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Employment

DIGL Founder: $348M in Insider Sales

Just when you thought you'd heard every story of outlandish executive enrichment in the telecommunications industry, along comes a real jaw dropper.

Ready? At the latest tally, it appears that Bryan Zwan, chairman and founder of Digital Lightwave Inc. (Nasdaq: DIGL), has taken no less than $348 million out of the company. Meanwhile, Digital Lightwave's business has collapsed, it has a market capitalization of less than $40 million, and it's now almost trading as a penny stock, at $1.22.

Zwan moved the money via arrangements to sell his stock at fixed prices across complex strings of transactions involving: a Nevada company he controls, ZG Partnership; investment bank Credit Suisse First Boston Corp. (CSFB); and one of the bank’s subsidiaries, CSFB SAILS Corp. This is according to several 13D forms filed with the Securities and Exchange Commission (SEC) over the course of the last few years.

Just Tuesday, Zwan, who is the controlling shareholder of Digital, stepped out of the CEO post for the second time, moving back upstairs as the company's chairman. His tight control over the company, the company's falling fortunes, and his affiliation with the Church of Scientology has made his leadership a popular item of debate (see Losses, Lawsuits, and Scientology).

Over the years, Zwan made arrangements to lock in gains for sales of millions of shares of stock at prices ranging from $31 to $121, raising $23.8 million in cash for himself and another $348.5 million in guaranteed purchase agreements for his company, ZG Partnership, of which he is the sole owner and president, according to the SEC filings.

Investment banking and hedge-fund experts consulted by Light Reading say Zwan's technique, though bordering on the extreme, is not unusual. Many executives use sophisticated arrangements involving limited partnerships and investment banks to lock in gains on stock. But the sheer magnitude of Zwan's sales -- which in dollar terms now amount to nearly ten times the current market capitalization of his company ($38 million) -- is astounding, say experts.

"That's ridiculous," says one investment banker, asking to remain unnamed.

Nearly all investment banks work with executives to come up with arrangements to hedge positions or "forward sell" stock, which usually involves the banks fronting money for the stock while they protect themselves with hedging instruments [ed. note: not to be confused with the Strimmer™ or pruning shears].

Though Zwan's particular deal appears to be more complicated than most, here's how such deals usually work: An insider goes to an investment bank, looking to sell shares of the stock without actually putting them on the open market. The investment bank grants a "forward purchase" agreement guaranteeing the seller a price at some future point in time. Then, in order to hedge itself against the stock falling, the investment bank usually "short-sells" the stock or buys options that would rise in value if the stock falls.

What makes Zwan's case interesting is the number of shares involved (at least 4.5 million) and the fact that he is the majority shareholder of the company, owning some 60 percent of the stock. As Zwan and ZG Partnership were "forward selling" millions of shares of stock to the investment bank, the investment bank likely had to short-sell the stock (sell shares it did not yet own) to hedge its bet. If this was the case, the transactions would have resulted in enormous selling pressure on Digital Lightwave's stock.

It's not clear what action CSFB took. CSFB declined to comment for this article. According to SEC filings and Zwan himself, he still controls all of the stock at issue in the forward purchase agreements. At some point in the future he will need to hand over control of certain numbers of the shares in the agreements, depending on the market price, beginning in 2004, according to SEC filings.

By going through ZG Partnership, Zwan did not have to declare, in his own name, the cash value of the transactions involving Digital Lightwave stock in filings to the SEC. Zwan did disclose that he was transferring 4.5 millions shares of DIGL to ZG Partnership's control in several "non-market" dispositions; these transfers were disclosed in SEC 144 forms filed in 2000 and 2001. Other insider transactions registered in Zwan's name show that Zwan purchased 992,000 shares at prices of between $4.91 and $5.249 a share (a total cost of about $5,039,000) in February 2002, according to SEC filings.

The complicated ways in which Zwan has sold Digital Lightwave stock are evident in a 13D form filed with the SEC on May 13, 2002. It started with 4.56 million shares of Digital Lightwave stock that Zwan unloaded to ZG Partnership by means of the "non-market disposition." Then, in a series of transactions, "forward purchase agreements" for massive lots of stock (millions of shares) were moved among ZG Partnership, CSFB, and CSFB SAILS Corp., usually in exchange for cash amounts specified by purchase agreements.

At any rate, just figuring out what was going on takes some careful reading. The 15-page 13D filing outlines a complex series of deals. One of the transactions went like this: On December 8, 1999, Dr. Zwan entered a "forward sale agreement," by which he pledged 1,000,000 shares to CSFB SAILS Corp. and CSFB.

Says the filing:

    Pursuant to the Zwan Agreement, Dr. Zwan received a purchase price of $23,790,580. In connection with the Zwan Agreement, Dr. Zwan entered into the Pledge Agreement dated December 8, 1999 among Dr. Zwan, CSFB SAILS Corp. and Credit Suisse First Boston Corporation. Up to 1,000,000 shares are subject to this pledge agreement.

Other agreements in the filing, 11 in total, paint a more complex picture, one in which the ZG Partnership then placed its own "forward sale" agreements with CSFB, at the same time as it was buying shares on the open market. In these transactions, ZG received cash from CSFB. For example, on February 9, 2000, ZG Partnership entered into a term sheet outlining the terms of forward sale arrangements with respect to 1,500,000 shares of stock with CSFB. In a related transaction, on March 1, 2000, ZG Partnership entered into a forward sale agreement for 750,000 shares of stock.

Says the filing:

    In consideration therefore, ZG Partnership received a purchase price of $38,152,131.00. In connection with Agreement I, ZG Partnership entered into the Pledge Agreement dated March 1, 2000 among ZG Partnership, CSFB SAILS Corp.

In February and April of 2001, ZG registered with the SEC to sell 2 million shares of Digital stock for a total of $93 million.

A Digital Lightwave spokesman, Paul Harris, confirmed that ZG Partnership is connected with Dr. Zwan but said it is of no concern to the company: "I see what you see. He controls this ZG Partnership. I don't comment on Dr. Zwan's personal business."

Zwan commented through his lawyer, and information he shared was included in an update of this story.

There are no government investigations into these dealings, according to available information. The SEC already threw out a March 2000 complaint that it filed against Zwan. Light Reading is not aware of any shareholder litigation arising from Zwan's sales of Digital Lightwave stock.

Zwan puts the recent losses and reduced revenue at the company to an “unexpected sales decline” in the second quarter (see Digital Lightwave Reports Q2).

— R. Scott Raynovich, US Editor, Light Reading
http://www.lightreading.com

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