E&Y audit of TelexFree reveals evidence of Ponzi scheme
Much importance has been placed on the Ernst & Young report on TelexFree that was due out this month.
Despite the SEC’s case against TelexFree, criminal proceedings currently taking place against its owners and Trustee Stephen Darr’s damning evaluation of the company earlier this month, many Brazilian investors believed the Ernst & Young audit would somehow absolve the company.
Those hopes appear to have been dashed, with preliminary reports of Ernst & Young reports confirming fraudulent activity has been found.After a series of delays, attributed to the complexity of auditing TelexFree’s business operations, Ernst & Young’s report was due on the 11th of February 2015.
Thus far Judge Borges, currently hearing the case, has only acknowledged receipt of the audit.
According to information obtained from the Acre Court, the magistrate of the 2nd Civil Court, Thais Borges, who is responsible for the Telexfree case, acknowledged receipt of the expertise, but stated that she will not provide any information or summary of the content.
“The magistrate will not provide any information to the press. It will not speculate, because in their understanding, speculation can harm the (judicial) process, since (the case) has not yet reached the final stage, that is the conclusion, ” she said through an assistant.
“Those who would like information about what is contained in the report can get it through TelexFree company representatives involved or even the MPE,” concluded the assistant.
Already it would appear those interested in the report have done just that, with several reports written about the contents of Ernst & Young’s audit.
At the forefront of the information released thus far, is the claim that ‘that there is evidence that the activities of Telexfree have characteristics of a “financial pyramid”‘.
The term “financial pyramid” is commonly used in Brazil to describe what are otherwise known as Ponzi and pyramid schemes.
For more information we turn to Acre Alert, a blog otherwise known for being quite pro-TelexFree, who have published what they claim are various excerpts from Erst & Young’s audit:
Sale and viability of the product or service
We observed evidence that even in a “financial pyramid” there can be the existence of a product or service, but with low utilization.
The results of our tests (in relation to TelexFree) indicate that in addition to low utilization of minutes (there were) limitations regarding the guaranteed functionality of the product.
Telexfree guarantees providing only 10% (ten percent) of quality service and does not allow the use of the minutes made available for commercial activities.
We also note that (i) the principal advisers did not use the minutes that they had at their disposal; and (ii) the use of minutes of Telexfree Network comprises 0.23% (twenty three percent) of the total available to its users.
Describing what is otherwise known as a “product-based pyramid scheme”, where a product is attached to a Ponzi or pyramid scheme solely to lend it some credibility (“how can we be a scam, we have a product?”), Ernst & Young state that only 0.23% of the minutes TelexFree’s investors accumulated were actually used.
This is typical of product-based pyramid and/or Ponzi schemes, where the attached product or service is purchased in large quantities as a side-effect of participating in the scam, but is ultimately insignificant (in this case, the VOIP minutes bundled with TelexFree investment were not used).
The definition of staggered gains permeates the fact that the members at higher levels within a financial pyramid, would show higher yields with respect to lower levels of members.
(In TelexFree), the Promoters may purchase more than one kit, and therefore have more than one access login.
To observe the existence of scaling, we selected certain participants and noted that they had several access logins and the sum of their incomes were higher compared to the other levels.
We emphasize that we were not able to examine the entire Telexfree Network to collect evidence of staggered gains, due to limitations in the quality of the database in relation to advisers and partner’s registration.
Did TelexFree investors who invested more receive a higher ROI than those who invested less?
As described in the Technical Note 116 of the Department of Consumer Protection and Defense, one of the clues to the identification of a “financial pyramid” would be free access to transfer of benefits between participants of the pyramid.
As shown in the aforementioned aspect, we observed the existence of elements that show that they have made transfers of balances between Promoters and Partner’s, totaling the equivalent of USD $4,555,256,256.86 (four billion, five hundred fifty-five million, two hundred and fifty-six thousand , two hundred fifty-six US dollars and eighty-six US cents), which correspond to 7,141,821 (seven million, one hundred forty-one thousand, eight hundred twenty-one) transfers.
Did TelexFree investors transfer funds among their respective investor accounts (including multiple accounts owned by the same investor to reduce withdrawal processor fees?
Of note is that four billion dollar figure. Darr recently pegged TelexFree at $1.8 billion, with this latest figure more than doubling that.
Promise to pay, sales efforts and attraction for the benefits
As described throughout the detailed reply in this regard, the high remuneration promise in a short time, with low sales effort is indicative of the existence of pyramid.
As a result of our procedures on this point we observed the existence of elements indicating promises of high returns and high financial returns in a short time.
In addition, we can see the attraction of Promoters and Partner’s by high yields, since they and their advisers networks, have low use of minutes and a high volume of ad posting, activity this that allowed access to the volume of benefits to the universe of publishers, without generating economic value for this activity, and, representing 67% (sixty-seven percent) of the total compensation of Telexfree.
We also note that we observed the existence of computer programs that perform the posting of notices automatically, a fact that was confirmed in the database, and that would be evidence of low effort (“work”) to achieve the goals for the benefit of gain.
