Zi booster Cowen takes the stand in Kelly fraud trial
2003-10-08 13:26 ET - Street Wire
Also Street Wire (C-ZIC) Zi Corp
Also Street Wire (U-ZICA) Zi Corp
by Erik Schelzig in Miami and Lee M. Webb
James T. Kelly, on trial for securities fraud in the U.S. District Court for the Southern District of Florida in Miami, listened as a second former co-defendant and business associate, Bruce Cowen, took the stand to testify against him. If convicted on all seven counts relating to wire, mail and securities fraud, Mr. Kelly could face 25 years in prison.
Mr. Kelly, the former head of Pennsylvania-based Shamrock Partners Ltd., is accused of conspiring with former co-defendants Mr. Cowen and Joseph Huard in a kickback and stock manipulation scheme involving shares of Lighthouse Fast Ferry Inc. All three were arrested in August of last year as part of Operation Bermuda Short, a two-year joint FBI-RCMP undercover sting that led to the arrests of 58 U.S. and Canadian penny stock players.
Mr. Huard and Mr. Cowen negotiated separate plea bargains in the case and are key prosecution witnesses against Mr. Kelly. As reported by Stockwatch, Mr. Huard has already testified against his former Shamrock associate.
While Mr. Huard copped a plea in December of last year, Mr. Cowen maintained his innocence until just one month before the trial. After filing more than 750 pages of motions and pleadings, Mr. Cowen hammered out a plea agreement on Aug. 21.
Mr. Cowen's deal with the government included a non-prosecution agreement for his wife, Kathryn Cowen, also identified as Kathryn Braithwaite in regulatory filings.
Court filings and earlier testimony suggest that Mr. Cowen played a key role in the alleged kickback and stock manipulation scheme that included a planned transaction involving $5-million worth of Lighthouse Fast Ferry shares. (All amounts are in U.S. dollars.)
The proposed sting transaction involved approximately 3.12 million Lighthouse Fast Ferry shares owned by the purported $1-billion Lancer Group. In a separate civil action, the U.S. Securities and Exchange Commission (SEC) shut Lancer down on July 10, levelling allegations of massive fraud against the hedge fund operation and its disgraced leader Michael Lauer. Lancer's assets are now under the control of a court-appointed receiver.
"Lauer and Lancer Management swindled hundreds of millions of dollars from unsuspecting investors and reaped tens of millions of dollars in fraudulent management fees," the SEC claims in a Sept. 8 court filing. Mr. Lauer has denied the substantive allegations in the SEC civil complaint.
According to court documents filed by the SEC in that action, Mr. Cowen is identified as a managing director of Lancer. The U.S. regulator has described Mr. Cowen as "Lauer's right hand man." Mr. Cowen's plea agreement in the Bermuda Short case resolves any federal criminal liability with respect to his involvement with Lancer.
Notwithstanding the fact that he is identified on Lancer documents as a managing director of the hedge fund operation, Mr. Lauer claims that Mr. Cowen was just a consultant to the firm. Whatever the exact nature of Mr. Cowen's relationship with Lancer, his connections to the allegedly fraudulent operation and Mr. Lauer as revealed in court and regulatory filings are extensive.
Among other things, Mr. Cowen and his wife were participants in a number of penny stock companies that made their way into the Lancer portfolios allegedly stuffed with large concentrations of massively overvalued shares of virtually worthless OTC Bulletin Board and pink sheet companies.
According to the SEC allegations, Lancer and Mr. Lauer engaged in fraudulent manipulative trading practices, "marking the close" of a number of stocks in the Lancer portfolios, including thinly traded Lighthouse Fast Ferry. In the separate Bermuda Short criminal case now being heard in Miami, Mr. Kelly is also charged with stock manipulation involving Lighthouse Fast Ferry on behalf of Lancer.
As first reported by Stockwatch on Aug. 6, documents filed in connection with the SEC complaint against Lancer indicate that Mr. Lauer's hedge funds held a massive undisclosed stake in Zi Corp., a money-losing Canadian technology company headquartered in Calgary. Those court filings show that Lancer peeled off more than $97.6-million to sponge up an unreported 18.6 million Zi shares.
