Zi muddle over SEC target Lancer stake still unresolved
Zi Corp ZIC
Shares issued 39,216,821
Sep 10 2003 close $ 3.57
Thursday September 11 2003 Street Wire
Also Securities and Exchange Commission (U-*SEC) Street Wire
Also Zi Corp (U-ZICA) Street Wire
PROGRESS REPORT
by Lee M. Webb
Zi Corp., a Calgary-based technology company entangled in a scandal involving the U.S. Securities and Exchange Commission (SEC) target Michael Lauer and his Lancer Group, remains mired in that controversy following the court-appointed Lancer receiver's initial report. The Sept. 8 receiver's report offers no specific details regarding Lancer's murky Zi stake, though other court filings indicate that Mr. Lauer and his Lancer funds may have controlled as many as 21.6 million Zi shares.
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 massive Zi stake apparently controlled by Mr. Lauer and his Lancer funds was not disclosed to regulators. Indeed, regulators and investors are still largely in the dark with respect to that massive Zi stake. Nonetheless, regulators have not shown any overt concern with respect to the muddle involving Lancer and Zi; trading in the surprisingly buoyant stock continues on both sides of the border.
The SEC shut down Mr. Lauer's allegedly fraudulent Lancer operation on July 10. The U.S. regulator obtained a court order freezing the assets of the purported $1-billion (U.S.) Lancer funds and appointing a receiver.
As first reported by Stockwatch on Aug. 6, Bank of America documents filed in support of the SEC's civil complaint against Lancer and Mr. Lauer in the U.S. District Court for the Southern District of Florida indicated that the allegedly fraudulent Lancer funds held a staggering undisclosed stake in Zi. According to the Bank of America client position summaries as of April 30, three Lancer funds held a total of more than 18.7 million Zi shares.
On Sept. 8, Stockwatch broke the news that a subsequent court filing by Mr. Lauer indicated that the Lancer leader also held a significant personal stake in Zi. According to Mr. Lauer's personal Bank of America client position summary for July 14, the disgraced fund manager held a previously undisclosed 2.87 million Zi shares.
All told, at least according to the Bank of America documents, the Lancer funds peeled off more than $97.6-million (U.S.) to sponge up the unreported 18.7 million Zi shares and Mr. Lauer ponied up another $18.1-million (U.S.) to acquire his personal undisclosed stake of 2.87 million shares. The combined holdings of approximately 21.6 million Zi shares as revealed in the Bank of America documents represents 55 per cent of Zi's currently outstanding shares, giving Mr. Lauer majority control of the money-losing company before his Lancer operation was shut down.
In the wake of Stockwatch's Aug. 6 report of Lancer's surprising Zi stake and a tumbling share price, Zi issued a statement on Aug. 11 claiming that the company did not know how many of its shares were held by Lancer. Zi reported that it was "seeking clarification as to Lancer's holdings" from the court-appointed receiver. "As of Aug. 8, 2003, the receiver said that it had been unable to verify the extent of the Lancer position in Zi," the company reported.
Evidently the receiver has still not been able to verify the extent of the Lancer position in Zi or the extent of Lancer's position in any other company, for that matter. In any event, that seems to be what can be gleaned from Lancer receiver Marty Steinberg's initial report filed with the SEC and the Florida court on Sept 8.
According to Mr. Steinberg, he has received custody reports from Lancer's prime broker, Bank of America, reportedly the only financial institution that holds securities for the various Lancer entities. The Bank of America custody reports identify the Lancer securities that the prime broker has in its possession and the estimated value of those securities. However, those custody reports do not reconcile with the Lancer portfolio statements.
The initial report by the Lancer receiver states that the significant differences between the information in the custody reports and the Lancer portfolio statements include differences in the number and type of securities held and the value of those securities. According to the receiver, Mr. Lauer suggests that the differences regarding the number of securities is attributable to the fact that some of securities "were issued to Lancer in certificated form" and some were purchased by Lancer without receiving a certificate.
In other words, it appears that some of the shares acquired by Lancer were registered and some were simply in investment dealer book entry form. The receiver has contacted more than 40 transfer agents and security issuers to obtain confirmation of the existence of the "unconfirmed securities." Presumably Zi's transfer agent, CIBC Mellon Trust, is among those transfer agents contacted by the Lancer receiver.
Mr. Steinberg reports that a number of "certificated securities" were located during the receiver's review of 105 boxes of materials obtained from Lancer offices in New York and Connecticut. To this point, between the positions maintained by the Bank of America and the original stock certificates found by the receiver, ownership has been confirmed in only approximately 40 per cent of the positions represented in the Lancer portfolio statements.
The receiver reports that he has prepared a spreadsheet setting out the differences for each Lancer fund and each security held by the Lancer funds between the number of securities reportedly held according to the Lancer portfolio statements and the number of securities confirmed by the receiver. However, that spreadsheet is not included in the court filing.
"The Receiver has identified numerous substantial Investment Position Discrepancies," Mr. Steinberg reports. "The Receiver has also determined that the estimated market value of many securities listed on the Portfolio Statement are different, and typically appreciably higher, than the estimated market value of such securities on the Custody Statements. The Receiver has not yet determined which of the two statements, if either, is accurate."
Much of the Sept. 8 report is really just a progress report sketching out the steps the receiver has taken to this point, including hiring the attorneys, investigators, forensic accountants and so on as required to fulfill his obligations as laid out in the court order. Among other things, the receiver has also been searching for a fund manager with the skills necessary "to oversee the management and operation of not only the Funds, but where appropriate due to ownership percentages, the portfolio companies as well."
