SEC May Lack Basis to Bar Stock Touting
Some view Web chat boost of share prices as naughty but legal
The National Law Journal
March 14, 2000
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Early in the Securities and Exchange Commission's Internet enforcement efforts, agency staffers came across a problematic Web site. Eager to shut it down without "making a federal case of it," John Reed Stark, the chief of Internet enforcement at the SEC, called the site's designer and launched into a reading of his rights. The alleged offender interrupted, "Wait a minute -- I'm only 13." Stark and the others on the call were shocked, but figured out how to sanction the boy: "We told his mother," Stark said.
And as is now well-known, Georgetown University law student Douglas Colt also opted to tell his mother about his site -- not to confess, but allegedly to include her in his scheme to inflate stock prices through "Fast-Trades.com." But now that the dust has settled, some lawyers are questioning the strength of the legal basis of the case.
Some say privately that the SEC is stretching the law to fit what is the alleged bad behavior: launching a Web site to tout a few thinly traded stocks that Colt and the other defendant had purchased -- and for which they had executed sell orders before making the recommendations. One lawyer posited that such conduct can be enjoined only when the person making the recommendation is an investment adviser who owes a fiduciary duty to his clients. But without that duty, the conduct cannot be considered illegal "front-running."
The SEC, however, sought prosecution under a straight market-manipulation theory, under which proof of a fiduciary duty is unnecessary, said Paul Berger, an assistant director of enforcement at the agency who worked on the case.
MESSAGE-BOARD CONNECTION Still, the agency must show a material misrepresentation made "in connection with" the sale or purchase of stock. But the agency is not alleging any misstatements regarding the stock itself; rather, the SEC contends, the misrepresentations arose from Internet message board statements praising Fast-Trade's track record that induced readers to log onto the Web site and, ultimately, to purchase the recommended stock. But can a case stand under õ10(b) of the Securities Exchange Act of 1934 when the allegedly fraudulent statements are one step removed from the stock traded?
Several experts see no problem with that theory. Howard Friedman, a professor at the University of Toledo College of Law who has written a book on securities issues in cyberspace, calls the matter an actionable "pump and dump" case. Columbia University School of Law professor John Coffee also thought the case was strong, but he questioned its appearance, as the agency settled without collecting any money, despite the $345,000 in profits. "The facts justify the fraud prosecution, but the settlement is so weak [that it appears to express] the SEC's own doubts of the merits," Coffee said, adding that "it's rare to quantify ill-gotten gains with no attempt to get restitution."
Berger said that while the settlement order included disgorgement, payment was waived because after reviewing the financial statements, the SEC determined that the defendants couldn't pay. John Hewitt, a securities lawyer in the New York office of Chicago's Mayer, Brown&Platt who specializes in securities law, said the waiver was not atypical.
Some press accounts attributed the inability to pay to legal fees, but at least two of the firms representing Colt's roommates -- O'Melveny&Myers L.L.P. and Kirkpatrick&Lockhart L.L.P. -- are said to have taken the cases pro bono; lawyers there would not comment on the fee arrangement. And neither Harry Weiss nor William McLucas, the partners at Washington, D.C.'s Wilmer, Cutler&Pickering who are representing the Colts, would speak about their fees. The SEC has employed many Georgetown grads and some of its lawyers teach there on an adjunct basis. Stark himself teaches there and, as a result, recused himself from the case. But, he said, he was relieved to learn that "these students were not in my class."
Copyright ¸ 1999 ALM IP, LLC -- American Lawyer Media. All rights reserved.
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