SEC Enforcement and the Internet: Meeting the Challenge of the Next Millennium A Program for the Eagle and the Internet

By Joseph F. Cella III and John Reed Stark *
 
* Mr. Cella serves as Chief of the Office of Market Surveillance in the Division of Enforcement of the U.S. Securities and Exchange Commission. Mr. Stark serves as Special Counsel for Internet Projects in the Division of Enforcement of the U.S. Securities and Exchange Commission and is in charge of the Division's Internet Program; he also is an adjunct professor of law at Georgetown University Law Center. The U.S. Securities and Exchange Commission, as a matter of policy, disclaims any responsibility for any private publication or speech by any of its members of staff. The views expressed herein are those of the authors and do not necessarily reflect the views of the Commission or the authors' colleagues on the staff of the Commission. See 17 C.F.R. § 200.735-4(e)(1996). The authors would like to thank David P. Gionfriddo for his assistance in the preparation of this Article.


"WHAT WE'VE GOT HERE IS A FAILURE TO COMMUNICATE" n1

n1 All quotes cited in the section headings of this Article are from the film COOL HAND LUKE (Warner Bros. 1967), produced by Gordon Carroll, directed by Stuart Rosenberg, and starring Paul Newman.

That is, of course, for those who invest the old fashioned way. Since being hit by the tidal wave of information available through the Internet, investors can communicate as never before, reaching out and researching potential investments from the comfort of their own living rooms almost as easily and as comprehensively as the most astute, informed Wall Street insider. Instead of handing over their life savings for all of this information, they need only invest a small amount of capital.

Outfitted with a home computer, some software, a phone line, and an Internet access provider, the investor can visit the cyber-office of a potential investment and gather all sorts of important data and information. From detailed product designs and comprehensive financial statements to annual reports and earnings projections, the cyber-investor can review a wide range of known facts about a company, plus a whole lot more. On the Internet, the investor can even meet the owners of a company and learn about their vision first hand or, instead, choose to investigate a company by meeting its partners and employees, or even its competitors or customers. If an investor wants to find out what happened at a shareholders meeting or simply how many cars are parked outside a company's headquarters on a Sunday afternoon, the Internet might have the answers to these and other questions.

As for trading data, investors are linked through the Internet to a growing number of services that provide current stock quotations, price/earnings ratios, historical price and volume information, and a host of other empirical and analytical breakdowns. With the click of a mouse, users can custom design their own personal information superhighway and gather automatically all the information they need. In addition, with the growing popularity of bulletin board systems n2 (BBSs), newsgroups, and other cybermessage areas, the investor can talk with existing shareholders (both happy and disgruntled), former shareholders, short-sellers, analysts, brokers, venture capitalists, and just about any other type of securities professional, amateur, or neophyte.

n2 A BBS is a central system accessed using a computer, a modem, phone lines, or a network connection, where data is placed by users for dissemination to one or more other users. Technically, America Online is really just a gigantic BBS, although most BBSs are much smaller. DANIEL P. DERN, THE INTERNET GUIDE FOR NEW USERS 196-98 (1994).

How much does it cost for the investor to arrange all these meetings and gather all this research? The information itself is almost always free. So, other than ever-decreasing start-up costs of buying the necessary hardware, software, and access (from one of the estimated 1100 access providers in the United States), n3 unlimited information comes free of charge. That is quite a bargain.

n3 There are over 100 competing Internet service providers in the Washington, D.C. area alone, some charging less than $ 20 a month for all a user would need for complete and unlimited Internet access. Rob Pegoraro, The FFWD Directory of Internet Service, WASH. POST, Sept. 25, 1996, at R2.

The investor, though, is not the only one cheering. 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. Moreover, securities historically doomed to bathe in their own illiquidity and large bid and asked spreads, such as limited partnerships, thinly traded over-the-counter (OTC) "Pink Sheet" stocks, and other securities unavailable for purchase or sale in the traditional marketplace, now have unprecedented ways of increasing their trading volume. Whether through a pairing of a buyer and seller via a simple Internet BBS, or through a more complicated arrangement such as an online trading facility, promoters, buyers, and sellers can meet instantly and transact business at very little cost to one another.

In only a matter of years, the Internet will unquestionably serve as important a role as the telephone or fax machine does for today's investors. Unfortunately, however, as investors turn to the Internet as a source of information and guidance, and as a place where they can discover that golden investment opportunity, they will undoubtedly also encounter the dark side of the Internet. Inhabitants of the dark side, the crooks and thieves who are always on the lookout for a fresh scheme or a neoteric hook, will take advantage of the Internet to lie, cheat, steal, and spoil the boom for the rest of us. With the establishment of a new playing field in cyberspace, so also arrives more opportunities to rip-off unsuspecting investors for ill-gotten gains.

This is where the U.S. Securities and Exchange Commission (SEC or Commission) and its Division of Enforcement (Division) come in. The Division has prepared itself to remain effective tomorrow and tackle headon the problems the widespread use of the Internet will engender. Since its inception, the Division's program for the Internet has taken advantage of the Internet's growth and has approached new problems from all angles. Most importantly, however, the Division has sought no new enforcement statutes, regulations, or remedies to catch and prosecute securities violations committed over the Internet.

 
"I CAN EAT 50 EGGS"

The hype about the Internet is not all just hype, and we "ain't seen nothin' yet." The seemingly tall stories about the Internet's staggering growth and its increasing use as a tool for the investor (big and small) are true. Overall, Internet usage statistics continue to swell at a ferocious pace; depending on who you ask, the number of users reported from various sources range from thirty to sixty million (with ten to thirty million in the United States). n4 A recent survey conducted by Find/SVP and Jupiter Communications claims that the number of U.S. households with access to the Internet more than doubled to 14.7 million in 1996 and, as of September 1996, roughly nine million adult Americans logged onto the Internet daily, while nearly twenty million logged on weekly. n5 Predictions for the year 2000 run as high as 500 million, with some claiming that the number of users actually doubles every six to nine months. n6 Retail sales over the Internet are expected to skyrocket from $ 530 million in 1996 to $ 6.6 billion by the end of the decade. n7 Of course, as the numbers have expanded, the Internet itself has also grown in size, from a small network of computers born from a U.S. Department of Defense experimental network, n8 to a boundless cooperative message forwarding system linking computer networks all over the world.

n4 Andrew Kantor & Michael Neubarth, Off the Charts, INTERNET WORLD, Dec. 1996 at 45, 46-47; see also Nua Ltd., Internet Surveys (last modified Jan. 10, 1997) <http://www.nua.ie/surveys/1996graphs/USpopulation.html>.

n5 Jared Sandberg, U.S. Households with Internet Access Doubled to 14.7 Million in Past Year, WALL ST.J., Oct. 21, 1996, at B11.

n6 KENT D. STUCKEY, INTERNET AND ONLINE LAW, at xx (1996).

n7 Lisa Greim, Navidec Targets Net Commerce, ROCKY MTN. NEWS, Feb. 23, 1997, at 7F; Tim McCollum, Making the Internet Work for You, NATION'S BUS., Mar. 1997, at 6.

n8 STUCKEY, supra note 6, at xvi.

Online investing through brokerages has experienced corresponding dramatic growth. According to a study by Forrester Research Inc., a Cambridge, Massachusetts consulting firm, entitled "Brokers and the Web," Forrester predicts that the number of online accounts will grow from 1.5 million in 1996 to ten million by 2001. n9 According to the American Association of Individual Investors, thirty-three brokers now offer some form of online trading, up from twenty in 1996 and only twelve in 1995. n10 PC Financial had only 10,000 accounts in 1990. n11 After its hook-up with Prodigy, however, it has increased to over 275,000. n12 Charles Schwab & Co. has more than 170,000 online accounts and more than twenty-eight percent of its daily volume is attributable to online trades. n13 Online investors also tend to be more active, holding larger positions, making bigger trades, and enjoying better discounts trading through a computer than they could obtain by trading through a full-service broker. n14

n9 Kimberly Weisul, Report: New 'Mid-Tier' Brokers to Get 60% of On-Line Trades; From Zero to Sixty in Five Years, INVESTMENT DEALERS' DIG., Sept. 30, 1996, at 11. Forrester predicts that "'17% of wired households will be participating in the markets, managing over $ 524 billion in on-line accounts--8.5% of total retail investment assets.'" Id.

n10 Theresa W. Carey, Surf's Up, BARRON'S, Mar. 17, 1997, at 33.

n11 Gary Weiss, Online Investing, BUS. WK., June 5, 1995, at 64.

n12 PC Financial Network, Why PC Financial Network is # 1 (visited Feb. 20, 1997) <http://www.pcfn.com/pcfn/why1.htm>.

n13 Gary Weiss, supra note 11, at 64; email from Tom Taggart, Charles Schwab & Co., to Christopher Clark, Staff Member, The Business Lawyer (Feb. 26, 1997) (on file with The Business Lawyer, University of Maryland School of Law).

n14 Andrew Lackey, On-line services broaden options, FRESNO BEE, July 14, 1996, at C3; Martin Zimmerman, Fishing with the Net, DALLAS MORNING NEWS, July 2, 1996, at 13D.

Trading is no longer limited to stocks and related securities; Internet users can now even trade U.S. Treasuries online. Recently, Daiwa Securities America, Inc., brought its electronic trading system, known as The Odd-Lot Machine, to the World Wide Web (Web), enabling institutions to trade U.S. Treasuries over the Internet. n15 The first trade, for $ 1 million in two-year government notes, took place between Daiwa and First Union Capital Markets Group on August 30, 1996. n16

n15 Kimberly Weisul, First U.S. Treasury Trade Takes Place on Internet, INVESTMENT DEALERS' DIG., Sept. 16, 1996, at 15; Web Finance, News Stories (visited Feb. 20, 1997) <http://www.webfinance.net/brokerage/psaus47.html>.

n16 Weisul, supra note 15, at 15.

