SEC Cracks Down on Internet Stock Fraud
(October 29, 1998) The Securities and Exchange Commission announced yesterday that it has brought 23 enforcement actions against 44 individuals and companies for committing fraud over the Internet. All of the cases involve alleged illegal touting of securities in violation of Section 17(b) of the 1933 Securities Act. The SEC also promised that it would be filing more actions.
The Securities and Exchange Commission (SEC) held its press conference at its Washington DC headquarters to publicize the "sweep." SEC Director of Enforcement, Richard Walker, stated that:
"In all of these cases, the Internet promoters gave ostensibly independent opinions about Microcap companies that in reality were bought and paid for. 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. Today's sweep demonstrates the SEC's commitment to cleaning up the Internet, by aggressively prosecuting securities violations occurring in Cyberspace."
Also present were John Stark, Chief of Internet Enforcement, and Jay Perlman, its Deputy Chief.
The SEC explained in its press release that:
The 23 cases involve a range of Internet conduct including fraudulent spams (Internet junk mail), online newsletters, message board postings and Web sites. The allegations include violations of the anti-fraud provisions and the anti- touting provisions of the federal securities laws. The authors of the spams, online newsletters, message board postings and Web sites unlawfully touted more than 235 Microcap companies, by either: (1) lying about the companies; (2) lying about their own "independence" from the companies; and/or (3) failing to disclose adequately the nature, source and amount of compensation paid by the companies. The creators of the Internet touts purported to provide unbiased opinions in their recommendations, but failed to disclose that they had received in total more than $6.3 million and nearly two million shares of cheap insider stock and options in exchange for touting services. In some instances, the fraudsters sold their stock or exercised their options immediately following their recommendations, a deceptive practice commonly referred to as "scalping."
Section 17b, Securities Act of 1933
|"It shall be unlawful for any person, by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails, to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof." (15 U.S.C. § 77q(b).)|
All twenty-three cases involve allegations of illegal touting of securities under Section 17(b) of the Securities Act of 1933. "17(b) provides that it is unlawful to publicize a security, if you are being paid to do so, unless you disclose three things," said Walker. "The first thing that is required to be disclosed is nature of the compensation you are receiving, whether it is cash, or whether it is stock. The second is the amount of compensation you are receiving. And the third is the source of the compensation."
Walker added that, "17(b) does not prohibit free speech. It does not prohibit spamming, online newsletters, posting on message boards, without other activity as well. But lying to investors, or failing to disclose compensation, does violate the law."
|SEC v. The Future Superstock, Inc. and Jeffrey Bruss, (U.S.D.C., N.D.Ill., Case No. 98-C-6772, filed October 27, 1998.) In this case the SEC seeks a permanent injunction, disgorgement, civil penalties and other relief against The Future Superstock, Inc. (FSS) and Jeffrey Bruss. The Complaint alleges that an Internet newsletter called The Future Superstock, is published by FSS and researched and written by Bruss. It further alleges that the newsletter and website have recommended to the over 100,000 subscribers that they purchase about 25 microcap stocks which it predicted would double or triple in the next three to twelve months. In most instances, the prices increased for a short period of time after a recommendation was made, but then dropped substantially. The complaint also alleges FSS and Bruss violated federal securities laws by failing to provide adequate disclosure in several areas: (1) neither the newsletter nor the web site disclosed that Bruss or FSS received compensation, in cash and stock, from nearly every issuer profiled; (2) FSS and Bruss failed to disclose that in many instances they sold the stock shortly after a recommendation in The Future Superstock caused its price to rise; (3) FSS and Bruss represented that they performed independent research and analysis when, in fact, little, if any, research was conducted; and (4) statements regarding the success of past stock picks made in The Future Superstock were false and misleading. The complaint alleges that FSS and Bruss have violated §§17(a) and 17(b) of the Securities Act of 1933 and 10(b) of the Securities Act of 1934 and Rule 10b-5.|
Walker reviewed five of the 23 cases at the press conference. One such case involves a newsletter and website called The Future Superstock. "This case is a poster child for the sweep, and provides a laboratory to examine many of the kinds of fraudulent activity that are alleged in our cases," he said.
