The Securities and Exchange Commission (“SEC”) recently filed an emergency action in the United States District Court for the Western District of North Carolina against Rex Venture Group (d/b/a/ ZeekRewards.com) (“ZeekRewards”) alleging the company was operating an illegal Ponzi and pyramid scheme. The scheme raised $600 million from approximately one million investors.

The SEC defines a Ponzi scheme as an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Generally, the perpetrators of a Ponzi scheme solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. They focus on attracting new money to make the promised payments to earlier-stage investors instead of engaging in any legitimate investment activity.

According to the SEC, participants in a pyramid scheme attempt to make money solely by recruiting new participants into the program. They promise high returns in a short period of time for doing nothing other than handing over money and getting others to do the same. Money raised from new recruits is used to pay off early-stage investors. The scheme eventually collapses when the promoter cannot raise enough money from new investors to pay earlier investors.

Both the Federal Trade Commission (“FTC”) and the Securities and Exchange Commission have jurisdiction over Ponzi schemes and pyramid schemes. While the FTC can only pursue civil remedies, usually in the form of an injunction and financial judgment for investor losses, the SEC can pursue civil and criminal complaints. The SEC’s jurisdiction in based on their finding that a Ponzi scheme and pyramid scheme is the fraudulent unregistered offer and sale of securities in an unregistered investment contract that constitutes a security.

In the instant case, ZeekRewards founder Paul Burks (“Burks”) created Zeekler.com in 2010, a penny auction website offering items ranging from personal electronics to cash. The penny auctions required participants to pay a non-refundable fee to purchase and place each incremental bid (typically one cent) on merchandise sold via Internet auction.  The penny auctions were not very successful.

In 2011 Burks launched ZeekRewards, which was described by Burks as a “private, invitation-only, affiliate advertising division” of Zeekler.com. ZeekRewards attracted investors with the promise of daily profit-share awards distributed through a Retail Profit Pool, which operated as a Ponzi scheme, according to the SEC. In order to qualify to share in the daily net profits and become a “Qualified Affiliate,” investors were required to satisfy four criteria:

1. Enroll in a monthly subscription plan requiring payments of $10, $50, or $99 per month;
2. Enroll new penny auction customers personally, through the ZeekRewards co-op program, or through third-party businesses endorsed by ZeekRewards;
3. Sell at retail or purchase and give away as samples a minimum of ten Zeekler.com bids, earning Profit Points; and
4. Place one free ad daily for Zeekler.com and submit proof of the ad to ZeekRewards.

Becoming a Qualified Affiliate took little to no effort on the part of the investor. Qualified Affiliates were paid their share of net profits from the Retail Profit Pool in the form of daily “awards” or dividends on accumulated Profit Points, which functioned like shares of stock.

The size of each Qualified Affiliate’s daily award was dependent solely on how many Profit Points that investor accumulated. Buying and giving away more Zeekler.com bids earned greater Profit Points, meaning a larger daily profit share award, without any additional effort required. Qualified Affiliates were given the option of receiving their daily award as a cash payment, as additional Profit Points or a combination of the two. ZeekRewards.com encouraged Qualified Affiliates to convert at least 80% of their daily award as additional Profit Points and most followed that approach.

In addition to the Retail Profit Pool, ZeekRewards.com operated a pyramid “Matrix” which rewarded investors for recruiting others to join the scheme. The company placed each new affiliate into a 2x5 forced-fill matrix, which was a pyramid with 63 positions that pooled new investors’ money and paid a bonus to affiliates for every “downline” investor within each affiliate’s personal matrix.

Qualified Affiliates earned bonuses and commissions for every paid subscription within their downline, whether or not he or she personally recruited everyone within the matrix. Affiliates were rewarded merely for recruiting new investors without regard to any efforts by the affiliates to sell bids or otherwise support Zeekler.com, the online auction site.

At the time the SEC shut down ZeekRewards.com, the company had nearly 3 billion Profit Points outstanding. If all Qualified Affiliates opted to receive their daily award in cash, ZeekRewards.com would have been obligated to pay out approximately $45 million per day. During the life of the ZeekRewards program, the company took in more than $600 million, paid out $375 million to affiliates and held approximately $225 million in affiliate funds. Burks agreed to settle the SEC’s charges against him without admitting or denying the allegations and he has agreed to cooperate with a court-appointed receiver.

The business operated by Burk is distinguishable from a legitimate multi-level marketing company in that the participants in ZeekRewards.com were not receiving compensation for selling a product or service but were merely rewarded for buying into the program themselves and recruiting new participants into the program.

Legitimate multi-level marketing companies utilize a sales force of independent business owners to sell a product or a service. The independent business owner receives a commission from the multi-level marketing company based on the amount of products or services they are able to sell to end users. Compensation is not primarily based on the number of people the independent business owner is able to recruit into the program.

DSA will continue to monitor the instant case as well as other actions taken by the SEC with regard to Ponzi schemes and pyramid schemes. DSA has engaged in outreach to the SEC asking them to participate in upcoming DSA events.