Cyberspace Fraud and Abuse
investors are in danger today of being taken for a ride on the information
superhighway. State securities regulators around the U.S. are concerned about
the explosion in illicit investment schemes now flourishing on commercial
bulletin board services and the informal web of computer networks that make up
the Internet. An estimated four million U.S. households that already have access
to the major online services are being exposed to hundreds of fraudulent and
abusive investment schemes, including stock manipulations, pyramid scams and
While the experienced pioneers who explored the online frontier are aware of
some of the major rip-off techniques now in use, the investment fraud problem
could reach epidemic levels over the next few years as several million
unsophisticated newcomers crowd onto the information superhighway. Cyberspace,
as the online world is known, has the potential to educate investors and help
them to become better consumers. Today, any home equipped with a computer and
modem is just a few keystrokes away from a wealth of instantly accessible
research data and financial news. It will be a tragedy, however, if cyberspace
comes to be regarded as a lawless "Wild West" haven for investment swindlers
and, as a result, is shunned by the very financial consumers who could be
empowered by it.
take on Cyber-Schemes
The Missouri Securities Division and the New Jersey Bureau of
Securities announced on June 30, 1994, the first regulatory actions taken in
the U.S. against online investment schemes. At least three other states
currently have investigations underway involving suspected investment fraud and
abuse in cyberspace. Here are the highlights of these and other key developments
in known or suspected abuses in the online investment world:
to a cease-and-desist order filed on June 30, 1994, by the Missouri
Securities Division, a stockbroker unlicensed to do business in Missouri
touted his own services and also made dubious claims for stocks not
registered for sale in the state. The broker identified himself on one of
the largest commercial online services in the U.S. as "A GOOD TRADER." In
the online messages, the broker included his toll-free telephone number and
an offer to provide more information by e-mail or regular mail. In an effort
to entice customers, he made a number of dubious claims, implying in one
case that Donald Trump was a major, behind-the-scenes player in a tiny
cruise line with a thinly-traded stock. The Missouri action resulted in his
employer, Investors Associates, withdrawing from the state of Missouri. The
brokerage firm claimed to have been unaware of the suspect online promotion
by the broker, who supposedly engaged in the activity after-hours from his
were told "how to make big money from your home computer"` as part of the
"Electronic Message"` scheme promoted by a San Antonio man and at least nine
other individuals scattered around the U.S., according to a cease-and-desist
action filed on June 30, 1994, by the New Jersey Bureau of Securities. In
what might be referred to as an "e-mail chain letter," the promoter claimed
that in exchange for five dollars, investors could earn a return of $60,000
in just three to six weeks. Participants were told to send one dollar to
each of five people on an online list. Then, those who sent money were to
add their own name to the list and post a message explaining the scheme on
ten different computer bulletin board sites. In practice, the scheme
amounted to a high-tech variation on the old pyramid scam, which is barred
under federal and state laws.
of the shares of stock in another Canadian company, Wye Resources, Inc.,
which was reported to own a Zaire diamond mine where a major strike had been
made, more than tripled in price in early 1994. After extensive online
hyping, the stock, which was traded over-the-counter in Canada outside of an
established exchange, collapsed. Authorities stepped in and called a halt to
the trading. As one online observer of this apparent "pump and dump" scheme
noted: "The companyís story was made to sound like the biggest
get-rich-quick prospect this side of Mars, and a lot of naive investors
began buying. The stock, as ALWAYS happens, went from 20 cents to $1.40 in a
matter of a month, and the hypesters were talking about how great they all
were ... until the Alberta Exchange halted trading on the stock the next
day, investigating the manipulation of the share price...."(Emphasis in
securities regulators emphasize that the problem of illicit and abusive online
investment schemes has the potential to spread like wildfire as the result of
the increasing popularity of commercial bulletin board services and the
Internet. "We are just now starting to get complaints, and a growing number of
states and other regulators are in the first stages of focusing on this latest
variation on the unending theme of investment fraud and abuse," explained Iowa
Superintendent of Securities Craig Goettsch, who served as president of the
North American Securities Administrators Association (NASAA) in 1994. "The
states recognize the high value that is placed on privacy and minimal government
intrusion in cyberspace, but the reality is that investment fraud is illegal and
will be combated by the states wherever it takes place. We want to make sure
that online investors know that they should proceed with extreme caution when
traveling the information superhighway."