Walker said that the SEC has over 125 people in offices around the country working on Internet fraud. Most of their investigation is conducted from their offices using desktop computers, although Walker added that complaints from individuals play an important role.
Walker was asked whether the SEC would be able to prosecute Internet securities touters who operate outside of the U.S. He stated that the SEC could pursue them. "We will, with treaties we have with other countries, and memoranda of understanding, be very aggressive in finding them, provided there is the jurisdictional basis to go against them here in this country."
Walker concluded by saying that, "I hope that I have succeeding in convincing you that the Internet is not impossible to police. Today's crackdown is just a first step. We are marathoners, and we are in it for the long haul. We will file more cases. We will bring more actions. We will be unrelenting in our efforts to clean up the Internet, and to secure its benefits for investors."
William Walker, SEC Director of Enforcement
Excerpts from Opening Statement
Answers to Questions from the Press
"The Internet provides unquestionable phenomenal benefits for investors. It enables investors to communicate directly with all market participants. You can sit in your living room and sit in the annual meeting of a company that you own shares in. You can communicate directly with officers, directors, and management of a company, or with other shareholders. You have direct and instant access to market information that was never before available. And you can get this 24 hours a day, 7 days a week."
"Unfortunately, there is no mechanism to sort good information from bad information on the Internet. Information comes at you in an undifferentiated fashion. Unfortunately, we have seen a rise of fraud on the Internet. A few examples will make this clear. We filed 38 cases so far this year, including the 23 that we announced today. We have filed a total of 61 cases since we started to police the Internet in 1995. All of these cases allege fraud. Now, the types of cases that we have seen on the Internet are no different than the other types of enforcement cases that we bring. The Internet does not bring us any new fraud. It is the same scams, but a new medium. The types of cases that we have brought so far involving Internet fraud, including classic fraud, such as offering scams, pyramid and ponzi schemes, market manipulations, microcap fraud, including pump and dump schemes, and the subject of today's sweep, touting."
"Now, we call our approach to enforcement over the Internet "enforcenet." It is a five prong approach. It can consist of, first, aggressive surveillance, which is conducted through our cyberforce of trained staff. It also includes vigorous prosecution, as witnesses by today's sweep. The third prong is investor education. We have updated our cyber alert, and posted some new information on our website today by our office of investor education and Nancy Smith. The fourth prong is liaison with other government offices and authorities. In particular, criminal law enforcement authorities. And the fifth, is self is self policing, which is done through our online enforcement complaint center, which is a very valuable source of complaint information that we use in our cases and investigations."
|Related Story: SEC Forms Internet Fraud Unit, 7/30/98.|
"Overseeing these efforts, is our Office of Internet Enforcement, which was formed in July of this year, and is headed by John Stark and Jay Perlman, who are seated to my right. This is the first office of its kind in federal law enforcement."
|Section 17(b) Touting|
"Today's cases all have a common thread. They all allege fraudulent touting of securities, which violate Section 17(b) of the 1933 Act. So, what does Section 17 prohibit? 17(b) provides that it is unlawful to publicize a security, if you are being paid to do so, unless you disclose three things. The first thing that is required to be disclosed is nature of the compensation you are receiving, whether it is cash, or whether it is stock. The second is the amount of compensation you are receiving. And the third is the source of the compensation."
"17(b) does not prohibit free speech. It does not prohibit spamming, online newsletters, posting on message boards, without other activity as well. But lying to investors, or failing to disclose compensation, does violate the law."
"Now, to whom does 17(b) apply? It applies to anyone person who publicizes a security through any means. When it comes to the Internet, that includes publicizing securities over World Wide Web pages, online investment newsletters, bulletin boards, chat rooms, or through Internet junk mail, which is popularly known as spam. Why is 17(b) important? 17(b) is important because investors have a right to know if information is objective, or whether someone is paying to provide that information to investors. Notwithstanding the attention that has been brought to requirement of the law, people continue to flout 17(b)'s requirements."
