in the SEC Case, by TelexFree principals and top promoters), civil penalties, and disgorgement of ill-gotten gains from the violative conduct. The respective defendants will be entitled to varying forms of discovery (likely more in the SEC Case due to the administrative nature of the Massachusetts Case), and will then likely file dispositive motions seeking a court order finding in their favor without the necessity of trial. If necessary, a trial could be held. Notably, neither the Massachusetts Case nor the SEC Case includes a request for the appointment of a receiver to secure and marshal assets; rather, as explained below, the consensus seems to be that responsibility for the recovery of assets is properly in the realm of the Bankruptcy Case.
While the Civil Cases contain a somewhat predictable path to finality, the Bankruptcy Case is not as certain. On April 14, 2014, TelexFree Inc., TelexFree LLC, and TelexFree Financial, Inc. (collectively, “TelexFree”) each filed voluntary bankruptcy petitions under Chapter 11 of the U.S. Bankruptcy Code. Under a Chapter 11 proceeding, the filing entity seeks to continue operating during and bankruptcy and ultimately emerge from bankruptcy after restructuring various aspects of the business, including debts. In comparison, a Chapter 7 bankruptcy involves the cessation of operations and a complete liquidation of a business, with the proceeds being distributed to company creditors.
In the press release announcing its bankruptcy, TelexFree cited “certain operational challenges,” and indicated it intended to “restructure its debt obligations.” In a subsequent bankruptcy filing, the company sought approval from the Bankruptcy Court to reject “all agreements between the debtors and the promoters under both the Original Comp Plan and the Revised Comp Plan.” According to the Commission, this included at least $174 million in compensation demands submitted by “promoters” after the company drastically revamped its compensation plan.
Of note, while bankruptcy filings under other Chapters, including a Chapter 7 or Chapter 13 bankruptcy, includes the appointment of an independent trustee, a Chapter 11 bankruptcy typically features only a U.S. Trustee associated with the Department of Justice. This is explained by the theory that the debtor, which is seeking bankruptcy protection not to liquidate but rather to continue operations, is best equipped to oversee day-to-day operations and is thus tasked with the duties of a case trustee. However, pursuant to 11 U.S.C. 1104, the court may order the appointment of a case trustee:
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.
According to Kathy Bazoian Phelps, a California attorney with significant experience in Ponzi scheme bankruptcy cases and the author of The Ponzi Book, “the first step is to see what both the assets and liabilities of the debtor entities are, which is information that will be included on the Schedules and Statement of Financial Affairs to be filed in two weeks.” This information is important, because this information will ultimately influence the Bankruptcy Court’s decision whether a Chapter 11 bankruptcy – rather than a Chapter 7 – is ultimately approved. According to Phelps, a successful reorganization under Chapter 11 requires that “the companies will need to generate profits from a legitimate business operation that are sufficient to pay the creditors more than they would receive in a Chapter 7 liquidation.”
The allegations in the Massachusetts Case and SEC Case could pose a problem to this determination. As Phelps observed, “The Massachusetts regulatory action [and subsequent SEC Case] has labeled the businesses as a pyramid or Ponzi scheme, calling into question whether there are legitimate business operations sufficient to fund a plan of reorganization.” Indeed, the Commission alleged that TelexFree had only approximately $1.3 million in VoIP sales revenue from August 2012 to March 2014 – approximately 1% of the $1.1 billion in accrued obligations to “promoters.” Factoring in the other allegations, including that (i) TelexFree transferred over $30 million to company principals and promoters, and (ii) tens of millions of investor funds remain unaccounted for, this could be a difficult showing for TelexFree. Thus, one of the main issues decided in the interim will be whether the company will be permitted to reorganize or forced to liquidate.
Currently, several preliminary TelexFree motions are pending before the Bankruptcy Court, including the motion seeking court approval for the company to “reject” all agreements (and resulting compensation obligations) with “promoters” under the former compensation plans. The Bankruptcy Court has asked for objections from interested parties, including the SEC and Massachusetts regulators, by April 21, 2014, and a hearing is scheduled for May 2, 2014.
One of the primary concerns posed by those interested parties is the extent and likelihood of any compensation for losses. Unfortunately, it is much too early to offer an informed answer to that question. Several factors will influence whether that question may be answered in the affirmative or negative. The first factor, logically, is the existence of assets. As Phelps alluded to earlier, various financial statements and schedules must accompany a bankruptcy petition within two weeks of the initial filing, and the assets disclosed on those statements will provide a glimpse into the “operational challenges” facing TelexFree. The second factor is the form of bankruptcy ultimately employed by the Court – will TelexFree seek to set aside certain assets and/or a portion of future revenues under a court-approved reorganization plan, or will the companies be forced to liquidate all assets.
What Can Victims Do?
Unfortunately, neither the Civil Cases or the Bankruptcy Case are expected to have an immediate resolution; rather, it is likely that the cases (and recovery efforts) could take several years. While this may be difficult for some to fathom, the reality is that such a a duration is likely due to the complexity of the alleged scheme, the worldwide nature of the business, and the sheer number of victims. It is anticipated that simply gaining an understanding of TelexFree’s true operations could be a complicated task that could take several weeks, if not months.
One step that those affected parties can take today is to begin gathering all evidence of their relationship and investment with TelexFree. This includes agreements, negotiated checks and credit card statements, and bank statements showing any deposits and/or withdrawals. This information will be necessary, if not required, in connection with submitting claims to the Bankruptcy Court.
Regarding claims, each interested party will most likely have the opportunity to submit Proof of Claim Forms to the Bankruptcy Court to properly document their entitlement to any earmarked funds. Perhaps the most crucial guidance surrounding these claims is that attention must be paid to the deadlines imposed by the Court for submission of Proof of Claim forms and any other documents – untimely or tardy claims fare a much less chance of being approved than a timely claim. A copy of a blank Proof of Claim Form is embedded below and downloadable here. While the filing of a Proof of Claim may not be required if the case proceeds as a Chapter 11 proceeding and the particular debt is listed in the correct amount in the schedules filed with the Court, the submission of a Proof of Claim may still be advised.
All interested parties are advised to pay close attention to the proceedings. Some other sites that have been covering TelexFree in detail include BehindMLM, PatrickPretty, ASD Updates, and MLM Help Desk.
A copy of the Proof of Claim Form is below: