Internet Fraud:
How to Avoid Internet Investment Scams
October 1998
The Internet serves as an excellent tool for investors, allowing them to easily and
inexpensively research investment opportunities. But the Internet is also an excellent
tool for fraudsters. That's why you should always think twice before you invest
your money in any opportunity you learn about through the Internet.
On October 28, 1998, the SEC announced charges against 44 stock promoters
caught in a nationwide enforcement sweep to combat Internet fraud. These
promoters failed to tell investors that more than 235 companies paid them millions
of dollars in cash and shares in exchange for touting their stock on the Internet.
"Not only did they lie about their own independence, some of them lied about the
companies they featured, then took advantage of any quick spike in price to sell
their shares for a fast and easy profit," said SEC Director of Enforcement Richard
H. Walker.
This alert tells you how to spot different types of Internet fraud, what the SEC is
doing to fight Internet investment scams, and how to use the Internet to invest
wisely.
Navigating the Frontier: Where the Frauds Are
The Internet allows individuals or companies to communicate with a large audience
without spending a lot of time, effort, or money. Anyone can reach tens of
thousands of people by building an Internet web site, posting a message on an
online bulletin board, entering a discussion in a live "chat" room, or sending mass
e-mails. It's easy for fraudsters to make their messages look real and credible. But
it's nearly impossible for investors to tell the difference between fact and fiction.
Online Investment Newsletters
Hundreds of online investment newsletters have appeared on the Internet in recent
years. Many offer investors seemingly unbiased information free of charge about
featured companies or recommending "stock picks of the month." While legitimate
online newsletters can help investors gather valuable information, some online
newsletters are tools for fraud.
Some companies pay the people who write online newsletters cash or securities to
"tout" or recommend their stocks. While this isn't illegal, the federal securities laws
require the newsletters to disclose who paid them, the amount, and the type of
payment. But many fraudsters fail to do so. Instead, they'll lie about the payments
they received, their independence, their so-called research, and their track records.
Their newsletters masquerade as sources of unbiased information, when in fact they
stand to profit handsomely if they convince investors to buy or sell particular
stocks.
Some online newsletters falsely claim to independently research the stocks they
profile. Others spread false information or promote worthless stocks. The most
notorious sometimes "scalp" the stocks they hype, driving up the price of the stock
with their baseless recommendations and then selling their own holdings at high
prices and high profits. To learn how to separate the good from the bad, read our
tips for checking out newsletters.
Bulletin Boards
Online bulletin boards – whether newsgroups, usenet, or web-based bulletin
boards – have become an increasingly popular forum for investors to share
information. Bulletin boards typically feature "threads" made up of numerous
messages on various investment opportunities.
While some messages may be true, many turn out to be bogus – or even scams.
Fraudsters often pump up a company or pretend to reveal "inside" information
about upcoming announcements, new products, or lucrative contracts.
Also, you never know for certain who you're dealing with – or whether they're
credible – because many bulletin boards allow users to hide their identity behind
multiple aliases. People claiming to be unbiased observers who've carefully
researched the company may actually be company insiders, large shareholders, or
paid promoters. A single person can easily create the illusion of widespread interest
in a small, thinly-traded stock by posting a series of messages under various aliases.
E-mail Spams
Because "spam" – junk e-mail – is so cheap and easy to create, fraudsters
increasingly use it to find investors for bogus investment schemes or to spread false
information about a company. Spam allows the unscrupulous to target many more
potential investors than cold calling or mass mailing. Using a bulk e-mail program,
spammers can send personalized messages to thousands and even millions of
Internet users at a time.
