Zi booster cops a plea in Operation Bermuda Short case
by Lee M. Webb
August 22, 2003
Zi Corp., entangled in a controversy and lamenting the negative media coverage involving U.S. Securities and Exchange (SEC) target Michael Lauer and his allegedly fraudulent Lancer Group, may face more unflattering public exposure following the Aug. 21 plea bargain of key Lancer figure Bruce Cowen in connection with charges arising from Operation Bermuda Short. Mr. Cowen was one of Zi's principal boosters.
It should be noted at the outset that Zi is not implicated in any wrongdoing in connection with either the SEC probe of the allegedly fraudulent activities of Mr. Lauer and his purported $1-billion (U.S.) Lancer Group, which was shut down by the SEC on July 10 of this year, or Operation Bermuda Short, a joint FBI-RCMP undercover sting that led to the arrest of 60 penny stock players including Mr. Cowen last year. However, Zi has several connections to Mr. Lauer and Mr. Cowen.
Mr. Cowen, identified in the grand jury indictment as a managing director of the Lancer Group and chairman of Capital Research Ltd., entered his plea of guilty to one count of conspiracy to commit securities fraud, wire fraud and mail fraud before Judge Cecilia Altonaga of the U.S. District Court for the Southern District of Florida yesterday.
After entering his plea, Mr. Cowen sat next to his lawyer and answered Judge Altonaga's questions with respect to whether he understood the details of his plea agreement. While not noted in the Aug. 21 news release issued by the U.S. Attorney for the Southern District of Florida, Mr. Cowen's plea bargain included an agreement to co-operate with authorities.
Mr. Cowen answered affirmatively when Judge Altonaga asked whether he would co-operate with further government investigations, including "working in an undercover role," if requested.
The defendant sat silently as the prosecutor read out the factual basis of what the government would have proven had the case gone to trial. Once the prosecutor was finished reading the factual basis to the court, Judge Altonaga asked Mr. Cowen whether he agreed with the recital. Mr. Cowen again answered affirmatively, and with that the judge accepted his guilty plea.
Mr. Cowen faces a maximum prison sentence of five years, to be followed by a term of supervised release, a fine of up to $250,000 (U.S.), and payment of court costs. A status conference has been scheduled for Feb. 9, 2004.
As summarily laid out in the Aug. 21 news release, in the sting that netted Mr. Cowen, the Federal Bureau of Investigation, using an undercover agent posing as a corrupt securities dealer for a fictitious foreign mutual fund unearthed a larger conspiracy whereby Mr. Cowen, the Lancer Group and others defrauded investors by manipulating and controlling the stock of Lighthouse Fast Ferry Inc.
Mr. Cowen and his co-conspirators effected the conspiracy in two ways: first, by artificially inflating the market price of Lighthouse to enable Lancer to fraudulently claim that its holdings of the stock were more valuable than they truly were; and second, by agreeing to pay and then paying undisclosed kickbacks to the FBI agent and two fictitious officers of the equally fictitious foreign mutual fund to buy a large amount of overpriced Lighthouse stock, allowing Mr. Cowen and his associates to take an undisclosed payment on the deal for themselves.
According to the prosecution, Lancer employees rigged the month-end prices of Lighthouse from April through December of 2001 by running the fraudulent trades through Shamrock Partners Ltd. and Hermitage Capital Corp.
By July of 2001, Mr. Cowen and his co-conspirators negotiated a stock-purchase-and-kickback deal with the undercover FBI agent whereby the fictitious foreign fund would buy $5-million (U.S.) worth of restricted Lighthouse stock in exchange for sharing a $1.5-million (U.S.) undisclosed side-payment, with $900,000 (U.S.) going to the undercover agent and $600,000 (U.S.) going to Mr. Cowen and his associates.
A $16,000 (U.S.) test transaction was conducted in which $10,000 (U.S.) was kicked back to the undercover agent. After that deal was concluded the undercover agent cancelled the larger $5-million transaction, but by then the FBI had what it needed.
