Zi a surprising favourite of SEC target Lancer
NORTHERN EXPOSURE
by Lee M. Webb
Zi Corp., an Alberta-based technology company listed on the prestigious
Toronto Stock Exchange (TSX) and Nasdaq, was a favourite stock of Michael
Lauer and his purported $1-billion (U.S.) Lancer group of funds recently shut
down by the U.S. Securities and Exchange Commission (SEC) for alleged fraud.
On July 10 the SEC obtained a court order freezing the assets of Mr. Lauer's
Lancer Partners LP, Lancer Offshore Inc. and OmniFund Ltd. and appointing a
receiver "to marshall and safeguard the entities' assets."
A significant number of Zi shares may be among the frozen Lancer assets, many
of them of dubious value, the receiver will be marshalling and safeguarding.
At this point it is not clear just how many shares of Zi Mr. Lauer controlled
through his various funds when his operation was shut down; however, that
number may be considerably higher than reported in a recent Zi regulatory
filing.
According to Zi's annual report on Form 20-F for the year ending Dec. 31,
2002, filed with the SEC on May 20, 2003, Lancer Offshore controlled 2,594,854
shares of Zi and Lancer Partners controlled 1,080,250 shares, making Mr. Lauer
the beneficial owner of approximately 3.7 million Zi shares or 9.6 per cent of
the company's stock. The only other reported beneficial owner of more than
five per cent of Zi's shares was Michael Lobsinger, the company's chief
executive officer, with just over 5.5 million shares.
In a note to the disclosure regarding the company's major shareholders, Zi
reported that Mr. Lauer's holdings were based upon information provided in
connection with the annual report on 20-F for the previous year ending Dec.
31, 2001. "The company has been unable to obtain more current information
regarding the Lancer Group's holdings, which may be greater or less than
reported herein," the company stated.
In fact, if documents filed by the SEC in the U.S. District Court for the
Southern District of Florida in connection with its action against Mr. Lauer
and the Lancer Group are accurate, Mr. Lauer's funds may have sponged up a
further 15 million Zi shares, evidently entirely unbeknownst to the company,
giving him control of more than 18.7 million shares of Zi or just under 50 per
cent of the 38 million shares outstanding at March 31.
Included among the more than 1,800 pages of exhibits filed by the SEC in
support of its successful claim for injunctive relief against Mr. Lauer and
his funds are Banc of America Securities Prime Brokerage client position
summaries for Mr. Lauer's funds as of April 30, 2003. According to those
documents, OmniFund held a relatively modest 756,700 Zi shares acquired at a
not-so-modest average price of $15.13 (U.S.) per share; Lancer Partners held
2,746,637 shares acquired at an average $5.52 (U.S.) per share; and Lancer
Offshore held a whopping 15,220,975 shares purchased at an average cost of
$4.66 (U.S.) per share.
All told, at least according to the Banc of America Securities documents, Mr.
Lauer's funds shelled out in excess of $97.6-million (U.S.) to acquire the
more than 18.7 million Zi shares reportedly held at the end of April. With Zi
trading at $2 (U.S.) on April 30 those shares carried a market value of
approximately $37.4-million (U.S.), putting Mr. Lauer's funds more than
$60-million (U.S.) under water on the Zi holdings. The stock price has since
improved, trading recently above $3.50 (U.S.), but it is still well under Mr.
Lauer's average cost of $5.20 (U.S.) per share.
Zi, which reports in Canadian dollars, has a history of losses, including a
$40.4-million loss tallied last year, and that money-losing tradition
continued in its most recent reporting period. For the first quarter ending
March 31, 2003, Zi lost $1.67-million on revenues of $3.63-million, bumping
its accumulated deficit to more than $93-million. Zi had a working capital
shortfall of approximately $2.2-million at the end of the first quarter and
was once again on the hunt for financing to meet its capital requirements. The
company subsequently closed a $2-million (U.S.) private placement, using the
money to retire a $1.94-million (U.S.) credit facility due June 30.
