A surge in investment crime over the Internet prompts state and federal enforcement agencies to beef up activities
7/28/00 - Old fraud, new medium
Old fraud, new medium
A surge in investment crime over the Internet prompts state and federal enforcement agencies to beef up activities
By Patrick Danner
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Like the Wild West of a century and a half ago, the Internet is a place where outlaws strike quickly and fade into anonymity, often with little fear of consequences.
And as with that earlier frontier, law enforcement is coming to the Internet. In recent months, the U.S. Securities and Exchange Commission, the FBI and Florida state regulators have all announced new initiatives to crack down on online perpetrators of investment scams. The SEC created new Internet fraud units in its offices, including the office in Miami that handles the southeastern United States.
It’s clearly time. Nicholas A. Monaco, Internet branch chief in the SEC’s Miami office, says of Internet fraud: “I wouldn’t say it’s going to explode. It has exploded.”
The local efforts follow national ones, which this year have yielded some well-publicized results.
The SEC sued “Tokyo Joe,” a South Korean who regulators say was pumping up stocks in online chat rooms before he dumped his shares. The agency also went after a part-time Wall Street clerk who allegedly shared insider information in a chat room in exchange for kickbacks from trading profits, and a Georgetown University law student whom it accused of creating a stock-picking Web site where he persuaded visitors to buy stocks that he would unload once they had jumped in price.
Locally, the SEC’s Miami office last week fined Tampa’s JMAX Online Communications Inc. $20,000 for allegedly publishing an online recommendation that falsely claimed a stock had been issued by Chase Manhattan Bank.
The agency’s new Miami-based Internet unit previously halted trading in Lifekeepers International Inc., a New Jersey medical diagnostics firm, which used the Internet to distribute financial information that the SEC had doubts about. And it’s currently investigating the dissemination of 10 million e-mails containing what the agency believes is blatantly false information.
Florida state enforcement officials have been active too. The attorney general’s office claims Boca Raton’s Professional Resources System International Inc. (PRSI) ran a scheme that took $18 million from 60,000 investors. PRSI sold them into a private intranet, promoted as a family friendly alternative to the Internet because pornography and the like would be excluded. PRSI, which denies wrongdoing, allegedly wooed members via Internet postings and mass conference calls with thousands of people at one time, says Miami forensic accountant Lewis B. Freeman, who is working on the case.
Florida Attorney General Bob Butterworth said PRSI was little more than a traditional Ponzi scam, in which money from new investors is used to pay off earlier investors, thus creating the illusion of a profitable enterprise. It was, he said: “an old-fashioned pyramid scheme cloaked in modern technology.”
That notion, that securities scams are an old tune played on new instruments, is a familiar refrain in descriptions of contemporary fraud. Nowadays, says the SEC’s Monaco, “Pretty much all fraud has some Internet component.”
The reason is obvious. Share prices depend on trading activity, and trading can be triggered by most any relevant information or speculation that can be made to seem believable. Hence, stock touts and so-called pump-and-dump artists — who profit by provoking a run-up in a share price — are naturally drawn to the most efficient channels available to spread that information. Enter the Web.
Internet fraud last year was ranked at the top of the 10 most common investment ploys by the National American Securities Administrators Association (NASAA), an organization of regulators.
“A scam artist is committing malpractice if he’s not using the Internet,” says Bradley W. Skolnick, Indiana’s securities commissioner and president of the NASAA.
Perpetrators are using Web sites, message boards, chat rooms and e-mails to tout stocks, sell unregistered securities and build pyramid schemes. Little about the scams is new, apart from the way they are marketed.
“It’s the same old scams dressed up with new technologies,” says Christian R. Bartholomew, a former SEC lawyer and now a partner with Morgan Lewis & Bockius in Miami. “The new aspects are primarily media changes, not substantive changes in the kinds of frauds.
“E-mail spams [broadcast junk mail] essentially are a highly advanced cold-calling technique,” he says. “Chat rooms are no different than the guy going on the radio or television and saying, ‘This is the greatest stock since Microsoft,’ without disclosing he’s getting paid to say that.”
With more Americans than ever investing in the stock market, and record amounts of investment money wafting around, there’s greater opportunity than ever for unscrupulous financial professionals.
