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Money gone, time runs out for Znetix/HMC

Of the $74 million raised from 5,000 investors nationwide, only some $500,000 appears to have gone unspent.

And saying she saw no hope that the Bainbridge-based businesses Znetix/HMC would become viable, federal Judge Marsha Pechman Thursday appointed a receiver to find whatever assets remain -- a decision company attorneys said is a death knell for the operations.

“I see nothing to go forward with, no assets from which a company can function,” Pechman said, ruling from the bench after a two-hour hearing in a packed Seattle courtroom.

The receiver, Michael Grassmueck of Portland, Ore., was given permission to take over operations of the businesses immediately. He said he would be on Bainbridge Island before the end of the week to begin his work at company headquarters, the health club variously known as Health Maintenance Center/Human Performance Center on Madison Avenue.

Grassmueck said one of his priorities would be determining the future of the fitness center, but he declined further comment.

The ruling came in proceedings following a civil lawsuit filed by the federal Securities and Exchange Commission against Health Maintenance Centers, Inc., Znetix principals Kevin Lawrence of Bainbridge Island and Donovan Claflin of Redmond, and a number of so-called “relief defendants” -- people who the SEC does not claim violated securities laws, but who may have received financial benefits arising out of the alleged violations of others.

The SEC also sued entities called Cascade Pointe, which allegedly tried to raise money from investors to buy HMC/Znetix. The money was being raised, in part, to pay off any HMC stockholders who wanted their money back.

Cascade Pointe raised some $17 million, the SEC claimed. No statements were made in court about those funds, but Pechman’s order prevents any further sales of Cascade Pointe securities.

When the SEC filed its action of Jan. 23, it secured a temporary freeze on assets of the various defendants. That order was obtained without notice to the defendants.

The hearing Thursday was on the SEC’s motion to extend the freeze until final resolution of the case, and to give the defendants a chance to be heard.

ADVERTISING FOR IMAGE

The SEC laid out its case that Lawrence and Claflin had sold some $74 million in unregistered HMC stock, and had made various misrepresentations in so doing.

“No matter whether people bought stock in HMC or any other entity, they were ultimately investing in Znetix,” said senior SEC trial counsel Nicolas Morgan.

According to the SEC’s complaint, HMC investors were told that Znetix would buy out HMC, then offer its shares to the public in an initial public offering (IPO). They were told that the would receive multiple shares of Znetix for each share of HMC stock, and could sell their Znetix stock on the open market after the IPO.

But Morgan said the Znetix IPO was a mirage.

“There were no financials, no underwriters and no registration statement,” he said.

Instead, there was advertising through sponsorship of racing hydroplanes and a Safeco Field sign -- “efforts to create an image that this was a substantial company,” Morgan said.

And there were large sums of money paid to the principals, especially to Lawrence, Morgan said.

Morgan showed the court a pie chart of where the SEC believes the $74 million went. The SEC’s percentage breakdown, together with a dollar breakdown based on those percentages:

* Salaries and payroll taxes – 27 percent ($20 million);

* “Misappropriated” – 22 percent ($16.25 million);

* Undetermined – 11 percent ($8 million);

* Acquisitions – 9 percent ($6.6 million);

* Advertising and sponsorships – 8 percent ($6 million);

* Land, furniture and assets – 7 percent ($5.2 million);

* Supplies and office expenses – 5 percent ($3.7 million);

* Professional services – 4 percent ($3 million);

* Travel and entertainment – 4 percent ($3 million);

* Rent, insurance and utilities – 3 percent ($2.2 million).

“Note that there is no slice there representing assets,” Morgan said. “We have only been able to find $500,000 in the various bank accounts.

“Basically, there is nothing left.”

‘DON’T DESTROY THE COMPANY’

Counsel for the defendants did not try to refute the SEC’s claims of illegal security sales or improper diversion of assets. Nor did they contest that little remained of the $74 million in investor funds.

Rather, they tried to distance the companies from Lawrence, and pleaded with Pechman for a chance to move forward with the concept.

“We have an investor willing to put $5 million into the company on Feb. 22 if the court does not appoint a receiver,” said Mark Holscher of the Los Angeles firm of O’Melveny & Myers, representing Znetix and HMC.

“The fusion of going to the gym and working out, being monitored by cutting-edge equipment and going to the doctor is so powerful that unsolicited investments have been rolling in despite Lawrence’s youth and inexperience,” he said.

Going forward with a new and independent board of directors and giving the idea a chance to work is the only way the investors could recover any of their money, Holscher argued.

“The receiver the SEC wants appointed is a specialist at finding assets, not at running health clubs,” Holscher said. “The SEC is asking the court in the name of the shareholders to destroy this company today.”

But Pechman noted that the proposed board of directors contained a number of individuals who had previously been associated with Znetix or HMC.

“If they have enough experience to run the company,” she said, “why didn’t they catch these problems earlier?”

The judge also expressed concerns about allowing additional money to come into companies with highly uncertain prospects.

“How can I tell investors willing to pour money in that I’m willing to let this company operate without books and records?” she asked.

‘NOTHING LEFT FOR INVESTORS’

Lawrence’s attorney, Robert Chadwell of Seattle, did not comment on the allegations against his client. Rather, he said that Lawrence is willing to disassociate himself completely from HMC and Znetix, and said Lawrence is considering a job offer with a marine design company.

Chadwell also argued that appointing a receiver would be futile.

“As the SEC points out, the assets appear to be limited,” Chadwell said. “If we appoint a receiver, accountants will be paid and attorneys will be paid, but there won’t be anything left for the investors.”

The courtroom was packed with 80 to 100 spectators, many of them investors or one-time employees.

Further court proceedings will resolve, among other issues, the priorities for asset recovery among past and present employees who claim they have not been paid; settlements for other creditors, including various lien claimants; and repayment of shareholders.

For the investors, the news was bad -- there will be no Znetix IPO, there are virtually no assets, and the chances for getting any substantial portion of their money back -- much less a profit -- appears remote.

One message posted on the an Internet message board dedicated to the Znetix operations seemed to capture the feelings of many.

“This sucks bad,” the poster wrote after learning of the judge’s decision. “We’re done!”

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