In addition to Lancer's staggering Zi holdings, Mr. Lauer also anted up more than $18.1-million to personally acquire an undisclosed 2.87 million shares of Zi. All told, court filings now indicate that Mr. Lauer controlled approximately 21.6 million Zi shares or almost 55 per cent of the company's outstanding shares. Zi claims ignorance regarding the extent of Lancer's stake in the company.
Mr. Cowen evidently had more than a passing interest in Zi, too, given his participation in a number of the company's conference calls along with Mr. Lauer. Mr. Cowen, who variously identified himself as a representative of Capital Research Ltd. and Sterling Technology Partners, claimed to be a major Zi shareholder and served up boosterish comments about the company and its prospects in several conference calls.
Capital Research, Mr. Cowen and his wife, then identified as Kathryn Braithwaite, featured in another Lancer deal involving Zi. According to regulatory filings, Mr. Cowen and Capital Research were instrumental in brokering a deal whereby Mr. Lauer, operating under the auspices of Alpha Omega Group, acquired 82-per-cent control of an American Stock Exchange (AMEX) shell company subsequently renamed JKC Group Inc. for $1.5-million. Following the transaction, Ms. Braithwaite was briefly appointed to the company's board of directors.
Shortly after Mr. Lauer took control of JKC last year, the fortuitously primed AMEX shell acquired a Zi subsidiary in a promissory note and share transaction and changed its name again to Magic Lantern Group Inc. Richard Geist, a penny stock tout and Lancer director, was appointed to Magic Lantern's board of directors along with three Zi directors. Once the dust settled, Lancer and Zi each held approximately 45 per cent of the outstanding Magic Lantern shares.
The jury in Mr. Kelly's fraud trial will not hear much about Mr. Cowen's many connections to Mr. Lauer and Lancer or anything at all about his Zi boosting or his own regulatory baggage.
As previously reported by Stockwatch, 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. Cowen was sworn in following Mr. Huard's testimony on Friday, Oct. 3. The court did not sit on Monday, allowing a jury member to observe Yom Kippur, and Mr. Cowen took the stand again on Tuesday.
GUILTY AND ASHAMED
U.S. prosecutor Thomas McCann called Mr. Cowen to the stand after Mr. Huard's testimony concluded on Friday afternoon. Among his early questions, Mr. McCann asked Mr. Cowen why he had entered a plea of guilty to the kickback and stock manipulation conspiracy charge.
"I pled guilty because I was guilty," said Mr. Cowen, who pleaded guilty just weeks before the trial opened. "I came to terms with something I was ashamed of, and want to put this behind."
Mr. McCann went on to ask about the deal received by Mr. Cowen's wife.
"It's called a non-prosecution agreement," Mr. Cowen said. "That non-prosecution agreement basically gives her immunity."
(In his opening statement on Sept. 24, Mr. Kelly's defence attorney Norman Moscowitz hammered at the non-prosecution deal signed by Mr. Cowen's wife on the same day that Mr. Cowen inked his plea bargain with the prosecutors. Making the argument that Mr. Cowen had much to gain by pleasing the prosecution, Mr. Moscowitz told the jury that the deal with Mr. Cowen's wife included a clause that said her agreement depended on her husband's full co-operation with the government.)
Under Mr. McCann's questioning, Mr. Cowen described himself as a "management consultant" who owned his own company called Sterling Technology Partners. He went on to testify that he began his career with Price Waterhouse in 1974 as an auditor accountant. Over his five years with the company, Mr. Cowen said that he was promoted to senior accountant and finally manager.
Mr. Cowen told the court that he left Price Waterhouse in 1979 to join a subsidiary of TRC Companies where he worked as controller. In 1980 he was promoted to accountant of the parent company and later worked through the vice-president ranks to become president of TRC Companies.
Mr. Cowen testified that his relationship with Mr. Kelly dated back to 1979 or 1980 when Mr. Kelly was a stockbroker. Moving forward, Mr. Cowen said that he later met with Mr. Kelly in 1998 to talk about consulting possibilities.