Currently, mutual fund families, including major players such as Fidelity Investments and Vanguard Group, use their home pages to educate consumers on specific types of funds, brokerage services, and the importance of savings. n17 In addition, investors are able to download prospectuses through these pages. Fidelity has even begun to roll out an Internet trading capability for its clients. n18 Recently, Twentieth Century Mutual Funds quietly began to allow customers to buy shares of its funds through the Web, even allowing customers to order electronic fund transfers from their bank into a mutual fund (and customers can use any bank they want). n19 Customers can also purchase mutual funds over the Internet through several discount brokers, including Charles Schwab & Co. and K. Aufhauser & Co. n20 In all, Forrester Research, Inc., predicts total assets handled through online mutual fund transactions will reach $ 173.5 billion in 2001; it was $ 41.9 billion in 1996. n21

n17 Fidelity Investments, Homepage (visited Feb. 20, 1997) <http://www.fidelity.com>; The Vanguard Group, Homepage (visited Feb. 20, 1997) <http://www.vanguard.com>.

n18 Bruce Rule, Fidelity Quietly Rolls Out Internet Trading Capability, INVESTMENT DEALERS' DIG.,Jan. 27, 1997, at 14.

n19 Kimberly Weisul, Mutual Fund Co. Becomes First to Offer Web Sales, INVESTMENT DEALERS' DIG., Sept. 30, 1996, at 10. The Twentieth Century Group is now American Century Investments. See American Century Investments (visited Feb. 22, 1997) <http.//www.american century.com/funds/twentieth century.html>.

n20 Charles Schwab & Co., e.Schwab Online Investing (visited Feb. 20, 1997) <http://www.schwab.com/SchwabNOW/SNLib003/SN003Bodyi.html>; K. Aufhauser & Co., Home Page (visited Feb. 20, 1997) <http://www.aufhauser.com>.

n21 Kathryn Haines, Fund Firms See Savings on Web Trades, WALL ST.J.,Jan. 2, 1997, at 35.

Although small investors often remain out of luck when it comes to getting in on the hottest initial public offerings (IPOs), the Internet has at least narrowed the gap in terms of access to information. For instance, IPO information, long considered unobtainable for the average investor, is now available on the Internet for anyone interested. n22 Moreover, a plethora of IPO-related sites, including the SEC's own EDGAR site, n23 provide basic and enumerated IPO information to users, all instantaneously and free of charge. n24

n22 Although any investor usually can receive IPO information by contacting an underwriter or other participating entity, the investor must first know about the offering, before it becomes oversubscribed, and would likely have to wait in order to receive the most recent information.

n23 U.S. Securities & Exchange Commission, EDGAR Database of Corporate Information (last updated Mar. 5, 1997) <http://www.sec.gov/edgarhp.htm>.

n24 Deborah Lohse, Want IPO Information? Try the Internet, WALL ST.J., Oct. 21, 1996, at C1.

Even insurers, such as Hartford Life Insurance Company and Massachusetts Mutual Life, have hopped aboard the "Cyber Express" with their own home pages. Their sites provide listings of financial products, interactive estate tax calculators, and a wealth of information incorporating financial and investment concepts. n25 Mutual fund and U.S. equities data is also now available through Morningstar's presence on services such as America Online (AOL) and Compuserve, both of which are Internet access providers and worldwide, subscriber-based electronic communications services. n26

n25 Hartford Life Insurance Co., Welcome to The Hartford (visited Feb. 22, 1997) <http://www.thehartford.com>; Mass Mutual, Home Page (visited Feb. 22, 1997) <http://www.massmutual.com>.

n26 Subscription information can be obtained from Wall Street Directory, Inc., on the Internet. See Wall Street Directory, Inc., Morningstar Mutual Funds--AOL (last modified Feb. 22, 1997) <http://www.wsdinc.com/products/p1659.shtml>.

Even more startling, though, along with the Internet's increase in popularity over the last several years, is that use of the Internet as a forum for discussion of investments has grown correspondingly. Prodigy, an Internet access provider, estimates that some fifty percent of its two million users access the financial forums and features, which puts investments in a tie with news as the service's second most popular feature. n27 Similar growth explosions have occurred on the Motley Fool Bulletin Boards of AOL and the Silicon Investor, as well as AOL's Investor's Network, n28 and the many popular and emerging publicly available Internet newsgroups, Web bulletin boards, and other online investment forums dedicated exclusively to investing, securities, and commerce.

n27 Weiss, supra note 11, at 64.

n28 See, e.g., The Motley Fool, The Motley Fool (visited Feb. 22, 1997) <http://fool.web.aol.com/index.htm>.

Digital legal tender is also rapidly becoming a reality and, given its inherent ease and efficiency (open for business twenty-four hours a day, 365 days a year), will make commerce on the Internet not just an option, but a necessity. Recently, the nation's two largest credit card associations, Visa and Mastercard International, Inc., announced an agreement on industry-standard software which they claim will allow consumers to buy goods over the Internet without fear that their credit card numbers will be stolen. n29 This could eventually alleviate the public's hesitation to send personal financial information pulsing through the wires of the Internet. DigiCash of Amsterdam, CyberCash of Virginia, ECash, smart cards such as the Mondex n30 system being consumer-tested in England, and other forms of virtual greenbacks are already a reality on the Internet, and continue to grow by leaps and bounds.

n29 Judith Evans, Who Was That Masked Cybershopper?, WASH. POST, Feb. 2, 1996, at Fl.

n30 Mondex is a joint venture of NatWest Bank, Midland Bank, and British Telecom formed to join the electronic cash game. MasterCard International recently said it would buy 51% of Mondex and promised significant investments to create a global electronic cash system. Valerie Block, MasterCard Will Buy 51% Of Smart Card Firm Mondex, AM. BANKER, Nov. 19, 1996, at 1.

 
"WELL SOMETIMES NOTHIN' IS A REAL COOL HAND"

Sometimes, however, investors get ripped off. Given the potential for scam artists to use the Internet to sell investors a "whole lot of nothin'," just what are the Division's concerns? At present, the Division can break its concerns down into six categories. Given the rapidly changing environment, however, no Internet worldview is set in stone. The Division, therefore, remains poised to shift its attention to any new problem area that arises.

THE OFFER AND SALE OF BOGUS INVESTMENTS

In light of the wide range of (largely unregistered) investment opportunities offered over the Internet, and, in particular, the opportunities peddled over the Web and newsgroups, the Division is well aware of the use of the Web as a convenient means for scam artists to steal from investors. Ranging from traditional securities like stocks and bonds, to more esoteric investment opportunities involving anything from eel farms, cattle breeding, and oil and gas drilling to cyber-casinos, multi-level marketing programs, and portable nuclear reactors, securities hawked over the Internet come in a huge variety of shapes and sizes. The SEC has brought a host of cases thus far involving offerings over the Internet (which will be discussed in more detail) and, given the popularity and ease of offering securities over the Web, combined with the sheer simplicity of using newsgroups, message areas, and other BBSs, the SEC will probably bring more of these cases in the future.

The Web is a hypertext based information and resource system for the Internet n31 and, as the fastest growing part of the Internet, it is most likely responsible for the amazing interest in the Internet itself. Each screenful of information includes menu choices and highlighted words through which the user can call up further information, either from the same computer or by linking automatically to another computer anywhere in the world. n32

n31 STUCKEY, supra note 6, at xvi.

n32 Id.

The popularity of the Web as a means of solicitation of investors is obvious: the cost and ease of producing and activating a sophisticated and impressive looking Web site n33 has changed dramatically, empowering the offeror. Not just for the plain vanilla home page of yesteryear, though; rather, investors are presented with sleekly designed, multipage Web sites that include all the latest bells and whistles such as search engines, interactive graphics, sounds, video, and futuristic looking formats and links. n34

n33 A Web site is the space on a server occupied by the information maintained by a company or individual. The information often occupies multiple "pages," the first of which is usually referred to as a "home" or index page because it guides the user through the information available at the site. See CRICKET LIU ET AL., MANAGING INTERNET INFORMATION SERVICES 309-10 (1994).

n34 A link is embedded in a Web page and enables a user to jump from one piece of information to a related item no matter where on the Internet the information may be stored. G. BURGESS ALLISON, THE LAWYERS GUIDE TO THE INTERNET 147-49 (1995).

Finding space on a server is easy and cheap; promoters of servers have become ubiquitous on the Web and in the telephone yellow pages. Many access providers even allocate to users free space for their own Web sites, in exchange for merely signing an access agreement. Moreover, countless software packages offer users simple and easy to follow instructions that make constructing a good looking Web site as easy as typing a word processing document. So, building the Web site is a breeze, hooking it up on the Web is a snap, and you need not be a programmer or technophile to succeed.

This is nothing less than an outstanding opening for the crooked securities solicitation. At very little cost and from the privacy of a basement office or living room, the fraudster can produce a home page that looks better and more sophisticated than that of a Fortune 500 company. Thieves have many tools at their fingertips; even a link can serve as an aid for an investment ruse. Just like visiting a site, using a link is usually free, so the fraudster might even provide a link to the home page of the SEC next to a representation that a particular security has received "approval" from the SEC or a link to a phony investment newsletter page (also owned and operated by the fraudster) which touts the investment as a tremendous investment opportunity.

Newsgroups are popular message areas that form part of Usenet. n35 Usenet is a group of systems that exchange debate, chat, and discussion in the form of newsgroups across the Internet. n36 BBSs, however, serve as message boards, where users can post messages, typically to solicit a reply or to comment on a prior message. n37 Message boards, cheap, easy to use, and potentially reaching millions of users, provide a great tool for offering securities. Recent reports have identified as many as 23,000 newsgroups (although some Internet service providers only carry between 10,000 and 20,000 newsgroups). n38

n35 Usenet actually stands for Users Network, a collection of discussion groups on almost any subject of interest to people, including investment and business opportunities. One should note, however, that in Usenet participants can maintain anonymity or disclose as much personal information as they desire.

n36 DERN, supra note 2, at 196-98.

n37 Id. at 36.

n38 Rob Pegoraro, Input/Output, WASH. POST, Oct. 30, 1996, at R2.

