Zi short sellers zapped with forced buy-ins
by Lee M. Webb
September 5, 2003
Zi Corp., a controversial Calgary-based technology company facing market pressure because of its ties to U.S. Securities and Exchange Commission target Michael Lauer and his allegedly fraudulent Lancer Group, saw its flagging share price get a boost this week as short sellers faced forced buy-ins to cover their short positions.
From Sept. 2 to Sept. 4 Zi gained 92 cents as it climbed from $3.01 to $3.93 on the Toronto Stock Exchange (TSX). In heavier Nasdaq trading the stock notched similar gains, climbing 53 U.S. cents during the same period and closing at $2.83 (U.S.) on Sept. 4.
On July 10 the SEC shut down Mr. Lauer's purported $1-billion (U.S.) Lancer Group, freezing the assets of the allegedly fraudulent operation. The U.S. regulator also obtained a court order appointing a receiver to "marshall and safeguard" the Lancer assets. As first reported by Stockwatch on Aug. 6, as many as 18.7 million Zi shares or almost half the company's outstanding shares may be among the frozen Lancer assets.
After Stockwatch broke the news of Mr. Lauer's previously undisclosed massive stake in Zi as revealed in court documents filed by the SEC, other media outlets in Canada and the U.S. picked up the story. In the wake of the widening media attention, Zi issued a statement on Aug. 11 indicating that it did not know how many shares of the company Mr. Lauer controlled. The company said that it was working with regulators and the Lancer receiver to determine the number of Zi shares held by the allegedly fraudulent Lancer funds.
Zi has a number of connections to Mr. Lauer, who reportedly peeled off more than $97.6-million (U.S.) as his Lancer funds sponged up 18.7 million shares of the company. Among other things, Zi sold a subsidiary, Magic Lantern, to a Lancer-controlled American Stock Exchange shell in a share and promissory note transaction last year. Three Zi directors also serve as Magic Lantern directors along with Lancer director Richard Geist, a psychologist and penny stock tout who has heavily promoted Zi in his tout sheet.
Zi's share price tumbled in the wake of Stockwatch's report of Mr. Lauer's massive undisclosed holdings and subsequent reports of some of the company's other links to the disgraced hedge fund operator. Within a week of the first Stockwatch article Zi's share price shed almost $2, dropping from $5.05 to $3.12. While some of that selling pressure undoubtedly came from investors bailing out on the troubling news of Mr. Lauer's surprising stake in Zi, much of it came from short sellers trying to capitalize on the negative implications of that previously undisclosed stake.
The reported Canadian short position for Zi on Aug. 15 was nearly double the short position reported two weeks earlier, climbing from approximately 784,000 shares on July 31 to more than 1.4 million shares by mid-August. A U.S. reporting agency indicates a similar short position of approximately 1.4 million shares south of the border as of Aug. 8. According to the latest Canadian short report for Aug. 31, the short position levelled off at just over 1.47 million shares at the end of the month.
Put simply, short sellers sell shares that they do not yet own in the expectation that the price will fall, allowing them to later purchase the shares at a lower price than they originally sold them for and realize a gain on the difference. To facilitate the initial sale, the short seller arranges through a broker to borrow stock to deliver to the buyer.
Eventually, however, the short seller must purchase shares to return to the account from which they were borrowed. That does not always occur at a time of the short seller's choosing; occasionally they are forced "to cover the short." This is known as a "short squeeze" and often results in the stock price climbing as short sellers scramble to purchase the required shares.
Some market players have been puzzled for some time over the difficulty in borrowing Zi shares in order to effect a short sale. In fact, Zi has long been known as a "no-borrow" stock. At least some of the mystery surrounding the difficulty in borrowing stock for short sales was solved when Stockwatch revealed that Mr. Lauer reportedly controlled almost 50 per cent of Zi's outstanding shares as of April 30.
Zi's resilience in the face of recent negative media attention and the continuing difficulty that short sellers reportedly encounter in attempting to borrow stock has some close industry followers of the money-losing company suggesting that in addition to the Lancer sponge there may be one or more other large investors supporting the share price.
Early on Sept. 4, a brokerage analyst told Stockwatch that there were "buy-in threats all over the street" regarding the Zi short positions. The analyst suggested that the stock price was being run up in advance of the pending forced buy-ins so that they would have to be executed at higher prices.
If a Canadian brokerage firm shorts more shares than it has been able to borrow, it can be forced to purchase the number of shares required to bring its position into balance. The forced buy-ins, transacted through the TSX, are executed at a 10-per-cent premium to the prevailing market price of the stock just prior to the transaction.
At 3 p.m. on Sept. 4, with Zi trading at $3.93 per share, the TSX executed the forced buy-ins on a total of 88,576 Zi shares. Jones Gable accommodatingly acted as the seller for 85,576 of those shares and Wolverton Securities chipped in with the remaining 3,000 shares. With the 10-per-cent premium tacked on, the transactions were executed at $4.32 per share.
Understandably, short sellers are not particularly enthusiastic about short squeezes or forced buy-ins, though it is not likely that they would get much sympathy from people who hold long positions in a stock. Meanwhile, some brokers insist that investors, particularly retail investors, should not be investing in Zi while it is mired in the Lancer controversy.
Indeed some brokers, perhaps motivated as much by their own short positions as any concern for the financial well being of retail investors, have been attempting to nudge regulators into taking some action. At the very least, they say, Zi should be halted until the uncertainty over the number of shares controlled by Mr. Lauer and Lancer is resolved. Evidently the regulators think otherwise.
Meanwhile, with the short squeeze that pleased some market players apparently softening, Zi gave up some of its gains in the final trading session of the week. In Nasadq trading, 202,000 shares changed hands on Friday as the stock shed 10 U.S. cents to close at $2.73 (U.S.). In much quieter TSX trading, a modest 39,900 shares were exchanged and Zi was off 15 cents to close at $3.78 on Sept. 5.
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