SEC's 'Cyberforce' Scours Net
To Combat Investment Scams
By NANCY BOYD KENNEDY
Special to THE WALL STREET JOURNAL INTERACTIVE EDITION
Back in the days of Netscape 1.0, when the nascent Internet community
had barely formed, a fellow named Daniel Odulo solicited subscribers
to several investing newsgroups offering bonds for sale to raise money
for his company, Golden Waters.
At the time, he promised 20%
returns -- far more than bonds
generally return -- and
insurance against losses. But
according to the Securities and
Exchange Commission, Mr.
Odulo's sweetheart deal turned
out to be a heartbreaker.
The SEC filed a complaint against Mr. Odulo in August 1995 for failing
to mention what his company intended to do with the money, which
was to buy and raise eels, an enterprise in which Mr. Odulo had no
experience. Additionally, the SEC claimed, investment advisers who
vouched for the bonds were fabricated, as were the glowing
endorsements Mr. Odulo put in his solicitations.
Faced with a court order, Mr. Odulo immediately agreed to stop.
But putting a stop to this kind of a
on-line investment fraud is no
longer so simple. The SEC today
has far more scams and schemes to
contend with: maverick brokers
soliciting illegal business in stock
chat rooms, small-stock
manipulation on investment bulletin
boards, plausible sounding
securities that don't exist, shady
offshore investments and
get-rich-quick, money-making
cons.
With so many on-line financial
scams cropping up in every
conceivable corner of the Web, the
SEC has decided to fight back with
its own "cyberforce" -- a team of
agents on a mission to track down,
and shut down, on-line investment
fraud.
Two years ago, John Reed Stark,
special counsel for Internet Projects
for the SEC's Division of
Enforcement, began to notice an
increase in questionable Internet activity. As senior counsel for the
SEC's Division of Enforcement at the time, Mr. Stark got fired up
about combating the rising tide of on-line investment fraud after he
completed a six-month detail with the U.S. Attorney General's office
battling street crime in the District of Columbia.
"I was put on a succession of jury trials involving guns, drugs and
domestic violence," Mr. Stark recalls. "Something about that experience
motivated me and I came back really wired. I saw the Internet as
somewhat akin to the Wild West, clearly the next frontier for us."
Upon his return to the SEC, Mr. Stark composed a memo to his boss
about Internet fraud that he says turned into a 100-page proposal for an
Internet "cyberforce." Mr. Stark's proposal was accepted and he was
appointed to oversee the SEC's antifraud efforts.
Rather than a single Internet-focused department, Mr. Stark oversees a
program that encompasses SEC attorneys, accountants and analysts
from the SEC's regional offices around the country. It's Mr. Stark's
mission to educate the entire SEC work force about how to track down
and stop Internet scammers.
"In the early days, we tended to classify cases as to whether they were
Internet-related or not," Mr. Stark says. "Now, I think the distinction is
becoming blurred, because most investments touch on the Internet in
some way. That's why our entire staff is being educated about the
dynamics of the Internet."
As part of the educational process, Mr. Stark has spent the last year
traveling to each of the SEC's 11 regional offices to run workshops on
finding and prosecuting suspected cases of Internet fraud.
Mr. Stark and others at the SEC are convinced that they have the
regulatory tools they need to make their mission effective. "At this
point, we believe the legislation we have is sufficient, even though my
sense is that we'll see an increasing number of Internet cases," says
Joseph Cella, chief of the Office of Market Surveillance in the SEC's
Division of Enforcement.
The SEC to date has pursued about a dozen Internet cases, and while
that number may not appear impressive Mr. Stark believes it's enough
to "send a message." Two of the cases he pegs as the most important
involve on-line manipulation of stock prices.
The most notorious case tried yet involved Charles Huttoe, chairman
and chief executive officer of Systems of Excellence, a Virginia
manufacturer and distributor of video teleconferencing equipment. In
November 1996, the SEC brought action against Mr. Huttoe for
manipulating the company's stock, which traded under the alluring
symbol SEXI.
The SEC alleged that Mr. Huttoe issued false information about
Systems of Excellence and its business, then sold his shares into a
market inflated by the fraudulent information. As part of the scheme,
Mr. Huttoe distributed millions of unregistered shares to friends and
family members, as well as 250,000 free shares to Theodore Melcher,
publisher of SGA Goldstar Research, a Memphis, Tenn.-based on-line
investment newsletter, to recommend the stock to his subscribers.