Although message areas provide a fantastic opportunity to match the small investor with the unknown small company located thousands of miles away, no doubt there are those who will exploit these message areas as a fast and easy way to find a credulous investor and divorce them from their savings. Message boards exist on the Web and throughout the Internet that are specifically designated for postings from promoters who seek investors in search of less traditional investments, such as those not traded on an exchange or thinly traded in the OTC markets or listings. Posting a message, such as a solicitation for investors in a new company, like everything else on the Internet, costs next to nothing. In fact, in most cases, it is as simple as sending an email message. Moreover, the Internet also hosts hundreds of classified advertisement areas exclusively dedicated to investment opportunities.

So, when a scam artist seeks an investor who might be particularly vulnerable to promises for easy money, he or she need look no further than a message board specifically tailored for those who want to "Make Money Fast" or a classified advertisement area such as "Get Rich Quick." (These are actual titles, available to just about every Internet user.)

Whether a posting or Web page on the Internet would fall within the purview of the federal securities laws depends on a number of factors, including whether the instrument of capital formation qualifies as a "security" under applicable definitions, whether the particular electronic communication constitutes an "offering," or whether the offering falls under an applicable exemption from registration. Under the modified Howey test, among the "investment opportunities" that have qualified as securities have been orange groves, Ponzi and pyramid schemes, and ostrich and eel farms. n39 Internet offerings will no doubt force the courts continually to reapply the Howey test to novel situations.

n39 See SEC v. W.J. Howey Co., 328 U.S. 296 (1946); SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974) (pyramid scheme); SEC v. Goodman, Litigation Release No. 15,079, 62 S.E.C. Docket (CCH) 2668 (Sept. 27, 1996) (ostriches); SEC v. Odulo, Litigation Release No. 14,616, 60 S.E.C. Docket (CCH) 120 (Aug. 24, 1995) (eels).

Other issues would include whether the manner of an Internet solicitation's "public dissemination" satisfied legal requirements. Online communication links cut across geographical borders and could result in issuers violating securities laws by transmitting offering documents into states where the issuer had failed to satisfy blue sky requirements. Spring Street Brewing Co., a New York microbrewery and believed to be the first issuer to offer securities through a formal online prospectus, faced this problem when it won specific approval from the SEC to market its $ 5 million IPO over the Internet last March. n40 Its solution was to include on the electronic offering document a warning specifying the states in which the offer was valid. n41

n40 Spring Street established a home page on the Web which allowed potential investors using the Internet to examine and download its offering documents. Spring Street Brewing Co., Homepage (visited Mar. 19, 1997) <http://plaza.interport.net/witbeer>. Spring Street's IPO qualified as a Regulation A offering (i.e., the total amount to be raised by the offering was under $ 5 million) and was therefore exempt from SEC registration. Regulation A, 17 C.F.R. § 230.251 (1996). Nonetheless, the offering was registered in 18 states and the District of Columbia.

n41 Spring Street Brewing Co., WIT BEER Public Stock Offering (visited Feb. 20, 1997) <http://plaza.interport.net/witbeer/wit 5.html>; see also Spring Street Brewing Co., SEC No-Action Letter, 1996 SEC No-Act. LEXIS 435 (Apr. 17, 1996).

Although courts may consider viewing a document on the Web or Usenet as a de facto public offering or solicitation, offers made in a chat room by one user to another, offers made via private emailings, or offers conducted on a bulletin board for exclusive use may create questions about how "public" an offering is or raise issues about whether a user actually made an "offer" at all. n42 Email presents a particularly sticky situation as it can either be one-to-one or one-to-many (as is the case with "listservs" or mailing lists, which send messages to a finite subscriber group), n43 and still remain "private" as the information is not intended to go beyond the designated recipients. Sometimes, however, the sender wishes to send an email for the world to see, like a posting to a Web site, a file transfer protocol (FTP) n44 site, or a Usenet group.

n42 In some SEC investigations, promoters defend themselves by saying that the Web page announcing the offering of securities was merely a vehicle to demonstrate the promoters' online expertise. In such cases, SEC staff must use both online (newsgroup posts, listings on Internet search engines) and conventional communications to establish the promoters' scienter.

n43 DERN, supra note 2, at 131.

n44 FTP stands for File Transfer Protocol Service, which allows the transferring or copying of files from one computer to another. Users and organizations can make information available to the public over the FTP and remain anonymous.

The promoters of unregistered Internet securities offerings often show little concern for the mandates of federal securities law. A company called "Pocket Made Inc.," which planned to introduce a "revolutionary automated cleaning device for which it has patent rights," recently posted newsgroup messages seeking to raise capital online. n45 Was the offering registered with the SEC? According to a recent report, no, and the offering's promoter seemed strangely nonchalant:

 
"In a sense it was not legal, but the SEC will never enforce it," says Bill McAninch [vice president of operations, secretary, and treasurer of Pocket Made]. "Basically ... we were advised not to panic, that the government understands that it's not legal but never has prosecuted anybody. They deliberately ignore low-level violations." n46

n45 Gary Weiss, supra note 11, at 70.

n46 Id.

Mr. McAninch may indeed change his tune nowadays, however, given that the SEC has brought at least nine cases thus far involving offerings over the Internet. n47 Further, given the popularity and ease of offering securities over the Web, combined with the sheer simplicity of using newsgroups, message areas, and other BBSs, the SEC will probably bring more of these cases in the future. Past cases were brought under the antifraud provisions of the Securities Act of 1933 (Securities Act) n48 and the Securities Exchange Act of 1934 (Exchange Act), n49 specifically, section 17(a) of the Securities Act, n50 and section 10(b) and Rule 10b-5 of the Exchange Act. n51

n47 See infra text accompanying notes 97-122.

n48 15 U.S.C. §§ 77a-77aa (1994 & West Supp. 1997).

n49 Id. §§ 78a-78ll.

n50 Id. § 77q(a) (1994).

n51 Id. § 78j(b); 17 C.F.R. § 240.10b-5 (1996).

In the area of disclosure issues, the SEC's Division of Corporation Finance addressed, in a no-action letter, certain practices by an entity called IPONET. n52 IPONET involved a registered "dealer," who, vis-a-vis the IPONET Web site, wanted to solicit investors and determine if the investor is an "accredited investor" within the meaning of the standards of Regulation D. n53 After such a determination, the dealer would then allow the accredited investor access to a list of Regulation D offerings set forth on the IPONET Web site.

n52 IPONET, SEC NO-Action Letter, 1996 WL 431821 (S.E.C.) (July 26, 1996).

n53 17 C.F.R. §§ 230.501-508 (1996).

The SEC granted IPONET's request, stating that indications of interest may be accepted by an electronic "coupon" or "card" that are sent directly from a home page or independently via email if the requirements of Rule 134(d) are otherwise met. n54 The no-action letter also required that, in accordance with Rule 502(c) of Regulation D, the posting of a notice of a private offering should only be accessible by IPONET members, who would have to qualify as accredited investors. n55

n54 IPONET, 1996 WL 431821 (S.E.C.), at *5.

n55 Id. at *6.

MARKET MANIPULATION

In addition to the offer and sale of securities over BBSs, the posting of information pertaining to particular securities over BBSs has become a critical source of information for the entire range of market participants, from the small investor to the multi-billion dollar mutual fund manager. A user can easily find information and postings on individual securities using a Usenet search engine to navigate the Internet newsgroups and review all postings concerning an individual security. Even easier is searching the contents of access-provider BBSs and dedicated Web forums, where the user can find information and postings on a particular security by simply reviewing the contents of a folder exclusively dedicated to that security. Postings describe everything from first-hand reporting of the discussions at a public company's annual shareholders meeting to whether the steak the Chief Executive Officer (CEO) had for dinner the night before was done rare or medium-well.

The sheer volume of messages contained in BBSs pertaining to individual stocks (in particular the BBSs of access providers) has grown considerably over the last year or so, mandating that market participants such as brokers, analysts, and short sellers monitor carefully all relevant message areas for the latest news. The word is out on the street that stock information posted over a BBS can, within minutes of a posting, influence the price of a stock or group of related stocks.

Along with such a tremendous flow of important information comes again the opportunity for exploitation by the unsavory. Stockholders, both short and long, now can reach millions of people instantly (at very little cost) and use false information to attempt to manipulate the price of a stock. Two methods in particular can serve the crook as a means of fooling the legitimate investor.

The first method is the cloaking of an author's true identity by false pretense or anonymity. In the simplest case, a user merely disguises himself, for example, by falsely proclaiming to be an insider of a public company while actually being an investor having a short interest in that company's stock. In the more sophisticated instance, the user sends postings via a "remailer" or other "anonymizing" tool n56 which provides anonymous email addresses to users who wish to hide their true identities. Anonymizing tools strip the identifying information from the message "header" when sending a message, removing any possible audit trail of the message. n57 One can procure the services of an array of anonymity tools over the Internet, with little effort and at little expense. n58

n56 Andre Bacard, Anonymous Remailer FAQ (last modified Nov. 15, 1996) <http://www.well.com/user/abacard/remail.html>.

n57 Id.

n58 The Surfing Lawyer, Email: Issues and Software (visited Feb. 22, 1997) <http://www.netlegal.com/email.html>.

The second method, even more disturbing than the first, is altering or falsifying emails, commonly called "spoofing." Spoofing involves the use of the identity or user ID of a real person for the purposes of impersonation. n59 Contrary to popular belief, email is far from private; if someone wants to read your email or newsgroup posting, or if someone wants to alter it, "spoof," or "forge" it, there exist many ways to do so. For example, when a user sends a message across cyberspace, a spy program called a "packet sniffer" can monitor your keystrokes, allowing a cracker n60 to read what you type and use that information to create a bogus posting that appears to be from you. n61 A nefarious system administrator might read your mail as it sits in a spooler waiting for delivery or as its sits in the newsgroup waiting to be read. An unscrupulous user on any of the series of other mail-routing computers might intercept your mail, alter it, and send it on, or may simply steal user information for a future plot of impersonation.

n59 DERN, supra note 2, at 378.

n60 Some confusion exists with respect to the terms "hacker" and "cracker." Hackers are those whose lives are completely immersed in computers and computing. Crackers, on the other hand, focus on illegal activity. Id. Though crackers often call themselves hackers, the genuine hacker considers crackers a lower form of technophile.

n61 Computer Network Security, Eavesdropping (visited Feb. 22, 1997) <http://www.weru.ksu.edu/people/dudley/SECURITY/Security.html>.

