Steve, I know that you try to help investors by sharing your knowledge. Thought this article from the Chicago Tribune would be of real value to all of us who prowl Silicon Investor. I would have just posted the link, but I'm afraid it would not be accessible after the paper puts out their next days articles.
CYBERFORCE PATROLS
THE INTERNET
By Merrill Goozner
Chicago Tribune Staff Writer
January 24, 1999
SAN DIEGO -- The Silicon Investor Internet
site has one of the hottest stock chat rooms
in the nation. Each day, hundreds of
investors post notices lauding some relatively
obscure high-tech firm whose stock is poised
for blastoff.
So it wasn't unusual a little over two years
ago when the Springfield, Ill.-based Strategic
Investment Advisory Inc. (SIA) began a
thread on the Silicon Investor site about a
company called American Biomed Inc. of
Woodlands, Texas.
SIA didn't have much to say about the firm's
high-tech medical devices, which still have
negligible sales though $29 million was spent
on development over the past 14 years.
Despite that track record, SIA "initiated
coverage" with a "strong buy." The company
was sure to grow to $5 to $6 a share from its
current $1 level, the Internet posting said.
In its Internet posting, SIA also failed to note
that its president, 31-year-old Wayne F.
Gorsek, and three other officers of the firm
had received tens of thousands of shares of
American Biomed as payment to promote
the firm, according to a Securities and
Exchange Commission complaint filed in
Washington earlier this month.
Most important, SIA officers didn't tell
readers, who quickly pushed the stock past
$2.50 a share, that they were simultaneously
dumping their American Biomed shares,
realizing a $40,000 profit, the SEC complaint
charged. Gorsek's attorney, who has 60 days
to respond, would not comment on the
complaint.
In one sense, SIA's alleged scam is nothing
more than the latest example of one of the
oldest stock fraud schemes in the book.
Longtime SEC officials call it the
pump-and-dump.
What's new, though, is that a new generation
of scam artists has found a largely
unpatrolled venue for their operations: the
wild and woolly chat groups of the Internet,
where millions of relatively inexperienced
investors go every day for stock tips.
The problem has become so severe that the
SEC last year set up a special task force in
its enforcement division to crack down on
Internet fraud. Known as the SEC's
cyberforce, the agency trained 100 of the
division's 850 staff members to troll the
Internet for at least part of their day to look
for possible violations.
The SEC's new team last October launched
a nationwide crackdown on 44 stock
promoters who had allegedly engaged in
pump-and-dump schemes involving 235
low-priced firms, known as microcaps
because of their small market capitalization.
"This is an area where fraud is growing,"
Richard Walker, the chief of SEC
enforcement, told Northwestern University's
annual Securities Litigation Institute, which
brings together the nation's leading
practitioners of securities law. "It has
paralleled the growth of the Internet."
However, many observers and Internet
advocates dismiss the idea that the SEC has
the tools to police what the government
agency suspects is burgeoning stock fraud on
the Internet. With 30 percent of all stock
trades now taking place on-line and millions
of electronic messages being clicked on
daily, spotting the illegal touts amid the
innocuous rumors and tips that constitute
most Internet chat becomes an almost
impossible task.
"It is like draining the ocean one drop of
water at a time," said Larry Downes, who
teaches law and technology at
Northwestern's School of Law. "It's beyond
their ability to even begin to cover the
volume of transactions and communications
that are now taking place."
The laws governing fraudulent stock selling
schemes are simple in principle. It's perfectly
legal for a person or company to tout a firm's
stock in exchange for compensation, either in
the form of cash or stock. But failing to
disclose that fact to potential investors is a
crime.
And while knowingly passing false
information in order to pump up a stock's
price is against SEC rules, it's extremely hard
to prove. There's nothing illegal about
offering advice. There has been no shortage
of stock analysts who have delivered
wrongheaded opinions over the years,
presumably based on facts.
