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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Investing in the Internet Age: What You Should Know and What Your Computer May Not Tell You . . .

Remarks by

Commissioner Laura S. Unger

U.S. Securities & Exchange Commission

At the Association of Retired Persons National Legislative Council Annual Meeting,
Washington, D.C.

February 3, 2000

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Ms. Unger and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff.

I am quite pleased to address the AARP National Legislative Council today. I know that one of your main goals is to enrich the experience of the aging. I also know that few things could more directly affect the well-being of the elderly than being robbed of their life savings, money that they count on to live, day in and day out. This is precisely what happens when the elderly become the targets of fraud artists, as unfortunately, is too often the case.

A mere five years ago, we were first learning what the Internet was and few of us had access. Today, the Internet has transformed the way we live. And that "we" includes seniors. It is undisputed that more and more seniors are spending time surfing the net for various reasons, including investing. In fact, I read just last week of a study finding that older users of the Internet (those over 75 years of age) are as likely to chat online as younger people (those under 25 years of age).

Iíd like to spend my time today addressing how seniors can best protect themselves when investing online and what we at the SEC are doing to ensure that the Internet remains valuable and safe for all investors. This discussion is not just academic. As noted in a recent press release by NASAA, the state securities regulators, "today many seniors on fixed incomes are having a hard time economically with interest rates under 5 percent. Their financial anxiety makes them particularly vulnerable to scam artists who promise a quick hit in the stock market."

Complaints Against Online Brokers

The number of complaints against online brokers has increased dramatically over the last two years. That may be explained in part by the fact that more investors are coming online. During fiscal year 1999, the Commission received over 3,000 complaints against online brokers, an increase of close to 200% over fiscal year 1998 and about 1200% over fiscal year 1997. Bear in mind that during those three years the number of online investor accounts jumped from 3.7 million in 1997 to 7.3 million in 1998 to about 12 million today.

About a third of our complaints against online broker-dealers for fiscal year 1999 involved brokers failing to process orders or delaying their execution and investors experiencing difficulty in accessing their accounts or contacting their brokers. An additional 20% of complaints against online broker-dealers involved brokers making errors in processing orders, brokers making errors in account records, or investors experiencing best execution problems. As you can see from these categories, most of these complaints against online brokers involved glitches in the technology.

By way of contrast, only one of the top five complaints against offline brokers -- failures or delays in processing orders -- could potentially be attributed to technological glitches. The remaining top four complaints: 1) transfer of account problems, 2) unauthorized transactions, 3) failure to follow a customerís instructions, or 4) misrepresentations by the broker -- probably involved a human component.

As the technology for online brokerage develops further, we may very well see a different top five category of complaints.

Our Enforcement Program on the Internet

The Commissionís Enforcement Division has been very proactive in ferreting out Internet related fraud. At this point, I will take credit for my Enforcement Review -- conducted early in my tenure -- for encouraging the division to seek out cases that involve current market developments and send a strong deterrent message as early as possible.

As a result of Enforcementís vigorous Internet program, their online complaint center now receives between 200 and 300 e-mails a day -- just about potential offering scams. Enforcement also has a "cyberforce" composed of about 240 SEC staff members who surf the Internet part-time looking for potential fraud. In the last two years of focusing on Internet fraud, Enforcement has conducted three sweeps involving fraudulent offerings online and touting. The 115 Internet fraud cases we have brought so far confirms that there are some shady characters exploiting this medium to line their pockets.

Although some of the Internet fraud cases involve novel scenarios -- such as someone on the eBay website auctioning securities -- they do not present novel securities laws interpretations. In fact, in the area of Internet enforcement, the policy decisions have mostly involved the degree to which we should sanction certain fraudulent conduct online.

Most of the cases to date have involved yesterdayís garden variety fraud using todayís technology. But while the Internet may make it easier and cheaper for fraudsters to carry out their schemes, the Internet also makes it easier for us to find them. Not unlike caller ID, the Internet tracks the identity of those who think they are anonymously committing fraud online.

Generally, three types of fraud occur online: market manipulation, offering frauds, and illegal touting of securities. Market manipulation, or "pump and dump" schemes, usually involve persons illegally trying to inflate the price of a stock. Oftentimes, they post the fraudulent information in online message boards to hype the stock. The Commission recently sued two former UCLA students and a third defendant for allegedly using UCLA computers to hype a stock. Amazingly, their efforts succeeded in raising the stock price from 13 cents to $15 in one trading day.

