Magic Lantern flickers on Zi and SEC target Lancer
2003-08-12 21:07 ET - Street Wire
Also Street Wire (C-ZIC) Zi Corp
Also Street Wire (U-ZICA) Zi Corp
Also Street Wire (U-*SEC) Securities and Exchange Commission
SLIDE SHOW
by Lee M. Webb
Magic Lantern Group Inc., a Canadian-headquartered company with dimming prospects trading on the American Stock Exchange (AMEX), features Calgary-based Zi Corp. and U.S. Securities and Exchange Commission (SEC) target Michael Lauer and his purported $1-billion (U.S.) Lancer group of funds as major shareholders. The respective Zi and Lancer stakes account for almost 90 per cent of Magic Lantern's outstanding shares.
The SEC shut down Mr. Lauer's allegedly fraudulent hedge fund operation on July 10, appointing a receiver to marshall and safeguard the funds' frozen assets, most of them of highly dubious value.
According to the SEC allegations, since at least March of 2000, Mr. Lauer used fraudulent manipulative trading practices and bogus valuation opinions to overstate the performances and net asset values of Lancer Partners LP, Lancer Offshore Inc. and the OmniFund Ltd., which were stuffed with virtually worthless shares of OTC Bulletin Board and pink sheet companies. The SEC claims that Mr. Lauer manipulated the month-end prices of many of those stocks, known in the industry as "marking the close," and then used the rigged prices to assign values of hundreds of millions of dollars to the near-worthless holdings.
As reported by Stockwatch on Aug. 6, a significant and surprising number of shares of Zi, which trades on both the Toronto Stock Exchange (TSX) and Nasdaq, may be among the frozen Lancer assets. While a May 20 Zi filing with the SEC includes a qualified disclosure indicating that to the best of the company's knowledge Mr. Lauer's funds held approximately 3.7 million Zi shares as of Dec. 31, 2002, court-filed Banc of America Securities documents put those holdings at more than 18.7 million shares as of April 30, 2003.
It should be noted that the SEC allegations against Mr. Lauer and his funds do not include any specific reference to Zi. Indeed, there is nothing in the SEC complaint and more than 1,800 pages of exhibits filed in the U.S. District Court for the Southern District of Florida to suggest that the SEC is at all curious about the Lancer funds peeling off more than $97.6-million (U.S.) to sponge up nearly half of Zi's outstanding shares, apparently entirely unbeknownst to the company, its other shareholders or regulators.
Similarly, the SEC complaint makes no specific mention of Magic Lantern, another of the holdings in Mr. Lauer's funds. According to the Banc of America Securities documents that make up part of the four volumes of exhibits filed by the SEC, the Lancer funds collectively held more than 28.8 million shares of Magic Lantern as of April 30.
The breakdown of the Magic Lantern holdings among Mr. Lauer's funds may perhaps be as interesting as the fact that the shares of cash-strapped company teetering on the brink of insolvency were valued at $27.4-million (U.S.) at the end of April.
The court documents reveal that Lancer Offshore held more than 25.1 million Magic Lantern shares acquired at an average cost of two U.S. cents and Lancer Partners held 3.7 million shares acquired at 2.2 U.S. cents per share. Oddly, with two of his funds already stuffed with more than 28.8 million dirt-cheap Magic Lantern shares, somewhere along the line Mr. Lauer felt compelled to purchase 40,800 shares of the thinly traded stock for OmniFund at an average price of $1.63 (U.S.) per share.
It remains to be seen whether regulators and others involved in the continuing Lancer investigation find anything peculiar about the distribution of Magic Lantern shares and, in particular, the OmniFund holdings. While there is nothing in the SEC complaint to indicate that the U.S. regulator has the least suspicion that Magic Lantern was ever the subject of manipulative trading, it does make clear that the companies specifically mentioned in the complaint do not comprise an exhaustive list of Mr. Lauer's alleged price rigging.
Mr. Lauer's beneficial ownership of more than 28.8 million Magic Lantern shares does not make him the company's largest shareholder. That distinction goes to Zi, which reportedly owned 29.75 million shares of Magic Lantern as of March 31 of this year.
