The Business Lawyer
ENFORCENET REDUX: A RETROSPECTIVE OF
THE SEC'S INTERNET PROGRAM FOUR YEARS AFTER ITS GENESIS.
By John Reed
Stark *
* An eleven-year veteran of the Division of Enforcement of the United States
Securities and Exchange Commission, John Reed
Stark is Chief of the Office of Internet Enforcement and is in charge of
the Enforcement Division's Internet Program. He is also an Adjunct Professor of
Law at Georgetown University Law Center where he has taught a course on the
Securities Laws and the Internet for the past five years and also serves as
Co-Chair of the American Bar Association Subcommittee on Securities Law and the
Internet. The Securities and Exchange Commission as a matter of policy disclaims
any responsibility for any private publication or speech by any of its members
or staff. The views expressed herein are those of the author and do not
necessarily reflect the views of the Commission or the author's colleagues on
the staff of the Commission.
"A new life awaits you in the Off-World colonies. The chance to begin again in a golden land of opportunity and adventure . . . New climate, recreational facilities . . . absolutely free. Use your new friend as a personal body servant or a tireless field hand--the custom tailored genetically engineered humanoid replicant designed especially for your needs. So come on America, let's put our team up there . . . ." n1
n1 The quotes contained in the headings of this Article are from the futuristic
cult film BLADE RUNNER (Warner Bros. 1982), directed by Ridley Scott, produced
by Michael Deelay and featuring Harrison Ford, about a jaded ex-cop forced out
of retirement to hunt down a group of genetically engineered "replicants."
More than four years ago, together with the Securities and Exchange Commission's
(SEC's or Commission's) Chief of the Office of Market Surveillance, I wrote an
article for this publication outlining a program for the SEC Enforcement
Division (Division) and the Internet. n2 Dubbed "EnForcenet,"
the article anticipated great changes in the Commission's enforcement program
for the future and promised to tackle head-on any problems the widespread use of
the Internet would engender for investors. Rather than simply reiterating the
common themes among law enforcement agencies and lamenting about the magnitude
of Internet fraud and the financial restraints that prevent federal agencies
from effectively policing the Internet,
EnForcenet set out to act immediately, using whatever resources were
available.
n2 Joseph J. Cella III & John Reed
Stark, SEC Enforcement and the Internet: Meeting the Challenge of the
Next Millennium; A Program for the Eagle and the Internet, 52 BUS. LAW. 815
(1997).
By initiating a plan for the Internet without delay, the Commission hoped to
discourage perpetrators of Internet fraud before they could find their niche. So
now, after more than four years of its implementation, has that plan worked?
Yes, it has--in fact, a careful study of the Commission's track record of the
past four years reveals that the program has experienced success far greater
than anyone originally anticipated.
After providing some background on the growth of the Internet, both as an
investment resource and as a vehicle for securities fraud, this Article will: (i)
discuss the overall history and development of the Commission's Internet
program; (ii) examine some of the Enforcement Division's on-line surveillance
methods; (iii) describe the most effective enforcement techniques the Division
has employed to deter on-line securities law violations; and (iv) highlight some
important cooperative enforcement efforts undertaken with outside agencies.
BACKGROUND
"Replicants are like any other machine, they're either a benefit or a
hazard, if they're a benefit, its not my problem."
Before beginning any discussion of Internet fraud, it is important to note the
many benefits that the Internet has created for investors--benefits that far
outweigh any negative impacts on the investor community.
Quite simply, the Internet continues to have a profound effect on the way
investors participate in the capital markets. n3 According to recent reports,
there are approximately 160 on-line-trading broker-dealers servicing
approximately 11.7 million on-line investors in the United States--nearly double
the number of investors using on-line firms in 1999. n4 Through the second
quarter of 2000, online brokerage accounts held approximately $ 1.08 trillion in
assets--a twelve percent increase from the last quarter of 1999. n5 Average
on-line trading volumes for the second quarter of 2000 were approximately 1.1
million trades per day, a decrease of approximately twenty percent from the
first quarter of 2000. n6 Since that time, average daily trading volume has
remained above or around 900,000, but on-line trading firms are still spending
money to update their technology and to attract new customers (reports
anticipate growth in the number of on-line accounts from 24 million by the end
of 2001 to 33 million in 2002, and 43 million in 2003). n7 Although some reports
even show that the on-line trading system is losing established investors faster
than it can replace them with new traders, n8 clearly, on-line broker-dealers
have had a vastly heightened presence over the last several years in terms of
the number of firms offering on-line services, the number of accounts they
handle, and the dollar value of these accounts. Further, reports also show that
these statistics will undoubtedly increase. n9 Regardless of what the statistics
show (as they tend to change like the weather), on-line trading is forever
entrenched into the landscape of U.S. and global securities markets.
n3 See SEC Chairman Arthur Levitt, Testimony Concerning Appropriations
for Fiscal Year 2001 Before the House Subcommittee on Commerce, Justice, State
and the Judiciary Committee on Appropriations (Mar. 30, 2000), available at
http://www.sec.gov/news/testimony/ts062000.htm.
n4 U.S. BANCORP PIPER JAFFRAY EQUITY RESEARCH, ONLINE FINANCIAL SERVICES UPDATE
4, 6 (Oct. 2000), available at
http://www.gotoanalysts.com/piperpublic/goto/internetconference/reports/online_fin_oct2000.pdf.
n5 Id. at 8.
n6 Id. at 6.
n7 Elizabeth Lamb, Trading Takes a Breather, RED HERRING, Sept. 15,
2001, at 30.
n8 Press Release, J.D. Power and Assoc., Weakening Market Fuels Efforts by
Online Brokerage Firms To Provide Consolidated Account Services (Sept. 10,
2001), available at
http://www.jdpa.com/presspass/pr/pressrelease.asp?ID=153.
n9 Press Release, J.D. Power and Assoc., Online Brokerage Firms Continue to Have
a Strong Hold on Current Investment Pool; Study Shows Many Online Investors Plan
to Maintain, or Increase Trading Volume (Mar. 27, 2001), available at
http://www.jdpa.com/presspass/pr/pressrelease.asp?ID=106.
The Internet also has changed the way investment research is conducted, making a
wide array of information available to even relatively unsophisticated
investors. Investors today have unprecedented access to all manner of
investment-related publications, from real-time stock quotes, SEC filings, n10
and corporate news releases to the kind of spirited and provocative investment
opinions found in Internet message boards, Web sites, and chat rooms. n11 It is
not uncommon today to see entire communities of Internet users develop to trade
information, insight, and invective about CEOs, companies, and particular
industry segments or trading markets. Today's retail investor is much more
likely to feel overloaded than overlooked.
n10 A wide range of Commission filings by publicly-traded issuers are available
to investors free of charge through the SEC's Electronic Data Gathering,
Analysis, and Retrieval System (EDGAR), available at
http://www.sec.gov/edgar.shtml.
n11 See Jonathan Lansner, A New Brand of Spam: Stock Touting on
Reputable Bulletin Boards Can Inflate the Value of Obscure Companies,
ORANGE COUNTY REG., Feb. 12, 2000, at K01 ("Stock message boards on Internet
financial sites have long been breeding grounds for rumors and stock hype. These
sites are almost universally derided as bad places to get investment advice,
Still, they draw plenty of online eyeballs.").
