SEC Brings Another Pyramid Scheme Action

Following the disclosure of the massive Madoff fraud, Ponzi scheme cases became a staple of SEC enforcement. More recently the agency seems to be focusing on another type of investment fraud scheme — pyramid schemes. At the close of last week the Commission obtained a freeze order for another pyramid scheme after filing its complaint under seal. SEC v. TelexFree Inc., Civil Action No. 1:14-cv-11858 (D. Mass. Filed April15, 2014).

The action names as defendants the company and TelexFree, LLC along with two groups of individual defendants. One group is composed of the principals – James Merrill, Carlos Wanzeler, Steven Labriola and Joseph Craft. The second group is composed of the promoters – Sanderley Rodrigues de Vasconcellos, Santiago De La Rosa and Faith Sloan.

Since 2012 TelexFree claims to have operated a multi-level marketing company based on a VoIP business. Using its “99TelexFree” VoIP service, customers can register their telephone numbers and receive software that enables their computer to place phone calls through the company network for $49.90 per month.

The firm business model had two key components which promised investors returns as high as 200%. An investor could become a “member” or “partner” by purchasing a membership which the complaint alleges is a security. Profits could come from either: 1) placing internet advertisements for the company and recruiting new members or 2) selling the VoIP service. Under this business model promoters were promised large returns even if they were unable to sell the VoIP service. The slogan repeated over and over was that “everybody gets paid weekly.”

This business model resulted in a huge volume of virtually identical internet advertisements and few sales of the VoIP service. The volume of virtually identical advertisements meant that they were largely meaningless since a search using the term “telexfree” would tie back to the firm website. At the same time, investors found it virtually impossible to sell the VoIP service.

The business model generated significant revenue from the sale of memberships and little from the sale of the VoIP service. From August 2012 through March 2014 the defendants obtained over $300 million from investors, solicited primarily from the Brazilian and Dominican immigrant communities in Massachusetts and twenty other states. During the same period only $1.3 million was raised from selling the VoIP service. Yet the firm would need revenue of over $1 billion to meet its commitments to investors. This meant that the only way investors could be paid the large returns promised was from the funds of other investors. Stated differently, the firm was a classic pyramid scheme.

Misrepresentations were made to solicit investors. Those concerned the back ground of the promoters and the operation of the business model. At least $30 million of investor funds were transferred to the defendants or their affiliates.

In March 2014 the business model was changed. Subsequently, investors can no longer get paid for simply placing internet advertisements. This resulted in a storm of protest. On April 14, 2014 the company was forced to file for bankruptcy. The Commission filed its complaint under seal the next day. That complaint alleges violations of Exchange Act Section 10(b) and Securities Act Sections 5(a), 5(c) and 17(a). The case is pending. See Lit. Rel. No. 22976 (April 17, 2014).

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