Re: 8/7/00 - SEC Acts at Cyberspeed To Halt Suspect Trades
August 7, 2000
SEC Acts at Cyberspeed
To Halt Suspect Trades
By MICHAEL SCHROEDER and JOHN R. EMSHWILLER
Staff Reporters of THE WALL STREET JOURNAL
On March 9, the Securities and Exchange Commission's Los Angeles office received a telephone tip that the skyrocketing stock price of a little Internet company called eConnect Inc. was being fueled by false press releases.
The Internet company's shares had rocketed to $16.50 a share the day before from under $1.50 on Feb. 28, giving eConnect -- which had a loss of $23.3 million in 1999 on revenue of just $40,000 -- a market value of more than $2 billion.
Under the standard procedure followed for most of its seven decades, the SEC would have assigned the case to a lawyer, who would have investigated ... and investigated, often for years. But that was then; this is cyber-now, and the SEC is scrambling to get on Internet time.
Within hours of the tip, three SEC attorneys were working on the case. They quickly decided that two of eConnect's press releases were inaccurate, and began preparing what became a 17-page memo for the agency's Washington office, which they e-mailed late that evening. By the next afternoon they had gotten approval to halt trading in the stock the following week.
The rapid attack on eConnect, which says it provides technology for financial transactions over the Internet, shows a push by the SEC to move against at least some suspected violators -- mostly involving small companies -- before their alleged wrongdoings have been long forgotten. This new urgency was prompted by the Internet, whose enormous impact on stock trading caught the SEC, like much of Wall Street, off guard.
In 1998, Chairman Arthur Levitt called for an overhaul of the enforcement division, in part to respond to the burgeoning fraud involving the Internet. At the time, the SEC's Internet-fraud unit only had two full-time staffers and most of the agency's enforcement staff didn't have Internet access at their desks.
With new funding, the SEC's Office of Internet Enforcement now has a staff of 15 and has opened small branches within the agency's regional offices. Another 240 staff attorneys have been trained in fighting online fraud. Since early last year, more than three dozen fraud cases, mostly Internet related, have been filed within a week to eight months -- sprint-like times compared with past standards.
The SEC also has found new ways to combat burgeoning Internet stock fraud. The past year, rather than open time-consuming investigations, the SEC sent warning letters to 95 Web site operators who appeared to be illegally selling stock. Of those, 65% withdrew the offerings or closed their Web sites. Most of the others are talking with the SEC. Three are under investigation.
SEC officials acknowledge there may be many more opportunities for fraud than the agency can handle. "We can't be everywhere," says Richard Walker, a 49-year-old former Wall Street lawyer who became the SEC's enforcement chief 28 months ago. "Speed helps reinforce a strong deterrent message," he says
However, defense lawyers argue that the SEC is sometimes spinning the wheels of justice too fast to get the necessary facts. In the eConnect case, the agency "reacted too quickly" and "the wrong people got sued," says Irving Einhorn, a lawyer for the company and a former head of the SEC's Los Angeles office.
EConnect had already had one run-in with the SEC. The agency had filed a complaint against the company in March 1999, when it was operating under a different name, for failing to file certain required financial statements, but eConnect had acknowledged its failure and promised to do better.
Then earlier this year, the stock of eConnect caught on fire. On Feb. 28, the company announced a "strategic alliance" with a Florida brokerage firm, Empire Financial Group Inc. The next day, a group called Independent Financial Reports distributed the first of four "buy" recommendations for eConnect, saying the stock could easily reach $12 to $25 a share. By the end of that day, the stock price had nearly doubled, to $2.50 a share.
On March 1, IFR put out a second release on eConnect, noting its "explosive" market performance. Two days later, eConnect issued a press release about a "unique" licensing arrangement involving the Palm Pilot handheld computer. And the same day, a third IFR press release extolled the Palm Pilot deal and eConnect's "universally in-demand technology."
On March 8, IFR issued its fourth press release on eConnect, predicting that this "new powerhouse in the emerging technology sector" could "easily" hit $100 to $135 a share within the next year. The stock climbed as high as $20 a share during the day before retreating to $16.50. The next day, a short seller -- who makes money when a stock's price falls -- called the SEC to complain about the company's press releases.