Not only are investors accessing the securities markets through the Internet
more frequently than they did before the advent of on-line trading, but the
technological advances of the digital age are also changing the breadth of the
markets themselves. Established securities markets are moving toward extended
trading hours, and alternative trading systems are creating new points of entry
to those markets. n12 This increase in the scope of the trading markets means
that the Commission's capacities for regulation and enforcement will likely be
tested as never before in coming years. n13
n12 See SEC, SPECIAL STUDY: ELECTRONIC COMMUNICATION NETWORKS AND
AFTER-HOURS TRADING (June 2000), available at
http://www.sec.gov/news/studies/ecnafter.htm.
n13 See, e.g., SEC Chairman Laura S. Unger, Raising Capital on the
Internet, Remarks at the 2001 Corporate Law Symposium, University of Cincinnati
School of Law (Mar. 9, 2001), available at
http://www.sec.gov/news/speech/spch471.htm; see also, Press Release
2001-119, SEC Historical Society to Hold Major Issues Conference on Securities
Regulation in the Global Internet Economy (Oct. 25, 2001), available at
http://www.sec.gov/news/press/2001-191.txt ("The theme of Securities
Regulation in the Global Internet Economy was chosen because the rapid
development of global marketplace requires a careful reexamination of the
fundamental principles of securites regulation.").
SECURITIES FRAUD AND THE INTERNET
"I am not in the business. I am the business."
Unfortunately, "while the Internet has brought significant benefits to
investors, it also has created significant dangers for the unwary. [During the
late 1990s,] the Internet, coupled with the greatest bull market in history, . .
. brought millions of relative novices to the markets, while also providing
simple, effective, and anonymous ways for unscrupulous people to defraud them."
n14 Various forms of internet media, including a single mass e-mail, "spam," a
message board posting, an on-line investment newsletter, or any other form of
electronic message can reach millions with the click of a computer mouse. Con
artists today can exploit the benefits of cyberspace and easily and cheaply
reach a more customized audience of investors far better than they could making
thousands of cold calls from an old-fashioned boiler room, and the use of
digital media can lend fraudulent material an air of credibility simply
unachievable by a boiler room cold call. Still from their own living room,
anyone with a home PC and some knowledge of the latest software (which is often
available for free) can create an interactive, sleek Web site rivaling that of a
Fortune 500 company--only now he or she can do so at even lesser cost and with
even less training in the use of computers than four years ago. n15
n14 Levitt, supra note 3.
n15 See Cella &
Stark, supra note 2, at 816 ("The entrepreneur, the inventor,
and the small business owner now have a cheap and efficient alternative means to
reach millions of potential interested parties without the expense of a road
show, without hiring the usual cadre of lawyers and financial advisers, without
hiring a printing service, and, most of all, without leaving the house.").
INITIAL EXPERIENCES: NEW MEDIUM, FAMILIAR SCAMS
In the earliest days of the Commission's Internet fraud program, the securities
frauds that prevailed on-line were simply electronic versions of scams that had
long been conducted through more traditional media such as paper newsletters,
mass organizational meetings, and orchestrated telephone solicitations. n16
Principal among these were:
Stock manipulations: These are typically so-called "pump and dump" frauds in which false and misleading information concerning an issuer is disseminated on-line to generate interest in a stock, allowing insiders to sell their stock at artificially inflated prices. n17Offering frauds: These include fraudulent on-line offerings of exotic investments, n18 interests in pyramid schemes, n19 and so-called "prime bank" programs. n20
Illegal touts: These are on-line securities recommendations that fail to disclose that the persons making such recommendations were paid for their positive opinions. n21
n16 See Levitt, supra note 3; see also Cella &
Stark, supra note 2, at 835 ("The swindles of the Internet are
no different from the confidence games of the past; the only difference is the
medium.").
n17 See SEC v. Huttoe, Litig. Release No. 16,632A, 72 SEC Docket (CCH)
2194 (D.D.C. July 21, 2000) (discussing a large-scale pump and dump scheme
resulting in Commission actions against more than forty defendants over a
four-year period, and criminal charges against five defendants).
n18 See SEC v. Frye, Litig. Release No. 14,702, 60 SEC Docket 1882 (S.D.N.Y.
Oct. 30, 1995). In the spring of 1995, Scott Frye posted a notice over the
Internet soliciting investors by promising "riskless profits and above-average
returns" from investments in two Costa Rican enterprises that produced coconut
chips: ICP and the Jupiter Agro Development Project. According to the SEC
complaint, Frye misled potential investors by telling them a bank would
guarantee their principal and a fifteen percent return in one year and that one
of the companies was a major distributor for A&P Supermarkets. See also
SEC v. Odulo, Litig. Release No. 14,616, 60 SEC Docket 0122 (D.R.I. Aug. 24,
1995). In August 1995, the SEC filed a complaint against Daniel Odulo who
solicited investors over several newsgroups of the Internet. Odulo offered for
sale bonds meant to raise money for a company called Golden Waters which he
claimed would yield a "whopping 20% rate of return" for a "very low risk." Odulo
also assured potential investors that they would be insured against potential
losses, even though there was no such insurance and made up the names of
investment advisers who vouched for the bonds. According to the SEC complaint,
Odulo failed to disclose that Golden Waters was a proposed new venture involving
the acquisition and raising of eels and that he had no expertise in the
culturing of eels. Moreover, the solicitation included several glowing
endorsements from fabricated persons and entities. Odulo consented to an
injunction from further violations of the securities laws but a monetary penalty
was waived because of Odulo's financial condition. Id.
n19 See SEC v. Pleasure Time, Inc., Litig. Release No. 14,825, 61 SEC
Docket 1189 (S.D. Ohio Feb. 26, 1996). A complaint filed by the SEC on March 15,
1995, alleged that John C. Hicks and a partner raised more than $ 3 million by
selling securities to approximately 20,000 investors, contacted both on the
Internet and over the telephone. Investors were told that they would reap
astronomical profits from a worldwide telephone lottery and were encouraged to
recruit other investors through the Internet. The complaint alleged that the
sales pitch failed to disclose the legal and regulatory obstacles to starting a
lottery. The Commission requested a temporary restraining order (TRO),
injunctions, and civil penalties against various participants in the scam. On
the day the complaint was filed, the court entered the TRO, which included a
freezing of assets. Id. at 1190.
n20 See SEC v. Block, Litig. Release No. 14,828, 61 SEC Docket 1192 (D.
Mass. Feb. 27, 1996). Starting in 1994, Renate Haag, of Langen, Germany, and
Malibu, California, offered investors what seemed like a good deal, through a
business she called Haag and Partner. Soon, Gene Block of Durham, North
Carolina, operating through Block Consulting Services, and Robert T. Riley, Jr.,
of St. Louis, Missouri, operating through the Roberts Group, were pitching Haag
and Partner investments on the Web as well. They raised over one million dollars
by promising returns in some cases of 200% to 420% annually, and the promoters
told investors their initial investments would be guaranteed against loss
because they would be backed by "Prime Bank Guarantees." According to the
Commission, however, Prime Bank Guarantees does not, in fact, exist. Id.
at 1193. The court granted a TRO against Block and froze his assets; similar
penalties were issued against the other defendants. Id.; see also
SEC v. Octagon Tech. Group, Litig. Release No. 14,942, 62 SEC Docket 0377 (D.D.C.
