Zi a personal favourite of SEC target Lancer leader

TIGHTLY HELD

Canada StockWatch
by Lee M. Webb
September 8, 2003

Zi Corp., a Calgary-based technology company mired in the U.S. Securities and Exchange Commission (SEC) target Lancer Group imbroglio, may sink deeper into that morass. In addition to Lancer's massive undisclosed Zi holdings, recently filed court documents show that Michael Lauer, head of the allegedly fraudulent Lancer operation, personally owns a large Zi stake.

While "tightly held" is a popular phrase bandied about as a positive attribute by stock touts and boosters of many public companies, Zi may be an extreme example of a tightly held stock. Indeed, according to court documents, it now appears that between the Lancer holdings and his personal stake Mr. Lauer may have controlled approximately 21.6 million Zi shares or almost 55 per cent of the 39.28 million shares currently outstanding.

Zi trades on both the prestigious Toronto Stock Exchange (TSX) and Nasdaq. In contravention of securities regulations in both Canada and the U.S., the staggering number of Zi shares controlled by Mr. Lauer was not disclosed to regulators, leaving other investors in the dark.

The SEC shut down Mr. Lauer's allegedly fraudulent Lancer operation on July 10. The U.S. regulator also won a court order freezing the assets of the purported $1-billion Lancer funds and appointing a receiver.

As first reported by Stockwatch on Aug. 6, documents filed in support of the SEC civil complaint against Mr. Lauer and Lancer in the U.S. District Court for the Southern District of Florida revealed that as of April 30 the allegedly fraudulent Lancer funds controlled a previously undisclosed 18.7 million Zi shares.

In the wake of the Stockwatch report and a tumbling share price, Zi issued an Aug. 11 statement claiming that the company did not know how many of its shares were held by Lancer. It is not known whether Zi officials are aware of subsequently filed court documents disclosing Mr. Lauer's large personal Zi stake.

The latest revelation involving Mr. Lauer's undisclosed control of Zi appears in an Aug. 19 motion filed in the Florida court to vary the injunction against Lancer and the disgraced fund manager in order to free up some assets to allow him to meet his personal living expenses and pay his lawyers. Stockwatch will review Mr. Lauer's request for some cash more closely in a separate article, but apparently the Lancer leader thinks that he can make ends meet with approximately $93,000 (U.S.) per month.

Included among the documents filed in support of Mr. Lauer's Aug. 19 motion to vary the injunction is a client position summary for his personal Banc of America brokerage account as of July 14. According to the Banc of America, Mr. Lauer personally owned more than 2.87 million Zi shares as of July 14.

As noted, Mr. Lauer's 2.87 million Zi shares combined with the 18.7 million Zi shares he reportedly controlled through the Lancer entities gave him majority control over the Calgary-based company. Mr. Lauer reportedly paid more than $18.1-million (U.S.) to acquire his personal Zi stake, making it the most expensive holding in his portfolio, which largely mirrors the Lancer portfolios. Under his direction, Lancer peeled off more than $97.6-million (U.S.) to sponge up 18.7 million Zi shares, making money-losing Zi Lancer's largest investment in its portfolios otherwise primarily stuffed with virtually worthless stocks.

Even before the latest revelation regarding Mr. Lauer's personal Zi stake, which has gone unremarked prior to this Stockwatch article, several seasoned market watchers, including people who have been involved in running public companies, have expressed skepticism with respect to Zi's claimed ignorance regarding the Lancer holdings.

In E-mails sent to Stockwatch, some of those skeptics have taken direct aim at Michael Lobsinger, Zi's chairman and chief executive officer. Mr. Lobsinger has not responded to several requests for an interview by Stockwatch. However, in addition to the Aug. 11 Zi statement disclaiming any knowledge of the extent of Lancer's stake in the company, Mr. Lobsinger claimed in an Aug. 15 conference call that the company was "as surprised as anyone" at the alleged holdings.

"What the hell did Zi Corp. do when it came time to mail proxy forms to shareholders?" one E-mail correspondent asked. "Certainly it makes security regulation and control over Canadian-listed companies look farcical," the writer added. "It's difficult to believe that Michael Lobsinger was not aware of Lancer's fraudulent dealings and that gross manipulation of Zi's share price was a strong possibility."

Another correspondent who "used to run a small public company" expressed his skepticism even more bluntly. "I've been following the Zi story for a while and all I can say is the whole company reeks of impropriety," he wrote. To paraphrase and perhaps soften some of the rather scathing comments, the writer went on to offer his unflattering assessment of Mr. Lobsinger's veracity and intelligence. "Either way, he shouldn't be allowed to run the company," he opined.

