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How $100 million earned Znetix no interest

The lure to investors – HMC and Znetix would revolutionize fitness and medicine by integrating exercise and health care under one roof. Investors and lenders sunk over $100 million into that promise.

The reality – a spending spree of staggering proportions by HMC insiders. The bottom line:

Total cash inflows: $100.767 million.

Total cash outflows: $100.601 million.

Cash balance in 2002: $167,475.

Those figures are the result of a forensic accountant’s months-long investigation into the financial affairs of the Bainbridge-based companies and founder Kevin Lawrence, which were placed into receivership in February by federal Judge Marsha Pechman.

“The (money) received by HMC during its six years of existence flowed out nearly as quickly as it was received,” according to a report prepared by the firm of Financial Forensics, filed this week in Seattle federal court.

A good indication of how fast the money was spent – the $100-plus million earned only $3,910 in interest.

While investors were told that the money was being used to develop the integrated-health concept, the was not the case, according to court-appointed receiver Michael Grassmueck.

“The companies used significant amounts of investor money for purposes other than those described in the offering memoranda, including but not limited to using the companies’ money for the personal financial benefit of the officers and directors of each of the companies,” Grassmueck wrote in a report to Judge Pechman.

Tracking where the money went was complicated by the fact that HMC – and some 22 other related companies – did not keep any systematic financial records.

One place the money did not go, however, was to the Internal Revenue Service – none of the Lawrence businesses filed a tax return at any time during those six years, auditors found.

“The basic financial and accounting records expected for an entity with HMC’s characteristics were virtually non-existent,” the report said.

Lavishness

Those expenses that could be categorized suggested lavishness.

“The companies spent large sums on things that have no apparent relationship to the companies’ alleged business,” Grassmueck wrote in his report to Pechman.

“Everything from clothing to housing to recreational vehicles to travel, to exotic cars and watercraft, was paid for with investor proceeds.

“For example, it appears that over 130 vehicles were purchased with money from the companies and the companies spent $3.9 million on travel in 12 months.”

While the Madison Avenue health club brought in money – roughly $1 million per year – that amount was dwarfed by investments.

Money from investors poured in at a rapidly accelerating clip. In 1996, investors put some $240,000 into HMC. That number dropped to $54,000 in 1997, then grew to $835,000 in 1998.

In 1999, investor cash jumped to $6.5 million, then exploded in 2000 and 2001, topping $39 million in both years.

Ultimately, some 5,200 investors put money into the companies, authorities say.

The investment increase was fueled by what amounted to a multi-level marketing approach, according to state investigators.

“People asked other people to participate, and they recruited a network of hundreds of investors,” said Deb Bortner, head of the Securities Division of the Washington Department of Financial Institutions.

The DFI issued a cease-and-desist order preventing HMC from selling stock in April of 2001, and in that year, investment in HMC dropped from $31 million to just under $27 million.

But in 2001, Lawrence organized two new entities called Cascade Pointe – one based in Arizona and one in the Caribbean island of Nevis – which sold almost $12 million in stock, according to investigators.

“In theory, Cascade was to purchase shares of stock in HMC with investor money,” according to Grassmueck’s report. But instead, the money was just spent – Cascade had only $20,000 in the bank when the receiver took over.

The amount of money raised in 2001 convinces Bortner that Lawrence flouted the state’s cease-and-desist order.

“There is no doubt in my mind that they violated the order,” she said Friday. “That is another piece of evidence about the wanton nature of these violations.”

Pechman appointed Grassmueck as receiver in February at the behest of the federal Securities and Exchange Commission, which filed suit in Seattle seeking civil penalties against Lawrence, the companies he organized, and several other principals.

Civil proceedings have been stayed at the request of the U.S. Attorney’s office, which is conducting a criminal investigation. Federal prosecutors have said they expect indictments by the end of the year.

While state and federal authorities are working together with the receiver to look for assets that might satisfy the numerous claims against the companies, they report little success to date. Total recovered tangible assets are worth an estimated $2.3 million, Grassmueck’s report says.

Other avenues that are being pursued, Grassmueck says, include offshore bank accounts, assets in the hands of third parties that “were received based on little or no consideration,” and insurance policies, including policies covering director and officer liability.

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