June 11, 1996). In Octagon Technology Group, a computer software
company and two of its officers were sued for their roles in creating an
elaborate sham offering of offshore debt securities on the Web. The Web site,
established for the Agency for Interamerican Finance (AIF), a Panamanian shell
subsidiary of Octagon, advertised AIF "Interamerican hard currency bonds" for
sale to investors. The Commission alleged that this offering was essentially a
fraud because no bonds ever existed, and AIF had no business operations or
assets. AIF's web pages, however, promised prospective investors a risk-free
investment with guaranteed returns of 11.75% annually and portrayed AIF as a
successful provider of investment capital to Latin American businesses. See
also SEC v. Capital Acquisitions, Inc., Litig. Release No. 15,601, 66 SEC
Docket (CCH) 433 (D. Utah Dec. 23, 1997); SEC v. Interactive Prods. & Servs.,
Inc., Litig. Release No. 15,700, 66 SEC Docket (CCH) 2187 (N.D. Cal. Apr. 8,
1998); SEC v. Internet Casino Sports Gaming, LLC, Litig. Release No. 16,025, 68
SEC Docket 3283 (C.D. Cal. Jan. 13, 1999).
n21 See SEC v. Chelekis, Litig. Release No. 15,264, 63 SEC Docket 2900
(D.D.C. Feb. 25, 1997). In this case, the Commission's complaint alleged that
Chelekis, a publisher who distributed various investment newsletters, known as
the "Hot Stocks" publications, over the Internet and in print format, knowingly
or recklessly made materially false and misleading statements concerning six
publicly-traded companies and failed to disclose in the Hot Stocks publications
that he and entities that he controlled (defendants KGC, Incorporated and Hot
Stocks Review, Incorporated) received at least $ 1.1 million from more than 150
issuers and 275,000 shares of stock from ten issuers, as payment for
recommending the issuers' securities in the Hot Stocks publications. Without
admitting or denying the allegations in the complaint, Chelekis, KGC, and Hot
Stocks Review consented to the entry of a final judgment permanently enjoining
them from violating the antifraud provisions of the Securities Act of 1933 and
the Securities Exchange Act of 1934. Id. The final judgment ordered the
defendants to pay a total of $ 162,727, representing $ 75,050 in disgorgement, $
12,627 in prejudgment interest, and a $ 75,050 civil penalty. Id.;
see also SEC v. Samblis, Litig. Release No. 15,609, 66 SEC Docket (CCH) 576
(M.D. Fla. Jan. 6, 1998); SEC v. Savage, Litig. Release No. 15,954, 68 SEC
Docket 1122 (Oct. 27, 1998).
RECENT EXPERIENCE: ON-LINE FRAUDS BEGIN TO EVOLVE
As the Internet has evolved, so has Internet fraud. Virulent new variations on
the familiar frauds have begun to emerge. Among these are:
Recommendation "scalping": an on-line version of a fraudulent practice in which the promoter of a Web site secretly acquires blocks of a security he intends to recommend and then clandestinely sells into the run-up triggered by his recommendation. This scalping can be carried out through a "momentum trading" site, an investment Web site through which a promoter attempts to create a short-term price spike in a thinly-traded stock by inducing groups of "momentum" traders to invest on a particular date at a particular time. n22 Alternatively, promoters may use a variant on the standard momentum site, a daytrading recommendation site; the daytrading site can provide investors with multiple picks per day. Frauds conducted through these Web sites are often advanced by fraudulent descriptions of the promoter's qualifications or track record. n23"Imposter" message board frauds: an updated version of the pump and dump scheme, in which a manipulator (in a guise designed to lend the information credibility) posts false and misleading information on Internet message boards in order to influence the price of a stock. n24
"Misdirected" spam manipulations: attempts to manipulate a microcap stock's price through mass e-mails purporting to be accidentally delivered communications between investors unaffiliated with the recipient. n25
n22 See SEC v. Colt, Litig. Release No. 16,461, 71 SEC Docket 2387 (D.D.C.
Mar. 2, 2000). This was a civil action and administrative proceeding alleging
that Georgetown University law student Douglas Colt and a group of friends and
relatives defrauded investors of nearly $ 350,000 in illicit profits by
recruiting large numbers of investors to purchase small-cap stocks recommended
by the Fast-Trades.com Web site at particular times and failing to disclose that
they were engaged in scalping.
n23 See SEC v. Park, Litig. Release No. 16,925, 74 SEC Docket (CCH)
1183 (N.D. Ill. Mar. 8, 2001). This action involved a self-proclaimed
stock-picking expert, "Tokyo Joe," who, without admitting or denying the
Commission's allegations, consented to a permanent injunction against future
federal securities law violations and agreed to pay $ 754,650 to settle the
matter. In its complaint, the Commission alleged that Park not only engaged in
unlawful stock touting and scalping, but also published on his Web site more
than 200 misleading statements, including false statements about his track
record as a stock-picker.
n24 In these frauds, stock manipulators may disguise their touts as press
releases from established news organizations or the advice of an issuer's
corporate officer or a brokerage firm analyst. See SEC v. Hoke, Litig.
Release No. 16,117, 69 SEC Docket 1970 (C.D. Cal. Apr. 21, 1999) (involving a
Webpage posting which provided a bogus link to Bloomberg News Service
announcement); SEC v. Zbierajewski, Litig. Release No. 16,363, 71 SEC Docket
0285 (N.D. Ill. Nov. 18, 1999) (concerning a counterfeit PR Newswire release
posted on Yahoo! Finance); United States v. Jakob, Litig. Release No. 16,857, 74
SEC Docket (CCH) 214 (C.D. Cal. Jan. 8, 2001) (pertaining to a false press
release disseminated to news organizations via Internet newswire).
n25 See SEC v. Sheret, Litig. Release No. 16,451, 71 SEC Docket (CCH)
1787 (S.D.N.Y. Feb. 24, 2000) (involving numerous e-mail stock recommendations
addressed to appear to have been transmitted to recipients by mistake); see
also SEC v. Globus Group, Inc., Litig. Release No. 16,212, 70 SEC Docket
0506 (S.D. Fla. July 16, 1999). In the Globus Group case, the SEC
alleged that certain defendants sent paper fax transmissions which purported to
be mistakenly-sent messages from employees of banks or brokerage firms. This
technique has been adopted by electronic junk-mailers, who routinely draft their
stock recommendations in such a way that they appear to be misdirected
communications--sometimes containing inside information--between friends or
acquaintances.
THE SEC'S EFFORTS TO COMBAT INTERNET FRAUD
"More human than human is our motto."
A TEAM APPROACH
The Commission's ongoing program to combat Internet securities law violations
remains a team effort, in which every Division and Office plays a significant
part. n26 The Division of Corporation Finance has analyzed numerous Internet
securities offerings to determine their compliance with the Commission's
registration and disclosure requirements. The Division of Market Regulation has
monitored the impact of the Internet on the types of services offered to
investors by broker-dealers, such as on-line brokerage and day-trading, and is
developing an appropriate regulatory regime as more of the functions of
traditional exchanges and other market mechanisms move on-line. The Office of
Compliance Inspections and Examinations (OCIE) has been working to respond,
through the examination process, to the rising tide of concerns about the
operations of on-line brokerages, ECNs, and daytrading firms. n27 The Office of
the General Counsel has helped to develop the legal analysis applicable to new
types of on-line fraud and to provide guidance on the application of federal
privacy law to on-line investigations. The agency's Office of International
Affairs (OIA) works with the SEC's Enforcement staff and foreign authorities to
obtain information needed to investigate and prosecute SEC enforcement actions
and also assists foreign authorities in obtaining information needed from
persons or entities based in the United States. n28 The Office of Investor
Education and Assistance (OIEA) helps to build an educated, informed investor
community and advise the public on remedial strategies when investors are
victims of fraud. n29
n26 Levitt, supra note 3.
n27 For example, SEC examiners review: (i) the execution quality of orders
entered on-line; (ii) systems capacity and reliability; (iii) the on-line public
offering process; (iv) the use of and disclosure concerning margin; (v) customer
complaints; and (vi) the security of on-line trading systems. See
OFFICE OF COMPLIANCE INSPECTIONS AND EXAMINATIONS, SEC, EXAMINATIONS OF
BROKER-DEALERS OFFERING ONLINE TRADING: SUMMARY OF FINDINGS AND RECOMMENDATIONS
(Jan. 25, 2001), available at
http://www.sec.gov/news/studies/online.htm.
n28 See Press Release 2000-64, SEC, SEC and Regulators from Around the
World Conduct an International Surf Day to Help Combat Internet Fraud (May 15,
2000), available at
http://www.sec.gov/news/press/2000-64.txt.
n29 See, e.g., SEC, INTERNET FRAUD: HOW TO AVOID INTERNET INVESTMENT
SCAMS, available at
http://www.sec.gov/investor/pubs/cyberfraud.htm (last modified Mar. 16,
2001).
