Darr v. Argueta (In re TelexFree, LLC)

In re: TELEXFREE, LLC, et al. Reorganized Debtors

STEPHEN B. DARR Plaintiff v. BENJAMIN ARGUETA et al. DefendantsSTEPHEN B. DARR Plaintiff v. PAOLA ZOLLO ALECCI et al. Defendants

Case No. 14-40987-MSH

Case No. 14-40988-MSH

Case No. 14-40989-MSH

Adversary Proceeding No. 16-04006-MSH

Adversary Proceeding No. 16-04007-MSH

UNITED STATES BANKRUPTCY COURT DISTRICT OF MASSACHUSETTS EASTERN DIVISION

June 22, 2021

Chapter 11

Substantively Consolidated

MEMORANDUM OF DECISION ON CLASS DEFENDANTS' MOTION TO EXCLUDE EXPERT WITNESS TESTIMONY OF TIMOTHY MARTIN

Stephen B. Darr, the chapter 11 trustee of the estates of TelexFree, LLC, TelexFree, Inc., and TelexFree Financial, Inc.,¹ commenced these adversary proceedings to recover funds fromthe class of TelexFree participants who profited or were "net winners" in TelexFree's fraudulent schemes. As detailed below, this memorandum focuses on issues related to the trustee's ability to identify net winners and quantify their winnings. To assist him in accomplishing that task, the trustee retained a firm of professionals to develop a methodology for making net winner determinations. The professionals' work forms the basis for the claims asserted by the trustee in these adversary proceedings, and the trustee wishes to introduce that work as an expert opinion through the testimony of one of his professionals. The defendants retained their own expert, and based upon his evaluation, they seek to exclude the opinion of the trustee's expert as unreliable.

I. Background

On April 13, 2014, TelexFree and its affiliates filed voluntary chapter 11 petitions in the United States Bankruptcy Court for the District of Nevada.² Around the same time, the U.S. Securities and Exchange Commission initiated an action against TelexFree and others, asserting that TelexFree and its affiliates were engaged in an illegal Ponzi/pyramid scheme and in the fraudulent and unregistered offering of securities, and the U.S. Department of Homeland Security executed a search warrant, seizing TelexFree's computers and servers. Shortly after filing, the chapter 11 cases were transferred to this Court. Mr. Darr was appointed chapter 11 trustee to administer all three bankruptcy estates on June 6, 2014. TelexFree was later found to have been a hybrid pyramid and Ponzi scheme. The scheme began in 2012, and, operating from the United States, it ensnared participants domestically and worldwide. Millions are believed to have participated, and well over $1 billion was lost in the fraud.

TelexFree purported to be a multi-level marketing company selling Voice over Internet Protocol (VoIP) subscriptions, which could be used to make relatively inexpensive international telephone calls via the internet. In reality, TelexFree's business was to recruit participants as members. Almost all TelexFree's revenue came from membership subscriptions that enabled participants to earn "credits" by selling VoIP subscriptions, by posting make-work internet advertisements, and especially by recruiting new participants who bought memberships. Credits were redeemable for cash, used to offset membership fees, and often transferred between participants.³

Each time a participant purchased a VoIP plan or a membership, the participant created a user account. As discussed in more detail below, it was quite common for individual participants in TelexFree to have many user accounts. Unfortunately, TelexFree's record database did not directly link user accounts that belonged to the same participant. Determining the extent to which a given individual participant had paid in or received funds from the TelexFree scheme would require aggregating that participant's user accounts. Then, the transaction data associated with those user accounts could be combined to determine whether the participant had gained or lost in the end, that is, whether the participant was a "net winner" or a "net loser."

The trustee retained a team of professionals from Huron Consulting Group, LLC, led by Timothy Martin, to develop a methodology for determining net winners and net losers.⁴ More broadly, Huron's task was to develop a methodology for identifying who participated in theTelexFree scheme and the extent to which they gained or lost money. To do this, Mr. Martin and his team created an aggregation methodology for linking multiple user accounts to individual participants. The trustee has already used that methodology to assist him in the claims resolution process in the main chapter 11 cases by identifying net losers, who qualified as creditors of TelexFree.

