Lawyers for a telecommunications consortium accused of operating a $1.1 billion pyramid and Ponzi scheme are set to square off against government lawyers in a Nevada bankruptcy courtroom on Friday morning over the future of the three-week old bankruptcy case. TelexFree, LLC, which declared bankruptcy along with two related entities on April 13, 2014, is seeking to forge ahead with a bankruptcy proceeding to strengthen a legitimate voice-over-internet-protocol (VoIP) business that was hampered by overwhelming payment obligations to “promoters” that marketed its business. The Securities and Exchange Commission and other agencies dispute this characterization, instead alleging that the bankruptcy proceeding is a sham and that, in reality, TelexFree was a massive fraudulent scheme that may have raised over $1 billion from victims based on the guise of a nearly non-existent VoIP business. A pivotal hearing scheduled for tomorrow will likely set the tone for proceedings going forward and offer a glimpse into how well-received TelexFree’s efforts will be.
Late in the evening on April 13, 2014, a trio of nearly identical bankruptcy petitions were filed in the Nevada bankruptcy court. Blaming the company’s financial woes on an ill-fated change in compensation plan to promoters, TelexFree vowed to use bankruptcy to restructure company debts and emerge as a stronger company. However, 36 hours later, both the Massachusetts Securities Division (“MSD”) and the Securities and Exchange Commission (“SEC”) filed actions in Massachusetts accusing the company of operating as a massive Ponzi and pyramid scheme. While the MSD filed an administrative proceeding, the SEC’s civil enforcement action sought and was granted a temporary asset freeze against TelexFree’s assets. During a raid on TelexFree’s Massachusetts headquarters that same day, federal agents discovered more than $38 million in the possession of TelexFree’s acting CFO, Joe Craft.
In the ensuing two weeks, a flurry of activity took place on the Nevada bankruptcy court docket. The first significant filings were by TelexFree. In a flurry of “first day” motions, TelexFree asked the court for authority to, among other things, reject the compensation obligations it had incurred to what it estimated were over 700,000 “promoters” involved in the multilevel marketing aspect of its business. Several days later, TelexFree sought a six-week delay to file financial disclosures that were customarily required within two weeks of a bankruptcy filing, citing in support the significant resources devoted to addressing the MSD and SEC actions as well as the fact that the search warrant executed on its Massachusetts headquarters had deprived it of access to its files.
While TelexFree had perhaps envisioned a subdued response to their bankruptcy filing, the ensuing MSD and SEC actions brought intense scrutiny to the Nevada proceedings. A week after the filings, the U.S. Trustee made waves when she petitioned the court for the appointment of an independent bankruptcy trustee, arguing that “compelling evidence of fraud…[and] reasonable grounds to suspect…criminal conduct” warranted the immediate appointment of an independent fiduciary. This motion was followed by the SEC’s Motion to Change Venue, which argued that the bankruptcy proceeding was nothing more than a “coordinated effort to avoid the Massachusetts courts” and that a weighing of pertinent factors warranted a transfer of the bankruptcy proceedings to a Massachusetts bankruptcy court where they could proceed alongside the SEC’s civil enforcement proceedings in Massachusetts district court. Unsurprisingly, TelexFree has filed objections to each of these motions, and has sought to void certain parts of the SEC’s temporary restraining order based on conflicts with the bankruptcy court’s authority.
At least ten motions are set to be heard tomorrow in a hearing scheduled for 9:30 A.M. MST. From the parties’ respective filings, the tone likely to be taken by each side is fairly evident. In each of its filings, TelexFree has included the same verbatim narrative touting the future of the company and paying little heed to the allegations that the company made numerous material misrepresentations to investors in raising at least hundreds of millions of dollars. The company’s filings have increasingly sought to focus on the present-day change in management and future business while distancing itself from the company’s tumultuous past. In contrast, the SEC and the U.S. Trustee have consistently opposed TelexFree’s efforts to seemingly erase nearly two years of allegedly rampant fraud in favor of focusing on an aspect of its business that grossed approximately $1 million since November 2012. As the SEC stated in a recent brief, TelexFree is “in reality, a fraudulent enterprise not capable of reoganization.”
The company seeks a “do-over” that totally excuses the alleged rampant violations of securities laws through the U.S. Bankruptcy Code under the guise that the company is now (and can be going forward) a legitimate business. Perhaps adding insult to injury, the many millions of dollars that will be – and have already been – paid to the professionals hired to assist the company’s path through bankruptcy will inevitably come from investor funds; the SEC has charged that the company took in only $1.2 million in revenue from November 2012 to March 2014 despite incurring $1.1 billion in obligations to “promoters.” The SEC and U.S. Trustee have come out strongly against TelexFree’s efforts, with the SEC urging the court to either transfer the case to a Massachusetts bankruptcy court or to abstain from further proceedings.
There are several possible scenarios that could result from tomorrow’s hearing. Due to the numerous motions scheduled for hearing, it is possible that Judge August Landis could take many or all of the motions under advisement – that is, not make an immediate ruling. However, due to the time constraints involved in the Massachusetts proceedings, it stands to reason that some rulings may be made. The decisions will depend first on whether the court allows the bankruptcy to proceed. The SEC has urged the court to abstain from hearing the cases or suspend the proceedings while the SEC’s enforcement action proceeds in Massachusetts, arguing the bankruptcy is nothing more than a delay tactic. If the court grants that motion, then the remaining motions can likely be tabled until further notice as proceedings would halt while the Commission’s enforcement action proceeds. This would most likely be a death knell to TelexFree’s hopes of reorganization, and an appeal would likely ensue.
In the event the Court does not abstain from hearing or suspend the proceedings, the SEC has also asked for the transfer of the cases to Massachusetts. TelexFree has opposed this motion as well, as this would also serve to speed up the proceedings. Assuming the bankruptcy does move forward, it appears likely that the U.S. Trustee’s motion for appointment of an independent trustee would be granted in the face of the serious allegations made by the MSD and SEC. This, too, would likely be detrimental to Telexfree’s plans to control its destiny in bankruptcy.
Of note, the background of the presiding bankruptcy judge likely weighs against TelexFree’s efforts. Judge August Landis was appointed to the bankruptcy bench in November 2013, having served in the U.S. Trustee program since 2005 and most recently serving as the acting U.S. Trustee for the Nevada region since 2010. The current U.S. Trustee, Tracy Hope Davis, was the individual that likely replaced Judge Landis and who filed the motion for appointment of an independent trustee over TelexFree. Judge Landis’s history as a U.S. Trustee, including his understanding and grasp of bankruptcy law, leave him well-prepared for tomorrow’s hearing.
Previous Ponzitracker coverage of TelexFree is here.