THE DIVISION OF ENFORCEMENT
The lead role in combating on-line fraud is played by the Enforcement Division,
because it is charged with uncovering, investigating, and litigating civil
actions alleging federal securities law violations. The SEC brought its first
Internet enforcement action in 1995, n30 and at the same time, named its first
"Special Counsel for Internet Projects" and tasked him with beginning to build
an Internet enforcement program. The Division's Internet program has steadily
expanded since that time n31 and, through a mixture of traditional and novel
enforcement strategies, has achieved significant results.
n30 SEC v. Frye, Litig. Release No. 14,702, 60 SEC Docket 1882 (S.D.N.Y. Oct.
30, 1995).
n31 The Internet program received no formal budget allocation at its inception;
rather the program generally draws from the Commission's overall appropriation
from Congress. The Commission, however, reprogrammed $ 5.5 million to combat
Internet fraud during fiscal 1999, and in November 1999, Congress appropriated
an additional $ 7 million over the Commission's fiscal 2000 request to augment
the Commission's Internet fraud program. See Levitt, supra
note 3. With these new funds, the Commission created ninety-two new slots for
our Internet fraud program. Seventy-five of the slots have been assigned to the
Division of Enforcement. The remaining seventeen slots have been assigned to
other specialized divisions and offices within the Commission to aid their
Internet-related efforts. Two slots have been allocated to the Office of
International Affairs, three to the Division of Market Regulation, three to the
Division of Corporation Finance; four to the Office of Compliance, Inspections
and Examinations, and five to the Office of Internet Enforcement. These new
staff members focus on Internet enforcement and regulatory issues. Among other
things, they (i) provide technical expertise to the Enforcement Division; (ii)
develop policies for the securities industry's use of the Internet; (iii)
inspect and examine regulated entities operating on-line; and (iv) consider the
need for and, when appropriate, develop rulemaking alternatives or legislative
changes necessary to prevent and address market abuses involving the Internet.
The Commission has also used the funds (i) to develop its own customized search
engine that surfs publicly accessible areas of the Internet for potential
securities law violations; and (ii) to renovate the Commission's on-line
Enforcement Complaint Center. Both technology projects are discussed herein.
The Office of Internet Enforcement
In July 1998, as a result of the Internet's growing importance and the rising
incidence of Internet fraud, a formal Office of Internet Enforcement (OIE) was
created within the Enforcement Division. n32 Initially, OIE acted as a
coordinator of the Commission's Internet program and as a liaison with other
regulatory and criminal law enforcement agencies at the federal, state, and
local levels.
n32 See Press Release 98-69, SEC, SEC Creates Office of Internet
Enforcement to Battle Online Securities Fraud (July 28, 1998), available at
http://www.sec.gov.news/pressarchive/1998/98-69.txt. John Reed
Stark, formally the Division's "Special Counsel for Internet Projects"
was promoted to Chief of OIE.
Between the spring of 1999 and the present, OIE staff has grown from three to
twenty, including sixteen lawyers--all professionals who together possess
experience and expertise in a wide variety of areas pertinent to Internet law
enforcement. OIE's current functions include: conducting surveillance and
identifying new areas for future monitoring, analyzing the complaints received
in the on-line Enforcement Complaint Center (ECC), formulating investigative
procedures, conducting law enforcement training for SEC staff and outside
agencies, engaging in special technology-related projects, ensuring staff
compliance with federal privacy statutes and other applicable laws, conducting
certain important Internet-related investigations, and serving as a resource on
Internet matters for the entire Commission. n33
n33 See SEC, INTERNET ENFORCEMENT PROGRAM: ABOUT THE OFFICE OF INTERNET
ENFORCEMENT, available at
http://www.sec.gov/divisions/enforce/internetenforce.htm (last modified July
16, 2001) [hereinafter INTERNET ENFORCEMENT PROGRAM].
OIE has also constructed a state-of-the-art computer lab, warehousing a
separately secure and fire-walled local area network facility that includes the
latest software, hardware, and operating systems. The computer lab utilizes its
own T-1 line, n34 and has the capability to warehouse Web sites, Internet
protocol trails and other important electronic evidence.
n34 T-1 lines grant access at 1500 bits per second (significantly faster than
the average high speed modem which only transfers 56.6 bits per second).
OIE also maintains its own internal SEC intranet Web site, that centralizes
thousands of pages of useful Internet-related information, as well as an
Internet Web site that catalogs all public Internet-related SEC Enforcement (and
other) information.
Special Internet Investigative Branches
Within the Enforcement Division, this past year the SEC created ten new
investigative branches--two in Washington, D.C., and one each in San Francisco,
Los Angeles, Chicago, Miami, New York, Boston, Fort Worth, and another divided
among the three offices comprising the SEC's Central Region (Denver, Fort Worth,
and Salt Lake City). These branches consist of lawyers and, in some cases,
non-lawyer Internet specialists. Unlike the rest of the Enforcement Division's
staff, lawyers in the Internet branches are wholly devoted to conducting
Internet-related investigations. This specialization--a new and different
direction for the Division--has allowed the SEC to develop a cadre of Internet
experts throughout the country who can respond quickly and effectively to
on-line fraud when and where it happens.
The CyberForce
Alongside OIE remains the CyberForce--more than 200 Commission lawyers,
accountants, and investigators nationwide--whose purpose is to conduct regular
Internet surveillance as well as certain special projects such as internal "surf
days." n35 CyberForce members dedicate a portion of their workweek to surfing
the Internet, developing leads for potential enforcement cases. Formed in 1996,
the CyberForce began as an Enforcement Division "corps of [SEC staff] volunteers
who 'surf' the Web for a few hours each week in search of securities law
violations." n36 The CyberForce also originally provided many of the leads for
the first two Commission sweeps (the touting sweep in October 1998 and the
offering sweep in May 1999). Additionally, the CyberForce participates in
coordinated surveillance projects with other federal agencies, such as the joint
law enforcement initiative Internet fraud "surf days" orchestrated over the past
three years by the Federal Trade Commission and the International Organization
of Securities Commission's (IOSCO's) "surf days." n37
n35 See infra notes 36-39 and accompanying text.
n36 Cella &
Stark, supra note 2, at 836-37; see also Levitt,
supra note 3.
n37 See Press Release, Fed. Trade Comm'n, Surf Day Monitors Investment
Opportunities (Dec. 21, 1998), available at
http://www.ftc.gov/opa/1998/9812/iosd.htm; see also Press Release
2000-64, SEC, SEC and Regulators from Around the World Conduct an International
Surf Day to Help Combat Internet Fraud (May 15, 2000), available at
http://www.sec.gov/news/press/2000-64.txt.
SURVEILLANCE
"If only you could see what I've seen with your eyes."
Despite the apparent anonymity offered by the Internet, the Commission has had
no lack of success in finding suspect conduct on-line; by the very nature of
their businesses, securities fraudsters need to be easily found. Perpetrators of
online fraud want to disseminate their message to as many users as possible.
Further, the Internet offers an investigator a clear set of electronic
footprints (including easily captured Internet protocol) with which to trace
scammers. Even more importantly, thanks to the Internet, law enforcement
officials and regulators now have the opportunity to watch a fraud as it
develops in front of their own eyes. The Internet offers a "window" and "plain
view" into the schemes through any desktop computer, allowing for "real time"
observation of fraudulent activities. Fraudsters may not realize that by sending
their schemes via spam, Web site, newsgroup or otherwise, they do indeed reach a
vast audience--including the Enforcement Division of the SEC. With this fact in
mind, the Commission maintains an active fraud surveillance program with several
important prongs.