While some people might be puzzled by Mr. Lauer's apparent enthusiasm for
money-losing Zi, his penchant for stuffing his funds with virtually worthless
OTC Bulletin Board stocks and shares of even more dubious companies quoted on
the pink sheets may be more puzzling; perhaps even as puzzling as the fact
that he escaped regulatory notice for so long.
Mr. Lauer's mantle of respectability, not to mention his apparent cloak of
regulatory invisibility, began to slip away last September when investigative
journalist Christopher Byron wrote the first of a bruising series of articles
for the New York Post about the high-flying fund manager and his purported
$1-billion (U.S.) portfolio. Among other things, Mr. Byron's articles raised
questions about the real value of Mr. Lauer's funds, which were crammed with
illiquid penny stocks, and traced out ties to a number of known and alleged
securities violators as well as to individuals with alleged mob connections.
In a Sept. 11, 2002, letter to his investors, Mr. Lauer attempted to dismiss
the first of Mr. Byron's articles as the unfounded imaginings and distortions
of a sensationalist tabloid reporter who had launched a similar unwarranted
"assault" against the Lancer funds in 1998.
"This latest assault appears to have been sparked simply by our connection to
one of Lancer's consultants, Bruce Cowen," Mr. Lauer wrote. "In a nutshell,
the Justice Department has charged him with a conspiracy to collect a
'kickback' fee in a sting operation that took place over a year ago."
While Mr. Lauer did not flesh out the details, Mr. Cowen was among 60 penny
stock players arrested last August in Operation Bermuda Short, a joint
FBI-RCMP undercover sting. In a subsequent indictment identifying him as the
managing director of the Lancer Group, Mr. Cowen was charged with taking part
in an alleged kickback and stock manipulation scheme involving shares of
Lighthouse Fast Ferry Inc., a Lancer-controlled company.
Mr. Lauer went on to remark that he was constrained by his legal advisers from
commenting on the merits of the charges against Mr. Cowen. "However, his
personal achievements speak for themselves," Mr. Lauer wrote, going on to note
some of those achievements. "He was also a President of a New York Stock
Exchange company and a senior audit manager for PriceWaterHouse (sic)," Mr.
Lauer added.
Mr. Lauer did not mention the name of the New York Stock Exchange company
headed by Mr. Cowen, but presumably the reference was to TRC Companies Inc.;
nor did he make any mention of the fact that 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.
Notwithstanding those "achievements," Mr. Lauer advised his investors that
"the most prudent course" would be to suspend Lancer's "consulting activities"
with Mr. Cowen until his legal issues were resolved.
Whatever the exact nature of Mr. Cowen's association with Mr. Lauer and his
funds, the connections are extensive. Mr. Cowen and his California-based firm
Capital Research Ltd. have been involved in several companies that made their
way into Lancer portfolios, as has his wife, Kathryn Cowen, who is also
identified as Kathryn Braithwaite in a number of SEC filings.
Mr. Cowen, now awaiting a September trial on the Operation Bermuda Short
charges, appears to have had what may well have been more than a casual
interest in Zi, too, judging by his participation and boosterish comments in
several Zi conference calls. In at least two of those Zi conference calls Mr.
Cowen identified himself as a representative of Capital Research and in
another conference call he was identified as a representative of Sterling
Technology Partners. Mr. Lauer, representing Lancer Offshore, also
participated in Zi conference calls along with Mr. Cowen.
Mr. Lauer wrapped up his Sept. 11, 2002, damage control letter to investors on
an upbeat note. "As was the case in 1998, this negative press will pass and we
will continue to go about our business and thrive," he wrote. By January of
this year it was becoming clear that Mr. Lauer was wrong on both points: the
negative press continued; and rather than thriving Lancer was having
difficulty surviving.
