Securities Fraud Securities Fraud & the Internet
By Jay Perlman (TMF Jay)
February 23, 2000
"The pernicious art of Stock-jobbing hath, of late, so wholly perverted the End and Design of Companies and Corporations, erected for the introducing, or carrying on, of Manufacturers, to the private Profit of the first Projectors, that the Privileges granted to them have, commonly, been made no other Use of, by the First Procurers and subscribers, but to sell again, with Advantage, to ignorant Men, drawn in by the Reputation, falsely raised, and artfully spread concerning the thriving State of their Stock."
Huh? The above is from a 1697 report by the British Parliament that was the basis of a law enacted to combat stock manipulation. Four hundred years earlier, in 1285, London passed an ordinance requiring that stockbrokers be licensed. Between 1834 and 1836, two French bankers bribed optical telegraph operators (the optical telegraph was the predecessor to the modern telegraph machine) to transmit false information about stocks, allowing them to profit at the expense of unwitting investors. Securities fraud in the United States had its real coming out party in 1869 when Jay Gould, James Fiske, and Daniel Drew attempted to corner the gold market, causing a sudden drop in gold prices and triggering "Black Friday," one of the biggest financial panics in American history.
The 19th and 20th centuries have seen people victimized by railroad scams, ponzi schemes, oil and gas limited partnership scams, penny stock fraud, and insider trading, just to name a few. As the scams changed over the years, the one constant has been the ability of fraudsters to effectively use existing technology to defraud investors.
In the late 19th and early 20th centuries, telegraph machines, which were previously used as a medium to transmit stock market information, began to be used to send buy and sell orders from cruise ships crossing the Atlantic. When radio's popularity took off in the 1920s, it allowed investors and speculators access to information about stocks quicker than ever before. As the telephone gained popularity, brokers used it to hawk investment opportunities.
These technologies greatly increased access to the market, not only for investors but also those who sought to prey upon them quickly and efficiently (and annoyingly -- mostly during dinner hours). As investors received more information, rampant speculation became the norm. The Crash of 1929 is attributable, in part, to this increased speculation that was fueled by the effective use of technology.
As we move into the 21st century, the story is no different. The Internet has no doubt had a huge impact. There are now approximately 200 million Internet users, 90 million of whom logged on between 1995 and 1998. Putting the Internet's growth in perspective with other technological innovations, consider that to reach 60 million users, it took radio 30 years and television 15 years.
Let's look at how the Internet, with its incredible growth, has affected the financial world. In 1997 there were 17 firms that offered online trading; now there are more than 100. By 2002, it is predicted that there will be approximately 14.4 million online accounts, containing approximately $688 billion in assets -- up from 3 million accounts and $120 billion in assets in 1998. Commissions for online trades have decreased from an average of $52.89 in 1997 to about $14.00, with many brokers offering single-digit commission rates. As a result, about 37% of all retail trades are currently done online, and it is predicted that more than half of all trades will be done online by 2002.
Every day, the Internet becomes better organized and easier to navigate, making it as easy to use as the local library. Market information such as earnings announcements, press releases, and other relevant financial information is available to anyone with a computer and a modem. While individuals can now access all types of market information, they also have access to each other. Never before has the average investor been able to communicate directly with analysts, short sellers, other investors, and companies themselves so easily. More important than the ability to access this information is that the information is available 24 hours a day, 7 days a week, 365 days a year. (Can't sleep? Log on and chat about your portfolio.) The ability to constantly access market information and market participants is one of the biggest benefits that the Internet has brought to the financial world.
However, as with every technological innovation, the Internet does have a dark side: People use it to victimize others. What's interesting is that the scams on the Internet are almost identical to the scams that have been around since the 13th century. The Internet is merely a new means, although an extremely effective one, to commit the same old con jobs.
Why has the Internet become such an effective means of committing securities fraud? First, it's cheap. The average cost of a personal computer is around $800, and unlimited Internet access is around $15 per month. These two items, plus an idea, is all a fraudster needs to get started. Second, it's efficient. Mining and extractor programs (which are automated data-gathering mechanisms) allow a fraudster to target investors with specific investing objectives with seemingly personalized pitches. This approach works a lot better than a cold caller sifting through the white pages of a telephone book. Finally, using the Internet's easy. With little or no overhead, a little imagination, and a few mouse clicks, a fraudster can run a scam from the comfort of his own home.
Let's face another fact: Everyone's aware that we are in the longest bull market in American history. Everyone hears the stories about people who got in early on Yahoo!, eBay, or America Online and now can retire because of their investing prowess. Realizing there are a finite number of these types of investments, one's ability to think clearly and thoroughly analyze an investment is compromised by a desire to get rich quick. Put this with the fact that for some reason people tend to lend an air of credibility to what they see on the Internet, and you have the makings of an easy mark.
Additionally, compare Internet solicitations and opportunities to those in the offline world. If you get a cold call during dinner from some broker pushing the next dotcom megastar, you're more than likely to hang up. Why? Because this broker had the nerve to interrupt your dinner. Yet consider the situation where you finish your dinner and sit down at your computer to start perusing the Internet for the next dotcom megastar. Nobody has interrupted your life. You've made the affirmative decision to start looking for the investment that will allow you to retire early and travel the world in your private jet. Because you've made the decision to log on, you may tend to let your guard down a bit. Once you let your guard down, you may be less apt to do the necessary research, and as a result, you may be more likely to get sucked in to a scam. |