ENFORCEMENT COMPLAINT CENTER
In June 1996, the SEC opened the Enforcement Complaint Center (ECC), an on-line
mailbox through which investors can inform the agency electronically of
potential securities law violations. The ECC generally receives between 300 and
400 investor complaints per day--with fluctuations resulting from heightened
media activity involving the Commission--relating to virtually every type of
potential securities violation occurring on-line. ECC review and analysis is
resourceintensive, but very worthwhile. ECC complaints have thus far provided
(and continue to provide) the Enforcement Division with many of its most
promising investigative leads.
Recognizing that the ECC has evolved into probably the most critical part of the
Division's Internet program, the Commission has almost completed a $ 2 million
renovation of the ECC. The new system that will replace the simple ECC mailbox
is internally referred to as C.H.A.R.T. (Complaint, Handling, Assignment,
Response and Tracking). C.H.A.R.T. will greatly modernize the Commission's
electronic complaint process, making the system far more robust and enabling
lawyers throughout the SEC to process, track, and assign complaints, while
assembling a comprehensive, searchable complaint database.
SURF DAYS
In order to leverage staff and resources and to focus the Commission's efforts
on key investigative areas, the Office of Internet Enforcement coordinates
quarterly internal "surf days." The goal of each surf day is to locate potential
frauds in key program areas including market manipulation, fictitious investment
schemes, momentum trading, suspicious stock offerings, false statements, and
unregistered entities.
On the designated surf day, the CyberForce members from the SEC's home, regional
and district offices surf the web in a precisely-targeted manner, homing in on a
particular "territory" (such as a message board, Web site or web ring) or a
violation type (such as so-called prime bank schemes n38 or pyramid/ponzi
activities). CyberForce members send the results of their search efforts to OIE,
where the material is reviewed and potential investigative leads referred to
offices within the SEC or to other appropriate federal or state agencies. OIE
maintains extensive records of all surf day leads and constantly convenes to
improve surveillance techniques and discuss future surf day subjects.
n38 Prime bank schemes involve the sale of fraudulent investment opportunity in
so-called prime bank notes, debentures, and other types of interest. The
instruments, entirely fictional, purport to represent a secondary market for
stand-by letters of credit. Such a market does not exist and is simply a means
to defraud investors. See SEC, WARNING TO ALL INVESTORS ABOUT BOGUS
"PRIME BANK" AND OTHER BANKING-RELATED INVESTMENT SCHEMES (Sept. 15, 2000),
available at
http://www.sec.gov/divisions/enforce/primebank.shtml. Given that many prime
bank frauds now take place over the Internet, the Office of Internet Enforcement
now administers the SEC's prime bank program (in addition to the Internet
program).
SEC INTERNET SEARCH ENGINE
The SEC's Internet Search Engine is a customized automated search engine--the
most recent of its surveillance initiatives. On August 18, 2000, the Commission
awarded the contract for the Internet Search Engine to Science Applications
International Corporation (SAIC). SAIC designed and developed the system from
August to October 2000. In November and December 2000, the Internet Search
Engine became operational, and OIE received its first trial downloads of data;
these were analyzed to determine the Internet Search Engine's operational
capabilities and baseline site relevance.
Using search words and phrases, the Internet Search Engine identifies relevant
sites and newsgroup posts in the public areas of the Internet. In order to
protect the privacy of Internet users, the Internet Search Engine surfs only
public areas of the Internet, much as any other publicly-available Internet
search engine might. The Internet Search Engine's battery of search terms and
algorithims are constantly being updated and modified to reflect current
patterns of suspect on-line conduct identified by OIE.
After searching the Internet, the Internet Search Engine filters out irrelevant
material and ranks the remaining information by relevance. For each Web site the
Internet Search Engine delivers (vis-a-vis a user-friendly browser enabled
graphical user interface): (i) an archived version of the site; (ii) a link to
the live version of site; (iii) the site's domain registration information; and
(iv) Web site link information. The Internet Search Engine also captures and
warehouses other sites and posts that have met the search criteria, but that may
not have received a highly relevant score. As a result, the SEC has access to an
even larger searchable database of potentially fraudulent sites and posts. n39
n39 See Press Release 2000-44, SEC, Chairman Levitt Issues Statement on
Internet Search Engine (Apr. 5, 2000), available at
http://www.sec.gov/news/press/2000-44.txt.
OIE staff can access the Internet Search Engine's database through the T-1
connection in OIE's computer lab, or through a secure Web site viewable on
selected desktop computers. The Internet Search Engine delivers an average of
100 or so Web sites and newsgroup postings per month. Overall, the sites
delivered to date appear to be highly relevant, and the Internet Search Engine
is already providing strong leads for investigations. Future refinement of the
process should yield even better leads. Though the search engine will never
replace other important surveillance efforts, it is an effective complement to
the Division's other monitoring efforts.
TECHNIQUES FOR ADDRESSING ON-LINE FRAUD
"It's not an easy thing to meet your maker."
ENFORCEMENT SWEEPS AND COORDINATED FILINGS
One investigative technique that has helped the agency achieve its twin goals of
deterrence and education is the "sweep," the simultaneous filing of multiple
enforcement actions targeting similar misconduct and presented as a cohesive
package. The sweep allows the Commission to deliver its message more forcefully
and effectively than the filing of individual cases might. Sweeps have served as
an efficient tool of the Internet enforcement program, particularly during the
programs infancy. n40
n40 To review more information about all five SEC Internet fraud sweeps, see
INTERNET ENFORCEMENT PROGRAM, supra note 33.
The first enforcement sweeps targeted "touters" who recommended stocks without
disclosing adequately to investors that they received compensation from the
issuers. The October 1998 sweep involved the filing of twenty-three separate
enforcement actions against forty-four individuals and entities. n41 A follow-up
touting sweep in February 1999 included actions against an additional thirteen
individuals and entities. n42
n41 See Press Release 98-117, SEC, SEC Charges 44 Stock Promoters in
First Internet Securities Fraud Sweep (Oct. 28, 1998), available at
http://www.sec.gov/news/headlines/netfraud.htm.
n42 See Press Release 99-24, SEC, SEC Continues Internet Fraud
Crackdown (Feb. 25, 1999), available at
http://www.sec.gov/news/headlines/spamcase.htm.
In an effort to stem the tide of fraudulent on-line securities offerings, a May
1999 enforcement sweep combined actions against eighteen individuals and eight
entities who used the Internet to engage in securities offerings in violation of
federal law. These actions generally involved alleged offerings of non-existent
securities, or offerings in which exaggerated claims were made concerning
expected investor returns. This sweep demonstrated that the Internet gives
investigators a "window" into fraudulent activity and permits the offerings to
be halted, in many cases, before any investors are harmed. Of the fourteen
offerings that formed the basis of the May 1999 sweep, five were stopped before
investors lost any money. n43
n43 See Press Release 99-49, SEC, SEC Steps Up Nationwide Crackdown
Against Internet Fraud, Charging 26 Companies and Individuals for Bogus
Securities Offerings (May 12, 1999), available at
http://www.sec.gov/news/headlines/nets0599.htm.
Though not a full-fledged sweep, the Commission's coordinated filing of four
actions in July 1999 against the purveyors of so-called "free stock" proved an
important blow to a potentially dangerous and unlawful on-line practice. n44 The
designation "free stock" was really a "misnomer" in these offerings. n45 While
cash did not typically change hands in free stock offerings, the companies that
issued the stock usually received valuable benefits. n46 In an on-line
environment where merchants and retailers struggle for market share, information
about, and access to, potential customers are valuable commodities. Free stock
giveaways were typically employed to help generate these valuable customer
databases, or to stimulate other forms of commercial activity.
n44 See Press Release 99-83, SEC, SEC Brings First Actions To Halt
Unregistered Online Offerings of So-Called "Free Stock" (July 22, 1999),
available at
http://www.sec.gov/news/press/pressarchive/1999/99-83.txt.
n45 Id. (quoting SEC Enforcement Director Richard H. Walker).
n46 Id. Issuers of these offerings offer so-called "free" shares to
individuals under a variety of circumstances such as: (i) requiring an Internet
user to register with or visit the issuer's Web site, typically offering more
"free" shares if identified as a "reference" by future visitors to the issuer's
Web site who similarly register for "free" shares; (ii) requiring cash payments
for the "free" shares (as much as $ 10 per share) to "defray the printing costs
of the stock certificates"; and (iii) requiring the purchase of a product, such
as a phone card, or a service, such as an Internet service provider account, in
order to receive one or more "free" shares.