This is probably the most damning finding in Ernst & Young’s audit. That being that TelexFree and its affiliates advertised low to no effort “high-renumeration” (ROIs) within a short period of time.
AdCentral ROIs are attributed to 67% of the total commissions paid out by TelexFree, with the rest likely being recruitment commissions (the pyramid scheme component of the opportunity).
Ernst & Young note that the publishing of AdCentral ads failed to provide “economic value” to TelexFree (ie. it was a waste of time), and that automation of the posting of such ads (widely promoted by TelexFree investors), meant that the activity was also “low effort”.
In short, Ernst & Young found TelexFree investors were compensated large sums of money for performing meaningless tasks for the company.
With the tasks performed themselves generating no significant revenue for the company, left unsaid is the fact that the funds paid out were sourced from affiliate investors themselves.
Proportion of income
According to the CFE Manual at least 70% (seventy percent) of the commissions of a “distributor” must come from direct sales.
In regards to TelexFree, we note that the relative proportion of direct and indirect compensation arising from publishing advertisements, is 67% (sixty-seven percent) of all remuneration generated by Network Telexfree.
Regarding the direct commissions, we observed that these represent 30% (thirty percent) and indirect fees 3% (three percent), both on the total remuneration of the Network.
Here Ernst & Young apply TelexFree’s business model to a CFE Manual (not sure what that is) rule, which states that 70% of commissions must come from direct sales.
Finding that 67% of commissions paid out to affiliate investors were AdCentral ROI payments, TelexFree quite obviously failed this criteria.
Direct commissions, which I believe are the affiliate recruitment commissions component of TelexFree’s compensation plan, constituted 30% of commissions paid out.
Due to the high earnings generated by Promoters, contracts of Telexfree products and services required a position of Reservation Cost (CRP), which deducts 20% of all remuneration of Promoters and Partner’s obtained during the the contract period, in order for the Promoter’s position in the network to be maintained.
Thus, we understand that the CRP constitutes a way of encouraging reinvestment and hence the maintenance of the promoter in Telexfree Network indefinitely.
This reinvestment design was aimed at propping up the pyramid scheme for longer.
Was the 20% fee TelexFree charged affiliates a meaningless excuse to claw invested funds back into the system to stall the inevitable Ponzi scheme collapse?
Economic and financial viability of the services and products offered by Telexfree
We observed that Telexfree had the following scenarios regarding the financial viability of the operation:
Based on the preparation of financial information Combined “Pro-forma” of Telexfree Network, we can observe the absence of liquidity.
We developed four product feasibility studies on hypothetical scenarios and as a result of reviews, we noted the lack of financial support from the Telexfree business model; and we developed a projection considering the result of Telexfree Network from its 17th operating month and evaluated the viability of operations considering its actual results to June 2013.
As a result, we also observed that there was a lack of sustainability of the operation.
This was a bit of a headache to understand, but I believe Ernst & Young sought to ascertain the feasibility of TelexFree’s advertised VOIP product, by comparing it to the actual revenue generated till June 2013 (the month TelexFree was shut down in Brazil).
After running four product feasibility studies using separate hypothetical scenarios, they were unable to come up with a suitable model that would demonstrate the sustainability of TelexFree relying on its service product alone.
We observed that the services and products offered by Telexfree are paid in advance by Promoters and Partners.
However, this element itself is a feature that aggregate to the others and becomes clear when we supported the feasibility study.
Thus, as noted elements that show a lack of financial support Telexfree Network, there is evidence that the advance payment would have been used for short-term debt settlement with members of higher levels of the network.
What we’re talking about here is, in it’s most simple break down, the use of new affiliate funds to pay off existing investors.
Ernst & Young reason that TelexFree’s affiliates clearly weren’t using the service, so by making them pay for a year upfront (AdCentral’s were sold on 52 week contracts), TelexFree was quite obviously using new funds to pay off those they already owed.
It’s important to note that Ernst & Young weren’t charged with determining whether or not TelexFree was a Ponzi and/or pyramid scheme. They were handed a set of questions by the Acre Court which, through a thorough audit of TelexFree’s operations in Brazil, they have answered.
The court itself (Judge Borges) will now take that report and draw a conclusion.
That said, the writing is pretty much on the wall at this point. Any shred of hope Carlos Costa had of walking free from this Ponzi mess is dashed.
Or so one would think. Paid to do what they do, TelexFree’s lawyers were quick to denounce the Ersnt & Young report as “inconclusive”.
“It is one thing is to say that there are elements that indicate a pyramid (scheme), but another thing to say that it is a pyramid (scheme).
The report is inconclusive, so Telexfree is not a financial pyramid, “says Wilson Furtado.
I don’t know what crack TelexFree’s Brazilian legal team are smoking, but from what little we’ve seen of the 200 page Ernst & Young report – it sounds pretty darn conclusive to me.
Looking forward, both the Acre Public Prosecutor’s Office and TelexFree’s legal team now have 30 days to discuss the finer points of the audit in court.
After that, it’s game over.