It is not likely that Mr. Lauer will take any of this as good news; assuming that it is news to him and that he has heard it. Neither the original indictment filed last May nor a superseding indictment file this May contained specific allegations of Lancer's involvement in manipulating the price of Lighthouse stock. Moreover, neither indictment contained specific mention of Hermitage Capital, which is run by Lancer director John Bendall.
If Mr. Lauer has his ear to the ground, he may also find some other recent rumblings unsettling. There are persistent rumours circulating that individuals associated with companies in the Lancer portfolios have recently been served with grand jury subpoenas, drawing speculation that more indictments may be in the offing.
There are also unconfirmed reports that Mr. Lauer, who is of course as free to travel as any other law-abiding citizen, may currently be travelling outside of the U.S., perhaps visiting an eastern European country.
Mr. Cowen's plea bargain and any new attention it might draw to Mr. Lauer and his funds may also be unwelcome news for Zi, which is already reeling from the recent disclosure of Lancer's surprising stake in the company.
As reported by Stockwatch on Aug. 6, court documents filed in support of the SEC's civil complaint against Mr. Lauer and the Lancer Group that resulted in the freezing of the funds' assets and the appointment of a receiver indicate that Lancer Partners LP, Lancer Offshore Inc. and Omnifund Ltd. collectively controlled a staggering and previously undisclosed 18.7 million shares of Zi, almost 50 per cent of the outstanding shares, as of April 30.
Since the Stockwatch report was published, Zi chief executive officer Michael Lobsinger has publicly claimed that the company is "as surprised as anyone at the alleged percentage ownership of the Lancer Group" in Zi. It is possible, however, that Mr. Lobsinger may have unwittingly overstated the company's surprise or underestimated the surprise of some investors, particularly those who relied upon disclosures in Zi's regulatory filings.
In a May 20 SEC filing, for example, Zi claimed that, based on a report from its transfer agent CIBC Mellon, 187 registered shareholders in the U.S. held approximately 24.86 million shares or 64.7 per cent of the company's stock at Dec. 31, 2002. In the same filing, Zi put the Lancer holdings at approximately 3.7 million shares or 9.7 per cent of the outstanding shares, noting that it had been unable to obtain an update on the Lancer position and was reporting the figure supplied for the previous year.
In an Aug. 11 statement regarding the Lancer controversy, Zi contradicted its own claim regarding the number of registered shareholders reported in the SEC filing. In the Aug. 11 news release, Zi claimed that the vast majority of its shares were not registered but held in investment dealer book entry form. Stockwatch pointed that inconsistency out in an article published the same day.
The company did some backpedalling with respect to its conflicting claims regarding the number of registered shareholders when the contradiction was brought directly to its attention during an Aug. 15 conference call. In spite of the fact that the claim in the May 20 SEC filing was quite explicit with respect to 187 registered shareholders, Zi's chief financial officer insisted that the reference was actually to 187 investment dealers "because that's what we meant when we wrote it."
The Aug. 11 damage control news release also suggests that Zi may have had some concerns about the size of the Lancer holdings prior to filing its Form 20-F annual report with the SEC on May 20. According to the Aug. 11 statement, during the course of preparing its annual report, Zi "observed what appeared to be a concentration of its shares held at a major brokerage firm" and asked its lawyers to obtain an update on the Lancer holdings, to no avail.
Given the company's observation of a major concentration of its shares held by an unidentified brokerage firm, its apparent concern with respect to the Lancer holdings prior to May 20 and the peculiar meaning it now claims with respect to the purported 187 registered shareholders, Zi may not have been as surprised at reports of the alleged massive Lancer stake as shareholders who relied upon the company's inaccurate and, regardless of intent, misleading disclosures regarding the matter.