By offering an investment opportunity that on its face appeared to involve no
risk with seemingly no payment of money for the stock itself, issuers promoted
an expectation of financial gain for the holders of the "free stock" that was
dangerous for the investor and could be easily exploited by an issuer or
promoter at a later date, for example, in a manipulation scheme.
Further, despite several regulatory pronouncements pertaining to the illegality
of free stock offerings, n47 during 1999, such offerings continued to
proliferate online. Thus, given the potential danger to investors, the
Commission brought four matters at the same time in an effort to crackdown on
the unlawful practice. n48
n47 The Division of Corporation Finance has issued several no-action letters
advising that the distribution of "free stock" to individuals who visit or
register on an Internet Web site constitutes an event of sale within the meaning
of section 2(a)(3) of the Securities Act of 1933. Simplystocks.com, SEC
No-Action Letter, 1999 WL 51836 (Feb. 4, 1999); see also Vanderkam &
Sanders, SEC No-Action Letter, [1999 Transfer Binder]
Fed. Sec. L. Rep. (CCH) P77,520, at 78,585 (Jan. 27, 1999); see also In
re Capital Gen. Corp., Securities Act Release No. 7008, 54 SEC Docket (CCH)
1322, 1330 (July 23, 1993) ("Capital General's distributions of securities
[which were purportedly for free] constituted a 'sale' within the meaning of the
Securities Act since the distributions were dispositions for value . . . [which]
accrued to Capital General and Yeaman by virtue of the creation of a public
market for the issuer's securities . . . .").
n48 In each of the four actions, investors were required to sign up with the
issuers' web sites and disclose valuable personal information in order to obtain
their "free" shares. Free stock recipients were also offered extra shares, in
some cases, for soliciting additional investors or, in other cases, for linking
their own Web sites to those of an issuer or purchasing services offered through
an issuer. Through these techniques, issuers received value by spawning a
fledgling public market for their shares, increasing their business, creating
publicity, increasing traffic to their Web sites, and, in two cases, generating
possible interest in projected public offerings. For a discussion of all four
SEC actions, see Press Release 99-83, supra note 44. Two of these free
stock issuers offered stock through Web sites that featured false claims. In one
action, investors were told that the free shares they received would give them
interests in an aerospace company that would revive lunar exploration. In fact,
the company was never incorporated and its promoter had no space exploration or
aerospace engineering experience. See In re Loofbourrow, Securities Act
Release No. 7700, 70 SEC Docket 0391 (July 21, 1999). In another action
involving an Internet telecommunications marketing firm, the Web site informed
free stock recipients that their shares could eventually exceed $ 200 each in
value, even though the firm had realized less than $ 30 in gross operating
revenues. See In re Web Works Marketing.Com, Inc., Securities Act
Release No. 7703, 70 SEC Docket 402 (July 21, 1999).
Turning to another type of on-line fraud, in September 2000, the Commission
brought a sweep consisting of fifteen enforcement actions against thirty-three
companies and individuals who preyed upon investors in the volatile "microcap"
market to perpetrate so-called "pump-and-dump" schemes over the Internet. The
alleged perpetrators of these market manipulations "pumped" up the total market
capitalization of the seventy microcap stocks involved by more than $ 1.7
billion and reaped illegal profits of more than $ 10 million. n49 This sweep
reemphasized the fact that, in the digital age, frauds that used to require
large amounts of time and resources could now be done in minutes by a single
person using a home computer. Indeed, some of the individuals involved in these
sweep cases had no securities industry experience at all--one was a bus
mechanic, and another was a college student who drove for a car service.
n49 See Press Release 2000-124, SEC, SEC Continues Nationwide Crackdown
Against Internet Fraud, Charging 33 Companies and Individuals With Fraud For
Manipulating Microcap Stocks (Sept. 6, 2000), available at
http://www.sec.gov/news/press/2000-124.txt.
Recently in a March 2001 sweep, the SEC's fifth, the SEC simultaneously filed a
group of Internet fraud actions covering many aspects of on-line securities
fraud already mentioned. This sweep highlighted various on-line methods used by
fraudsters to lure investors to their scams: "spam" e-mails, electronic
newsletters, Web sites, hyperlinks, message boards and other Internet media.
This sweep included eleven enforcement actions against twenty-three companies
and individuals and involved both publicly-traded and privately-held companies.
In these matters, the alleged perpetrators used the Internet to "pump" the
market capitalization of the stocks by more than $ 300 million and to raise $
2.5 million in illgotten gains from investors in the United States and abroad.
n50
n50 See Press Release 2001-24, SEC, SEC Charges 23 Companies and
Individuals in Cases Involving Broad Spectrum of Internet Securities Fraud (Mar.
1, 2001), available at
http://www.sec.gov/news/press/2001-24.txt.
These sweep efforts seem to have had a positive impact in the on-line investment
community. Current surveillance suggests that touters have become more sensitive
to the law's disclosure requirements, and the SEC is seeing fewer blatantly
suspect on-line offerings. Further, the offering of so-called "free stock" has
almost ceased entirely. And investors--now more keenly aware of the need to
question what they see on-line--have been increasingly eager to notify the ECC
of conduct similar to that charged in the SEC's enforcement sweeps.
SWAT TEAMS
Another innovation utilized by the Division of Enforcement during the past few
years has been the "SWAT" team approach. The technique describes a method for
accelerating an investigation by increasing assigned staff and having these
staff members work full-time solely on a single matter.
Application of this technique in the Internet context led to the successful
criminal and civil prosecutions of Gary Dale Hoke, who published on the Internet
a phony Bloomberg press release designed to drive up the price of the common
stock of Pair Gain Technologies, Incorporated ("Pair Gain") by falsely reporting
that Pair Gain was a takeover target. n51 Within just three days of the false
Bloomberg release's posting, SEC staff and criminal investigators were able to
identify Hoke as the creator of the release. Within a week, Hoke was arrested
and charged with securities fraud by federal prosecutors and the Commission. n52
n51 See SEC v. Hoke, Litig. Release No. 16,266, 70 SEC Docket 1604
(C.D. Cal. Aug. 30, 1999). In settling the Commission's civil action, Hoke
consented to an antifraud injunction. In the criminal case, Hoke was sentenced
to five months of home detention and ordered to pay over $ 93,000 in
restitution. See also United States v. Jakob, Litig. Release No.
16,857, 74 SEC Docket (CCH) 214 (C.D. Cal. Jan. 8, 2001) (SEC and criminal
action brought within a week of Jakob's publication of false news release).
n52 Id.
A second SWAT team investigation led, in four weeks, to the arrest of two
individuals alleged to have generated over $ 300,000 in illicit profits by
posting false rumors about a company to several Internet message boards over a
weekend in November 1999. n53 The rumors drove the price of the company's stock
from $ 0.13 per share to over $ 15 per share the following Monday, before
returning to $ 0.50 the same day. n54
n53 The Commission has obtained emergency relief against the three civil
defendants, including a TRO and a freeze on the defendants' assets. See
SEC v. Aziz-Golshani, Litig. Release No. 16,391, 71 SEC Docket (CCH) 721, 722
(C.D. Cal. Dec. 15, 1999).
n54 Id. The U.S. Attorney for the Central District of California
prosecuted criminally two of the SEC defendants, Arash Aziz-Golshani and Hootan
Melamed, for their manipulation of NEI Webworld.