[Response to question about whether companies hiring touters would be prosecuted.] "There is nothing illegal about companies paying fees to touters. The law requires the touters have to disclose ... The laws do not cover the companies themselves who make the payments."
"Let me tell you briefly about the mechanics of today's sweep. Many of cases that we brought, were, resulted, or were initiated, through coordinated surveillance by our cyberforce which now is more than 125 strong in offices throughout the country. The cyberforce did the prospecting for the most part, and came up with good leads for possible fraudulent activity. They did so by using desktop computers at their offices. As a result of the prospects that they developed, we initiated a large number of investigations, and those investigations were prioritized by our enforcement staff, and then completed quickly, and recommenations made in a package to the Commission."
"The cases were brought by SEC offices thoughout the country. ... "
"We have talked about indivudial investors helping police the Interent. And, were any individuals responsible for the cases brought today. Certainly, one of the cases did -- was a case where a lot of complaints registered on our enforcement complaint center -- that would give you a pretty good idea. We don't ever identify in any particular case who was responsible -- how we found the particular case. But this is a very very important tool for us. ..."
[Response to question about how the SEC finds out the touters are paid.] "... It would not be unreasonable to call the company itself to find out whether they had paid anyone to make promotions about the company, or call the newsletter itself and ask a question directly. Now, I cannot tell you whether you are going to be told the truth, but these are two ready and easy ways to start the process."
|Types of Cases|
"The cases involved all types of Internet activity. Seven of the cases involved spamming, junk email. Nineteen of the cases involved online newsletters which containing tour. Five of the cases involved postings on message boards. And twenty involved the use of websites ..."
"The cases also involved many different types of fraud that appear over the Internet. Five of the cases involved the practice known as scalping. Scalping occurs, unbeknownst to investors, a person making a positive recommendation about a security, sells that security shortly after making the positive recommendation, without making a disclosure to other people. Six of the cases involved misrepresentation, either about the companies themselves, or about the touter's independence and track record. All of the cases involved either partial disclosure, or no disclosure at all, about the nature and source of the compensation received."
"The question is have we had a problem finding people, because the beauty of the Internet is it can be very anonymous, and you don't have to disclose very much about yourself. But one thing you do have to do, if you are trying to commit fraud and take somebody's money, is have some vehicle, and identify yourself sufficiently, so that you can take somebody's money. So, the short answer is we have not in the cases that we have brought so far, encountered the difficulty where we simply cannot find the person that we are investigating, because at some point they have to reveal themselves. They have to ask for money. They have to give an address. They have to give a phone number. They have to give some way of getting in touch with them."
"The question is, were any of the touters offshore operations, and what are we going to do about offshore operations. John, I don't know what -- I do not think there were any offshore -- no offshore that I am aware of in this one. But certainly, offshore operators have come and made use of U.S. jurisdiction, are subject to our jurisdiction. And we will, with treaties we have with other countries, and memoranda of understanding, be very aggressive in finding them, provided there is the jurisdictional basis to go against them here in this country."
"The question was what kind of penalties do the scammers face in the cases that we have filed so far? Many of cases will be litigated cases that will be up to a court, or an administrative law judge, to decide what the penalties will be. What we have sought in these particular cases is injunctive relief, to enjoin people from violating the law, cease and desist orders, ... and penalties where appropriate. ... There is going to be a wide range of different penalties, depending on the conduct involved." [He mentioned no dollar figures.]
"The question was how large and how widespread fraud is on the Internet. And without trying to overstate the case, certainly, we have seen a rise of fraud on the Internet. ..." [The remainder of answer was non-responsive.]
"Well, we don't see it as an unregulated atmosphere because there are a lot of people who take the Internet very seriously, ourselves included."
"The question is whether I see any regulatory changes coming out of the enforcement efforts over the Internet. I think the short answer is, at the present time, no. ..."