"He told me that there might be a fit between myself and Michael Lauer," Mr. Cowen said.
According to Mr. Cowen, founding Capital Research was Mr. Kelly's idea.
"Capital Research was his brainchild," Mr. Cowen testified. "He had a vision that Capital Research could provide a good network for us and, as a result, the company was founded as a consulting group."
Mr. Kelly, Mr. Cowen, Mr. Lauer, through a Lancer-affiliated corporation called Alpha Omega, and another Lancer man, Martin Garvey, became four-way partners in Capital Research after another original partner was pushed out in January of 1999, Mr. Cowen said.
Mr. Cowen testified that Mr. Lauer introduced him to the principals of Lighthouse Fast Ferry in March of 2000.
"That meeting resulted in a contract between Lighthouse Fast Ferry and Capital Research," he said.
LANCER, LAUER AND LIGHTHOUSE
Mr. Cowen told the court that he became a consultant to Lancer in August of 2000. He was even issued a business card bearing the title managing director, though he said on the stand that he had no formal management responsibilities.
"I would characterize myself initially as a designated hitter," Mr. Cowen said in describing his association with Lancer.
"Lancer was not your typical hedge fund," Mr. Cowen testified. "They made a lot of investments in microcap companies, which I would characterize as high risk," he said.
As a consequence Lancer would give higher interest rates loans to companies, for which Mr. Lauer preferred to receive shares, Mr. Cowen said.
"Lauer lent money to Lighthouse, and what he received in return were free unregistered shares," he said.
Mr. Cowen calculated that by December of 2001, Mr. Lauer held "in excess of seven million shares" of Lighthouse Fast Ferry.
Capital Research, meanwhile, accumulated the equivalent of 1.2 million shares of Lighthouse Fast Ferry, Mr. Cowen said. Since Mr. Kelly at this point held about 22 per cent of Capital Research, he controlled an equivalent of 240,000 shares of the ferry company, Mr. Cowen testified.
The Capital Research shares brought Mr. Kelly's total holdings in Lighthouse Fast Ferry to 415,000 shares at the end of 2001, said Mr. Cowen. He calculated that with a 2001 year-end closing price of $1.80 per share, Mr. Kelly's total holdings of the company would have been worth $750,000. According to Mr. Cowen, a $100,000 loan from Mr. Kelly to Lighthouse Fast Ferry would remain on the books in addition to his share position.
Mr. Cowen said that the end-of-month purchases of Lighthouse Fast Ferry by Mr. Lauer through Shamrock became obvious to him in April of 2001. He identified Mr. Garvey and Mr. Lauer as being behind the purchases.
Mr. Garvey "had faith in Jim Kelly to execute his wishes, but didn't have the same faith in the other employees at Shamrock," Mr. Cowen said.
Mr. Cowen testified that the attempts to drive up the Lighthouse Fast Ferry share price at the end of the month did not make economic sense.
"Lauer was purchasing shares in the open market at a price that was substantially higher than the price they were getting from the company for extending loans," Mr. Cowen testified. "They could have gotten the shares for substantially less by going to the company and buying shares directly from them."
The strategy by Mr. Lauer was "to buy enough stock to move the price up, but to buy as few shares as possible," Mr. Cowen said.
Vast fluctuations in Lighthouse Fast Ferry share prices were not out of the ordinary, Mr. Cowen said.
"It wouldn't be unusual for the stock to be up to 30-per-cent lower during the month, and 30-per-cent higher at the end of the month," he said.
Mr. Cowen testified that after Mr. Huard had come to him and Mr. Garvey with concerns about the month-end trading, he had called up Mr. Kelly.
"I informed Jim Kelly about Joe Huard's concerns," Mr. Cowen testified. "I told him that Huard had spooked Mr. Garvey, and that he would probably be hearing from Mr. Garvey about it. And his response was: 'Don't worry about it; I'll handle it. Joe's a worrier.'"