Aziz-Golshani pled guilty to one count of securities fraud and one count of conspiracy to commit securities fraud. Melamed pled guilty to one count of conspiracy to commit securities fraud. Aziz-Golshani was sentenced on January 22, 2001 to 15 months incarceration, and ordered to pay restitution in an amount to be determined. Melamed was sentenced on January 12, 2001 to 10 months incarceration and ordered to pay restitution in an amount to be determined.
SEC v. Aziz-Golshani, Litig. Release No. 16,867, 74 SEC Docket (CCH) 519 (C.D.
Cal. Jan. 23, 2001).
Most recently, within just six days after the publication of a false press
release stating that the Commission was investigating Emulex Corporation, that
its CEO had resigned and that it would be restating its earnings to show a loss,
and the resulting sixty-one dollar plunge in Emulex's share price, the
Commission and criminal authorities had brought actions against the fraud's
architect, Mark Simeon Jakob. Jakob's fraud caused an estimated $ 110 million in
investor losses. In January of this year, Jakob pleaded guilty to two counts of
federal securities fraud and one count of wire fraud, n55 and on August 8, 2001,
the SEC announced that a district court judge sentenced Jakob to forty-four
months in prison for his role in the fraud. n56
n55 Jakob, 74 SEC Docket (CCH) at 214.
n56 See SEC v. Jakob, Litig. Release No. 17,094, 75 SEC Docket (CCH)
1317 (C.D. Cal. Aug. 8, 2001).
Each of these actions demonstrates the utility of the "SWAT" concept when
addressing major, high-impact securities frauds occurring over the Internet.
Early experiences employing this approach have been highly successful (allowing
for "real time" enforcement actions) and will likely remain an integral part of
the agency's remedial arsenal in months and years to come.
TRADING SUSPENSIONS
Although the number of trading suspensions sought has declined recently,
suspensions have proven to be useful during the early stages of the Internet
program as a means of minimizing the damage to investors who might put funds
into suspect issuers' securities. These actions alert investors to the fact that
information in the marketplace about the suspended stock is materially
inaccurate or incomplete.
One example of how the trading suspension can be beneficially used is the case
of Uniprime Capital Acceptance Inc. (Acceptance Inc.). n57 As
alleged in that action, the common stock of Uniprime, a purported owner of
automobile dealerships, had risen in price from $ 0.06 to nearly $ 8 per share,
along with similar increases in the stock's trading volume, on the strength of
dubious claims concerning a new AIDS treatment being developed by Uniprime's
principal subsidiary. Unable to find any basis for Uniprime's claims, the
Commission imposed a trading suspension against the issuer on July 22, 1999. By
mid-August, the Commission had filed a securities fraud complaint seeking a
temporary restraining order and asset freeze against Uniprime and the president
of its subsidiary. The trading halt may have saved thousands of investors from
being defrauded.
n57 See SEC v. Uniprime Capital Acceptance, Inc., Litig. Release No.
16,252, 70 SEC Docket 1181 (S.D.N.Y. Aug. 13, 1999). For a complete listing of
SEC trading suspensions, see
http://www.sec.gov/litigation/suspension.shtml.
EARLY INTERVENTION TECHNIQUES
Not every potential securities law violation warrants a full-scale enforcement
proceeding or investigation. Particularly in the case of more technical
violations, a simple "warning" letter may suffice.
To date, the Commission's Division of Corporation Finance has sent more than 340
such warning letters concerning unregistered on-line securities offerings
identified by the Division of Enforcement. The purpose of these letters is to
induce compliance with the law without the necessity of a lengthy,
resource-intensive enforcement investigation and in situations where simple
ignorance or inadvertence may be the cause of a technical violation. As a
result, the warning letter helps the agency's staff to address and remedy a
wider range of potential misconduct than it could using only conventional
investigative techniques.
Results thus far indicate this program is successful. In about seventy percent
of cases, persons or entities receiving a warning letter either removed their
securities offerings from the Internet, altered the terms of the offering, or
opened discussions with the Division of Corporation Finance regarding the terms
of their compliance with federal law. The Commission recently began a similar
warning letter program within the Commission's Division of Market Regulation
targeting unregistered broker-dealers. This program shows early signs of similar
success, having sent out more than twenty warning letters to date, with sixteen
recipients taking satisfactory steps to "cure" their violations.
EDUCATIONAL PROGRAMS
The SEC strongly believes that an educated investor provides the best defense
against securities fraud, including Internet fraud. Investors who know what
questions to ask and how to detect fraud will be less likely to fall prey to con
artists. And, because they are more likely to report wrongdoing to the SEC and
their state securities regulators, educated investors serve as an important
early warning system to help regulators fight fraud.
To educate investors about the risks presented by the Internet, the SEC uses the
following educational resources:
. Free Publications. The SEC publishes and distributes more than a dozen free brochures, including Internet Fraud: How to Avoid Online Investment Scams. n58
. Web site. In March 2001, the SEC significantly redesigned its Web site to make it more user-friendly, and launched a revised series of investor education webpages on the site. n59 The new Office of Investor Education pages feature information about on-line investing and Internet fraud. n60 The Commission has successfully encouraged on-line broker-dealers and others to link to the SEC's Web site.
. Investors' Town Meetings. The SEC has participated in more than forty investors' town meeting throughout the country. The last town meeting (like many others before) even included a dedicated segment on Internet fraud.
n58 See SEC, INTERNET FRAUD: HOW TO AVOID INTERNET INVESTMENT SCAMS,
available at
http://www.sec.gov/investor/pubs/cyberfraud.htm (last modified Mar. 16,
2001).
n59 See SEC, INVESTOR INFORMATION, at
http://www.sec.gov/investor.shtml (last modified July 31, 2001).
n60 See id.
LIAISON ACTIVITIES
"I was quit when I came in here, I'm twice as quit now."
JOINT CRIMINAL/CIVIL PROSECUTIONS
The Commission is firmly committed to working with other law enforcement
agencies to aggressively pursue Internet fraud. Criminal prosecutions are
perhaps the most effective form of deterrence. Accordingly, joint efforts with
prosecutors are another way for the Commission to leverage its resources.
The SEC's longstanding commitment to joint prosecutions in the Internet area has
produced a string of important cases addressing on-line fraud. n61 The
Commission is committed to building upon cases like these to forge even stronger
working relationships with criminal prosecutors in the future.
n61 See generally United States v. Jakob, Litig. Release No. 16,857, 74
SEC Docket (CCH) 214 (C.D. Cal. Jan. 8, 2001); SEC v. Moldofsky, Litig. Release
No. 16,493, 2000 SEC LEXIS 593 (S.D.N.Y. Mar. 30, 2000); SEC v. Aziz-Golshani,
Litig. Release No. 16,391, 71 SEC Docket 846 (C.D. Cal. Dec. 15, 1999); SEC v.
Hoke, Litig. Release No. 16,266, 70 SEC Docket 1604 (C.D. Cal. Aug. 30, 1999);
SEC v. Uniprime Capital Acceptance, Inc., Litig. Release No. 16,252, 70 SEC
Docket 1181 (S.D.N.Y. Aug. 13, 1999); SEC v. Interactive Prods. and Servs.,
Inc., Litig. Release No. 15,700, 1998 SEC LEXIS 630 (N.D. Cal. Apr. 8, 1998);
SEC v. Huttoe, Litig. Release No. 15,237, 63 SEC Docket 2383 (E.D. Va. Jan. 31,
1997).