These are just a few of the ways a swindler can get the information of a bona fide user, such as an official at a public company, and then create a posting from that bona fide insider to manipulate the stock. Thus, even if a user knows the identity of the named author of a particular posting, and trusts that person as a worthy and credible source of information, the author may not actually be that person; the writer may, in fact, be a crook who has used a packet sniffer to steal a legitimate user's identity. Like cat burglars who creep in without ever being seen, stock manipulators can steal an identity and make it their own, only the cyber-cat burglars need not climb up the drain pipe for a break-in or even don ski masks to hide their identities.

Overall, BBSs offer investors, particularly small investors in small towns, access to some of the same information as a Wall Street analyst. Given the potential lack of credibility and overriding lack of integrity of a posting, however, an investment decision based on a posting could lead to disaster.

What exacerbates this concern is the remarkably benevolent culture and trustworthy nature of Internet users. Do you have a medical problem? Post a message on a medical advice newsgroup and you will receive a range of responses from patients to nurses to doctors, all wanting to help you get better. Are you traveling to a foreign country? Post a message asking for suggestions and you will receive a range of responses from fellow travelers telling you everything from the best hotel (and its best room) to the best nearby restaurant (and its best dessert). In the realm of investments, this overwhelmingly helpful and endearing feature could turn into a nightmare for the trusting investor who gets hoodwinked into taking the advice of a perfidious short seller.

Several sections of the Exchange Act could directly prohibit the manipulation of securities prices through the dissemination of false or misleading information over BBSs and newsgroups, including section 9(a)(2), n62 section 9(a)(3), n63 section 9(a)(4) n64 and, of course, section 10(b) n65 and Rules 10b-5 n66 and 10b-1. n67

n62 15 U.S.C. § 78i(a)(2) (1994). Section 9(a)(2) provides a very broad prohibition on the manipulation of a market for a security, making it unlawful for any person

 
to effect, alone or with one or more other persons, a series of transactions in any security registered on a national securities exchange creating actual or apparent active trading in such security or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.

Id.

n63 Id. § 78i(a)(3). Section 9(a)(3) addresses indirect manipulation by third parties, such as agents paid by market participants, who manipulate the prices of securities by broadcasting false or misleading information, specifically making it unlawful for

 
a dealer or broker, or other person selling or offering for sale or purchasing or offering to purchase the security, to induce the purchase or sale of any security registered on a national securities exchange by the circulation or dissemination in the ordinary course of business of information to the effect that the price of any such security will or is likely to rise or fall because of market operations of any one or more persons conducted for the purpose of raising or depressing the prices of such security.

Id.

n64 Id. § 78i(a)(4). Section 9(a)(4) prohibits any broker, dealer, or other person, selling or offering for sale, or purchasing or offering to purchase, a security registered on a national securities exchange from inducing the purchase or sale of a security by means of any statement that was, in light of the circumstances under which it was made, false or misleading with respect to any material fact, and which he knew or had reasonable ground to believe was false and misleading. Id.

n65 Id. § 78j(b). Section 10(b) prohibits the

 
use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

Id.

n66 17 C.F.R. § 240.10b-5 (1996).

n67 Id. § 240.10b-1. Rule 10b-1 prohibits the use of such manipulative or deceptive devices or contrivances with respect to certain securities exempt from registration. Id.

To date, the SEC has brought several cases in which the issuer involved experienced a lot of "Usenet hype," with the most definitive market manipulation case being SEC v. Charles O. Huttoe. n68

n68 SEC v. Huttoe, Litigation Release No. 15,153, 63 S.E.C. Docket (CCH) 427 (D.D.C. Nov. 7, 1996). See infra notes 97-122 and accompanying text for a discussion summarizing all SEC Internet-related cases to date.

ONLINE TRADING FACILITIES

To date, the most innovative mechanism that has developed on the Internet's entrepreneurial platform falls within the realm of Internet trading of securities, specifically in the form of Internet trading by a company of its own stock and Internet trading facilities. These areas represent a tremendous opportunity for businesses and investors alike. A business can use the Internet as a cost-effective forum to reach more and more investors hungry for something new and different, while an investor can find liquidity for an investment and even find relief from the traditionally large and seemingly random bid and asked spreads on thinly traded stocks.

Whether cyberspace will become a mere medium for capital formation, or a jurisdiction unto itself, remains unclear at this time. Whether investors need protection from knave operators of such novel instruments of the capital formation process, however, has never been clearer. Although innovation and creativity have made U.S. securities markets the most efficient capital formation system in the world, careful and thoughtful government intervention from entities such as the SEC has ensured that U.S. markets also have the highest level of integrity and safety.

Of course, the SEC and the Division should not discourage such modernization but rather ferret out the abuses while offering assistance and guidance to the pioneers of the securities markets. In that vein, companies involved in the offering and trading of securities over the Internet must provide the same customer protections and capital safeguards often taken for granted in the context of the traditional trading of securities, such as with a registered U.S. exchange.

As with traditional exchanges, these protections should mandate that (i) investors' funds and securities be handled appropriately, (ii) investors understand the risks involved in purchasing the often illiquid and speculative securities that are traded over the Internet, (iii) buyers be made aware of the last sale prices on a particular stock, and (iv) companies provide ongoing and adequate disclosure. Overall, entities providing exchange-like services must carefully handle access to, and control of, investor funds to provide all users with adequate protections.

With respect to merely trading in the securities of one's own company or operating an online trading facility, an operator could trigger other registration requirements of the federal securities laws, such as those contained in section 19 of the Exchange Act. n69

n69 15 U.S.C. § 78s.

In addition, other related registration requirements may emerge when participating in the operation of an online trading facility. For example, when an issuer holds and maintains funds, securities, and accounts of investors, the issuer may be required to register as a broker-dealer under section 15 of the Exchange Act. n70 Even users of an Internet trading facility should understand that, if they choose to post quotations simultaneously on both its Buyer and Seller bulletin boards, the users could be considered "dealers," required to register and comply with broker-dealer requirements under section 15 of the Exchange Act. n71

n70 Id. § 78o(a).

n71 Id.

The SEC has issued four important no-action letters in this area, pertaining to PerfectData Corporation (PerfectData), Real Goods Trading Information (Real Goods), the Flamemaster Corporation (Flamemaster), and Angel Capital Electronic Network (Angel Capital). n72 PerfectData, Real Goods, and Flamemaster essentially sought to offer shareholders the opportunity to meet on a Web page and identify themselves as viable buyers or sellers of the issuer and potentially trade shares with each other. The crux of the SEC's position on this issue is that the issuer should have no proprietary, financial, or other interest in the operation of the Web page. n73 The Web site is simply a place where investors can meet, like a rented room at an annual meeting or an office inside a company's headquarters.

n72 Flamemaster Corp., SEC No-Action Letter, 1996 WL 762990 (S.E.C.) (Oct. 29, 1996); Angel Capital Electronic Network, SEC No-Action Letter, 1996 WL 636094 (S.E.C.) (Oct. 25, 1996); PerfectData Corp., SEC No-Action Letter, 1996 WL 480429 (S.E.C.) (Aug. 5, 1996); Real Goods Trading Corp., SEC No-Action Letter, [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) P 77,226, at 77,131 (June 24, 1996).

n73 Real Goods Trading Corp., [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 77,134.

With respect to Angel Capital, the staff of the SEC's Division of Market Regulation responded to a request from the U.S. Small Business Administration, stating that it would not object to the operation of the Angel Capital network if the nonprofit operators of the network do not register as an exchange, a broker-dealer, or an investment advisor. n74 The network is an Internet Web site that will allow accredited investors to gain access to small businesses whose shares are exempt from registration under Regulations A or D. n75

n74 Angel Capital Electronic Network, 1996 WL 636094 (S.E.C.), at *8-*9.

n75 17 C.F.R. § 230.251-263 (1996); id. §§ 230.201-508.

As with the early phases of any new trading facility, online Internet trading facilities will undoubtedly experience a rocky and uncharted genesis and the opportunity for manipulations, such as the popular "pump and dump" schemes of the 1980s and 1990s, will certainly arise. Online trading facilities raise critical issues regarding security, broker-dealer, exchange, and transfer agent registration, interdealer quotation system, and manipulation issues. The Commission must mandate that any operator of an Internet trading facility take prudent steps to address its regulatory concerns and also to deter manipulations by unprincipled promoters and broker-dealers.

SPAMMING

As investors begin transacting business over the Internet, inevitably, they will find it in their own self-interest to reveal more and more about themselves in order to allow the interactive systems to cater more effectively to their needs and preferences. Already users disclose a wide range of information on the Internet, from business requirements to leisure interests.

Sometimes, these disclosures are carried out intentionally by completing a survey or providing registration information, and sometimes such disclosures are done without the user even knowing it, like when sending a posting to a particular newsgroup. For example, using a practice called "mining," a user can collect all the email addresses from a particular newsgroup by operating a fairly simple automated software mining program. n76 The user can then publish such information on a directory site where anyone can retrieve it or keep the information for private application.

n76 Leslie Miller, Cashing in on Web Treasure: Personal Data, USA TODAY, Dec. 12, 1996, at D10.

Mining is only the tip of the iceberg; the Internet is not like radio, cable television, or any other traditional medium: it is a two way hook-up. Communication's technology on the Internet is interactive, meaning that information is constantly flowing in two directions, and an extraordinary long and unknown arm reaches into the office and into the living room through the Internet. For example, consider "cookie" files: files that are written onto a user's hard drive during visits to cookie-compatible Web sites. These cookies are not the kind found on a dessert tray; these cookies allow a particular site to track the activities of a user by recording details of that user's previous visits to the site. n77 A cookie file is created at the behest of the Web server but maintained automatically by a user's personal computer. n78

n77 See Kim Komondo, C is for Cookie, COMPUTER LIFE, Jan. 1, 1997, at 193.

n78 Zina Moukheiber, DoubleClick is Watching You, FORBES, Nov. 4, 1996, at 343.