In a January 2 letter to investors, Mr. Lauer effectively announced that he
was suspending redemptions because of the unprecedented number of withdrawal
requests that he characterized as "tantamount to a 'run on the bank'." Under a
new scheme, investors wanting to redeem their shares in the funds would have a
pro rata share of the assets transferred to a special purpose company, managed
by Mr. Lauer, set up to attempt to liquidate the assets in an orderly fashion.
A special purpose company was incorporated in the British Virgin Islands (BVI)
to handle the Lancer Offshore redemptions and a similar company was
incorporated in Delaware to handle Lancer Partner redemptions.
Less than two weeks later, Mr. Lauer penned another investor letter in an
attempt to discredit another of Mr. Byron's articles. He closed that Jan. 13
missive by remarking that he intended to "delegate this issue to attorneys to
explore our options vis-a-vis both the reporter and the publication." On Feb.
14 Mr. Lauer filed a libel suit against Mr. Byron and the New York Post, but
by that time the Lancer story had legs.
Soon after the libel suit was launched, Miami-based investigative journalist
David Marchant weighed in with a series of articles in his Offshore Alert. In
addition to corroborating and expanding on much of what Mr. Byron had written,
Mr. Marchant continued to follow the story and provided more details regarding
the Lancer operation, including its mounting offshore woes as BVI regulators
moved to force Lancer Offshore and OmniFund into administration and Lancer
Offshore was booted off the Irish Stock Exchange.
The less than flattering media attention continued as other publications began
to take up coverage of the unfolding story, which was given a new dimension
when Lancer Partners filed for Chapter 11 bankruptcy protection on April 16.
Included among the Lancer investors and adding some name-recognition to that
development were pop star Britney Spears and Alfred Taubman, the former
chairman of Sotheby's who was fined $7.5-million (U.S.) and jailed last year
for rigging art auction prices and commissions.
Meanwhile, a growing number of lawsuits were being filed against Mr. Lauer and
Lancer by unhappy investors. One of the earliest and most significant lawsuits
in terms of dealing a blow to Mr. Lauer's credibility was filed by Morgan
Stanley Alternative Investment Partners, which disclosed in a March 7 SEC
filing that it had written off its $15.6-million (U.S.) Lancer investment. In
its complaint Morgan Stanley alleged that it had discovered material
discrepancies between Lancer's records and information provided by Lancer's
third-party custodian, Bank of America, before Lancer "suddenly and without
explanation" denied Morgan Stanley access to the information it was seeking.
On June 13, the University of Montreal pension plan, one of Mr. Lauer's
largest investors, joined the mushrooming list of plaintiffs in lawsuits
against Lancer. According to a July 5 report in the National Post, the
university pension fund ploughed a whopping $67-million (U.S.) into Lancer
Offshore between 1998 and 2000.
At the time of the Lancer investments, the University of Montreal pension fund
was under the direction of investment manager Germain Bourgeois, who
subsequently moved on to take up the position of vice-president of investments
for the Lucie and Andre Chagnon Foundation. Mr. Bourgeois is now also an
adviser to newly formed and complexly structured Tremont Capital Opportunity
Trust, which is ultimately dependent upon the performance of BVI-incorporated
Tremont Hedge Fund Ltd., an offshore hedge fund set up in March to invest in
units of offshore hedge funds. Tremont Capital raised $45-million in an
initial public offering and began trading on the TSX on April 17 of this year.
Mr. Bourgeois's successor at the University of Montreal pension fund, Andree
Mayrand, decided to reduce the exposure to Lancer, which accounted for
approximately 10 per cent of the pension plan's assets at the end of 2001. In
June of last year, the university pension fund reportedly sent a letter to
Lancer requesting a $25-million (U.S.) redemption and then followed up in
September with another $44-million (U.S.) redemption request. Rather than
honour the redemption requests with cash payments, Mr. Lauer proposed a
pro-rata interest in his special purpose BVI company. As with other
disgruntled investors, the University of Montreal pension fund balked at that
proposal and sued.