The Commission is also partnering with the FBI in an ongoing nationwide
investigatory initiative called "Operation InvestNet," conducted through the
Financial Crimes Section of the Bureau's Economic Crimes Unit. The Commission
shares leads and information with FBI investigators, and provides training and
legal guidance to investigators and prosecutors on securities matters the FBI is
pursuing. n62
n62 See FED. BUREAU OF INVESTIGATIONS, SECURITIES AND COMMODITIES
FRAUD: A PRIMER, available at
http://www.fbi.gov/majcases/uptick/secprim.htm.
As the Internet program has evolved, criminal prosecutors at the state and
federal levels have demonstrated a strong willingness to prosecute securities
fraud over the Internet. Criminal prosecution involves four major categories of
cases: (i) market manipulation; (ii) offering fraud; (iii) insider trading; and
(iv) money management. Market manipulations cases comprise the bulk of on-line
prosecutions, numbering nine to date. n63 In all of these types of actions,
prompt, efficient and meaningful cooperative efforts clearly achieve results.
n63 See Richard H. Walker & David M. Levine, "You've Got Jail":
Current Trends in Civil and Criminal Enforcement of Internet Securities Fraud,
38 AM. CRIM. L. REV. 405, 410-415 (2001).
CONTINUING TRAINING PARTNERSHIPS
Commission staff have always maintained an active schedule of training sessions
for outside criminal and civil enforcement agencies. OIE staff have been regular
lecturers at the FBI training facility at Quantico, Virginia. For the past two
years, the Commission has sponsored yearly Internet Securities Fraud Training
Programs, which are attended, in person and via videoconference link, by more
than 600 representatives from a wide range of criminal and civil enforcement
agencies and self-regulatory organizations (SROs). These training efforts will
certainly continue, as will formal and informal liaison programs to insure that
all law enforcement remains up-to-date on the latest trends or development in
the securities-related Internet fraud arena.
ONGOING WORK WITH DOMESTIC CIVIL AGENCIES, SROS, AND FOREIGN SECURITIES
REGULATORS
In addition to its work with criminal authorities, the Commission intends to
continue its cooperation with civil enforcement agencies, such as the Federal
Trade Commission, and SROs, including the National Association of Securities
Dealers, Inc. and the New York Stock Exchange. The Commission is also active in
a number of interagency working groups designed to fight Internet fraud. n64
n64 The SEC participated with the FTC and several other civil and criminal law
enforcement agencies and cabinet departments, in the President's Working Group
on Unlawful Conduct on the Internet, a body that wrote a comprehensive report on
Internet fraud pursuant to executive order. In addition, the Commission is part
of the National Securities and Commodities Fraud Working Group. Its Internet
Securities Fraud subcommittee, co-chaired by the Commission and the FBI, is
designed to focus on issues relating to on-line fraud affecting the securities
markets. The SEC also is a member of the Telemarketing and Internet Fraud
Working Group, a joint effort by various state and federal law enforcement, tax,
and banking agencies to target unlawful financial, commercial, and securities
activity on the Internet. The Commission also works closely with the states and
the North American State Securities Administrators, Incorporated on an ongoing
basis to address fraudulent Internet activity.
The Commission also understands that cooperation cannot stop at our shores. The
Internet is inherently international and the SEC's Internet cases evidence a
growing incidence of overseas conduct. The Commission is undertaking initiatives
to help alleviate the problem of foreign-based Internet fraud, both by
establishing relationships with foreign regulators and systematically bringing
suspicious foreign-based conduct to their attention, and by participating in
training programs designed to help international regulators identify and target
securities frauds emanating from their countries. For example, the Commission's
Office of International Affairs offers a wide range of training and liaison
programs with foreign nations, including an annual Fall International Securities
Institute with delegates attending from more than fifty countries.
CONCLUSION
"Too bad she won't live, but then again who does?
"
The Commission is dedicated to ensuring that the Internet remains a valuable and
safe medium for investors. The Commission has now brought more than 275
Internet-related securities fraud actions, charging close to 930 individuals and
entities and there is no sign of a slowdown.
Of course, some of the same questions of four years ago still linger: Do we need
to rewrite the securities laws in light of the Internet's onslaught? Can the
SEC's Internet program reconcile its mission to root out fraud with the
cherished freedom endemic to an evolving and revolutionary medium like the
Internet? Only now, based on the Commission's track record in combating Internet
fraud, there may indeed be some answers to these critical questions.
First, it remains as true today as it was four years ago, that the SEC's
anti-fraud provisions serve the public quite well whether the violation occur in
a boiler room or a chatroom. n65 After more than 275 enforcement actions
charging more than 920 persons and entities, no SEC defendant or respondent has
ever prevailed by arguing that the anti-fraud provisions of the securities laws
(or any other provision of the securities laws) do not apply to conduct in
cyberspace. n66
n65 The same holds true for the investigation and civil prosecution of
securities violations committed over the Internet; the laws need not change,
only their application will need to evolve. The Division's traditional
firearms, embodied in the current Securities Act and Exchange Act, will likely
provide adequate legal bases for prosecuting Internet securities fraud. For
instance, the antifraud provisions of the section 10(b) of the Exchange Act
and Rule 10b-5 thereunder obviously would apply to any fraudulent
communication over the Internet, just as they apply to any information
communicated on paper, or over the radio or television.
Cella &
Stark, supra note 2, at 835. Of course, improving the securities
laws is always a goal of any Commission, and to the extent that any change in
the securities laws will benefit investors and other market participants such
changes will also likely result in similar benefits for the Internet program.
n66 Nor has any defendant prevailed by arguing that the First Amendment protects
those who perpetrate fraud in cyberspace. See e.g.,
SEC v. Park, 99 F. Supp. 2d 889 (N.D. Ill. 2000).
Second, the cherished freedoms of the Internet remain firmly intact despite a
vigorous SEC Enforcement program. By focusing its on-line enforcement efforts on
fraud, the Commission has reaffirmed the adage that neither the First Amendment,
nor any other law on the books, confers the right to lie, cheat, or steal from
investors. n67 In fact, by rooting out the small number of users who attempt to
pollute the Internet with fraudulent schemes, the Commission insures that
precious civil liberties remain firmly intact.
n67 Id.
Finally, e-commerce has clearly flourished because of, not in spite of, the
SEC's Internet Enforcement program. By launching an Internet program that makes
bringing the perpetrators of on-line fraud to justice a top priority, the
Commission has made the virtual streets safer (and thereby, more profitable) for
lawful on-line enterprises. From its inception, the point of the SEC's Internet
program was to act swiftly and forcefully and send the message to those
contemplating on-line scams that they had better think twice before doing so.
In fact, even if the perpetrated fraud has not involved major investor losses
(which many have not), n68 the Commission has still remained poised to act with
unequivocal resolution. The approach remains somewhat akin to New York City
Mayor Rudolph Giuliani's successful implementation of the "broken window theory"
during the early 1990s. Just like the New York City cops on the beat who would
not ignore petty, quality-of-life crimes, the Enforcement staff would similarly
not neglect petty, quality-of-cyber-life, securities frauds. In both instances,
such inaction only leaves ordinary citizens, or Internet users, concerned that
nobody is in charge and leads the bigger crimes, or on-line securities frauds,
to thrive.
n68 For example, the Commission has brought a slew of Internet-related actions
in which investor losses were not only minimal but even non-existent, such as
five of the actions in the May 1999 Internet fraud offering sweep. In those
sweep actions, the Commission initiated a pre-emptive strike, stopping a range
of sophisticated and potentially dangerous securities frauds before
investors lost a penny. See Press Release 99-49, supra note
43.
More than four years after the original
EnforceNet pronouncement described in this publication (which is probably
more akin to four decades ago in "Internet years") the Commission's hefty track
record in the area of Internet-related securities fraud prosecution not only
evinces that vigorous, robust and aggressive Internet enforcement efforts can
work, but also and more importantly, that when it comes to securities frauds,
policing the Internet is not just possible, it is proven.