The Online World: A Primer
Cyberspace was once a place inhabited largely by government agencies and
academics linked together through a decentralized collection of computer
networks that came to be known as the "Internet." The late 1980s and early 1990s
gave birth to a torrent of commercial entrants into cyberspace, with the way led
by CompuServe, then Prodigy and America Online. By the end of 1994, some four
million American households were online with these services. Additionally,
hundreds of smaller companies also provided bulletin board services and local
access to the Internet.
The result: cyberspace is no longer an ivory tower world. The number of
Americans online jumped 90 percent from 1992 to 1994. Thanks to a new generation
of sophisticated software programs that take much of the pain out of navigating
the Internet, more and more of those who are online spend much or all of their
time outside the confines of the commercial services.
For newcomers, cyberspace can be an enormously complicated and confusing place.
But the appeal of the online world is easy to understand. Those who go online
have opened up to them a dizzying array of computer bulletin boards (where
messages can be posted under specific topic headings), live discussion groups
(in which members have real-time "chats" through their keyboards), e-mail (the
cyberspace equivalent of what is referred to as "snail mail"), information (in
the form of research, newswires, and electronic versions of magazines), ways to
buy goods and services (including airline tickets and office supplies), and
Investments Online: Not "Commercial Free"
Those who have never journeyed to cyberspace may be under the impression that
the online world has not been "commercialized." This misunderstanding arises not
only from the former "ivory tower" reputation of cyberspace, but also as a
result of a few, widely publicized incidents in which commercial interests have
attempted to advertise their services through indiscriminate use of e-mail
messages and message-posting on multiple bulletin boards. Such individuals have
been "flamed" (a sort of "hate e-mail"), with the result that some have been
driven into silence or even out of cyberspace altogether.
There is little evidence of such anti-commercial sentiments when it comes to
bulletin boards and discussion groups devoted to investing topics. Commercial
bulletin board services offer special areas to subscribers on a wide range of
professions and other interests, ranging from the law to romance. But one of the
most powerful "magnets" drawing consumers to the commercial services and the "unmoderated"
world of the Internet today is the growing number of bulletin boards and
discussion groups devoted to investment tips, advice, and solicitations. Many of
the investment-specific messages now appearing on commercial services and the
Internet openly hawk brokers, investment advisers, financial newsletters, and
specific investment deals.
Though many of the messages simply offer general stock-picking advice or mention
other investment possibilities, others tout specific stocks, money-making
enterprises, and service providers. Far from being free from commercialism,
investment-specific bulletin boards are now littered with sales pitches, offers
of details transmitted privately via e-mail and toll-free numbers. All three of
the largest commercial computer bulletin board services also offer electronic
trading links to major brokerage firms.
The Rise of Online Investment Schemes
Combine the circulation of the Wall Street Journal (1.8 million) and the
USA Today (1.6 million) and you still fall short of the "self-publishing"
reach available to someone who joins a few commercial computer bulletin board
services. As one online investor has marveled: "With the online world growing
quickly, we can all reach hundreds of thousands of people with a single
(message) posting. With a few keystrokes, a couple of accounts, and a macro or
two, I can make it appear that many people are posting on many different
systems, all talking up a stock... never before has an individual been able to
reach so many people, so easily, quickly, or inexpensively."
Just as investment con artists and other fast-buck operators wasted no time in
taking advantage of the mails and the telephone as means by which to fleece
large numbers of unsuspecting investors, so too have swindlers started in with a
vengeance to exploit cyberspace. While many of those on bulletin boards
dedicated to investment topics are interested in little more than swapping ideas
about specific stocks and exchanging general financial advice, there is
increasing evidence that a shady group of individuals are milking the online
world in order to enrich themselves in what is often a blatantly fraudulent and
State securities regulators have identified the following as being among the
major investment scheme problems in the online world today:
Manipulation of obscure, thinly traded stocks. Most commercial bulletin
board services allow individuals to post messages not only under an alias...
but multiple aliases. Since it may be impossible for another subscriber to
ascertain the true identity of the individual behind the message (or even if
a series of messages are being entered by just one individual under various
aliases), there is enormous potential for manipulation of little-known
companies that have a small float (the number of shares available to be
bought and sold). Acting alone or with accomplices, one company insider,
broker, public relations executive or even just a large shareholder can
leave numerous messages calculated to spark interest in an obscure stock.
Once a "thread" (in this case, a series of related messages about a stock)
is started, it will show up on the computer bulletin board and be readily
accessible by anyone who enters the bulletin board.