“I like to say the bull market on Wall Street has spawned a bull market in fraud,” the NAASA’s Skolnick says.
“Today’s atmosphere is just ripe for the easy-buck mentality,” adds Richard Sharpstein, a Miami defense lawyer. “Things like overnight billionaires, dot-com IPOs [initial public offerings] and stock-market killings have created this atmosphere where, to quote the late, great Jimmy Durante, ‘Everyone wants to get into the act.’ ”
But the Internet does make a difference. It enables scam artists to tap a wider pool of potential victims faster than ever before. And it offers scammers both a degree of anonymity and, in some cases, a veneer of credibility, making the vetting process even more difficult for investors, regulators and enforcement officials alike.
Even the SEC’s Web site, which offers investors advice on how to avoid scams, warns, “It’s nearly impossible for investors to tell the difference between fact and fiction.”
An analysis of civil suits brought by the SEC in South Florida suggests the area remains, as ever, a hotbed for Ponzi schemes, boiler rooms, micro-cap frauds and the sale of unregistered securities, many now involving the Internet.
Many more go undetected. Today’s scam artists can set up Web sites to tout certain stocks, acquire and then liquidate their holdings, and vanish before regulators even discover fraud has been committed.
“The problem is the lead time. These people are in and out,” says forensic accountant Freeman. “With the advent of electronic banking and money being moved around the world, it makes it that much more difficult to stop the financial fraud.”
That raises the question of whether sufficient resources are being committed to the fight against fraud. Regulators at all levels claim they’re rising to the challenge of the Internet.
Says Ross Gaffney, supervisory special agent in the FBI’s Miami office: “Securities fraud now is my No. 1 priority, and I think that’s significant because I also have responsibility for investigating money laundering for non-drug cases,” Gaffney says, adding securities fraud has assumed top priority only within the last 10 months.
Still, many of the people who help sift through the debris left by these scams believe regulators lack the staff and technical resources to track perpetrators before they wreak havoc.
“They’re outgunned and undermanned,” says Arthur Rice, a Miami lawyer who serves as a receiver in financial-fraud cases. “We start with the proposition that resources are finite. … Every dollar that goes to fraud prosecution is a dollar that doesn’t go to violent crime.”
Indeed, the numbers suggest that whatever new zeal officials might proclaim in fighting securities fraud, there’s little sign of it in increased enforcement. Civil actions initiated locally by the SEC haven’t changed in the last couple of years, with 36 cases for the year ended Sept. 30, 1999, and 37 cases a year earlier, figures provided by the SEC’s Southeast office. The number of actions has remained level even though officials believe Internet scams have exploded.
“It’s primarily a resource issue,” says David Nelson, deputy regional director. “We only have as many attorneys as we have. Plus, [securities-fraud] cases are complicated, and they’re very labor intensive,” with cases often taking more than a year to build.
Nelson expects the Miami office will ratchet up its enforcement efforts with the arrival of more staff. Over the past 18 months, the office has added a combined total of 10 attorneys and accountants — most of them arriving in the last couple of months, Nelson says. Eight more slots will be created in the Miami office, which now has 35 professionals.
“I think, given the amount of securities fraud in South Florida, we have lifetime job security here,” Nelson jokes. “The additional staff is a recognition of many fronts on which we have to wage the war on fraud. There will be some time delay before the benefits of an increased staff show up.”
The SEC couldn’t provide data relating to the outcomes or penalties in the cases it has filed, but Nelson says he believes the agency has raised the bar on what it deems an “acceptable level of settlement terms.”
Other regulators are rethinking their approach. The Florida Department of Banking and Finance this month launched a pilot program that will focus on education, reasoning that more education will lead to fewer victims and less need to track down perpetrators.
At the same time, authorities say they’re more eager to pursue criminal prosecutions, rather than just filing civil actions to halt the scams.
“In too many instances, when the SEC brings a case, the [scammers] look at what we do as a cost of doing business,” says Randall Fons, who was the SEC’s regional director in South Florida until taking a similar post in Denver this month. (His replacement hasn’t been named.) “A real message is sent when these people spend time in prison, because then it’s not a cost of doing business.”