Two days after publishing the story of the University of Montreal pension
fund's costly entanglement in Lancer, the National Post followed up with an
article in which Mr. Bourgeois defended his decision to invest in Mr. Lauer's
hedge fund. According to the July 7 article, Mr. Bourgeois said he invested in
Lancer because it was taking a "very astute and sophisticated approach" to
investments and posting impressive results.
"[Mr. Lauer] was buying companies that were not on the radar screen,
undervalued companies where you could have something happen like a takeover or
merger or event-driven," Mr. Bourgeois reportedly told the National Post.
"That was very legitimate. He's a very bright guy, who was showing very good
returns."
Mr. Bourgeois's glowing, if perhaps ill-timed, assessment of Mr. Lauer
appeared just three days before the SEC shut down the Lancer operation.
According to the SEC, Mr. Lauer engaged in a fraudulent scheme to overinflate
the performances and net asset values of Lancer Offshore, Lancer Partners and
OmniFund.
Among other things, the SEC alleges that the month end closing prices of
certain securities held by the funds were systematically manipulated to
overstate the value of holdings in virtually worthless companies and that
bogus valuation opinions were used to obtain audited financial statements for
Lancer Offshore. In addition to the fraudulent manipulative trading practices
and pumped-up valuations, the SEC also alleges that the funds' offering and
marketing material contained numerous materially false and misleading
statements and omissions.
Mr. Lauer frequently used the phrase "liquidity event" in relation to shares
held by his funds. Given the nature of many of the securities in the Lancer
portfolios as revealed in the SEC court filings, a "liquidity event" may well
be Mr. Lauer's term for the market equivalent of a Lourdes-like miracle that
would cause some of the lame stocks in his funds to rise in value. Meanwhile,
according to the SEC allegations, Mr. Lauer fraudulently propped up the value
through manipulative trading, marking the close of a number of stocks.
Among the stocks Mr. Lauer allegedly manipulated are Biometrics Security
Technology Inc., Continental Southern Resources Inc., Fidelity First Financial
Corp., Lighthouse Fast Ferry Inc., SMX Corp., Total Film Group Inc. and
XtraCard Corp. With the exception of Continental Southern Resources, which
trades on the OTC Bulletin Board, shares of those companies trade only on the
pink sheets. At April 30, 2003, Mr. Lauer's funds collectively valued the
securities of those companies at approximately $695-million (U.S.).
While virtually worthless by any reasonably objective measure, the Lancer
holdings of three of those companies were valued at a staggering $570-million
(U.S.). Incredibly, Fidelity First alone carried a reported value of
approximately $340-million (U.S.) in the Lancer portfolios at the end of
April. Fidelity First is a non-operating shell company that had total assets
of only $25,000 (U.S.) as of Dec. 31, 2002. XtraCard, valued at $123-million
(U.S.), reported chump change revenue of only $152,407 (U.S.) last year. In
its last public filing of financial results, Biometrics Security, valued by
Lancer at approximately $107-million (U.S.), reported a mere $68,936 (U.S.) in
revenues for the nine months ending Sept. 30, 2002.
Shares of the other companies that were allegedly the subject of Mr. Lauer's
month-end price rigging may also be of little real value. Moreover, some of
the Lancer holdings about which the SEC levelled no specific allegations of
manipulative trading may be worth far less than the valuations carried by Mr.
Lauer's funds at April 30. For example, Lancer's holdings of thinly-traded
Magic Lantern Group Inc., primarily a Canadian operation which is listed on
the American Stock Exchange, were valued at more than $27.4-million (U.S.) at
the end of April. Magic Lantern is teetering on the brink of insolvency and
has been searching for financing for several months. According to a July 16
SEC filing, without a cash infusion Magic Lantern only had enough money to
operate for 30 days.