Through a combination of puffery, speculation, and breathless claims of
supposedly inside information about pending announcements, product
innovations, and new contracts, the schemers seek to run up the price of the
stock, which starts rising as unwary investors read of the "great
opportunity" and buy shares. In response, the insiders take their shares
("bought at the low, "pre-hype" prices) and sell them into the rising
market. As interest builds, dozens of messages may be posted about the
stock. When the hype-fueled stock price falters, the promoters may blame
unnamed short sellers. Sometimes, losses suffered by the unsuspecting are
made even worse by ruthless promoters who urge victims to "dollar average"
and keep buying shares, even at the falling prices. Talk of the stock then
disappears from the board. Investors who are left holding the bag can do
little more than post plaintive messages: "Whatever happened to Company X?"
(See, "How a Typical Cyber-Scheme Works" below)
Misconduct by phony and unlicensed brokers/investment advisors. States
are concerned that brokers may be attempting to drum up new business...
without the supervision of their employers and while making liberal use of
illegal assurances about the potential for profit in certain investments.
The problem here goes far beyond the oral comments that an aggressive broker
might make to a sophisticated client, since an online message is available
to be read by, not one, but hundreds of thousands of investors.
Additionally, states are concerned about brokers who may try to rope in new
clients without regard for the clear state interest in keeping individuals
with a history of fraud and abuse outside of their borders.
Undisclosed interests of promoters. The anonymity of cyberspace is
exploited to the hilt by schemers who promote fraudulent and abusive
investment schemes. In reading a bulletin board message about a stock, you
have no way of knowing if the person involved is a company official, PR
representative or market-making brokerage firm. Has the person hyping the
stock been paid to do so and, if so, has that fact been disclosed? (In one
instance, an individual running a private bulletin board disclosed there
that he received compensation for his stock promotion activities, but did
not make a similar disclosure when he posted messages on major commercial
bulletin board services.) In some of these cases, the role of the person
involved in the scheme is such that he or she is considered an "agent" of
the stock issuer and, as a result, is subject to strict legal requirements
about public statements, disclosure language and penalties for intentional
"misrepresentations and omissions" intended to move stock prices.
How a Typical Cyber-Scheme Works
out there following Company X?"
"I heard that Company X is about to make a major announcement. E-mail me or call
this toll-free number to get an information package."
"I spoke to Company X `s CEO who confirmed details of next monthís big news.
Iíve bought 10,000 shares. Look for share price to double in next month! Get it
"Big news is just around the corner. We hear from a friend who has visited
Company X that is going to be even bigger than we thought. Thereís still time to
"Short sellers are in the market! Keep the faith... This will bounce back. The
smart money will use the price as an opportunity to buy more and dollar
The original message in this hypothetical bulletin board "thread" might be
posted by a company executive, public relations executive, market making
brokerage firm or large, individual shareholder. Subsequent messages could be
left by the same individual under an alias (or aliases) or by accomplices posing
as unconnected outsiders. The goal would be to interest unwary investors, who
then drive up the price of the stock through a surge in buying. The schemers
stand to make substantial profits when they sell their cheap shares into the
market. After the price collapses, talk of the company ceases and the schemers
move on to hyping a new stock.
Promotion of "Exotic" Scams
manipulation of the stock of publicly-traded companies and misconduct by
professionals are just two types of problems that state securities agencies have
detected on commercial bulletin board services and on the Internet. In hundreds
of other cases, messages have been posted promoting a wide variety of highly
suspect, unregistered investment deals (e.g., wireless cable television
"build-out" schemes, ostrich farming, and viatical settlements), as well as
flat-out rip-offs (e.g., pyramid schemes, including a number of twists on "chain
e-mail letters," and Ponzi scams). These so called "exotic" securities may pose
a greater threat to consumers than other cyber-schemes, since out-and-out scams
often appeal to individuals who do not feel sophisticated enough to speculate in
stocks. The experience of state securities regulators is that "exotics" are
often just as costly to burned investors, since many schemes involve minimum
investments of $5,000 or more.
Some of the investment fraud and abuse problems in cyberspace are
indistinguishable from those that have been in circulation elsewhere for
decades. But access to the online world represents an enormous advance in the
ability of con artists to victimize the unwary. Even the fastest-talking
boiler-room operator would be hard-pressed to make more than 150 "cold call"
telemarketing pitches in one day, whereas the fast-buck swindler with access to
Cyberspace can send e-mail to many thousands of individuals in less than an
hour. The same con artist can then post a message that may be read in a matter
of weeks by tens or even hundreds of thousands of individuals around the globe.
As one veteran state securities agency official has observed about cyberspace:
"In my 32 years of investigating fraud, this is by far the greatest money-making
machine for scammers that I have ever seen."
