Like Elliot Ness in "The Untouchables," who led the charge to clean up Al Capone's gangster operations in Chicago, the Securities and Exchange Commission executed its first major sweep against fraudsters on the Internet. In October, the SEC filed 23 enforcement actions against 44 individuals and companies for violating the antifraud and antitouting provisions in the federal securities laws.
In all of the cases, the authors of spams (junk e-mail messages), online newsletters, message board postings and Web sites unlawfully touted more than 235 microcap companies. They either lied about the companies; lied about their independence from the companies; or failed to disclose the nature, source and amount of compensation paid by the companies.
The message for investors is this: Information and recommendations they see on the Internet may be bought and paid for by less-than-respectable companies.
The SEC cannot prevent individuals from recommending stocks, and touting does not necessarily constitute fraud. However, if individuals receive payment for touting stocks, they are required to disclose specifically who paid them, and the amount and type of payment. This is where most of the fraudsters in the SEC's sweep went wrong--failing to disclose the specifics of such payments.
Highlights of the Sweep * Darin Spencer Ruebel wrote and published several online investment newsletters, including "The Equity Journal." In two issues, Ruebel touted the stock of company without disclosing that he received monthly compensation of $2,500 for "consulting services," which included increasing public awareness of the company's merits. The newsletter had only a general disclaimer that it and its affiliates "may receive compensation" from some of the profiled companies.
* George Schlieben, editor and publisher of the online newsletter "Global Penny Stocks," received payments from companies to write favorable "research reports" on their stocks. The newsletters were posted on Schlieben's Web site. In each newsletter, Schlieben disclosed in small type that he received a fee from the companies to write the reports. However, he did not state the exact amount of the compensation.
* Ed Taxin, the host of a radio infomercial show called "The Financial Hour," also publishes an online newsletter. Taxin and the Taxin Network received at least $200,000 from numerous small-cap companies for promotional services, including exposure on the radio show and in the online newsletter.
On "The Financial Hour," Taxin would introduce guests who were really promoters and officers of companies as "Wall Street notables and stock pickers" to disguise their relationship with the companies discussed. Taxin would also add to the rosy predictions for those companies. He made only general statements that some of his guests paid to be on the show or that he owned stock in some of the companies discussed.
* Donald Baillargeon promoted more than 50 companies through the cable television program "Emerging Company Report" and an online newsletter and Web site of the same name. He received from $2,500 to $17,000 for the guest appearance packages he sold and received stock from two companies he publicized. Baillargeon did not disclose the amount he was paid or that he received stock as compensation.
Other cases in the SEC's sweep involved scalping, or "pump and dump" schemes. In this classic fraud, an individual generates enough investor interest in a stock he owns so that the price soars.
Old Fraud Goes OnlineSince touting and scalping are familiar schemes, it seems that the Internet has not spawned new species of securities fraud. "It's the same old fraud, just a different medium," says Duncan King, a spokesperson at the SEC. An article on the SEC's Web site (www.sec.gov) lists fraudulent activities that have migrated to the Internet, such as pyramids, "risk-free" deals and off-shore frauds.
E-mail messages that announce, "Make big money from your home computer," represent the same classic pyramid scams that appear in classified newspaper ads. Fraudsters are attempting to make more money by recruiting participants from a different audience.
Offers of "exciting, low-risk opportunities" in exotic-sounding investments, like eel farms, have also appeared on the Internet. The investments promoted often don't exist.
The North American Securities Administrators Association (NASAA) has been encouraging investors to forward messages from scam artists to the association at [email protected]. Of the 1,500 messages received, about 40% promote microcap stocks, another 40% promote "business opportunities" like the ones mentioned above, and the balance are chain letters, according to Marc Beauchamp, a spokesperson for the NASAA.
Frauds for LessOff-shore schemes have proliferated on the Internet because the technology has removed barriers in conducting international fraud, such as time zone differences, expensive international phone calls and different currencies.
"The Internet cuts down on the fraudster's overhead," says Philip Rutledge, deputy chief council for the Pennsylvania Securities Commission.
Most securities fraud is conducted over the telephone from "boiler rooms." This kind of operation requires an initial investment for renting a room, installing phone lines, paying for sales people, writing scripts and training the salespeople. The cost can amount to thousands of dollars. But with e-mail and bulletin boards, an individual can reach thousands of potential victims at a minimal cost.
And avoid the regulators, too. "You could close down [a Web site] and open another site, which is no different from closing tent, moving to another state and setting up another boiler room," Rutledge says.
This past July, the SEC established a separate Office of Internet Enforcement, dedicated to investigating fraud on the Internet. The SEC has also enlisted about 100 of its attorneys to be a "cyber force." They surf the Web for several hours each week looking for fraudulent activity.
Nearly a year ago, the NASD announced plans to launch an Internet search engine, dubbed NetWatch, to seek out fraud. The search engine would look for phrases such as "guaranteed moneymakers" or "the next Microsoft." As of December, the regulator says it's refining the system and inputting the key phrases that are possible indicators of fraud.
In October, the North American Securities Administrators Association (NASAA) opened an e-mail address ([email protected]) for investors to alert regulators of suspected Internet fraud. So far, the NASAA has received about 1,500 messages.
Regulators seem to be more cooperative in overseeing this new frontier, says Philip Rutledge, deputy chief council with the Pennsylvania Securities Commission. "We're not getting into our turf battles at all."
The SEC and the NASAA are increasing their efforts in investor education. The SEC's Web site (www.sec.gov) is loaded with information on how to avoid being victimized by Internet fraud. Investors can call the SEC or state regulators to see if a company is registered, or check the SEC's Edgar database for firms that file electronically. Some telltale signs of online investment fraud:
* Promises of quick profits
* Promoters who use aliases
* Phrases like "high return," "limited offer" or "as safe as a CD"
* Foreign investments