In the midst of some unflattering press and shareholder unrest over the Lancer controversy, the Aug. 21 plea bargain of Mr. Cowen may present another public relations challenge for Zi. In addition to being one of Zi's principal boosters, a purported major shareholder who participated in a number of the company's conference calls along with Mr. Lauer, Mr. Cowen was also a key figure in priming the American Stock Exchange-listed Lancer-controlled shell that purchased Magic Lantern from Zi last November in a share and promissory note transaction.
Mr. Cowen was arrested last August, well before Zi completed the sale of Magic Lantern, along with co-accused James T. Kelly and Joseph R. Huard on charges of conspiracy to commit wire, mail and securities fraud. Even before being nabbed in the Operation Bermuda Short undercover sting, Mr. Cowen and Mr. Kelly were packing some regulatory baggage.
In 1999 the SEC enjoined, fined and barred Mr. Cowen from acting as an officer or director of any public company for five years for his fraudulent conduct, including misallocating securities to himself while acting as chief financial officer and then president of TRC Companies Inc.
Mr. Kelly and Mr. Huard were also well known to securities regulators, as was their Pennsylvania-based brokerage firm Shamrock Partners, which just happens to share the same address as Mr. Cowen's Capital Research. Indeed, Mr. Kelly is reportedly a principal of Capital Research as well as an officer of Shamrock.
Shamrock's colourful, though far from illustrious, history includes serving as a key conduit for a ring of mob-linked penny stock promoters that allegedly used extortion, threats, and violence to coerce brokers and co-conspirators while running penny stock rig-jobs through boiler rooms, according to several U.S. indictments.
In one case, spanning from November of 1995 or April of 1996 through to November of 1998, New York-area defendants Peter Liounis, Christian Rizzo, Walter Culkin, Vladimir "Vinny" Shtutman (also known as Vinny Shtuts), Oleg "Alex" Feldman and Shaun Neal flogged Sports Vision and Surequest shares from a boiler-room office in Manhattan. The ring allegedly received more than $8-million (U.S.) from the sale of Sports Vision shares and more than $2-million (U.S.) from the sale of Surequest shares through nominee accounts at Shamrock and a few other accommodating brokerages.
In an unrelated matter, on Nov. 12, 1998, the SEC administered a wrist slapping to Mr. Kelly and Shamrock for violating the National Association of Securities' Dealers Rules of Fair Practice by charging clients excessive markdowns. The SEC assessed a joint fine of $15,000 (U.S.) against Mr. Kelly and Shamrock, restitution of $10,000 (U.S.) and payment of hearing costs.
Shamrock is perhaps best known for its former star broker Rafi Mohamad Khan, a close associate of notorious boiler-room operator and paperhanger Irving Kott. Mr. Kott, who has been involved in shady deals from Canada to the Netherlands to the U.S., has been at the centre of a multiyear SEC investigation that leads right to Howe Street, home to many dubious Vancouver stock promotions. Mr. Khan, the former Shamrock star, flipped to become a star witness for the U.S. Department of Justice in 1998 and is believed to have shed some light on Mr. Kott's activities.
In April of 2001, the SEC fined Shamrock and Mr. Kelly for their roles in Mr. Khan's 1995 rig job of L.L. Knickerbocker Co. Inc., a Nasdaq-listed stock that soared from $6 (U.S.) to $52 (U.S.) per share before collapsing. While Mr. Khan walked away from the Knickerbocker scam with a five-year brokerage ban and no fine, Shamrock was subsequently fined $50,000 (U.S.) and Mr. Kelly was tagged with a $25,000 (U.S.) fine and suspended from acting in a supervisory capacity at any brokerage for six months.
Mr. Kelly and his Shamrock associate Mr. Huard added yet another chapter to the firm's colourful history when they were indicted last year along with Mr. Cowen. All three first entered pleas of not guilty, but Mr. Huard was the first to abandon the notion that hanging together might be better than running the risk of hanging separately.
On Dec. 18, 2002, Mr. Huard flipped and changed his plea to guilty in a plea bargain that included an agreement to co-operate with government authorities, including aiding in the prosecution of Mr. Kelly and Mr. Cowen.