Asked whether Lighthouse Fast Ferry was successful in finding any investors outside of Lancer and the undercover team, Mr. Cowen said they were not.
"Absolutely zero," Mr. Cowen said. "They were totally unsuccessful at getting any other investors."
Asked for his overall assessment of what turned out to be the undercover sting operation and whether it was a legitimate deal, Mr. Cowen said it "was definitely illegitimate."
Following the extended weekend break, Mr. McCann picked up his direct examination of Mr. Cowen on Tuesday.
The U.S. prosecutor displayed for the jury a term sheet of loans from Lancer to Lighthouse Fast Ferry, for which the ferry company gave unregistered shares to Lancer.
At the end of the year, Lancer kept track of two values of Lighthouse shares on their books, Mr. Cowen testified.
"One, what the cost of the shares was, which they had as zero," Mr. Cowen said. "And the other, which was the market price at the end of the year, which I believe was $1.90."
Mr. McCann asked whether multiplying the number of shares by the year-end trading price of the stock "was an accurate value."
"It wasn't a value that could be realized because they were restricted shares, and there was no liquidity," Mr. Cowen replied.
Mr. Cowen said that for the four funds that made up the Lancer Group, none reported the unit cost of Lighthouse Fast Ferry shares to be higher than 44 cents.
MAKING THE DEAL
Mr. Cowen testified that Mr. Kelly was the first person he heard from regarding the British fund that would later turn out to be a fictitious entity used by the undercover team as part of the sting operation. He subsequently learned more about the British fund from Mr. Huard.
"The initial consultation that I had was with Mr. Huard," Mr. Cowen said. "He stated that there was a British fund, he did not know the name..." Mr. Cowen went on. "They were looking to make an investment up to $8-million. They typically looked to make an investment through an existing shareholder because their fee of 30 per cent could not be disclosed."
"Did this undisclosed payment seem legal to you?" Mr. McCann asked.
"It did not sound proper," the witness answered.
Mr. Cowen responded in a similar fashion to Mr. McCann's question about a $10,000 kickback to two purported due diligence officer, remarking that it "didn't sound appropriate."
Mr. McCann moved to another line of questioning directed toward the alleged stock manipulation of Lighthouse Fast Ferry.
"They told us early on that they were going to open an account at Shamrock, and that they thought the share price could rise to $2.50 or $3, so it was our impression that they were going to make the price go up," Mr. Cowen testified when asked about the undercover team's plans for Lighthouse Fast Ferry.
Mr. Cowen said that he spoke to Mr. Kelly about the time of the month that the British fund liked to have the price the highest, which was at the end of the month.
Mr. Kelly "sounded very upbeat" on the phone when he told him about it, Mr. Cowen said.
"How did you know Lancer was pushing up the price of Lighthouse stock to offset the fall in price of other stock in its portfolio?" Mr. McCann asked.
Mr. Moscowitz objected to that question before Mr. Cowen could respond. The attorneys met with Judge Cecilia Altonaga in a sidebar discussion out of hearing of the jury. When the judge returned to the bench, Mr. Cowen was allowed to answer the question.
"I observed it," he said. "I overheard telephone conversations, I was in the room when it was discussed."
"Did you hear anyone talk about this with the defendant?" the prosecutor asked.
"I heard a conversation where Martin Garvey was speaking to Mr. Kelly," Mr. Cowen said.
Mr. Cowen reiterated that his understanding was that the deal was illegal. Asked by Mr. McCann whether Mr. Kelly had the same understanding, Mr. Cowen said he did.
That statement was struck from the record by Judge Altonaga when Mr. Moscowitz objected to asking the witness about what Mr. Kelly's "understanding" of things might have been.
"Did the defendant seem concerned," Mr. McCann asked, trying a different approach.
"No, he did not," Mr. Cowen said.
Mr. McCann asked whether Mr. Cowen ever told Mr. Kelly about the undisclosed payments that comprised part of the deal with the undercover operatives. Mr. Cowen replied that "at some point" he did.
Mr. Cowen said he tried to get out of paying the $10,000 kickback to the undercover team.