The trustee commenced these adversary proceedings as "reverse class actions" to seek to recover funds from the class of TelexFree net winners. He divided the proceedings into one against the class of alleged net winners who reside in the United States (Darr v. Argueta) and a second against the class of alleged net winners who reside abroad (Darr v. Alecci). For purposes of this memorandum, the adversary proceedings are considered together, as the issues in contention are identical. To recover from alleged net winners in these adversary proceedings, the trustee uses the same methodology that he used in the claims resolution process in the main cases. In doing so, the trustee relies upon the expert opinion of Mr. Martin as to how the methodology was developed and applied. The defendants have retained their own expert, Joshua Dennis of StoneTurn Group, LLP, to evaluate Mr. Martin's work.

Recognizing that the admissibility of Mr. Martin's expert opinion would play a decisive role in determining the course of these adversary proceedings, the parties jointly requested a limited discovery process followed by an evidentiary hearing on this issue.⁵ During a two-dayevidentiary hearing, which was conducted remotely by video due to the Covid-19 pandemic, each party's expert testified and all expert reports were admitted into evidence. Subsequently, the defendants filed the motion that is now before me to exclude Mr. Martin's expert opinion. The trustee responded in opposition. This memorandum sets forth the reasoning for my ruling on the defendants' motion.

II. Legal Standard

The defendants' arguments focus on the reliability of Mr. Martin's expert opinion, raising questions about the validity and use of the data upon which Mr. Martin relied and about various assumptions and choices that Mr. Martin made throughout the process of developing his opinion. The parties agree that the admissibility of Mr. Martin's expert opinion is to be determined under the standards set forth in Federal Rule of Evidence 702.

A witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if: (a) the expert's scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue; (b) the testimony is based on sufficient facts or data; (c) the testimony is the product of reliable principles and methods; and (d) the expert has reliably applied the principles and methods to the facts of the case.

Fed. R. Evid. 702. The rule incorporates key Supreme Court decisions—including Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993) and Kumho Tire Co., Ltd. v. Carmichael, 526 U.S. 137 (1999)—and their progeny in which the trial judge's gatekeeping role as to expert testimony has been emphasized and clarified. Fed. R. Evid. 702 advisory committee's note to 2000 amendment. The rule applies to all expert testimony, requiring the same level of scrutiny regardless of the area of expertise being offered. See Kumho, 526 U.S. at 141, 146-52.

The party seeking to have the expert witness's opinion testimony admitted bears the burden of establishing by a preponderance of the evidence that the expert is sufficiently qualified, is offering a reliable opinion, and the opinion is relevant to understanding or determining a fact inquestion. See Fed. R. Evid. 702 advisory committee's note to 2000 amendment; Daubert, 509 U.S. at 592 n.10; Ruiz-Troche v. Pepsi Cola of P.R. Bottling Co., 161 F.3d 77, 81 (1st Cir. 1998). In considering reliability and relevance, the expert's methods, not the expert's conclusions, are"the central focus." Ruiz-Troche, 161 F.3d at 81. Because the two, however, "'are not entirely distinct,'" the trial judge may consider the adequacy of the information offered to support the expert's ultimate conclusion. Ruiz-Troche, 161 F.3d at 81 (quoting Gen. Elec. Co. v. Joiner, 522 U.S. 136, 146 (1997)). The point being that the trial judge should not and cannot simply take the expert's word for it, as there may be "too great an analytical gap between the data and the opinion offered." Joiner, 522 U.S. at 146; see also Kumho, 526 U.S. at 157 (noting that expert's assurances of accuracy in selection and application of methodology are insufficient alone); Ruiz-Troche, 161 F.3d at 81 (indicating need to guard against admitting expert opinion based on "guesswork" rather than having been properly grounded).

Because each case's circumstances will vary, even among cases necessitating seemingly similar expertise, the procedures applied and the factors considered in determining whether an expert's opinion meets Rule 702's criteria can also vary. See Kumho, 526 U.S. at 152-53; Fed. R. Evid. 702 advisory committee's note to 2000 amendment (collecting cases). The Daubert Court identified several factors that might be helpful in reviewing a scientific expert's opinion, including "the verifiability of the expert's theory or technique, the error rate inherent therein, whether the theory or technique has been published and/or subjected to peer review, and its level of acceptance within the scientific community." Ruiz-Troche, 161 F.3d at 80-81 (citing Daubert, 509 U.S. at 593-95). The Kumho Court noted that such factors could be relevant in non-scientific situations, as could untold other factors. Kumho, 526 U.S. at 141, 149-52....