An account of Zi's involvement in Magic Lantern along with Mr. Lauer and his funds hardly makes for a tale of corporate giants and high finance. Nonetheless, it may well provide some insights into an intriguing penny stock deal and the players who put it together. That story involves a series of transactions in which Magic Lantern had four different owners in the span of eight months last year, including a double shuffle involving Zi in which the company changed hands twice in one day, a fortuitously primed AMEX shell company and supporting roles played by at least two individuals with some regulatory baggage.
Founded in 1975, Magic Lantern's principal business turns on distributing educational videos to schools and libraries in Canada. Given the nature of its operations, the company has a catchy, and perhaps in some respects apt, name.
As cinematography history buffs and others may know, "magic lantern" was the name given to the first projector, basically little more than a lantern dimly lit by a candle that was used to "magically" project a crude image onto a wall. At first little more than a parlour curiosity, by the 1700s itinerant "lanternists" with refined technology were wowing and frightening audiences at inns and castles across Europe with their often macabre slide shows featuring devils, goblins and ghosts, adding to the association with magic. Some nimble-fingered lanternists could even change slides quickly enough to give the impression that the images were moving.
During the 19th century, magic lantern halls sprang up throughout Europe and North America and the slide shows became more elaborate, some even featuring special effects like projecting images onto clouds of smoke. In the same period, magic lanterns made their way into schools and libraries where they were used for educational purposes. The once popular magic lanterns quickly disappeared with the advent of the motion picture industry that it helped to spawn in the early 1900s. The movie industry in turn helped drive the technology that led to the development of videos, including the educational videos that Magic Lantern tries to flog to Canadian schools and libraries.
In October of 1996 Magic Lantern was acquired by Networks North Inc., the predecessor to Chell Group Corp., and plopped into its wholly owned subsidiary, NTN Interactive. Chell Group, once listed on Nasdaq, is the namesake of its principal architect and promoter, Cameron Chell, formerly a broker with McDermid St. Lawrence Securities in Calgary.
In a 1998 consent settlement with the Alberta Stock Exchange (ASE) involving a number of alleged securities violations while employed by McDermid, including unauthorized trading in clients' accounts and using a forged authorization, Mr. Chell was fined $25,000 and effectively booted out of the securities industry for five years. He was acquitted of a related criminal charge by an Alberta court in 1999.
While that baggage might have badly tripped up other people, Mr. Chell barely broke stride; though it may have presented at least a couple of hurdles for the Calgary promoter. For example, Mr. Chell was forced to temporarily step aside as head of his then current promotion, Nasdaq-listed FutureLink Corp., a much-ballyhooed applications service provider (ASP), pending the resolution of the criminal charge.
Mr. Chell's regulatory baggage put another minor bump in his career path in October of 2000 when Chell Group's auditor, Ernst & Young LLP, resigned. Ernst & Young advised the company that it was "unwilling and therefore unable to rely upon the representations of Mr. Cameron Chell." That little obstacle was overcome by hiring a less persnickety auditor, Lazar Levine & Felix LLP.
Meanwhile, Mr. Chell's relationship with FutureLink turned sour in early 2000 as the company and its former leader traded multimillion-dollar lawsuits in the Alberta courts. At the heart of the dispute was Mr. Chell's new promotion C Me Run Corp., touted as the latest thing in the ASP business. According to FutureLink, Mr. Chell and other former company employees had simply made off with some of FutureLink's business plans to set up C Me Run. Mr. Chell denied the allegations.
With Mr. Chell's C Me Run promotion just ramping up and FutureLink's share price under pressure as a result of the spate of lawsuits, the dispute that threatened to spill over into open court was quickly and "amicably" resolved in April of 2000. The companies, both continuing to tout their supposedly splendid wares, went their separate ways, eventually disappearing within months of each other. C Me Run, which traded as high as $40.75 (U.S.) per share on Nasdaq in February of 2000, terminated all of its employees and ceased operations on May 21, 2001. FutureLink, which topped out at $36.37 (U.S.) per share in March of 2000, vanished after filing for Chapter 11 bankruptcy protection on Aug. 14, 2001.