The details recorded by cookie files include the date and time that a user visited a site or the user's "click stream," which is a user's history of what the user has viewed on the Web. n79 The cookie could possibly collect even more personal information like a user's address and phone number. n80 Some even argue that a Web site operator could design a cookie file that would "snoop through a user's hard drive, looking for something that resembles a Social Security number or a bank balance." n81

n79 Id.

n80 Id. at 344.

n81 Id. at 342. Browser software may alert a user that a Web page has "dropped a cookie on them," but the user never learns the purpose or extent of the cookie file. Id. at 343.

Despite the "Big Brother" inferences, the ability to collect such crucial research information can prove instrumental for a company when planning its future growth and development, and can bring the consumer and the business closer together for a mutually beneficial purpose: profit for the corporation and satisfaction for the customer. n82 Unfortunately, here is the bad news: the most critical piece of consumer information, the user's email address, now becomes part of the public domain, and that could lead to unforeseen intrusions and abuses. Moreover, other sites can look at one's cookie file, get information about a user's Internet provider and his or her Internet protocol address, and compile some surprising information about a user, ranging from what part of the country a user lives in to the resolution of the user's monitor. n83 The cookie file might even indicate the last site a user visited and which browser the user utilized at the time. n84

n82 For example, DoubleClick, Inc., an Internet advertising broker in New York, has amassed profiles on 10 million anonymous Web users simply by tracking people's Web behavior, Internet addresses, operating systems, browsers, and Internet-service providers. Id. at 342-43.

n83 Id.

n84 Id.

This is how a company, albeit unknown to the user, knows all about the user's habits and, most importantly, how to reach the user. So, in addition to receiving junk mail claiming that the recipient has just won $ 1 million, and answering annoying phone calls peddling the latest get rich quick product or service or the knock on the door from the traveling salesman, the user can now expect the beep notification of an email from the friendly neighborhood Internet "spammer."

Spammers, who practice their art by transmitting a message to an email list, combine the skills of mass mailers with the hard-pressure sales tactics of "boiler-room cold-callers." n85 Perhaps the spammer pulls a list of users from newsgroups catering to investors and then hits them with the latest news about the hottest new investment, directing the recipient to a Web site or simply offering an 800 number. With very little effort of time or money, the scam artist can reach an unlimited number of potential victims, and contact them over and over again at little additional cost.

n85 Internet lore has it that the term "spam" derives from a famous Monty Python skit which featured the word spam repeated over and over. The term may also have come from someone's derision of the eponymous generic processed meat product, which some perceive as lacking in substance or content. (Spam is a registered trademark of Hormel Corporation.)

Of the complaints received by the Division relating to the Internet, complaints about spamming in connection with investments rank first. Until laws are on the books to deter spamming, Internet spammers have free rein to send information about bogus investment products to anyone with a modem, whether they like it or not.

UNREGISTERED INVESTMENT ADVISERS AND INVESTMENT NEWSLETTERS

With the proliferation of all sorts of goods and services offered over the Internet, investment advisers peddling their services have not lagged far behind; just about every type of investment adviser has sprouted in cyberspace. Although the original drafters of the Investment Advisers Act of 1940 (Investment Advisers Act) n86 probably never contemplated the cyberspace investment adviser, the provisions of the Investment Advisers Act appear flexible enough to ensure its safeguarding provisions (disclosure, record-keeping, and other customer protections) apply equally to Internetrelated activities.

n86 15 U.S.C. §§ 80b-1 to -21 (1994 & West Supp. 1997).

Under certain circumstances, a person or entity acting as an "investment adviser" could trigger certain registration requirements of the federal securities laws. n87 Section 203(a) of the Investment Advisers Act generally makes it unlawful for any "investment adviser," unless registered, to use any means of interstate commerce in its advisory business. n88 The Investment Advisers Act also requires investment advisers to maintain certain books and records, which are subject to periodic SEC examinations, n89 and makes it unlawful for "any investment adviser" (whether or not registered) to engage in fraudulent activities. n90

n87 The Investment Advisers Act defines the term "investment adviser" to include

 
any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.

 
Id. § 80b-2(a) (1994). Any person or entity that satisfies these criteria must register under the Investment Advisers Act, unless an exemption applies. Id. § 80b-3(b) (1994 & West Supp. 1997). The most significant of these exemptions relate to banks and holding companies, brokers or dealers, and publishers of bona fide newspapers, magazines, and other publications of general and regular circulation.

n88 Id. § 80b-3(a) (1994); 17 C.F.R. § 275.204-3 (1996). The written disclosure statement required may be either a copy of Part II of the Adviser's Form ADV or a written statement containing the information required in that part of the form. Id.

n89 15 U.S.C. § 80b-4; 17 C.F.R. § 275.204-2.

n90 15 U.S.C. § 80b-6.

On a related note, the proliferation of investment newsletters over the Internet has also grown considerably in the last few years. Again, like other innovations, this creates a real windfall for investors as they can use the Internet to research the opinions of others who may have significant experience or better knowledge about a particular company. Moreover, investment newsletters serve an important role for many market participants and can significantly impact the price of a publicly traded company's stock with a glowing tribute or scathing condemnation.

Merely because the investment newsletter is circulated in cyberspace, however, does not create an automatic exemption from the federal securities laws for its authors. For example, section 17(b) of the Securities Act could prohibit a user from posting certain promotional information and opinions concerning a security in an investment newsletter without also disclosing the nature and substance of any consideration received from the issuer of the company underlying that security. n91

n91 Id. § 77q(b). Specifically, § 17(b) of the Securities Act states that:

 
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 amount thereof.

 
Id. (emphasis added).

In the SEC's case against Systems of Excellence (SOE), n92 one of the most serious allegations concerned violations of section 17(b) by SGA Goldstar (SGA), an investment newsletter with wide dissemination over the Internet. The SEC accused SGA of receiving bribes from certain defendants, including SOE, to tout SOE stock to SGA's subscribers. n93 The use of an online newsletter as a co-conspirator for a manipulation scheme can have serious ramifications, not only by duping trusting investors but also by jeopardizing the integrity of important financial markets.

n92 SEC v. Huttoe, Litigation Release No. 15,185,63 S.E.C. Docket (CCH) 1011 (D.D.C. Dec. 12, 1996).

n93 Id. This case is discussed in more detail infra text accompanying notes 119-22.

OFF-SHORE BROKER-DEALERS AND OTHER FINANCIAL SERVICE ENTITIES

International financial service entities such as foreign brokers, dealers, and investment advisers continue to enter the cyberarena, offering Web sites along with some interactive services for potential clients and customers. From their home countries, they vend their services to U.S. investors without ever crossing the border. Although these entities may indeed be wholly legitimate in their own countries, their actions may still trigger U.S. registration requirements.

For instance, take the case of offshore broker-dealers; many have already settled onto the Web, providing glossy and sophisticated sites describing their operations and customer service record. Some have even succeeded in aligning themselves next to legitimate U.S. broker-dealers on Web sites that provide classified listings of all available brokers and dealers. Bearing in mind that these brokers and dealers may have never landed on U.S. soil and may not have even ever picked up a telephone to solicit U.S. customers, they still might be violating the federal securities laws. Overall, Exchange Act Rule 15a and its provisions carefully regulate the activities of foreign broker-dealers in the United States and provide a very thorough and demanding list of requirements that pertain to the conduct of business by foreign broker-dealers with U.S. persons. n94

n94 17 C.F.R. §§ 240.15a-2 to -6 (1996).

Specifically, the Exchange Act makes it unlawful for any broker or dealer (including any foreign broker or dealer) to make use of any jurisdictional means to effect any transactions in, or to induce or to attempt to induce the purchase or sale of, any security unless such broker or dealer is registered with the SEC. n95 The SEC interprets this registration provision broadly. In the SEC's view, this provision could require registration by a broker-dealer operating outside of the United States, using only U.S. mail or telephone lines to trade securities with or for U.S. persons located in the United States, n96 or possibly a foreign broker-dealer whose only U.S. contacts are the execution of unsolicited orders from U.S. customers. n97

n95 15 U.S.C. § 78o(a)(1) (1994).

n96 Registration Requirements for Foreign Broker-Dealers, Exchange Act Release No. 27,017, 54 Fed. Reg. 30,013, 30,016 n.41 (July 11, 1989).

n97 Id. at 30,017 n.52.

The same could also hold true in the case of foreign investment advisers. Depending on the services offered or rendered, the foreign entity may have to meet the requirements previously outlined and could violate these provisions even if wholly legitimate within its own borders.

With respect to the violations of the antifraud provisions of the federal securities laws by international entities, the entire area has become a massive can of worms. Given the many problems associated with investigating and prosecuting offshore entities, from serving subpoenas to locating assets to extradition, international authorities must work together, using present treaties, memoranda of understanding, and other formal and informal international agreements.

 
"WELL, I AIN'T HEARD THAT MUCH WORTH LISTENIN' TO. . . . JUST A LOT OF GUYS LAYIN' DOWN A LOT OF RULES AND REGULATIONS"

Before examining what the Division is doing about the previously raised concerns, it is important to note what the Division is not doing: the SEC has sought no new statutes, regulations, or rules to help protect Internet investors. Moreover, congressional intervention appears unnecessary. The swindles over the Internet are no different from the confidence games of the past; the only difference is the medium. Thus, present antifraud weapons will more than suffice.

Historically, the SEC has responded quickly to evolving markets and changing industry practice, such as the foreign payments program, the insider trading program, the municipal securities program, and the recent posture on derivatives cases. n98 Each program shared a common theme: a commitment to protect the investor from illicit, unethical conduct within a developing legal area. Most importantly, none of the programs required any new law, rule, or regulation for successful implementation.

n98 See generally William R. McLucas et al., Common Sense, Flexibility, and Enforcement of Federal Securities Laws, 51 BUS. LAW. 1221 (1996).

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 n99 and Rule 10b-5 n100 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.

n99 15 U.S.C. § 78j.

n100 17 C.F.R. § 240.10b-5 (1996).