Protecting Yourself Against Online Investment Schemes
What are the rules of the road for investors who decide to travel the
information superhighway? Perhaps the most important thing to keep in mind is
that there will never be enough "cybercops" to keep the online world free from
fraud and abuse. Even though state securities agencies and other investment
regulators have mounted serious efforts in recent months to spot and stop
cyber-fraud, the simple truth is that there are far too many places in the
online world (particularly in the almost entirely unregulated Internet) for
swindlers to set up shop. Even if the several thousand people in the United
States who work at the Securities and Exchange Commission (SEC), state
securities agencies, National Association of Securities Dealers (NASD), and the
stock exchanges were somehow able to put aside all other tasks in a massive bid
to shut down online investment scams, it is doubtful that this problem could be
stamped out altogether.
This does not mean that you should avoid cyberspace. Rather, it means
that investors who venture into the online world should do so with caution,
being mindful of the danger of fraud and abuse. The good news is that there are
self-defense steps that you can take to fend off cyber-fraud:
expect to get rich quick. The online world is filled with timely and
accurate information that can help you become a smarter investor.
Unfortunately, it also is home to a growing amount of investment fraud and
abuse. The trick here is to keep your excitement and expectations about the
promise of the online world in perspective. You have to evaluate the
information you get online in the same way that you would any news magazine
article, television report or whispered "hot tip." A failure to exercise the
caution and skepticism that is a healthy response to all unfamiliar
investment opportunities could be a fatal misstep here!
assume that your online computer service polices its investment bulletin
boards. Most donít. The vast majority of services take a "hands off"
attitude to validating claims made in message postings. Even the ones that
do minimal policing are swamped by the volume of postings, which add up to
literally millions of messages each month. In the "wild and woolly" world of
the Internet, just about anything goes. Nothing is in place to prevent a con
artist from posting one (or dozens) of pitches for a swindle. In the
unregulated environment of the Internet, often the only check on abusive
messages is "flaming" by other users.
thinly-traded, little known stocks strictly on the basis of online hype.
These are the stocks that are most susceptible to manipulation. Unlike blue
chips and other stocks with substantial floats (the number of shares
available to be bought and sold), the price of low-volume stocks can be
moved through relatively small strategic trades. This is why online hype
usually involves previously unknown securities, often for companies involved
in mining or the world of high-tech. Even if a stock that is being hyped
starts to move up, proceed with extreme caution, since this may just be part
of the overall manipulation scheme. You could still end up holding the bag!
Always take the time to do your own research using reputable resources, many
of which are available online.
on the advice of a person who hides his or her identity. Keep in mind that
many computer bulletin board services allow people to use aliases and
nicknames. Though this is intended to protect privacy, it also can be
exploited by fast-buck artists. As a result, you may end up dealing with an
undisclosed broker, investor, or company insider intent on driving up the
price of a stock through false information or baseless speculation that is
difficult or impossible to disprove. Donít assume that two or more people
talking up a stock are actually two or more different people! Review the
motives of the person sharing investment opinions and information online and
take the time to search out other information on your own before making an
suckered by claims made about "inside information," including pending news
releases, contract announcements, and products. Investment bulletin boards
and discussion groups are crammed with hot tips about impending developments
sure to send a stock soaring in value. Just because these tips appear in
cyberspace does not mean that they are exempt from federal insider trading
laws and rules. It is extremely unlikely that genuine "insider information"
is going to be publicly broadcast on an investment bulletin board.
assume that just because someone says that they have checked something out
that they have actually done so. Online stock hypesters make all sorts of
claims about visiting companies, inspecting mining operations, and having
personal conversations with company officials. Keep in mind that you may not
be able to verify who is making these claims much less whether any of the
information is true or the supposed research ever took place. On a related
note, keep in mind that an established tactic of investment schemers is to
talk up mines and factories in remote corners of the U.S. (or elsewhere
around the globe) where it is impossible for you to either visit in person
or get meaningful information.
forget to always be on the look-out for conflicts of interest. A growing
number of those who analyze stocks online are receiving cash or stocks in
exchange for making glowing comments about the companies in question. Some
of these individuals prominently disclose this fact, while others make
little or no mention of the fact that they are paid touts. Make sure that
you always know why someone is so "high" on an investment opportunity!
forget to first make sure that an investment opportunity and the person
promoting it are properly registered with your state securities agency. Laws
designed to protect small investors from fraud and abuse do apply in
cyberspace. A failure by an issuer or broker to follow the state
requirements here is often a major "red flag" of an investment scam.