Mr. Chell's public profile, which frequently benefited from boosterish coverage in the Alberta press, particularly the Calgary Herald, received even wider flattering exposure in July of 2001 when National Post Business magazine put him in eighth spot in its list of the 40 wealthiest Canadians under the age of 40. According to the National Post, the then 32-year-old Calgary promoter's reported net worth of $169-million put him ahead of international singing star Celine Dion, worth $164-million, movie star Jim Carrey, worth $140-million, and retired NHL superstar Wayne Gretzky, worth $116-million.
The National Post image boost came even as Mr. Chell's latest disastrous Nasdaq promotion, Jawz Inc., was heading for the dumpster. Within a year, however, Mr. Chell's seeming Teflon image was showing signs of wear, largely because of his close association with disgraced former Thompson Kernaghan & Co. Ltd. chairman Mark Valentine and some of his dubious dealings.
Thompson Kernaghan, once a respected independent Bay Street brokerage, suspended and locked out its chairman Mr. Valentine on June 13, 2002, after an internal investigation revealed a number of questionable transactions. The results of the investigation were handed over to the Ontario Securities Commission (OSC), which picked up the probe and suspended Mr. Valentine on June 17, 2002.
A week later, the OSC issued a statement of allegations citing Mr. Valentine for several securities violations with respect to transactions involving a muddle of offshore accounts and funds. While not implicated in any wrongdoing, Mr. Chell and some of his promotions featured prominently in the OSC allegations against his pal Mr. Valentine.
In addition to being Thompson Kernaghan's chairman and largest shareholder, Mr. Valentine performed many other roles. Among other things, he was the president, chief executive officer, director and shareholder of VMH Management Ltd., the general partner of Canadian Advantage Limited Partnership (CALP), which had a corresponding offshore account Advantage (Bermuda) Fund Ltd. He was also president, director and shareholder of VC Advantage Limited, the general partner managing VC Advantage Fund Limited Partnership, with VC Advantage (Bermuda) Fund Ltd. as its corresponding offshore account.
The busy Mr. Valentine also acted as the registered representative and controlling shareholder for Bermuda-based Hammock Group Ltd. The trading nominee for Hammock was Paul Lemmon, a Canadian who served as Mr. Valentine's offshore front in a number of deals.
The OSC allegations identify Mr. Chell as "a known associate of Valentine" and a shareholder and chairman of VC Advantage. While not mentioned in the allegations, VC Advantage and Hammock played significant roles as large backers of Mr. Chell's flagship Chell Group.
Among other things, in a section of its 16-page statement of allegations unflatteringly titled "The Chell Transaction" the OSC cited Mr. Valentine for securities violations involving shares of Chell Group. According to the OSC, on March 28, 2002, Mr. Valentine received 1.06 million shares of Chell Group from CALP for no cash consideration and then proceeded to slop them around through various accounts including VC Advantage and VC Offshore, apparently in an effort to decrease his own margin accounts and the amount owing in his trader receivable account.
Thompson Kernaghan determined that there was not adequate documentation to support the transactions and reversed them, bumping Mr. Valentine's margin requirements to $1.7-million, increasing his trader receivable by $717,000 and creating an excess margin of $2-million in the funds' accounts.
Mr. Valentine was also cited for securities violations involving a death spiral financing for Mr. Chell's Jawz. After Mr. Valentine's VC Advantage funds acquired the floorless warrants in the toxic Jawz financing, Thompson Kernaghan's research department issued a buy recommendation on the company without disclosing its chairman's role as holder of the death spiral warrants for VC Advantage.
Mr. Chell's C Me Run was also featured in the OSC allegations. According to the OSC, during 2000 Mr. Valentine's funds were net buyers of C Me Run, racking up a loss of approximately $4.5-million. The other side of the trades were made by offshore accounts, including Bermuda-based Ashland Resources for which Mr. Valentine was the registered representative and over which his offshore front Mr. Lemmon had trading authority. Ashland trotted off with a $6.4-million profit on the C Me Run trades while Mr. Valentine's funds took a beating on the stock.