Five months after Mr. Huard flipped, a superseding indictment containing details of the month-end price rigging of Lighthouse and other information that was absent from the original indictment was filed against Mr. Cowen and Mr. Kelly.
Following the superseding indictment, the trial of Mr. Cowen and Mr. Kelly was scheduled for Sept. 22. Facing the prospect of 25 years in prison if convicted, Mr. Cowen apparently had a change of heart and decided that he, too, would cut a deal, leaving Mr. Kelly alone proclaiming his innocence.
Given that Mr. Huard was already singing, it seems likely that Mr. Cowen knew a ballad or two of interest to the U.S. prosecutors. It remains to be seen just who, if anyone, will be invited to dance to Mr. Cowen's tunes.
At this point it is not known whether U.S. securities regulators or law enforcement agencies have any interest in Mr. Lauer's previously undisclosed massive Zi stake, for which the Lancer funds reportedly peeled off more than $97.6-million (U.S.), the respective major stakes of Lancer and Zi in Magic Lantern, or Mr. Cowen's role in priming the Lancer-controlled AMEX shell that acquired Magic Lantern from Zi last year.
As it happens, Mr. Kelly was also involved in setting up that AMEX shell, then operating as Stage II Apparel Corp. In fact, Mr. Kelly's involvement almost derailed the whole deal when someone apparently tipped AMEX officials to the previously undisclosed fact that he was a principal of Mr. Cowen's Capital Research, which was to receive 2.1 million shares for brokering the deal with Mr. Lauer. With that bit of information in hand, AMEX stalled on the application to list the 30 million shares that Mr. Lauer was to acquire for $1.5-million (U.S.).
With the AMEX listing in doubt, Mr. Lauer tried to back out of the deal on Jan. 9, 2002. Stage II responded two weeks later by filing a lawsuit in the U.S. District Court for the Southern District of New York against Mr. Lauer and his Lancer-affiliated Alpha Omega Group, Capital Research and the two principals of the firm, Mr. Cowen and Mr. Kelly.
Among other things, the lawsuit sought damages for Mr. Lauer's purported termination of the stock purchase agreement as well as damages for securities fraud and tortious interference with the company's contract rights. According to Stage II, Capital Research "and its principals failed to resolve issues raised by AMEX about Mr. Kelly, whose involvement in Capital had not been disclosed to the company."
The dispute was rather quickly and quietly resolved; the temporarily interrupted transaction was consummated on April 16, 2002, and the Lancer-controlled company was renamed JKC Group Inc. On June 5, 2002, the fortuitously primed JKC signed a letter of intent to acquire Magic Lantern from Zi.
While the regulatory histories of both Mr. Cowen and Mr. Kelly, as well as Mr. Kelly's association with image-challenged and SEC-sanctioned Shamrock, were available to anyone conducting even a modest amount of due diligence, JKC evidently passed muster with Zi. On Nov. 7, 2002, Zi dealt Magic Lantern off to the Lancer-controlled company in exchange for a $3-million (U.S.) promissory note and 29.75 million shares, cementing another tie to Mr. Lauer.
Magic Lantern, which is also mired in the Lancer scandal, reportedly only had enough cash to stay afloat until last week, which suggests that the $3-million (U.S.) promissory note and the 29.75 million shares still held by Zi are worth just about the paper they are printed on. However, Magic Lantern may be among the least of Zi's concerns, given that the company is also on the hunt for financing, something that may turn out to be a rather daunting task while enveloped in the Lancer cloud. Any further unpleasant revelations could make that task even more difficult.
Meanwhile, Zi continues to show some resilience in the face of recent unflattering media coverage. With a modest 35,900 shares exchanged in Nasdaq trading on Thursday, Zi gained six U.S. cents to close at $2.39 (U.S.). Only 25,100 shares changed hands on the TSX as the stock added 11 cents to close at $3.38 on Aug. 21.
(With files from Miami correspondent Erik Schelzig.)
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