Some of the alleged pump-and-dumpers are
trying to bring their operations within those
rules. One of the alleged violators singled out
by top SEC officials when they announced
the Internet fraud crackdown last October
was a newsletter publisher in West Chicago.
The SEC alleged that Jeffrey C. Bruss' "The
Future Superstock" recommended buying
shares of 23 companies that had paid him
$300,000 in cash and stock, which he
allegedly sold as his 100,000 e-mail recipients
jumped on the bandwagon of his latest tips.
The complaint said he never disclosed the
compensation to his readers.
Bruss and his attorney did not return phone
calls. But a visit to his Web site reveals that
the home page now prominently warns
readers that "companies featured by The
Future Superstock Inc. publication usually
pay consideration to The Future Superstock
Inc. for the electronic dissemination of
company information," and he carefully
refers to his touts as "opinions."
That was not the case before the SEC filed
its complaint, agency officials said.
"He didn't tell subscribers that he was buying
stock and then selling it after he published
buy recommendations on the Internet," said
Ken Israel, one of the SEC's cyberforce
agents.
Israel did not learn of the allegedly fraudulent
scheme by reading Bruss' newsletter, a
product of one of the hundreds of
stock-touting firms that have popped up in
recent years as popular interest in the stock
market swelled.
"We received complaints," Israel said.
"People were buying these stocks and losing
a lot of money."
Indeed, the prices of stocks touted on the
Internet usually take a steep dive after the
promoters dump their stocks and end their
campaigns. The shares of American Biomed,
for instance, closed at 16 cents a share
Friday, wiping out virtually the entire
investment of anyone who bought on SIA's
advice.
The rapid growth of electronic stock trading
firms, most of which run internal chat groups,
is forcing them to begin self-policing of their
Internet bulletin boards. E*Trade, for
instance, which is the nation's leading on-line
trading broker-dealer with 700,000 accounts,
a year ago created a 15-member internal
compliance group.
"Any communication from the public that
goes up on the Web site is reviewed by my
group," said Henry Carter, vice president for
compliance at E*Trade.
The company uses artificial intelligence to
weed out profanity and inappropriate stock
symbols and has its own staffers sweep the
chat rooms to eliminate electronic messages
that are clearly inaccurate.
"As a broker-dealer, we have a fiduciary
responsibility to monitor the information that
goes to our clients," Carter said.
Like most Internet firms, the company is
feverishly looking for new ways to bring in
revenue and add spice to its site. So it has
cut a number of deals with newsletter
publishers, who either have links on the
E*Trade site or actually post their
newsletters there. Carter said that "every
newsletter that goes up must meet a due
diligence test. . . .They have to have a track
record. We look to see if their
prognostications and analyses meet the smell
test of reasonableness."
Yet those measures didn't stop The Future
Superstock of West Chicago from buying a
banner ad on the site. After the SEC
complaint, E*Trade now warns customers
they are leaving the E*Trade site if they
click on an ad on its site.
The growing importance of the stock market
to the Internet world can be viewed through
the prism of American Online Inc., the
nation's leading Internet service with 15
million subscribers. Its personal finance
channel has emerged as its most popular
destination. But when it comes to regulating
conversations in its busy stock chat rooms,
the firm rigorously adheres to one of the core
values of denizens of cyberspace: that the
freedom of expression encouraged by the
medium is an absolute. When it comes to
getting stock advice on the Internet, an AOL
spokesman said, let the consumer beware.
"We certainly aren't interested in screening
people with bad information or who are
giving out bad advice on a stock," said Tom
Ziemba, a spokesman for AOL. "That's not
something we're in a position to do."
That's not an attitude Carter of E*Trade,
who practices securities law, feels his firm
can afford to take. The company limits
discussion to exchange-traded stocks, and
erases any messages that refer to microcaps,
which are sometimes called penny stocks.
"There's no doubt in my mind that the SEC
and the NASD (National Association of
Securities Dealers) could ban chat rooms by
broker dealers tomorrow," he said. "It's up to
us to make it work."
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