It should be noted that Mr. Valentine has not yet had the opportunity of presenting his story regarding the substantive allegations in a hearing before the OSC, largely because he was overtaken by other events.
Shortly after the OSC allegations against Mr. Valentine resulted in some unflattering public exposure for Mr. Chell and his promotions, Mr. Chell received some more direct bad news. On June 27, 2002, Nasdaq delisted Chell Group.
In successive news releases on June 28 and July 1, 2002, Chell Group almost stridently insisted that the Nasdaq decision, with which it "vehemently" disagreed and intended to appeal, had nothing to do with "any investigation, accounting irregularity, or impropriety." In any event, in an immediate reorganization Mr. Chell stepped down as president and chief executive officer of Chell Group. Neither the reorganization nor the Nasdaq appeal had any positive effect; Chell Group drifted to the pink sheets where it occasionally trades below a penny.
Just over a month later, Mr. Chell was again the subject of some unflattering exposure related to Mr. Valentine. On Aug. 14, 2002, Mr. Valentine was among 60 penny stock players arrested in Operation Bermuda Short, a joint FBI-RCMP undercover sting. Mr. Valentine's offshore front Mr. Lemmon was also arrested.
Mr. Chell was not implicated in any wrongdoing in connection with the undercover sting operation. However, according to the indictment, Mr. Valentine and Mr. Lemmon were the principal conspirators in a kickback, bribery and stock manipulation scheme involving Mr. Chell's C Me Run and two other Thompson Kernaghan stocks, SoftQuad Software and Jagnotes.com.
According to the allegations, the C Me Run conspiracy involved a scheme in which a bogus mutual fund actually operated by an undercover agent would purchase $9.4-million worth of C Me Run from Thompson Kernaghan and Mr. Valentine, receiving a 30-per-cent kickback from Mr. Valentine and Mr. Lemmon. It was also alleged that as part of the conspiracy Mr. Valentine and Mr. Lemmon would bribe other brokers to manipulate and artificially inflate the share price for a period of months while the stock was unloaded.
Mr. Lemmon flipped in a plea bargain in which he got off with a 21-month sentence and a $7,500 (U.S.) fine, agreeing to co-operate fully with authorities, including assisting in the prosecution of Mr. Valentine. Mr. Valentine maintains his innocence and is awaiting trial on one count of conspiracy to commit wire, mail and securities fraud, and two counts of related securities fraud.
Before Mr. Chell was unflatteringly linked to Mr. Valentine and then had the coveted Nasdaq-listing of his flagship "strategy bank" yanked, Chell Group unloaded Magic Lantern to an unidentified management group for $1.85-million. That transaction was consummated on March 18, 2002.
With a deftness worthy of a nimble-fingered lanternist of yore, the unidentified management group dealt off Magic Lantern the very same day to Zi in a cash and share transaction. Zi peeled off $2-million in cash and issued 100,000 shares then carrying a total value of approximately $850,000 to acquire Magic Lantern in the same-day double shuffle.
"The acquisition of Magic Lantern provides Zi with a North American-based company with which we can leverage our relationships in China and capitalize on our Oztime investment," Mr. Lobsinger stated in a March 20, 2002, news release announcing the acquisition. "It is Zi's current intention to monetize our e-learning investment through a separate public company. The complementary businesses of Magic Lantern and Oztime provide us with the opportunity to source North American content for the Chinese market and a strong international management team with depth and breadth of experience."
Meanwhile, Mr. Lauer was working his magic on an AMEX shell, JKC Group Inc., with the assistance of his associate and key Lancer figure Bruce Cowen. Mr. Cowen was later among the 60 penny stock players arrested in Operation Bermuda Short. He was indicted for his alleged role in a kickback and stock manipulation conspiracy involving Lancer-controlled Lighthouse Fast Ferry Inc. and is awaiting a September trial.
