FES Temp Receiver has “concerns” on business legality
The Financial Education Services preliminary injunction was scheduled to take place on June 30th.
As far as I know the hearing took place. As of yet though there have been no further updates to the case docket.
I’m putting this down to the holiday weekend in the US. I’ll check back sometime next week.
In the meantime on June 28th, the Temporary Receiver filed his First Interim Report.
Among other things, the Temporary Receiver expressed “concern regarding the legality of the business model”.
The Temporary Receiver’s report begins by detailing seizure of Financial Education Services’ assets – namely buildings, electronic assets and two vehicles.
My team and I were on-site at the Premises on May 25 and 26, 2022 together with representatives of the FTC. During that time, in addition to conducting the above noted interviews, the following actions were taken in furtherance of the TRO:
-All locks on the Premises were changed, and electronic entry disabled
-Imaging of personal computers and lap computers of several key employees and Individual Defendants
-Disabling customer and Agent enrollment on the Corporate Defendants’ websites and terminating automatic payment functions for existing customers to prevent future payments
I identified one vehicle – a 2020 Lincoln Navigator – leased by Corporate Defendant Financial Education Services, Inc.
I concluded this vehicle is not a necessary expense for the receivership estate.
As such, on June 22, 2022, I directed that the vehicle be turned in and the related lease terminated.
I identified one owned vehicle – a 2022 Lincoln Aviator – titled in Parimal Naik’s name.
Nevertheless, bank records I reviewed show that the funds used to purchase this vehicle were sourced directly from Corporate Defendant Financial Education Services, Inc. … in the amount of $84,400.
As such, on June 13, 2022 my counsel directed counsel for Mr. Naik … to mail the vehicle’s title and keys to my attention and to safeguard the vehicle pending further direction regarding disposition of the vehicle.
$12 million was located in Financial Education Services bank accounts, and is in the process of being transferred to the Temporary Receivership.
In assessing the viability of Financial Education Services’ business model (the Temporary Receiver has to decide whether the business can continue to operate while the FTC litigation plays out), the Temporary Receiver identified FES’ “Protection Plan” as its “key product”.
The key Product is the Protection Plan, accounting for nearly 100 percent of the Corporate Defendants’ revenues (exclusive of CM Rent), which is a bundle of 12 distinct products and services.
Of these Products, it appears that credit restoration is the most popular and highly used Product, with 34,480 customers (out of the total 48,441 customers) active in the last 12 months as of May 31, 2022.
It appears that the credit restoration and repair Product consists of a form letter customers themselves complete and submit to credit agencies.
Based on my interviews with employees, it does not appear that YFL employees spend any individualized time with customers to customize or otherwise assist in the analysis of their credit problems, nor in the preparation or submission of any correspondence to the credit agencies.
If you ignore the majority of FES customers are also affiliates, that doesn’t look too bad.
Thing went downhill though when the Temporary Receiver asked for reports on customer and affiliate (Agent) retention.
In 2019 FES enrolled 84,103 customers. As of June 21st, 2022;
- 53% of those accounts were terminated due to declined charges and chargebacks
- 46% were terminated after the customer requested a refund or cancellation
- 1% were terminated due to an online request received by the customer
- 1% of the 84,103 customer accounts were active
In 2020 FES enrolled 205,958 customers. As of June 21st, 2022;
- 52% of those accounts were terminated due to declined charges and chargebacks
- 38% of those accounts were terminated after the customer requested a refund or cancellation
- 7% were terminated due to an online request received by the customer
- 2% of the 205,958 customer accounts were active
In 2021 FES enrolled 142,178 customers. As of June 21st, 2022;
- 49.28% of those accounts were terminated due to declined charges and chargebacks
- 25% of those accounts were terminated after the customer requested a refund or cancellation
- 11% were terminated due to an online request received by the customer
- 12% of the 205,958 customer accounts were active
Agent recruitment is similar, with FES retaining 5% of enrollments in 2019, 6% in 2020 and 17% in 2021.
The Temporary Receiver concluded this data
demonstrate(s) a high-degree of turnover in customers and Agents, which starts to materialize almost immediately following enrollment.
With respect to FES’ compliance, in an interview co-founder and President Michael Toloff
indicated that managing the activities and conduct of the Agents was the “most difficult” part of the Corporate Defendants’ business.
Following regulatory action, FES’ compliance efforts appear to have concentrated on the state of Georgia.
it is unclear that the Corporate Defendants track violations by Agents outside the State of Georgia.
Based on my interviews … there is no regular company produced and required formal compliance training conducted by the Corporate Defendants for the Agents or customer service representatives.
Moreover, the Corporate Defendants lack any formal external or internal reporting structure and independent resolution for compliance concerns or issues.
As to whether the Temporary Receiver can continue to operate FES legally, he opines;
My review of the businesses of the Corporate Defendants raises significant concerns regarding their ability to operate legally and profitably
While sales generate commissions under the Comp Plan, it appears that Agents are heavily incentivized to recruit other potential Agents to increase their compensation.
After reviewing the Comp Plan and the attrition rate of customers and Agents, I believe there are significant questions regarding whether the Corporate Defendants’ multilevel distribution model constitutes an unlawful pyramid scheme.
The Corporate Defendants’ business model is heavily dependent upon the continued recruitment of new customers and Agents, and sales to nonparticipants (i.e., customers) are not required as a condition to receiving commissions.
The Temporary Receiver believes significant changes to FES’ Protection Plan are “required in order to ensure compliance”.
FES’ current compliance practices would also need to be overhauled.
A substantially more robust compliance regime is needed to ensure the Corporate Defendants and the Agents are in compliance with applicable law.
Absent the necessary compliance measures and with the exception of the Credit Restoration services, the Products still could be offered legally.
However, the sales history casts significant doubt on whether they could generate a profit without credit repair and restoration sales and marketing.
Excluding credit repair and restoration services from the Protection Plan likely would have a materially adverse effect on the profitability and on-going viability of the businesses.
To the extent operations were to continue, I would want to clarify and streamline the Comp Plan so that sales to customers are compensated in a more straight forward manner, which may in turn reduce profitability.
In addition to what’s being subscribed to, the Temporary Receiver points to the previously referenced customer and affiliate retention rates.
The rate of cancellation among customers and Agents is staggering.
When reviewing the data over the last three years, a clear pattern emerges – within two to three months of enrolling as a customer, the majority of customers (i.e., more than 50 percent) cancel their services – a percentage that steadily grows each month until almost all customers have cancelled their services within a year of enrollment. The story is similar for Agents.
This rate of attrition by customers and Agents is a red flag that strongly suggests the Products are of very dubious quality and effectiveness, and supports a conclusion that Agents are more motivated to bring in new Agents (rather than procuring sales of low quality products).
Ultimately, the Temporary Receiver concludes;
Given the significant challenges noted above in maintaining the Corporate Defendants’ business operations, it is my opinion that the businesses cannot be operated legally at this time and without significant modifications, which would likely have a materially adverse effect on the profitability of the Corporate Defendants’ businesses.
This lends itself to FES shutting down permanently under a permanent Receivership. That would require a prelimininary injunction be granted against the FES Defendants.
As stated at the start of this article, at time of publication I don’t have anything to report on the June 30th preliminary injunction proceedings.
Stay tuned for an update mid next week.