How to Use the Internet to Invest Wisely
If you want to invest wisely and steer clear of frauds, you must get the facts. Never,
ever, make an investment based solely on what you read in an online newsletter or
bulletin board posting, especially if the investment involves a small, thinly-traded
company that isn't well known. And don't even think about investing on your own
in small companies that don't file regular reports with the SEC, unless you are
willing to investigate each company thoroughly and to check the truth of every
statement about the company. For instance, you'll need to:
get financial statements from the company and be able to analyze them;
verify the claims about new product developments or lucrative contracts;
call every supplier or customer of the company and ask if they really do
business with the company; and
check out the people running the company and find out if they've ever made
money for investors before.
And it doesn't stop there. For a more detailed list of questions you'll need to ask –
and have answered – read Ask Questions. And always watch out for tell-tale signs
of fraud.
Here's how you can use the internet to help you invest wisely:
Start With the SEC's EDGAR Database
The federal securities laws require many public companies to register with the SEC
and file annual reports containing audited financial statements. For example, the
following companies must file reports with the SEC:
All U.S. companies with more than 500 investors and $10 million in net
assets; and
All companies that list their securities on The Nasdaq Stock Market or a
major national stock exchange such as the New York Stock Exchange.
Anyone can access and download these reports from the SEC's EDGAR database
for free. Before you invest in a company, check to see whether it's registered with
the SEC and read its reports.
But some companies don't have to register their securities or file reports on
EDGAR. For example, companies raising less than $5 million in a 12-month period
may be exempt from registering the transaction under a rule known as "Regulation
A." Instead, these companies must file a hard copy of the "offering circular" with the
SEC containing financial statements and other information. Also, smaller companies
raising less than one million dollars don't have to register with the SEC, but they
must file a "Form D." Form D is a brief notice which includes the names and
addresses of owners and stock promoters, but little other information. If you can't
find a company on EDGAR, call the SEC at (202) 942-8090 to find out if the
company filed an offering circular under Regulation A or a Form D. And be sure to
request a copy.
The difference between investing in companies that register with the SEC and those
that don't is like the difference between driving on a clear sunny day and driving at
night without your headlights. You're asking for serious losses if you invest in small,
thinly-traded companies that aren't widely known just by following the signs you
read on Internet bulletin boards or online newsletters.
Contact Your State Securities Regulators
Don't stop with the SEC. You should always check with your state securities
regulator to see if they have more information about the company and the people
behind it. They can check the Central Registration Depository (CRD) and tell you
whether the broker touting the stock or the broker's firm has a disciplinary history.
They can also tell you whether they've cleared the offering for sale in your state.
Check with the NASD
The National Association of Securities Dealers, Inc. can also give you a partial
disciplinary history on the broker or firm that's touting the stock. Call their toll-free
public disclosure hot-line at (800) 289-9999 or visit their website at
nasdr.com.
Online Investment Fraud:
New Medium, Same Old Scam
The types of investment fraud seen online mirror the frauds perpetrated over the
phone or through the mail. Remember that fraudsters can use a variety of Internet
tools to spread false information, including bulletin boards, online newsletters,
spam, or chat (including Internet Relay Chat or Web Page Chat). They can also
build a glitzy, sophisticated web page. All of these tools cost very little money and
can be found at the fingertips of fraudsters.
Consider all offers with skepticism. Investment frauds usually fit one of the
following categories:
The "Pump And Dump" Scam
It's common to see messages posted online that urge readers to buy a stock
quickly or tell you to sell before the price goes down. Often the writers will claim to
have "inside" information about an impending development or to use an "infallible"
combination of economic and stock market data to pick stocks. In reality, they
may be insiders or paid promoters who stand to gain by selling their shares after the
stock price is pumped up by gullible investors. Once these fraudsters sell their
shares and stop hyping the stock, the price typically falls and investors lose their
money. Fraudsters frequently use this ploy with small, thinly-traded companies
because it's easier to manipulate a stock when there's little or no information
available about the company.
The Pyramid
Be wary of messages that read: "How To Make Big Money From Your Home
Computer!!!" One online promoter claimed that investors could "turn $5 into
$60,000 in just three to six weeks." In reality, this program was nothing more than
an electronic version of the classic "pyramid" scheme in which participants attempt
to make money solely by recruiting new participants into the program.