"I didn't want to pay the $10,000 out of Capital Research," Mr. Cowen testified. "I thought it should be paid by Shamrock and Joe Huard. Jim told me that Joe didn't have the $10,000 and that Capital Research should pay and be reimbursed."
Mr. Cowen said he had discussed "papering" the agreement with the Mr. Kelly. Asked by Mr. McCann what he meant by papering it up, Mr. Cowen said "covering up."
Following Mr. McCann's direct examination of Mr. Cowen, Mr. Moscowitz cross-examined the witness.
NAMES ON DOCUMENTS
Just as he had with Mr. Huard earlier in the trial, Mr. Moscowitz attacked Mr. Cowen's motivations and actions regarding his guilty plea in the case.
"You told other people that you were not guilty of anything, correct?" Mr. Moscowitz asked about Mr. Cowen's behaviour before pleading in the case.
"That is correct," Mr. Cowen said after a brief sidebar between the lawyers and the judge.
"In fact you told other people that the case had no merit and would be dropped before going to trial?" the defence lawyer queried.
"I'm not sure if those were my exact words, but that's basically correct," Mr. Cowen replied.
Mr. Moscowitz asked a series of questions about Mr. Cowen's plea agreement and about what he had to gain by co-operating with the government.
Mr. Cowen agreed with Mr. Moscowitz that he could not receive a lighter sentence than five years, if the prosecutors did not make any recommendations to the judge.
And the prosecutors' decision about whether to make that recommendation was not reviewable, Mr. Moscowitz said, meaning that Mr. Cowen would have no recourse if they decided not to extend the recommendation. Mr. Cowen agreed that this was his understanding of the agreement.
Mr. Moscowitz moved on to another line of questioning regarding evidence of Mr. Kelly's involvement in the scheme or lack thereof.
Mr. Cowen acknowledged that he was on far more telephone recordings than Mr. Kelly and that his name appeared on far more documents in evidence than Mr. Kelly's did.
Mr. Moscowitz challenged Mr. Cowen's earlier testimony about having told Mr. Kelly about certain aspects of the undisclosed payments.
"There's no indication that you have any record of it, correct?" Mr. Moscowitz asked.
Mr. Cowen agreed that no record existed.
"You understand that what you have said here makes Jim Kelly more of a full participant in what you and Joe Huard have already pled guilty to?" Mr. Moscowitz asked.
Mr. Cowen said that was correct.
Mr. Moscowitz questioned Mr. Cowen about the agreement that his wife signed on the same day as he signed his deal with the government.
Mr. Cowen said that he had installed his wife as a board member and her non-prosecution agreement was contingent upon him fully co-operating in the investigation.
"Her involvement with this matter is entirely of your own doing?" Mr. Moscowitz asked.
"That is correct," Mr. Cowen replied.
Mr. Moscowitz asked whether he wanted to see his wife prosecuted, to which Mr. Cowen replied that he did not.
"You testified that ultimately you didn't want to write the cheque, correct?" Mr. Moscowitz asked, a reference to the $10,000 kickback to the purported due diligence officers.
"Correct," Mr. Cowen replied.
"But you never told that to Schlien and Jones," Mr. Moscowitz said. "In fact, you said, 'I'll take care of that.'"
Mr. Cowen explained that his thoughts on the matter were different than what he said to the co-operating witnesses.
Mr. Moscowitz asked Mr. Cowen whether there was anything illegal about Mr. Kelly making a personal $100,000 loan to Lighthouse Fast Ferry. Mr. Cowen replied that there was not.
Mr. Moscowitz challenged Mr. Cowen's direct testimony about the co-operating witnesses seeking to jack up the price of Lighthouse Fast Ferry with the assistance of Lancer.
Directing Mr. Cowen to segments of the transcripts not included in the evidence entered by the government, Mr. Moscowitz showed that members of the undercover team were concerned about the price going too high, and that there was no indication that Mr. Lauer agreed to pump up the price.
