CYBERFORCE PATROLS THE INTERNET
By Merrill Goozner
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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