Ponzi Tracker Reports: TelexFree Trustee Says Compelling Evidence of Fraud, Seeks Appointment Of Independent Trustee

 Given the facts alleged in the SEC Case, TelexFree appears to be engaged in a classic Ponzi scheme.

– Tracy Hope Davis, U.S. Trustee 

The United States trustee overseeing the bankruptcy cases of TelexFree, LLC, TelexFree, Inc., and TelexFree Financial, Inc. (collectively, “TelexFree”) has filed a motion seeking the appointment of a Chapter 11 Trustee based on “compelling evidence of fraud, dishonesty and gross mismanagement of the affairs of [TelexFree].”  Tracy Hope Davis, the U.S. Bankruptcy Trustee for the region in which TelexFree’s bankruptcy petitions were filed, filed a Motion For Order Directing the Appointment of a Chapter 11 Trustee Pursuant to §1104 (a) (the “Motion”) today, arguing that “for the Debtors’ investors and creditors seeking financial accountability, it is in their interests for an independent fiduciary to be appointed forthwith.”

Pursuant to Federal Bankruptcy rules, while the appointment of independent trustees is common practice in bankruptcy petitions under other Chapters, a Chapter 11 bankruptcy typically only includes a U.S. Trustee associated with the Department of Justice. The reasoning behind this is that, in a Chapter 11 bankruptcy where the petitioning entity(ies) seek to continue doing business and eventually emerge from bankruptcy, the filing entity is best equipped to oversee day-to-day operations and thus would assume the majority of the duties of an independent trustee.

However, as Ponzitracker noted in an article several days ago, the appointment of an independent trustee is specifically contemplated in a Chapter 11 case under 11 U.S.C. 1104, which provides that a case trustee may be appointed:

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.

Finally, the Motion dismisses TelexFree’s recent appointment of a CFO and CEO, arguing that these appointments do not negate past or protect against future fraudulent acts of the Debtors’ board members James Merrill and Carlos Wanzeler.  The Motion expresses doubt that the CFO and CEO truly have control or are independent of former management, and suggests “it is more likely than not that anyone handpicked by [Merrill and Wanzeler] to manage their wholly owned companies will be another cohort.”

Should a trustee be appointed, their duties are set forth in Section 1106.  These duties include the filing of a statement of investigation, as soon as practicable, that includes “any fact ascertainedpertaining 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.

TelexFree will have an opportunity to respond to the Motion pursuant to Court rules.

PatrickPretty also has coverage of the Motion.

A copy of the Motion is below:

Trustee Motion


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