In January, Mr. Huttoe was sentenced to a 46-month federal prison
term, two years' supervised release and a $10,000 fine. Just a few
weeks ago, SGA Goldstar's Mr. Melcher was sentenced to a prison
term of 12 months, followed by two years' supervised release, and a
$20,000 fine.
Mr. Stark believes the SEXI suit seems to have hit home with on-line
investors.
"I see people asking, 'Is this the next Systems of Excellence?' in the
same way investors talk about hitting on the next Microsoft, and that
pleases me," Mr. Stark says. "A lot of investment-newsletter operators
have contacted us as well, wanting to know how they can comply with
securities law."
It's hard to say, however, whether the SEC's Internet watchdog
program is deterring any would-be scammers. But some Internet
publishers are beginning to feel the effects of the SEC's enforcement
actions.
"Our users are becoming increasingly more reluctant to post," says Jill
McKinney, one of the three people who operate Silicon Investor, a
popular on-line small stock newsletter and discussion forum. "We are
starting to get requests from people who want to post anonymously so
as not to invite scrutiny."
A central focus of the SEC's efforts has been to involve the on-line
community in its surveillance efforts, a group that Mr. Stark says
traditionally has engaged in self-policing. The SEC maintains a busy
fraud hotline and on-line complaint center.
"We're getting 75 to 100 e-mails a day -- 440 this past weekend alone,"
Mr. Stark says. Recently, the SEC for the first time took the direct route
of posting trading suspension notices for two stocks -- Green Oasis
Environmental and Genesis International Financial Services -- on
bulletin boards run by America Online and Silicon Investor.
Mr. Stark's role as an adjunct professor of law at Georgetown
University Law Center also has added to the Internet program's
success. Over the summer, he taught a course on securities law and the
Internet -- a class he has been asked to teach again this year. As
classwork, students found and tracked suspected cases of fraud,
providing valuable information for the SEC. "Although I can't talk
about specifics, I can say that I learned quite a lot from the class," Mr.
Stark says.
The SEC is using what it's learning to help other regulators, particularly
those in other countries, to run their own Internet programs. In May,
the SEC joined forces with the Commodity Futures Trading
Commission to run a workshop for foreign regulators at the CFTC's
offices in Washington.
"We hosted regulators from about 16 jurisdictions at the workshop,
including Australia, the U.K., France, Italy, Canada and Taiwan," says
Phyllis Cela, chief counsel for the CFTC's Division of Enforcement.
"We heard afterward that as a result of the workshop Brazil is starting
up a program of its own."
Mr. Stark, Ms. Cela and colleagues from the two agencies briefed the
regulators on everything from setting up a Web page to identifying
problematic sites, using search engines, chat rooms, bulletin boards and
newsgroups, tracing information to its original sender and prosecuting
cases of suspected fraud.
International co-operation is becoming more important, Mr. Stark says,
as Internet fraud increasingly involves shady overseas products and
securities, or foreign entities offering legitimate services without the
authority to offer them to U.S. citizens. The SEC's Office of
International Affairs is playing an increasing role in brokering these
cases.
"We have a highly effective program for gathering information," says
Paul Leder, deputy director of that office. "We take a long-term view of
every case, including Internet-related ones. We'll pursue them as long
and as far as need be."
Mr. Leder's office has in place memorandums of understanding with 20
other countries under which they can go directly to their foreign
counterparts for assistance. In other countries, they ask for assistance
on a case by case basis. "Our network of contacts is continually
expanding," Mr. Leder says.
For evidence that the SEC's reach as a whole is broadening out to
encompass the wider Internet community, Mr. Stark points to the
numerous bulletin-board postings that are beginning to crop up about
him.
"I get postings from both sides." he says, "those that say 'You just
saved me millions of dollars and you're the greatest agency on the face
of the earth,' and others that say 'I'll meet you anytime, anywhere Mr.
Stark, you just lost me my life savings.'
"We don't have a big press office and most of what we do is
confidential, but we're bringing cases and we're doing our jobs. My
aim is to demonstrate that we are not wandering aimlessly -- we know
what we're doing." |
