SEC HIGHLIGHTS INTERNET FRAUD Can Agency Stop Scams Without Stifling
Trades?
Date: 7/8/99
Author: Joseph Guinto
Janice Shell has a deal for you.
Her company, Webnode.com Inc., is offering a piece of the Internet's future. For just
$100 you can own one of a few thousand nodes to the Internet, each
''representing a possible route for data to travel along the information superhighway,''
according to the company.
The offering is all there in full-color at www.webnode.com - details about the company,
its management and its $4 billion contract with the Department of Energy to
be the exclusive provider of the nodes that will open access to the next-generation
Internet.
''Consider it the 'real estate' of the Internet,'' the site said.
Ready to invest? If so, Shell might also want to sell you stakes in a certain bridge that
connects Manhattan to the place the Dodgers used to play.
That's because there is no Webnode Inc., no $4 billion government contract and no
such thing as a node to the Internet. There's just a Web site representing an April
Fool's joke that Shell and her colleagues played this year.
As ludicrous as it was - Webnode's parent company was said to be, among other
things, an arms trader - the prank lured 2,000 people to inquire about buying their
own nodes. The hoax was a deliberate showcase for how the Web is being used more
and more to sucker investors.
''A lot of people believe anything they see,'' said Shell, an art historian who started
battling against online investment fraud from her home in Milan, Italy, in 1996
when she fell victim to an Internet scam.
''We had serious techies from major companies desperate to get in on this,'' she said.
''People think it has to be a real company because it has a Web site.''
The Securities and Exchange Commission, the stock market's head cop, sees Internet
fraud as a big problem. Seasoned and novice investors alike are being fooled
by the slick Web scams that look expensive and legit but are in fact just cheaper
versions of the same old frauds that have been around for decades.
Instead of staffing ''boiler rooms'' with salespeople to cold-call investors, scam artists
can now just log on to thousands of investor chat groups and push their
offerings. And for a fraction of the old cost, Net hustlers can inflate the price of
legitimate securities or sell fictional ones.
No one, the SEC included, knows how much this is costing investors. ''The problem is,
you can't quantify how much fraud is going on,'' SEC spokesman Duncan
King said.
Still, SEC officials insist they've been effective in targeting Net-related scams. Maybe
so. But the agency is still vastly ill-equipped to patrol the Web's 40 million sites
and the Internet's endless array of chat rooms.
Of the SEC's 850 enforcers, just eight work full-time on Internet fraud in the agency's
year-old Office of Online Enforcement. Some lawmakers and investor
watchdogs are pushing to bolster the SEC's online financial resources and expand the
agency's regulatory powers to help it better keep pace with fast-moving
Internet scams.
Whether even those measures will make a dent in frauds conducted over the Internet is
unclear.
Still, some Web watchers and online trading companies worry that the SEC's focus on
Net-based fraud could hamper legitimate investing on the Web. They cite the
1985 case of Lowe vs. SEC, where the Supreme Court unanimously stopped the
agency from banning an investment newsletter because its publisher had been
convicted of fraud.
In a concurring opinion, Justices Byron White and William Rehnquist said general
investment advice that's not given from a professional to a client is protected by the
First Amendment and can't be regulated by the government. Similar restrictions on
online investment sites might not pass muster in court.
In one of the most far-reaching cases to date, this year the SEC charged Comparator
Systems Corp. with spreading misleading information on its financial status as
well as its core product, a fingerprint identification device.
The company claimed its product was proprietary and exclusive, but it had actually lifted
the technology from another firm, the SEC says.
Still, by posting thousands of misleading messages on investor chat groups, the company
generated interest in itself, the SEC says. So much so that 123 million
Comparator shares changed hands in a single day, breaking the Nasdaq's one-day
volume record.
The trading inflated Comparator's market capitalization to more than $1 billion. The
SEC has since obtained a trading suspension against Comparator, and it's taking
further actions against the firm's principals.
The Comparator case is one of 66 Net-related cases the SEC has brought since 1995.
The agency brought 23 of those cases simultaneously last year in part to
generate publicity for its online enforcement.
But those efforts are more a deterrent than a comprehensive crackdown.
''The SEC probably does not prosecute more than 5% of the fraud taking place online,''
said Kevin Lichtman, founder and president of FinancialWeb.com Inc.,
which publishes Stock Detective, an online service that highlights investment fraud.
Indeed, the SEC receives 200 to 300 complaints daily about potential online securities
fraud. It says half relate to cases the SEC is already aware of. That means
that as many as 150 reports a day are news to the agency.
Checking out those claims and finding new cases of fraud falls in part on the SEC's
mostly volunteer ''Cyberforce.'' The group consists of 200 agency attorneys,
analysts and accountants who sweep the Net for scams a few times a month.
Some say even that's not enough. Shell, who patrols the Internet for hours each day,
monitoring chat room conversations and Web sites with her ''museum piece'' of
a computer and 14.4-kbps modem, said it can take weeks to check out a single
company.
''These kinds of investigations take months and man-hours, and the SEC doesn't have
enough people to put on this,'' Shell said.
That may soon change. Last month the Senate Appropriations Committee approved a
9% increase in the SEC's budget, to $370.8 million.
Included in that was a $10 million increase for fighting Internet-related investment fraud.
Staffers say the budget boost may pass both houses of Congress. If so, it
would mark the first significant increase in SEC funding in nearly a decade.
SEC officials say the funding would help them to bring the Office of Internet
Enforcement's full-time staff to 10, boost its Cyberforce to 240 and buy more advanced
computers and Internet searching software.
There's another catch, of course. Even if more funding comes through and the SEC
uncovers more online fraud, stopping it may remain a problem.
Stock Detective's Lichtman says the SEC's old codes of conduct don't apply to the
fast-moving online world. ''If you use the same due process with the Internet, it'll
be too late by the time you stop something,'' Lichtman said.
Among Lichtman's suggestions:
Develop a mandatory online warning system that would alert online investors to the risks
of securities trading. SEC Chairman Arthur Levitt has recently hinted the
agency may suggest that online brokerages adopt such a system.
Expand the use of temporary trading halts so the SEC can immediately cease unusual
trading volumes prompted by potentially bogus online claims.
Adopt stricter guidelines for what company officials can say about their firms in online
forums and releases. Several companies rely on business news wires to spread
misleading information in what appear to be credible news reports.
Lawmakers are also mulling moves to give the SEC more power against securities
hucksters.
A bill sponsored by Sens. Susan Collins, R-Maine, and Max Cleland, D-Ga., would
bar individuals connected with fraudulent activities in other industries from
participating in the brokerage industry. Current law only bars brokers with violations
from continuing to represent securities dealings.
The bill has already gained the approval of the Senate's Permanent Subcommittee on
Investigations, which Collins chairs.
Committee officials note that the bill should help the SEC fight online scams. Still, it is
meant to protect the entire investment community and not to create
Internet-specific regulation.
''We want to fight the perpetrator rather than the medium,'' said Lee Blalack, the
committee's chief counsel.
The law could also run afoul of the Supreme Court's Lowe decision.
The SEC has hinted it wants other enforcement powers. For one, its agents cannot go
undercover on chat forums. State securities regulators can.
Ultimately, though, more money and new rules could still leave the SEC short of
conquering Net fraud. The caution, then, is no different for online investors and
those who gather investment information from the Internet than it is for traditional
investors: Investor, protect thyself.
''Making a phone call to the company is not doing due diligence,'' Shell said. ''Someone
can be just as misleading on the phone as they can be online. You've got to
take these investments seriously.''
So be careful. That great deal you come across next year may just be Janice Shell's next
April Fool's joke.
investors.com
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