Zi has fueled the controversy with its own conflicting claims regarding share ownership. As noted by Stockwatch, in its annual report for the year ending Dec. 31, 2002, Zi reported that 187 registered shareholders in the U.S. held 24,858,028 common shares or 64.7 percent of the common shares outstanding. In its Aug. 11 statement in response to the revelations regarding Lancer's massive undisclosed stake, however, Zi claimed the vast majority of its shares were held in investment dealer book entry form and not in registered form.

After Stockwatch pointed out the glaring contradiction, Zi was confronted with the conflicting claims in an Aug. 15 conference call. Responding to the pointed question regarding the contradictory claims, the company's chief financial officer, Dale Kearns, did some back-peddalling. Mr. Kearns claimed that the reference to 187 registered U.S. shareholders was actually a reference to 187 investment banks representing an unknown number of clients.

Pressed on the matter, Mr. Kearns adopted a stance reminiscent of Humpty Dumpty's approach to semantics. "When I use a word, it means exactly what I choose it to mean; nothing more, nothing less," the famous Lewis Carroll character said.

When the caller pointed out that the annual report specifically stated "registered shareholders," Mr. Kearns fired back with his Humpty Dumpty response. "And I'm telling you the reference is to the number of holders being banks because that's what we meant when we wrote it," Mr. Kearns insisted.

Zi's transfer agent, CIBC Mellon Trust, has not been of much assistance in shedding any light on the controversy. Stockwatch called the Calgary-based CIBC Mellon employee handling Zi's account on Aug. 21, but the call was shunted off to the firm's public relations manager in Toronto, Jennifer Mehra.

Stockwatch left a number of questions with Ms. Mehra, who said that she would call back with whatever answers she could provide the following day. That call did not come. When Stockwatch called again several days later, Ms. Mehra arranged a conference call later in the day with CIBC Mellon's senior vice-president and general counsel, Shawn Murphy.

Stockwatch asked Mr. Murphy whether CIBC Mellon had, as claimed in Zi's annual report filed with the SEC, provided the company with a report indicating that 187 registered U.S. shareholders held approximately 24.8 million shares or 64.7 per cent of the outstanding shares as of Dec. 31, 2002. Given Zi's subsequent conflicting claim in its Aug. 11 news release and back-peddalling in the Aug. 15 conference call, Mr. Murphy's response came as something of a surprise. "Yes, we did," Mr. Murphy said.

According to Mr. Murphy, the summary information in Zi's annual report was provided to the company by CIBC Mellon in an E-mail. The CIBC Mellon lawyer, who variously referred to "registered holders" and "registered accounts," would not specifically disclose whether Cede & Co, the U.S. clearing agent, was included among the reported 187 registered U.S. shareholders.

"As a transfer agent we do record the registered shareholders, whether that would be Cede & Co. as a depository or a broker or registered retail holder; so if Cede & Co. was a registered holder, then it would be on the list," Mr. Murphy said. "But as to further details of the list, because we are an agent of the public company, you would have to go to them as far as information that is on that list."

While Zi may continue to have some difficulty in convincing skeptics of its ignorance with respect to Lancer's stake in the company, the court-appointed Lancer receiver may have something to say about those holdings fairly soon. According to the July 10 court order appointing the receiver, Marty Steinberg, a report "reflecting the existence and value" of the Lancer assets is to be filed with the Florida court and the SEC by Sept. 8.

At this point it is not clear whether Mr. Steinberg will be able to meet the Sept. 8 report date or exactly how detailed that report will be in the event it is filed on time. On Aug. 28, the receiver filed an unopposed motion to expand the receivership to include two more Lancer-affiliated entities, G.H. Associates LLC and Alpha Omega Group Inc.

According to the receiver, during the course of his investigation he determined that G.H. Associates and Alpha Omega "likely possess funds, securities, or other related assets" and were integrally involved in the business operations of the Lancer entities.

"The close relationship among GH, Alpha Omega, and the Receivership Entities renders complete administration of the Receivership Entities' assets and liabilities impossible without an expansion of the Receivership Order to include GH and Alpha Omega," the Aug. 28 motion states. "Therefore, the requested expansion is essential to ensure that all available assets are brought within the receivership for the benefit of investors and creditors."