Lisa Gok, head of Internet enforcement in the Los Angeles office and a 10-year SEC veteran, noted eConnect's huge jumps in price and trading volume via Yahoo! She also saw the bullish press releases, some of which had been posted on Raging Bull, a popular Internet stock-discussion site. Then she told three more lawyers in the office's new seven-person Internet branch to drop what they were doing and start checking the accuracy of eConnect's public statements. By the end of the day, SEC officials said, they had gotten information from an official at Palm Inc. that the licensing deal praised in one of the releases didn't exist. Likewise, Empire, the Florida brokerage firm, said the announcement of its "strategic alliance" with eConnect overstated the relationship.
Ms. Gok and her colleagues decided to move to halt in the trading of eConnect stock. The SEC has authority to suspend a stock's trading for up to 10 business days. Last year, the regulator halted trading in 20 stocks, mostly Bulletin Board issues, up from one in 1994. With barely a minute to spare before the Los Angeles office's computer system automatically shut down for the night at 11 p.m., the lawyers sent their trading-halt recommendation by e-mail to Washington headquarters.
On March 23, two weeks after receiving the tip and shortly before trading was set to resume, the SEC filed suit in Los Angeles federal court accusing the company, and Thomas Hughes, its president, of issuing false press releases. Mr. Hughes and eConnect quickly settled, agreeing to an injunction against future wrongdoing without admitting or denying the allegations. Mr. Hughes says he settled with the SEC to avoid the cost of litigation. He and other eConnect representatives insist that the documents were essentially accurate and that the SEC never gave the company a chance to tell their story. "I would have liked to have had the SEC take the time to call," says Mr. Hughes. SEC officials say they didn't feel that talking to the company was necessary. "We were moving on an emergency basis," says Valerie Caproni, chief of the SEC Los Angeles office.
EConnect's stock, which trades on the over-the-counter Bulletin Board with other issues too small for a Nasdaq Stock Market listing, plunged after the trading halt was lifted and is currently about 55 cents a share. Meanwhile, more than 20 shareholder lawsuits have been filed against the company. An eConnect spokesman denies the company engaged in any wrongdoing and Mr. Hughes says that no eConnect officials sold any shares in the company during the stock's runup.
But the case had another twist. After the SEC announced the trading halt, it got a call from Stephen Sayre, the sole officer of Independent Financial Reports, the stock-research firm that had heavily recommended eConnect's shares. He offered the SEC his help and officials invited him to come by for a talk -- under oath.
On March 31, Mr. Sayre arrived alone, dressed in breakaway warm-up pants and a tight-fitting T-shirt. The 44-year-old Mr. Sayre said he had a correspondence-school degree in psychology and that he had spent time doing top-secret work for the U.S. military, according to a transcript of his SEC deposition. He said he was a would-be film producer but made his living operating a Los Angeles area tree-trimming business.
With IFR, he hoped to build a career as an independent stock picker. Mr. Sayre swore that he hadn't ever traded eConnect stock or been paid by the company -- although he had talked to Mr. Hughes while researching the company. (Mr. Hughes acknowledges talking with Mr. Sayre, but says that was the extent of their relationship.)
The SEC found that Mr. Sayre had also incorporated an entity called Silver Screen Industries. Agency investigators say they found that he had opened two brokerage accounts in Silver Screen's name that were used to buy and sell more than 177,000 eConnect shares, for a profit the SEC calculates at $1.4 million. In early April the SEC filed a civil fraud suit in Los Angeles federal court against Mr. Sayre and federal prosecutors filed criminal charges soon afterward. When the SEC attorneys subpoenaed Mr. Sayre's U.S. bank records, they found that funds had been transferred beginning in mid-March -- just after the eConnect trading halt started -- to a Canadian bank account. With the aid of Canadian authorities, the account was found to contain more than $19 million. SEC officials decline to speculate where all that money might have come from. Mr. Sayre's criminal attorney, Thomas Fehn, says his client is out of the country and he negotiating with authorities regarding Mr. Sayre's return. He said his client denies all the charges against him.
Write to Michael Schroeder at mike.schroeder@wsj.com and John R. Emshwiller at john.emshwiller@wsj.com
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