Mr. McCann objected to the questions about the transcripts not in evidence, but after a sidebar conference Mr. Moscowitz was allowed to continue his questioning.
"Michael Lauer said the price is going to go where it's going to go," Mr. Moscowitz said. "Lauer is not agreeing to controlling the price of the shares," the lawyer suggested.
Mr. Cowen said he did not understand the questions.
"He says he will not agree with them to control the price of the stock," Mr. Moscowitz said, not quite forming a question.
"I don't see it the way you describe it," Mr. Cowen replied.
"Do you recall Lauer saying, 'Where the price will be is a matter of supply and demand?'" Mr. Moscowitz asked.
Mr. Cowen said he did.
"And then he says, 'I say, let it go.'" Mr. Moscowitz added. "He's saying he's not willing to control the price to where they want it to be," Mr. Moscowitz offered.
Mr. Moscowitz wrapped up his two-hour cross-examination by asking Mr. Cowen about his remuneration from Lancer and his retirement benefits from Capital Research.
Mr. Cowen pegged his Lancer remuneration at $500,000 per year and said that his Capital Research benefits amounted to about $300,000.
NO CLUE
Mr. McCann quickly pointed his redirect examination toward a meeting between the co-operating witnesses and Mr. Lauer and Mr. Cowen.
"In that conversation with Mr. Lauer, what was he saying about his willingness to control Lighthouse stock?" Mr. McCann asked.
"He basically says if the stock goes beyond $2.50, he said it's going to go, there's nothing he can do about it," Mr. Cowen replied.
"So he says won't stop it from going up," Mr. McCann offered. "Does he say anything about the price going down?"
"No, he does not," Mr. Cowen answered.
Mr. McCann asked whether the Lancer shareholders knew about the details of Lancer's dealings with Lighthouse Fast Ferry.
"They didn't have a clue," Mr. Cowen said.
Mr. McCann went over the valuation of Lighthouse Fast Ferry stock held by the Lancer Group. Over the course of 2001, the Lancer group had acquired between three million shares and 3.3 million shares of Lighthouse Fast Ferry through loans and loan extensions, Mr. Cowen had testified.
Using Lighthouse's closing price on December 31, 2000, Lancer's Lighthouse Fast Ferry shares would have been worth $7.3-million. By June 30, 2001, Lancer's stake had risen to 4.84 million shares valued at $8.2-million based on the month-end price. By the end of the year, Lancer held approximately 7.2 million shares, which at $1.90 per share would have been worth $13.7-million, Mr. Cowen calculated.
Mr. McCann wrapped up his 20-minute redirect by asking why Mr. Cowen had told people he was innocent before he pleaded guilty a month before the trial.
Mr. Cowen said it was typical for people going to trial in a case to say they were innocent, even if it was not true.
In a brief recross by Mr. Moscowitz, Mr. Cowen explained that Lancer did not report earnings on its portfolio holdings to investors directly. Mr. Cowen said that Lancer did not report the performance of individual companies in the portfolio.
THE PROSECUTION RESTS
After Mr. Cowen's testimony was completed late Tuesday afternoon, the prosecution called Thomas Capocci, an employee of the criminal prosecution assistance group for the National Association of Securities Dealers (NASD).
Mr. Capocci briefly testified about the defendant's NASD certifications, telling the court that Mr. Kelly had four certifications: a Series 1; a Series 24; a Series 55; and a Series 63.
Mr. McCann asked whether in being certified Mr. Kelly would have learned all the requisite rules and regulations regarding trading securities.
Mr. Capocci said that Mr. Kelly would have learned all those rules.
After a quick sidebar with the judge, Mr. McCann announced that the government would rest.
Mr. Moscowitz, who may well have been looking forward to cross-examining David Jones, the co-operating government informant identified as a potential prosecution witness who has already been the subject of many credibility challenges by Mr. Kelly's lawyer, will open his presentation of the defence case on Wednesday.
(More information regarding Mr. Kelly's trial is available in Stockwatch articles published on Sept. 25, 26 and 29; and Oct. 1, 2, 3 and 7, 2003.) |