Interestingly, Zi also holds a major position in Magic Lantern. A shell
company controlled by Mr. Lauer purchased Magic Lantern from Zi last year in a
share and promissory note transaction. Upon completion of the deal Mr. Lauer's
funds held a 45-per-cent stake in Magic Lantern and Zi held a 44.6-per-cent
stake in the company. Three Zi directors, including Mr. Lobsinger, serve as
directors of cash-strapped Magic Lantern along with Lancer director Richard
Geist.
The SEC allegations against Mr. Lauer and his funds do not make any specific
reference to Zi, though it is possible that regulators and others involved in
ongoing investigations of Lancer may yet raise some questions about the
previously undisclosed 50-per-cent stake in the Alberta-based company. At the
very least, peeling off in excess of $97.6-million (U.S.) to sponge up 18.7
million shares of money-losing Zi may have had the perhaps entirely unintended
consequence of propping up the share price.
Quite apart from the possibility of some regulatory curiosity regarding the
Lancer sponge and its unreported major stake in Zi, the Lancer association may
hold further concerns for the company and its other shareholders. For example,
Zi might have considerable difficulty in flushing out more financing, if
needed, in the event that it has to disclose that almost half of the company's
shares are among the frozen assets of Mr. Lauer's allegedly fraudulent hedge
fund operation. Moreover, current Zi shareholders, at least those troubled by
such dark musings, may have concerns with respect to the impact on the share
price, if the role of the Lancer receiver changes at some point from
marshalling and safeguarding the frozen assets to liquidating them.
Zi chief executive officer Mr. Lobsinger was not available to discuss any of
these matters when Stockwatch called for an interview on Aug. 1.
Dale Kearns, the company's chief financial officer, would not comment on any
concerns the company might have regarding Mr. Lauer's higher than reported and
now frozen stake in Zi.
"Well, I mean you can appreciate we don't comment of the business of any
particular shareholder; so I can't say I'd have a comment on the basis that I
don't know what his business is and if I did, I still wouldn't have a
comment," Mr. Kearns told Stockwatch.
Mr. Kearns could not shed any light on when anyone from Zi had last spoken
with Mr. Lauer. "I've never spoken to him, but Mr. Lobsinger, I'm sure, has,"
Mr. Kearns said. "I mean he's--he was a significant shareholder and certainly
if a shareholder calls, you take their call. That's a question better put to
Mr. Lobsinger."
In fact, while Mr. Lobsinger may have been Mr. Lauer's principal Zi contact,
Mr. Kearns has also spoken with the Lancer leader; though that may well have
slipped the busy Zi executive's memory.
Mr. Kearns, who joined Zi in April of 2001, was introduced in a conference
call the following month in which he responded to questions from Mr. Lauer as
the person "responsible for all financial, treasury, investor relations,
administration and human resource functions." In addition to his Zi duties,
the multitasked Mr. Kearns also served as Magic Lantern's interim chief
financial officer as recently as May 20 of this year. With such a range of
responsibilities, an occasional memory lapse, even one involving the company's
largest shareholder who is now the subject of an SEC probe in connection with
the allegedly fraudulent activities of a purported $1-billion (U.S.) hedge
fund operation, may be understandable.
Mr. Lobsinger, who might be able to offer some thoughts on Mr. Lauer's
surprising Zi stake and what impact that might have on the company given
recent developments, was again unavailable when Stockwatch called on Aug. 5.
He has not yet returned messages left with Zi's telephone receptionist or Mr.
Kearns or his voice mail.
Meanwhile, Zi's trading volume has dropped off on both Nasdaq and the TSX,
along with the stock price. With less than an hour left in the Aug. 5 trading
session, only 31,700 shares had changed hands on Nasdaq and the stock had shed
12 U.S. cents to $3.57 (U.S.). On the TSX, the volume was even lighter at
21,700 shares and the stock was off 27 cents to $5.03.
Comments regarding this article may be sent to lwebb@stockwatch.com.
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