Now, having said all of the above, just what is the Division doing? Like all other prior Division programs, no single method of attack against Internet securities fraud will be sufficient; what is needed is a multifaceted approach.

SURVEILLANCE

With the many changes in technology and markets, surveillance at the Division has always remained in a constant state of flux and revision. Naturally, as the Internet has grown, the Division and other areas of the Commission have correspondingly beefed up surveillance activity, assigning staff members to monitor the Internet, especially the Web and message areas like the newsgroups and bulletin boards. The Division has all the necessary commercial online access accounts, employs the latest browsing software for viewing the Internet (such as Netscape and Microsoft Internet Explorer) together with the powerful hardware necessary to do the job right (such as Pentium processors). The Division even has certain designated T1 lines n101 for direct Internet access. The surveillance program has grown sophisticated and detailed, while technological advances allow some automation of surveillance.

n101 T1 lines grant access at 1500 bits per second (more than 50 times faster than the average high-speed modem which transfers only 28.8 bits per second).

It is never wise to tip off the scam artists about methods of surveillance; suffice it to say, the Division will find most of the fraud, wherever it may lie. Of course, given its infinite territory, no program can guarantee to cover every nook and cranny. Unlike traditional thieves, however, Internet grifters typically face a double-edged sword: they want the investor to find their materials with ease but they also want to keep the federal authorities from noticing their activities. They want investors to contact them, but they also want to hide their identities and location. When they surface, which they usually must do sooner or later, the Division's surveillance, or surveillance by others, will detect them.

The Web has also become more organized, as search engines have begun to catalog services, such as investment offerings and Internet exchanges. Even Web pages designed to organize other Web pages have cropped up. Moreover, navigation has also become far simpler and more comprehensive, and will continue to get better in the future.

As with all other securities-related fraud, staff attorneys in the Division are also encouraged to investigate anything they believe to be suspicious, whether during office hours or at home. Whenever confronted with a suspicious offering or other potential securities violation, the Division staff attorney (with the acquiescence of his or her supervisor) can initiate an informal investigation immediately. In fact, staff attorneys are encouraged to keep their eyes and ears open at all times, just like the cop on the beat, whose responsibilities do not disappear while off-duty. Staff attorneys who have no Internet familiarity can receive Internet training at work and patrol the Internet whenever they have the time. The only restriction is that the Division cannot participate in any undercover operations and, before communicating with any potential witness, staff persons must identify themselves, state their principal purpose for the communication, and conform with a range of other important due process requirements. n102 The SEC's staff recently formed the "Cyberforce," a corps of volunteers who "surf" the Web for a few hours each week in search of securities law violations.

n102 See, e.g., Privacy Act of 1974, Pub. L. No. 93-579, 88 Stat. 1897 (codified as amended at 5 U.S.C. § 552a (1994)).

AGGRESSIVE INVESTIGATION AND PROSECUTION

As with all Division programs of the past, the most deterring aspect of the Division's program for the Internet lies in the prosecutions the Commission initiates. The prosecution of cases gets the message out to potential transgressors while possibly stopping the fraud before victims fall prey and lose their money. In the last two years, the SEC has taken action in several of these cases.

Pleasure Time, Inc. n103

n103 SEC v. Pleasure Time, Inc., Litigation Release No. 1440, 1995 SEC LEXIS 611 (S.D. Ohio Mar. 15, 1995).

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. n104 Without admitting or denying the allegations, Hicks agreed to repay investors, although the condition was waived due to his inability to pay. n105

n104 Id. at *2.

n105 SEC v. Pleasure Time, Inc., Litigation Release No. 14,865, 61 S.E.C. Docket (CCH) 969 (S.D. Ohio Feb. 26, 1996).

IVT Systems n106

n106 SEC v. Spencer, Litigation Release No. 14,856, 61 S.E.C. Docket (CCH) 1679 (N.D. Ill. Mar. 29, 1996).

In July 1995, Chicago-based Donald Spencer began soliciting investors over the Internet for his company, IVT Systems, Inc. Spencer told potential investors that the firm was building an ethanol plant in the Dominican Republic, and promised potential returns of fifty percent or more even though "there was no reasonable basis for this prediction," according to an SEC complaint filed March 29, 1996. n107 Spencer and IVT raised at least $ 113,500 from twelve investors. The Commission alleged that Spencer's literature contained lies about contracts with well-known companies and omitted other important information from investors. After the SEC filed its complaint, Spencer and IVT consented to an injunction from violating the antifraud provisions of the securities laws. n108

n107 Id.

n108 SEC v. Spencer, Litigation Release No. 15,042, 62 S.E.C. Docket (CCH) 2271 (N.D. Ill. Sept. 12, 1996).

Scott Frye n109

n109 SEC v. Frye, Litigation Release No. 14,720, 60 S.E.C. Docket (CCH) 1787 (S.D.N.Y. Nov. 15, 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.

Gene Block and Renate Haag n110

n110 SEC v. Block, Litigation Release No. 14,828, 61 S.E.C. Docket (CCH) 971 (D. Mass. Feb. 27, 1996); SEC v. Block, Litigation Release No. 14,804, 61 S.E.C. Docket (CCH) 579 (D. Mass. Jan. 30, 1996); SEC v. Block, Litigation Release No. 14,711, 60 S.E.C. Docket (CCH) 1608 (D. Mass. Nov. 2, 1995); SEC v. Block, Litigation Release No. 14,598, 59 S.E.C. Docket (CCH) 2543 (D. Mass. Aug. 10, 1995).

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 $ 1 million 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 did not, in fact, exist. The court granted a TRO against Block and froze his assets; similar penalties were issued against the other defendants. n111

n111 Block, 61 S.E.C. Docket (CCH) at 971.

Daniel Odulo n112

n112 SEC v. Odulo, Litigation Release No. 14,616, 1995 WL 505138 (S.E.C.) (D.R.I. Aug. 24, 1995); SEC v. Odulo, Litigation Release No. 14,591, 59 S.E.C. Docket (CCH) 2538 (D.R.I. Aug. 7, 1995).

In August 1995, the SEC filed a complaint against Daniel Odulo who solicited investors over several newsgroups of the Internet, including "misc.invest" and "alt.make.money.fast." 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. n113 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. n114

n113 Odulo, 59 S.E.C. Docket (CCH) at 2538.

n114 Id.

Octagon Technology Group, Inc., Michael J. Tidd, and Jeffrey L. Punzel n115

n115 SEC v. Octagon Tech. Group, Inc., Litigation Release No. 14,942, 62 S.E.C. Docket (CCH) 380 (D.D.C.June 11, 1996).

In June 1996, the SEC sued Octagon Technology Group, Inc. (Octagon), a Schaumburg, Illinois, computer software company and two of its former officers 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. With the filing of the complaint, Octagon and its officers consented to an injunction against future violations of the antifraud provisions of the securities laws, and one officer paid a $ 5000 penalty. n116

n116 Id.

Octagon represents a good example of how small-time scam artists can paint a picture of a sophisticated and professional company and investment package by using a glittery Web page with the right bells and whistles. The AIF Web pages claimed that an entity known as Group American Pacific Financial, Ltd., S.A. (APF), a purported independent trust company, guaranteed principal and interest payments on the bonds up to $ 250,000 per investor. In fact, APF was another Panamanian shell subsidiary of Octagon which lacked assets or business operations. The AIF Web pages also included a facsimile reproduction of a World Financial Report magazine article touting the investment quality of the AIF bonds, the operations of AIF, and the quality of management. In fact, World Financial Report was nothing more than a fabrication of Octagon and its officers.

Obviously done to bolster their legitimacy, the AIF Web pages even mixed in legitimate publications with their investment puffery, such as a link to a Business Week article concerning online investing. The Web pages also incorporated resplendent graphic and multilingual voice components, and gave potential investors the ability to download directly to their computers, in one of multiple computer formats, all forms (in one of four languages) necessary to make an investment in AIF bonds. Octagon officers also used some of the more popular Internet newsgroups, such as "misc.invest," "misc.invest.stocks," and "misc.invest.funds," to advertise the brummagem and link potential investors to the Web pages.

There is no doubt that, as the interactive technology of the Web has increased, as access to newsgroups and links becomes faster and cheaper (it already costs nothing to add a link to a site or publish a posting in a newsgroup), and as software continues to eliminate the need for programming skills, lawbreakers like the Octagon Group can create the facade of a Fortune 500 company at little cost and with surprisingly very little effort.

William B. Sellin, Zaitech Holdings, Inc., and Baccaratt Holdings, Inc. n117

n117 SEC v. Sellin, Litigation Release No. 15,012, 62 S.E.C. Docket (CCH) 1603 (S.D. Fla. Aug. 12, 1996).

Since October 1995, according to the SEC, William B. Sellin, a convicted felon and repeat securities law violator, had been conducting an ongoing, fraudulent offering of securities through newsgroup and bulletin board postings on the Internet, and through advertisements placed on CompuServe. Sellin solicited investments through at least forty-three advertisements in at least twenty-one Internet newsgroups. Sellin, through Zaitech and Baccaratt, offered promissory notes which he claimed were secured and collateralized by U.S. government securities and other assets. Sellin represented that he could deliver "guaranteed" annual returns ranging from twelve percent to twenty-two percent and announced that an investor could earn "$ 150,000 annually, tax free." n118 The Commission believed that these representations were false and misleading because (i) the investment, in fact, was not secured or collateralized by U.S. government securities; (ii) Sellin failed to disclose his long criminal record of regulatory sanctions and criminal convictions, including a Florida felony conviction for grand larceny; and (iii) Sellin failed to disclose the material risks associated with the investment. Given that the Internet provided Sellin "with direct access to millions of prospective investors worldwide with great speed and ease, minimal expense, and virtual anonymity," on July 25, 1996, the U.S. District Court for the Southern District of Florida granted a TRO prohibiting the defendants from violating the antifraud provisions of the federal securities laws, froze the defendants' assets, and ordered the defendants to preserve records and account for proceeds received from their fraudulent scheme. n119 On August 12, 1996, the defendants consented to a permanent injunction from violating the antifraud provisions of the securities laws. n120

n118 Id.

n119 Id.

n120 Id.

