HMC and Znetix hoped to set themselves apart in the crowded field of health and exercise by integrating fitness facilities and medical care under the same roof.
But while the companies were marketing that concept to investors, they were not sure such an arrangement would be legal, according to documents filed in Seattle federal court by the Securities and Exchange Commission.
Those documents, generated by the companies themselves, show that while the firms had sold some $74 million in stock, they had done relatively little to actually create a marketable business.
“We have not engaged in any activity except for raising capital and committing resources to researching and developing the HPC model,” said a draft document prepared for Bainbridge-based Health Maintenance Centers, Inc.
The document goes on to state that HMC had no patents or pending applications, and that some of the revenue was used to operate the Human Performance Center fitness facility on Madison Avenue, which founder Kevin Lawrence referred to as the “lab” – a prototype for the fitness concept HMC hoped to market.
Lawrence’s attorney, Robert Chadwell of Seattle, declined comment this week.
The disclosures concerning HMC and Znetix operations are contained in an undated document prepared as part of a possible “rescission” offer – a refund to HMC investors requesting their money back.
The document was prepared sometime after April 2001, when the securities division of the Washington State Department of Financial Institutions charged HMC and Lawrence with selling unregistered stock. The DFI issued a cease-and-desist order, which the defendants did not contest.
Under state law, buyers of unregistered securities are entitled to a refund of their money, plus 8 percent interest. Conversely, a company selling unregistered securities can avoid civil liability by making a rescission offer, giving all investors the opportunity to get their money back, with interest.
But a company making a rescission offer must also file a registration statement, providing information from which investors can make in informed decision on whether to keep their stock or accept the rescission.
According to the SEC and DFI filings, Lawrence and others pushed HMC stock by saying that Znetix would buy out HMC, and that for every HMC share, an investor would get up to four Znetix shares.
The SEC and DFI say investors were told Znetix would “go public,” selling shares on the stock exchange, and that investors could sell their Znetix shares for substantially more than $1 each.
‘Project X’
When the federal SEC filed its suit against HMC Znetix and Kevin Lawrence in January – said by regulators to be the biggest “home grown” stock fraud case in the history of Washington – it filed a number of documents in support of the allegations. Among them were the draft HMC rescission registration, and Private Placement Memorandums for Znetix and its predecessor, which had simply been titled “Project X.”
Those documents suggest how precarious the companies’ business plans were, including the statement that the key concept of integrating fitness and medical care might be prohibited under laws regulating the practice of medicine.
HMC and Znetix were seeking an opinion from regulators about the legality of the idea, the documents say, but give no indication of when the opinion might be issued.
Without that “integration” concept, the document acknowledges that HMC would be competing in a crowded arena with at least 19 other competitors that had more experience and more financial muscle.
The documents say that after Znetix bought HMC, it would be engaged in three lines of business.
The first would be marketing the HMC “concept” to at least 50 buyers the first year for $1 million each, the documents said.
To demonstrate the feasibility of the plan, HMC generated “agreements” with a number of well-known athletes, including professional football players Marcus Allen, Shannon Sharpe and Tim Brown.
Those “agreements” say that the athlete would pair with “a predetermined health club,” which would pay Znetix $1 million for the HMC model. While the athletes signed the agreement, there was no indication that any health club had ever been selected, or had agreed to pay any sum of money.
Nor did the documents on file indicate how Znetix would prevent others from simply copying, for free, a concept not protected by patent or trademark.
‘Bio-Toys’
The second line of business was to be cutting-edge fitness machines, which would be marketed under the heading of “Virtis.” The third leg would be diagnostic tools, known as “Bio-Toys.”
The documents were not models of clarity. For example, the Project X memorandum describes Bio-Toys as “a concept of process and practice development, including the management and automation of those processes; tracking the activities of providers and participants for data collection; and trending that data via artificial neural networks and Bayesian algorithms for predictive health management.”
In excerpts of deposition testimony filed by the SEC, former Znetix CEO Charles Dillman testified that Znetix had not actually developed any hardware or software, and said those were Znetix goals, not accomplishments.
The HMC rescission memorandum acknowledges that the company did not have the money to repay all stockholders with interest, which it said would require an estimated $55 million.
That money was to come from an Arizona limited partnership called Cascade Point, which was attempting to raise that amount of money to buy HMC. The rescission registration said that if Cascade Pointe could not raise that sum of money, the rescission could not go forward. According to the SEC, Cascade Pointe had raised some $17 million, but had made some of it available to Kevin Lawrence for operations of HMC and Znetix. Cascade Pointe was also named as a defendant in the SEC’s suit, and was enjoined from any further sales.
Other documents and testimony filed by the SEC deal with expenses incurred by HMC, Znetix and Lawrence, which far outpaced those firms’ income.
Former Znetix president Charles Dillman testified by deposition that Znetix had income of some $30,000 per month from various consulting contracts, but expenses of $950,000 per month.
Some $800,000 per month was spent on salaries, Dillman said, with $30,000 spent on rent and office expenses and $120,000 per month on travel.
The documents disclose that Znetix spent $3.35 million sponsoring a hydroplane racing team, and paid the Seattle Mariners $900,000 to be a Safeco Field sponsor in 2000 and 2001, with the contract calling for a further $620,000 payment in 2002. That sponsorship contract included a large sign on the facade of the upper deck on the left-field side.
The SEC’s civil suit seeks restitution to HMC, Znetix and Cascade Pointe investors, together with unspecified civil penalties.
Criminal charges against some of the participants are a possibility, according to the SEC, which noted that the U.S. Attorneys’ office for Seattle and the criminal division of the Internal Revenue Service have participated in the investigation.
On January 23, the day the SEC filed suit, the federal court in Seattle issued a temporary order forbidding further stock sales and freezing all assets of the named defendants and a number of so-called “relief defendants,” who the SEC says did not violate federal law, but benefitted financially from the violations of others.
The “relief defendants” include the Human Performance Center corporation, Kevin Lawrence’s wife, his parents, his sister and his fiancee, all of whom received gifts from him, the SEC says.