The proposed fund manager contract has three primary compensation elements: a fee for providing valuation services; an annual management fee; and an asset disposition fee.
While the initial report of the receiver provides no details regarding either the number or the value of any specific Lancer holdings, including Zi, Mr. Steinberg's affidavit filed as an exhibit to his Sept. 8 report may offer at least a general hint regarding the value of the Lancer holdings.
In a section of his affidavit addressing Mr. Lauer's claim that his net worth is $114-million (U.S.) and that 90 per cent of that net worth is made up of his personal Lancer holdings, the receiver questions Mr. Lauer's real net worth and the value of the Lancer funds.
"If 90 per cent of Mr. Lauer's net worth is invested in Lancer funds, there are serious concerns about the value of the holdings in those funds and it would literally be impossible to ascribe any significant value to Mr. Lauer's holdings in the Lancer funds," Mr. Steinberg states. "Also, many of the securities held personally by Mr. Lauer are identical to the securities held in the portfolios of the Lancer Funds and, therefore, are subject to the same questions regarding their value that applies to the securities held by the Lancer Funds."
The final paragraph of Mr. Steinberg's affidavit may hold further concerns for investors who independently own shares of companies held by the Lancer funds, including Zi, which makes up a significant portion of the Lancer portfolios.
"As of this date, the Receiver cannot provide the Court with any value of Lancers' holdings, other than to say that the values listed on various reports appear to be much higher than any actual value that will be determined by the Fund Manager, for many of the reasons stated in the SEC's pleadings," Mr. Steinberg states.
Indeed, discounting the Lancer holdings allegedly subject to bogus valuations and the shares of illiquid companies that Mr. Lauer and Lancer allegedly manipulated, Zi may be the most valuable single holding in the Lancer portfolios. If that turns out to be the case, money-losing Zi will feature prominently in the receiver's efforts to wring some value out of the dubious Lancer funds.
Perhaps investors who have been buying shares of Zi since Stockwatch first reported Lancer's surprising undisclosed stake in the company have already factored that into their investment decision. Moreover, it may be that the regulators with the mandate to protect the interests of the investing public are satisfied that as much is known about Lancer's Zi stake as needs to be known. It remains to be seen just how well that possible factoring and satisfaction will stand up in the event the Lancer receiver starts liquidating as many as 21.6 million Zi shares.
Stockwatch will provide a closer review of the Lancer receiver's initial report in a separate article and will continue to follow developments involving Zi.
While the Lancer receiver's initial progress report does not shed any light on Lancer's murky Zi holdings, Stockwatch has made some progress with respect to resolving another Zi muddle; specifically, Zi's own confusing claims regarding its shareholders.
As previously reported by Stockwatch, in its annual report for the year ending Dec. 31, 2002, Zi claimed that based on a report from its transfer agent, CIBC Mellon, "there were 187 registered shareholders in the United States that held 24,858,028 common shares or 64.7 percent of the common shares outstanding." After Stockwatch revealed Lancer's staggering Zi stake on Aug. 6, however, Zi issued a conflicting claim.
In an Aug. 11 statement in response to the controversy triggered by Stockwatch's report, Zi set out a remarkably different claim regarding the number of registered shareholders. "Since the vast majority of the shares of Zi Corporation are held in investment dealer book entry form and not in registered form, the actual beneficial ownership position of a shareholder can only be provided by the individual beneficial owner of stock," the company reported.
Stockwatch pointed out the conflicting claims in an article the same day and an investor pointedly raised the matter during a Zi conference call on Aug. 15. In response to the investor's question, Zi's chief financial officer Dale Kearns spun out another interpretation of Zi's inaccurate and, regardless of intent, misleading disclosure in its annual report on Form 20-F filed with the SEC.
"That reference in the 20-F to 187 registered shareholders is in fact reference to 187 investment dealers who have a number of clients behind them that would be a sheer guess on my part," Mr. Kearns said.
"Now, Dale, that's not what it says," the investor pressed. "It says registered shareholders."
"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.
Notwithstanding Mr. Kearns's insistence on his Humpty Dumpty interpretation, that revised claim does not seem to bear scrutiny. Stockwatch has learned that Zi does have a number of registered shareholders, including individual shareholders and some corporate entities with registered shares, but as previously suggested by Stockwatch the vast majority of the company's shares are held by clearing agents in Canada and the U.S.
In the U.S., clearing agent Cede & Co. holds approximately 24.8 million Zi shares, which is almost exactly the number of shares that the company attributed to 187 registered U.S. shareholders in its filing with the SEC and Mr. Kearns subsequently attributed to 187 investment dealers. CDS & Co., the Canadian clearing agent, holds approximately 12.8 million Zi shares. Zi may make some progress toward getting the figures and the story right when it files an amendment with the SEC.
Meanwhile, in Nasdaq trading Zi shed six U.S. cents on a volume of 86,500 shares to close at $2.60 (U.S.) on Wednesday. On the TSX, 22,800 shares changed hands and Zi was off eight cents to close at $3.57 on Sept. 10.
Comments regarding this article may be sent to lwebb@stockwatch.com.
(More information regarding Zi is available in Stockwatch articles published on Aug. 6, 11, 12, 13, 18 and 22; and Sept. 5 and 8, 2003.)
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