Wye Resources, Inc. and Rehan Malik n121

n121 SEC v. Wye Resources, Inc., Litigation Release No. 15,073, 62 S.E.C. Docket (CCH) 2533 (D.D.C. Sept. 26, 1996).

On September 26, 1996, the SEC filed a complaint against Wye Resources, Inc. (Wye) and Malik alleging that, during 1993 and early 1994, Wye and Malik engaged in a fraudulent promotional campaign targeted towards U.S. investors and improperly distributed Wye stock to those investors. Wye, a Canadian corporation headquartered in Toronto, Ontario, claimed to own interests in various gold and diamond mining properties. Malik, a resident of Labrador City, Newfoundland, served as Wye's president from June 24, 1993 through March 25, 1994. The SEC's complaint alleged that Wye and Malik engaged in a scheme to distribute approximately 5.3 million shares of Wye stock that were not properly issued under Canadian law nor properly registered with the Commission. According to the complaint, Wye directly distributed approximately 2.5 million of these improperly issued shares to U.S. investors. As of February 1, 1994, approximately four million shares, representing 28.9% of the Wye stock then outstanding, were held by U.S. investors. The complaint alleged that Wye and Malik specifically targeted U.S. investors by advertising in U.S. publications and posting Internet messages through "Emerging Growth Stock BBS," a New Orleans-based BBS. The Commission also alleged that certain of these advertisements and messages were false and misleading because they misrepresented, among other things, the status of Wye's ongoing exploitation of certain Zairian mining properties. For example, beginning in March 1993, prior to the time that Malik became Wye's president, Wye falsely claimed that it had successfully completed a sampling program during which it recovered ten gem-quality diamonds from its Zairian concessions. In reality, Wye's contractors had not set foot on the concessions themselves and purchased the diamonds from Zairian vendors located elsewhere. The SEC's complaint sought a permanent injunction against Wye and Malik for violations of section 5 of the Securities Act, and section 10(b) and Rule 10b-5 of the Exchange Act. The complaint also sought civil penalties against Malik. Simultaneously, the SEC announced the institution of administrative proceedings against two U.S. residents, Murray Aaron Huberfeld and Broad Capital Associates, Inc. (Broad Capital), in connection with the unregistered distribution of Wye securities. Both defendants consented to the issuance of an order finding they had violated section 5 of the Securities Act. Additionally, the order required them to disgorge their Wye stock profits totalling $ 426,790.05, and prejudgment interest thereon. n122

n122 In re Broad Capital Assocs., Inc., Securities Act Release No. 7338, 62 S.E.C. Docket (CCH) 2430 (Sept. 26, 1996).

Western Executive Group, Cash Systems USA, Inc., Charles R. Rietz, Robert R. Parrish, Robert J. Struth, and R. Stephen Edgel n123

n123 SEC v. Western Executive Group, Inc., Litigation Release No. 15,106, 62 S.E.C. Docket (CCH) 2636 (C.D. Cal. Oct. 3, 1996); see also SEC v. Western Executive Group, Inc., Litigation Release No. 15,139,63 S.E.C. Docket (CCH) 191 (C.D. Cal. Oct. 23, 1996); SEC v. Western Executive Group, Inc., Litigation Release No. 15,121,63 S.E.C. Docket (CCH) 89 (C.D. Cal. Oct. 15, 1996).

On October 7, 1996, the U.S. District Court for the Central District of California entered a TRO halting an alleged Ponzi scheme involving investment contracts for the sale and leaseback of automated teller machines (ATMs). n124 The defendants solicited investments in the ATM program over the Internet and raised over $ 3.49 million from at least 132 investors nationwide. This was the first SEC lawsuit involving ATMs and the largest lawsuit involving Internet investment fraud brought by the Commission to date. The SEC alleged that the defendants operated the Ponzi scheme from at least September 1995, when they began offering and selling investments in the ATM program. Investors simultaneously executed agreements with Western Executive Group (WEG) and Cash Systems USA, Inc. (Cash Systems) to purchase ATMs from WEG and immediately lease them back to Cash Systems. Investors were guaranteed monthly lease payments for five years, representing a 100% return of the investors' principal and an annual yield of 17.4%. As of July 1996, however, forty-two of the total 195 ATMs sold were operational and only two of the forty-two ATMs were profitable. Consequently, the defendants were using new investor funds to meet the monthly lease obligations to existing investors. The complaint also alleged that the defendants solicited investors nationwide over the Internet and through private investment seminars, mass mailings, and cold calling, and that the defendants provided investors with offering materials that misrepresented the number of ATMs operating and the financial returns the ATMs could produce.

n124 Western Executive Group, Inc., 63 S.E.C. Docket (CCH) at 89.

Charles S. Huttoe n125

n125 SEC v. Huttoe, Litigation Release No. 15,153,63 S.E.C. Docket (CCH) 427 (D.D.C. Nov. 7, 1996).

Although the SEC has brought several cases in which the issuer involved experienced a lot of "Usenet hype," the most definitive case to date is SEC v. Charles O. Huttoe. On November 7, 1996, the U.S. District Court for the District of Columbia entered a TRO and other emergency relief to stop, according to the Commission, a massive and ongoing market manipulation of SOE stock. SOE was a manufacturer and distributor of video teleconferencing equipment with offices in Virginia and Florida. n126

n126 Id.

The Commission alleged that Huttoe, SOE's Chairman of the Board and CEO, secretly distributed millions of SOE shares to family members and corporations, manipulated the market by issuing false information concerning SOE and its business, and then sold his own shares into the inflated market. As the first part of that scheme, Huttoe executed an unregistered distribution of tens of millions of shares of SOE stock by causing false Form S-8 registration statements to be submitted to SOE's transfer agent. The Commission further alleged that Huttoe secretly issued millions of those unregistered, but unrestricted and free trading, SOE shares to various Huttoe family members and entities that served as Huttoe's nominees, including Word Corporation and NTSI, and his wife, mother, and niece.

As the second step in the scheme, the Commission alleged that Huttoe artificially inflated the price of SOE shares by issuing a series of materially false and misleading press releases. Among other things, the releases announced nonexistent multimillion dollar sales of SOE products, an acquisition that had not occurred, and false revenue projections for SOE. The Commission further alleged that Huttoe caused SOE to fail to file required periodic reports, filed false periodic reports, and bribed SGA with stock to recommend SOE to subscribers of SGA's electronically disseminated tout sheet. n127 Additionally, the Commission alleged that Huttoe caused unregistered but free trading shares to be issued to Melcher and Terry, the principals of SGA. n128

n127 Id.

n128 Id.

As the third step in the scheme, Huttoe, Melcher, and Terry took advantage of the inflated market for SOE stock, which they had created, by dumping their own SOE stock on unwitting investors. The Commission alleged that those sales were timed to take advantage of the false press releases concerning SOE. Indeed, such sales were heaviest when the price of SOE stock reached its peak in June 1996. As a result of this scheme, the defendants allegedly obtained illegal proceeds of more than $ 10 million. Throughout all the steps of the schemes, the Commission alleged that the defendants used the Internet as a means of manipulation; during the alleged scam, postings concerning SOE in Internet message areas totaled higher than 10,000. n129

n129 On January 31, 1997, Huttoe was sentenced to a federal prison term of forty-six months, followed by two years supervised release and a $ 10,000 fine, for one count of securities fraud and one count of money laundering in connection with the scheme. Huttoe had entered into a sealed plea agreement with the federal government on November 13, 1996. SEC v. Huttoe, Litigation Release No. 15,237,63 S.E.C. Docket (CCH) 2061 (D.D.C. Jan. 31, 1997).

George Chelekis, KGC, Inc., and Hot Stocks Review, Inc. n130

n130 SEC v. Chelekis, Litigation Release No. 15,264, 63 S.E.C. Docket (CCH) 2489 (D.D.C. Feb. 25, 1997).

On February 25, 1997, the Commission filed a complaint in the U.S. District Court for the District of Columbia against George Chelekis (Chelekis), KGC, Inc., and Hot Stocks Review, Inc. The complaint alleged that from at least January 1995 through August 1995, Chelekis, a publisher who distributes 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. The complaint further alleged that from April 1994 through September 1995, Chelekis failed to disclose in the Hot Stocks publications that he, and entities under his control, defendants KGC, Inc. and Hot Stocks Review, Inc., received at least $ 1.1 million from more than 150 issuers and 275,000 shares of stock from ten issuers, as payment for recommending securities of such issuers in the Hot Stocks publications. Without admitting or denying the allegations in the complaint, Chelekis, KGC, Inc., and Hot Stocks Review, Inc., consented to the entry of a final judgment permanently enjoining them from violating section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and section 17(b) of the Securities Act. n131 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. n132

n131 Id.

n132 Id.

SELF-POLICING

Historically, self-policing has always served as an important part of every Division program, not merely because it encourages responsibility and ethical behavior amongst Wall Street participants, but also because it serves as yet another useful tool for patrolling an increasingly large and complicated marketplace. In line with these traditions, self-policing in the context of Internet-related securities fraud has proven a valuable resource for help in discovering miscreant securities-related conduct over the Internet.

There exists a remarkable Internet culture of self-policing by individual users who resent the intrusion of the crooks and thieves trying to exploit the Internet. The Division hopes to tap into this culture, encouraging users to report dubious offerings on the Web or suspicious postings on the many Usenet groups and BBSs via the "Enforcement Complaint Center." The Enforcement Complaint Center, which opened on June 14, 1996, now allows users to contact the Division directly through the Internet. The center, located as a link on the SEC home page, n133 allows users to communicate with the Division either by email or by submitting an "Enforcement Complaint Form." The center also offers other means of communications, including snailmail, n134 fax, an Internet fraud hotline, and a toll-free number.

n133 U.S. Securities & Exchange Commission, SEC Division of Enforcement Complaint Center (last modified Oct. 25, 1996) <http://www.sec.gov/enforce/comctr.htm>.

n134 "Snailmail" refers to the U.S. Postal Service mail delivery system and is meant to imply the greater speed and convenience of email over postal mail. DERN, supra note 2, at 196-98.