At the time he facilitated Mr. Lauer's takeover of JKC, Mr. Cowen was already 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. Lauer, with the help of Mr. Cowen and operating under the auspices Lancer-affiliated Alpha Omega Group (AOG), took control of JKC on April 16, 2002, upon completion of a deal in which AOG acquired 30 million JKC shares for $1.5-million (U.S.). The AOG stake represented 83 per cent of JKC's outstanding shares. Mr. Cowen's Capital Research picked up another 2.1 million JKC shares for brokering the deal.
As part of the deal involving the equity infusion from AOG and the resulting change of control, JKC's board of directors was reconstituted with the addition of Richard Geist, a Lancer director, and Kathryn Braithwaite, Mr. Cowen's wife. The fortuitously primed JKC then began searching for a business acquisition. That search did not take long.
On June 5, 2002, JKC entered into a letter of intent and then a subsequent definitive agreement to acquire Magic Lantern from Zi in exchange for a $3-million (U.S.) promissory note and 29.75 million shares, representing just under 45 per cent of the outstanding shares. The deal, rather grandly valued at more than $12-million (U.S.), was consummated on Nov. 7, 2002.
Following the acquisition, JKC changed its name to Magic Lantern. Three Zi directors, Michael Mackenzie, Howard Balloch and chief executive officer Mr. Lobsinger, joined the Magic Lantern board where they served with Mr. Geist, a Lancer director. Dale Kearns, Zi's chief financial officer, was appointed Magic Lantern's interim chief financial officer, a position he held as recently as May 20 of this year.
In yet another move reminiscent of the skilled lanternists of yesteryear, at some point the 30 million shares originally issued to AOG almost magically ended up in the control of two Lancer funds. According to Magic Lantern's annual report for the year ending Dec. 31, 2002, certified by Mr. Kearns, Lancer Offshore owned 25 million shares and Lancer Partners owned five million shares, representing 45 per cent of the outstanding shares.
Notwithstanding their respective major stakes in Magic Lantern and other close ties between Zi and Mr. Lauer, who was among Zi's biggest boosters, the relationship is apparently suffering from some communication problems. According to a Zi statement issued on Aug. 11, the company has been unable to obtain an update on Mr. Lauer's Zi holdings despite several requests from its lawyers.
Oddly, that communications breakdown between Zi and Mr. Lauer predates Zi's sale of Magic Lantern to JKC. According to Zi, prior to the May 20 filing of its 2002 annual report on Form 20-F with the SEC, the company became concerned about a concentration of its shares in a major brokerage firm and instructed its lawyers to obtain an update on the Lancer holdings. In spite of that concern and the fact that the company's lawyers received no response to their several requests, Zi forged ahead with the Magic Lantern deal.
It is not known whether any of the three Zi directors serving on Magic Lantern's board ever prodded fellow board member Mr. Geist, the Lancer director, for information about the funds' Zi holdings. For that matter, it is not known why Mr. Lobsinger, Mr. Lauer's principal Zi contact, did not just pick up the phone and ask Mr. Lauer directly.
Notwithstanding an occasional bout of puffery, the Magic Lantern promotion never really got off the ground and the company is now entangled in the Lancer scandal along with Zi. Magic Lantern is out of cash and the prospects of flushing out any financing while under the Lancer cloud seem dim indeed.
Thinly traded Magic Lantern has recently become even more thinly traded, sometimes not trading at all for several days. It managed to tally a volume of 200 shares on Aug. 12, closing at 74 U.S. cents.
Meanwhile, the market is zapping Zi. Since Stockwatch's Aug. 6 report of Mr. Lauer's previously undisclosed major stake in Zi according to court-filed Banc of America Securities documents, the stock has lost almost 40 per cent of its value. In Aug. 12 trading on Nasdaq, Zi slipped another 20 U.S. cents to close at $2.29 (U.S.) on a volume of 371,800 shares. On the TSX, 352,700 shares changed hands as Zi shed another 38 cents to close at $3.15.
Comments regarding this article may be sent to lwebb@stockwatch.com.
(More information regarding Zi is available in Stockwatch articles published on Aug. 6 and Aug. 11, 2003.) |