Says the NASAA’s Skolnick: “Investment scams are little more than sophisticated criminal enterprises, and they need to be treated as such. Regulators have done a good job of bringing civil and administrative actions. However, white-collar criminals are seldom deterred by regulations themselves.”
Veteran securities lawyer Thomas Tew agrees: “One or two criminal indictments are worth 10 or 20 SEC injunctions.”
But if there’s a regulatory tilt toward more prosecutions, it’s not showing up in the numbers in any dramatic way. State regulators report that in the recently completed fiscal year, they conducted 117 securities-related investigations that led to 24 criminal enforcement actions, according to Don Saxon, director of the securities division of the Department of Banking and Finance. That compares with 22 criminal cases from 168 investigations the year before.
On the federal level, the SEC’s South Florida office has filed 23 civil actions so far in the fiscal year that ends Sept. 30, eight of which “have an element of criminal interest,” Nelson says. That compares with six last year and “four or five” in 1998, he says.
The U.S. attorney’s office for South Florida says it can’t give precise information on the number of securities-fraud cases it is handling, because such cases can be prosecuted under a variety of statutes, including mail fraud, wire fraud, money laundering and conspiracy. The FBI offers the same rationale in declining to give totals of securities-related actions.
Figures from Transactional Records Access Clearinghouse — a private data service in Syracuse, N.Y., that monitors federal law enforcement for news organizations and other clients — are inconclusive. For 1998, the latest year for which numbers are available, the clearinghouse found a total of 16 prosecutions for securities fraud in the Southern District of Florida, a sharp rise from five in 1997, but unimpressive when compared with the 13 in 1996.
Not everyone is convinced more aggressive prosecution is the answer. In a bull market where hundreds of stocks are vastly overvalued when measured by traditional valuation criteria, how easy is it to distinguish between aggressively promoting a promising stock and knowingly touting a dog?
“What’s happening is a blurring of the line between what’s a civil dispute and what’s getting called a criminal matter,” says Mark S. Nurik, a defense lawyer with Ruden McClosky Smith Schuster & Russell in Fort Lauderdale. “Not every loss, no matter how sizable, equates to a wrong having been committed by a broker, or a broker-dealer, or a promoter or some other related investment entity.”
Plus, criminal prosecution is tough and time-consuming. “Obviously, securities frauds are going to be substantially more complex to prove than, say, a narcotics case,” says Eric Bustillo, the assistant U.S. attorney in charge of criminal securities fraud efforts in Miami.
And, says Florida Comptroller Robert F Milligan, who oversees the state’s financial regulators, the public may be served better by moving quickly to halt the wrongdoing, rather than take the much longer route to building a criminal case.
“If it’s a choice between shutting people down and saving people money, or letting it go on and more people wind up losing more money, clearly, you want to make a choice of shutting it down,” Milligan says. “It’s not a difficult choice to make, frankly.”
In an effort to prevent fraud, the state Department of Banking and Finance this month initiated a pilot program to devote more resources toward education than on enforcement. The program, launched in the department’s 11-person Fort Myers office, intends to put 40 percent of its efforts on education, up from the division’s average of about 10 percent, says regional director Robert Pappas.
If the program is successful, Milligan envisions rolling it out elsewhere in the state. The objective is to help people resist the blandishments of scam artists and give them the information to scrutinize outlandish claims.
SEC deputy director Nelson agrees on the need for better education. “There’s a tendency for people to get dazzled by new technologies and that makes them less circumspect than they ought to be,” he says.
Says Miami attorney Rice: “I don’t think things are any more dangerous today than they were 10 years ago, or 50 years ago when they were selling swampland in Florida, or almost 200 years ago when they were touting the West, or 500 years ago when they were peddling horses that were deaf, dumb and lame. There have been dishonest people since time immemorial.”
Former Southeastern SEC head Fons says investors can protect themselves by doing just a little homework.
“If investors did a certain amount of due diligence, they would not be too willing to take the word of people selling these things,” he says. “If investors looked behind the materials that happened to be sent to them, make a few calls, to the Better Business Bureau, the NASD [the National Association of Securities Dealers] and the SEC, I think that would go a long way to making these scams less profitable.”
Web Published Friday, July 28, 2000
Published in Daily Business Review on: Friday, January 28, 2000
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