The Enforcement Complaint Center has thus far resulted in a vast supply of leads for investigations and referrals, while also keeping the Division apprised of the latest trends and modus operandi of online riffraff. The center typically receives between thirty and forty messages per day (including weekends). More than seventy-five percent of these complaints are useful for investigations or referrals. Moreover, the content and quality of the complaints continues to demonstrate the sophistication of users, and their burning desire to protect and maintain the integrity of the Internet.

Not only do users typically include the relevant names, addresses, phone numbers, and other pertinent information concerning the persons and entities involved, the complainants usually have undertaken some cybersleuthing of their own (using all the latest available Internet tools). Typically, the center receives complaints concerning Internet fraud, although it invites reports of all types of securities fraud. Most complaints contain descriptions of the relevant Web sites, attachments of related materials, and even include the most important and otherwise unknown details, such as a deciphering of the header of a suspicious posting or email. Some complaints even provide a full legal analysis of potential securities violations, including cites to legal authority.

EDUCATION

A critical aspect of every Division program has always been education. The best defense to any securities scam is an informed and wary investing public. This means more than merely harping on the old adage that if an offer sounds too good to be true it probably is. The Division must work with the investing community and alert potential victims to the types of investment fraud occurring over the Internet.

In this regard, the Office of Investor Education and Assistance, with input from the Division, has published an extremely useful Investor Alert which contains an analysis and discussion of the types of online investment fraud and abuse together with suggestions for investors on how to avoid becoming the next victim. The alert even provides a checklist of steps to follow before making an investment over the Internet, as well as a list of questions to ask about any investment opportunity, particularly an opportunity offered in cyberspace.

A variety of other useful publications and information remain available on the SEC Web site, while the Division's litigation releases (as well as a search engine dedicated to the site) are contained on the Division's Web page. The Division will also consider publishing various alerts and litigation releases on various BBSs, including the more popular investment related newsgroups and message boards. n135

n135 Such postings may not be necessary, however, given the persistent self-policing carried out by Internet users. For example, without asking users to do so, some have taken it upon themselves actually to attach a copy of the Cyberfraud Investor Alert to the bottom of postings that they deem suspicious. Thus, anyone reading the debatable posting will also read the SEC's investor alert.

The SEC also recently began posting relevant SEC information on Internet forums (such as commercial online providers, Internet forum areas, and newsgroups) where such information might help investors of a specific security. For instance, in the recent trading suspension of Omnigene Diagnostics, Inc., the SEC posted the press release concerning the trading suspensions and a copy of the actual suspension order in a stock forum on AOL dedicated to discussions concerning Omnigene. n136

n136 See Omnigene Diagnostics, Inc., Exchange Act Release No. 37966, 63 S.E.C. Docket (CCH) 565 (Nov. 20, 1996); see also U.S. Sec. & Exch. Comm'n, SEC Notice from AOL: OmniGene (visited Jan. 27, 1997) <www.sec.gov/news/extra/omnigaol.htm>.

LIAISON WORK

Given the breadth of illicit activities on the Internet, jurisdictional crossover happens at every turn. Securities violations, in particular, are often also federal and state criminal fraud violations, Federal Trade Commission (FTC) violations, and Federal Communications Commission (FCC) violations, as well as violations of a host of local, state, and federal criminal and civil statutes, rules, and regulations.

Historically, the Division has succeeded in coordinating its efforts with nearly every existing law enforcement authority. The Division's policing of the Internet will follow a similar path of cooperation, joint action, and teamwork. In the context of its Internet program, the Division's informal and formal liaison work includes operations with the FTC, the U.S. Department of Justice and the Federal Bureau of Investigation, the FCC, and a range of other civil and criminal law enforcement authorities. In December 1996, the SEC teamed up with three other federal agencies and seventy state and local law enforcement officials from twenty-four states on "Surf Day," which resulted in the identification of more than 500 possible Internet scams.

The Division also works especially close with self-regulatory organizations, such as the New York Stock Exchange and the National Association of Securities Dealers, Inc., as well as state regulatory authorities such as the North American Securities Administrators Association. The Enforcement Complaint Center also facilitates cooperative efforts with some of the more attenuated law enforcement entities that might not have developed any prior relationship with the SEC and simply want to forward certain information to the Division without having to create any new bureaucratic communications lines. The SEC will continue such liaison work and concentrate on working jointly to counter unlawful Internet activity, whether in the form of securities fraud or otherwise.

 
"IT'S BEGINNING TO LOOK LIKE YOU GOT THINGS FIXED SO I CAN'T NEVER WIN OUT. INSIDE, OUTSIDE, ALL THEM RULES AND REGULATIONS AND BOSSES . . . JUST WHERE AM I SUPPOSED TO FIT IN . . . WHAT DO I DO NOW . . . I GUESS I GOTTA FIND MY OWN WAY."

As the SEC addresses the excitement and challenge of the Internet, so moves the Division to find its own way as it undertakes to reconcile its mission with this exciting and futuristic medium of communication. The constant state of flux of Internet communications will continue to create fantastic opportunities for individual investors while also creating a formidable task for the Division to police this newly sprung turf. The synergy created by the joining of the Internet with global capital markets creates an ever-changing and developing investment emporium which has not only changed the way the players think but also the way the scofflaws think. Above all, the Division must position itself to respond quickly to the concerns of the investing public while also considering the mores of the Internet community.

Part of the difficulty that the Division (and other law enforcement officials) will have with policing securities violations on the Internet is the expansive interpretation of "free speech" principles applied to online communications by the leaders of the virtual community. Not only do users expect anonymity but they also expect to control whatever they transmit. The Internet's informal, uncensored, decentralized regulation, and often presumed-anonymous environment, encourages casual interaction among users, and something like a Wild West mentality among the critics and philosophers who give the medium its ideological direction. n137

n137 ALLISON, supra note 34, at ix.

Coupled with an almost libertarian strain of antigovernmental sentiment that accompanies many of the major writings on the Internet, it is not hard to imagine that assertions of regulatory authority by the SEC and other agencies may face vigorous public opposition similar to what congressional supporters of the Exon-Coats bill n138 (regulating Internet communications) recently observed when they were flooded with email from online free speech advocates. Some users on the Internet's radical fringe even believe cyberspace to be 100% free-terrain, immune from all laws of geographically-bounded countries.

n138 Communications Decency Act of 1996, Pub. L. No. 104-104, §§ 501-561, 110 Stat. 56 (to be codified in scattered sections of 47 U.S.C.).

Hence, although neither the First Amendment, nor any other law on the books, confers the right to commit fraud, n139 the free speech concerns of Internet users will require the Division to be as active in informing and molding public opinion as it will be in winning favorable judicial precedent. The Division, through its Internet program, must show its support for, and even facilitate the functioning of, Internet self-regulation by augmenting the flow of investor information. Internet financial newsgroup users pride themselves on the ability to discern and publicly debunk, or "flame," n140 phony securities offerings or illicit hype, and, until the freedom issues inherent in Internet speech are definitively worked out, the Division can aid the dialogue of online investors by publicizing the availability of its own online information sources and offering advice on how to discern Internet frauds.

n139 "Liberty, declared Tom Paine, should never be mistaken for license. It is too precious a prize to be degraded by those who accept no obligation to others in the exercise of their freedoms." The Pedlars of Child Abuse: We Know Who They Are; Yet No One Is Stopping Them, GUARDIAN, Aug. 25, 1996, at 1.

n140 The ILC Glossary of Internet Terms describes the evolution of the meaning of "flame":

 
Originally, flame meant to carry forth in a passionate manner in the spirit of honorable debate. Flames most often involved the use of flowery language and flaming well was an art form. More recently flame has come to refer to any kind of derogatory comment no matter how witless or crude.

 
Internet Literacy Consultants, ILC Glossary of Internet Terms, at 6-7 (last modified Mar. 18, 1997) <http://workshop.matisse.net/files/glossary.html>.

Resource allocation for policing the Internet will also unquestionably increase in the future. In deploying its resources, the Division must consider the number of people who are potential targets of frauds over the Internet. Perhaps the staff could ignore a scam in the past when the offeror had only solicited a few people at a seminar or by mail; perhaps the staff would not view the offer as enough of a potential threat to the public to warrant a specific allocation of resources. Could the staff, however, ignore the very same offering if it was made at a seminar for 100 million?

The Division now has a strategy and an operation in place to address Internet securities fraud and remains armed and ready for the coming of the next millennium. Rather than simply reiterating the common themes among law enforcement agencies, the magnitude of Internet fraud and the financial restraints that prevent federal agencies from effectively policing the Internet, the Division is acting now and is using currently available resources. Rather than reacting to a future crisis, the Division has proactively initiated its program.

The Commission as a whole owes a duty to the public to use existing enforcement weapons to frustrate and deter any new developments in securities fraud. In the Commission's favor, the statutory tools are already in place and the SEC has an eager and vigorous staff, many of whom welcome the opportunity to incorporate the world of the Internet into their professional and not just their personal lives. The SEC now need only adapt the existing laws to meet the growing number of violations in the continually evolving Internet medium.

The realities of a static agency budget, a laissez-faire Congress, and an electorate exhibiting a rising antigovernment sentiment dictate that the Division's approach, while calculated and intelligent, should be cost-effective, education-oriented, and expansive in its appeal to the computer industry. The present Internet program, given its inherent flexibility, together with its multifaceted approach of emphasizing surveillance, prosecution, education, and coalition-building, provides a sound basis to battle securities crimes committed over the Internet. Most of all, the Division's Internet program is not a foray into a new regulatory area and does not damage the basic core of the enforcement program; rather, the program remains consistent with the Commission's overall commitment to fair markets for all investors.

Despite its great potential to benefit the public, especially the investor, the Internet will prove an irresistible target for con artists. By initiating a program for the Internet with fairness, vigilance, and agility, the Division will discourage perpetrators of Internet fraud before they find their niche and insure that the eagle remains on the street, even when that street is in cyberspace.

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