The "Risk-Free" Fraud
"Exciting, Low-Risk Investment Opportunities" to participate in exotic-sounding
investments – such as wireless cable projects, prime bank securities, and eel farms
– have been offered through the Internet. But no investment is risk-free. And
sometimes the investment products touted do not even exist – they're merely
scams. Be wary of opportunities that promise spectacular profits or "guaranteed"
returns. If the deal sounds too good to be true, then it probably is.
Off-shore Frauds
At one time, off-shore schemes targeting U.S. investors cost a great deal of money
and were difficult to carry out. Conflicting time zones, differing currencies, and the
high costs of international telephone calls and overnight mailings made it difficult for
fraudsters to prey on U.S. residents. But the Internet has removed those obstacles.
Be extra careful when considering any investment opportunity that comes from
another country, because it's difficult for U.S. law enforcement agencies to
investigate and prosecute foreign frauds.
The SEC Is Tracking Fraud
The SEC actively investigates allegations of Internet investment fraud and has, in
many cases, has taken quick action to stop scams. We've also coordinated with
federal and state criminal authorities to put Internet fraudsters in jail. Here's a
sampling of recent cases in which the SEC took action to fight Internet fraud:
Francis A. Tribble and Sloane Fitzgerald, Inc. sent more than six million
unsolicited e-mails, built bogus web sites, and distributed an online newsletter over
a ten-month period to promote two small, thinly traded "microcap" companies.
Because they failed to tell investors that the companies they were touting had
agreed to pay them in cash and securities, the SEC sued both Tribble and Sloane
to stop them from violating the law again and imposed a $15,000 penalty on
Tribble. Their massive spamming campaign triggered the largest number of
complaints to the SEC's online Enforcement Complaint Center.
Charles O. Huttoe and twelve other defendants secretly distributed to friends and
family nearly 42 million shares of Systems of Excellence Inc., known by its ticker
symbol "SEXI." In this classic "pump and dump" scheme, Huttoe drove up the
price of SEXI shares through false press releases claiming non-existent multi-million
dollar sales, an acquisition that had not occurred, and revenue projections that had
no basis in reality. He also bribed co-defendant SGA Goldstar to tout SEXI to
subscribers to SGA Goldstar's online "Whisper Stocks" newsletter. The SEC fined
Huttoe $12.5 million. But he spent most of his ill-gotten gains, and investors did not
get their money back. Huttoe and Theodore R. Melcher, Jr., the author of the
online newsletter, were sentenced to federal prison. In addition, four of Huttoe's
cohorts pled guilty to criminal charges.
Matthew Bowin recruited investors for his company, Interactive Products and
Services, in a direct public offering done entirely over the Internet. He raised
$190,000 from 150 investors. But instead of using the money to build the
company, Bowin pocketed the proceeds and bought groceries and stereo
equipment. The SEC sued Bowin in a civil case, and the Santa Cruz, CA District
Attorney's Office prosecuted him criminally. He was convicted of 54 felony counts
and sentenced to 10 years in jail.
IVT Systems solicited investments to finance the construction of an ethanol plant in
the Dominican Republic. The Internet solicitations promised a return of 50% or
more with no reasonable basis for the prediction. Their literature contained lies
about contracts with well known companies and omitted other important
information for investors. After the SEC filed a complaint, they agreed to stop
breaking the law.
Gene Block and Renate Haag were caught offering "prime bank" securities, a
type of security that doesn't even exist. They collected over $3.5 million by
promising to double investors' money in four months. The SEC has frozen their
assets and stopped them from continuing their fraud.
Daniel Odulo was stopped from soliciting investors for a proposed eel farm.
Odulo promised investors a "whopping 20% return," claiming that the investment
was "low risk." When he was caught by the SEC, he consented to the court order
stopping him from breaking the securities laws. |