According to the receiver, G.H. Associates provided administrative services for the Lancer funds, "purportedly for the purposes of tracing the expenses." G.H. Associates employed "all or most of the employees" of the Lancer funds and paid the rent, utilities, phone and other routine Lancer expenses. Because G.H. Associates did not generate any revenue, any money the company currently has can be traced to investor deposits in Lancer.

Alpha Omega, owned by Mr. Lauer, may be of far more interest. "Lauer used Alpha Omega as a personal investment vehicle," the receiver states. "According to Lauer, he utilized Alpha Omega to occasionally participate in equity acquisition which may have involved the Lancer entities."

As reported in considerable detail in an Aug. 12 Stockwatch article, Alpha Omega was the investment vehicle used by Mr. Lauer in the timely priming of an American Stock Exchange (AMEX) shell. Key Lancer figure and vocal Zi booster Bruce Cowen, a previously SEC-sanctioned securities violator and subsequent felon facilitated that deal.

Mr. Cowen was arrested last August in connection with charges arising from Operation Bermuda Short, a two-year joint FBI-RCMP undercover sting that nabbed 60 penny stock players. On Aug. 21 of this year Mr. Cowen flipped and entered a guilty plea in a negotiated agreement. It is widely believed that as part of his plea bargain Mr. Cowen has been singing away about Mr. Lauer and the Lancer operation.

By some as yet obscure manoeuvre, Alpha Omega's 83-per-cent stake in the AMEX shell that was brokered by Mr. Cowen was transferred to Lancer. The Lancer-controlled shell subsequently acquired Magic Lantern from Zi in a promissory note and share transaction in November of last year. Following the transaction, Zi and Lancer each owned approximately 45 per cent of AMEX-listed Magic Lantern, which is out of cash and teetering on the brink of insolvency. According to Magic Lantern's most recent regulatory filings, Zi's Mr. Lobsinger has been providing the financial buoys that have been keeping the company barely afloat.

According to Banc of America account summaries filed in connection with the SEC civil complaint against Lancer, as of April 30 two of Mr. Lauer's allegedly fraudulent funds held more than 28.8 million shares of Magic Lantern acquired at approximately two U.S. cents per share. With two of his funds already crammed with 28.8 million dirt-cheap Magic Lantern shares, Mr. Lauer was apparently so enthusiastic about the company that he purchased 40,800 shares of the thinly traded stock at $1.63 (U.S.) for another of his funds. The Lancer leader also picked up 17,000 Magic Lantern shares at an average cost of approximately 95 U.S. cents for his own account.

Given that Lancer holds more than 28.8 million Magic Lantern shares and Zi currently holds another 29.75 million shares, accounting for almost 90 per cent of the company's outstanding shares, Magic Lantern is also a tightly held stock. However, apart from Mr. Lauer's peculiar enthusiasm for the company there has been little market interest in Magic Lantern and little in the way of controversy over its association with Lancer.

Indeed, much of what little public controversy there has been over Magic Lantern and Lancer has come from Zi critics, some of whom may well hold Zi short positions, raising questions about Calgary-based Zi's connections to Lancer and Mr. Lauer. Recently faced with forced buy-ins to cover their short positions, some of those critics are convinced that there are other large Zi shareholders supporting the stock price.

There is also open speculation that Jones Gable and Company Ltd., a small Canadian brokerage firm, holds a large number of Zi shares. If Jones Gable does have a significant position in tightly held Zi, the small firm is evidently willing to loosen its grip on some of those shares from time to time, especially as a seller during forced buy-ins executed at a 10-per-cent premium to the prevailing market prices.

Stockwatch's review of Jones Gable's trading activity in Zi over the past year indicates that the small firm executed purchases for 248,175 Zi shares while selling 846,824 shares. Forced buy-ins were executed at a 10-per-cent premium to the prevailing market prices through the TSX for 740,449 Zi shares during the same period. Interestingly, Jones Gable acted as the seller for 670,549 Zi shares in those transactions, accounting for more than 90 per cent of the shares tendered into the forced buy-ins.

While the speculation and controversy regarding the associations between Lancer and Zi continue, the company's share price remains surprisingly buoyant in the opinion of some market observers already troubled by last month's revelations regarding the possible overhang of more than 18.7 million frozen Zi shares under the control of Lancer's receiver. It is not likely that the news of Mr. Lauer's personal holdings of another 2.87 million Zi shares will allay any of those concerns. It remains to be seen whether the receiver's report expected shortly will at least remove some of the uncertainty with respect to the tightly held stock.

In Nasdaq trading, Zi closed out last week at $2.73 (U.S.). On the TSX, Zi closed at $3.78 on Sept. 5.

 

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