The second type of case involves offering frauds. Recently, the Commission prevailed in a case involving a claims examiner in the Department of Labor who solicited investors for a prime bank scheme. In fact, Enforcement has brought cases involving false offerings of everything from interests in eel farms, coconut plantations, to even a new underwater city meant to be a Caribbean tax haven.

There has also been an increase in the number of cases involving pyramid and Ponzi schemes. Another area that bears mentioning but where the Commission has not yet brought a case with an online component involves affinity fraud. Affinity frauds are scams targeting investors in particular groups, such as the elderly or minorities. It seems likely that online communities will be an inviting venue for those cases to migrate to the Internet.

One case, Oracle Trust Fund, involved an alleged $7.4 million prime bank scheme targeting church groups across Kansas, Nebraska, and Missouri. The defendants induced unsuspecting investors to invest with them by claiming that they were "born again," that they had a religious duty to provide these investments, and by giving the investments religious sounding names.

In another case involving the sale of promissory notes, the defendants allegedly used mailing lists to target elderly investors for estate and financial planning services in Texas but instead sold them $2.5 million worth of false promissory notes.

The final type of fraud involves stock promoters who are paid to tout a company but fail to disclose their compensation. By failing to disclose the compensation, these promoters create the impression that their commentary about the company is actually independent. Oftentimes, these stock promoters secretly sell their own shares as they are touting the stock to move the share price higher -- a practice known as "scalping."

The moral of these cases is clear: be exceedingly skeptical of investment advice you receive from strangers on the Internet (or elsewhere). You wouldnít buy a stock on the recommendation of a stranger approaching you on the street. So why would you based on chat room banter?

Although the Enforcement Division plays a very high profile and successful role in carrying out the Commissionís Internet agenda, the Commission is also dealing with other policy issues involving online trading.

Now I will return to my online trading report, which I briefly mentioned at the beginning of my remarks. Last year, I conducted a series of roundtables regarding online trading issues, which culminated in a report to the Commissioners issued in November. That report covered a number of issues and contains some very interesting data. I will just touch briefly on the areas I thought this audience would be most interested in: 1) the application of the suitability rules to online transactions, 2) privacy, and 3) investor education.


The suitability rule lies at the heart of a broker-dealerís responsibilities to investors. It very simply states that a broker-dealer must only recommend securities to a customer that are suitable for that particular customer. In making a suitability determination, a broker must consider certain factors, including the investorís investment objectives and financial situation.

Suitability has been the subject of hot debate recently -- some firms have argued that suitability has no application in the online trading environment. While I would agree that firms providing pure execution services for their customers do not incur a suitability obligation, the analysis is much more difficult under certain scenarios made possible by current and developing technology.

That technology, using data mining, will enable a broker to "push" (an Internet term of art) information to investors, either via e-mail, research reports, or by personalizing the trading screen that the investor sees. The question becomes what information can a broker provide its customers before that "information" becomes a recommendation. The report outlines a number of scenarios and an analysis of whether and how suitability would apply under certain facts and circumstances.

An interesting statistic regarding the debate on suitability is the relatively few arbitration cases involving a suitability claim. Out of 650 arbitration claims filed against nine of the largest online broker-dealers in terms of volume during the past three years, just 40 included a suitability allegation. In just under half of the 16 cases resolved to date, investors received damages from the firm involved. We could not determine whether the damages were based on suitability violations or a combination of claims; however, it is interesting to note that several of these cases involved a registered representative. Thus, we havenít seen too many arbitration cases turning on the suitability issue, and it is not clear that those cases involved true online trading. It will be interesting to see what happens if the market turns bearish.


Privacy has not exactly been a household word at the Commission in the past. This issue will become more relevant to the regulators as the Internet makes it easier to gather and develop user profiles and financial conglomerates seek to capitalize on their synergies by sharing individual information across industry groups. Glass-Steagall repeal -- the Gramm-Leach-Bliley Act (or GLB) actually mandates that the regulators implement the privacy provisions of that Act. As the Washington Post reported yesterday, how the regulators define "public" information versus "private" information will dictate how concerned consumers must be about their privacy protections online.

On privacy generally, a 1999 poll by AT&T Labs found that close to 90% of Internet users were either somewhat or very concerned about their personal privacy online. This concern is not without merit. Just this past month, Chase Manhattan Bank settled a case with New Yorkís Attorney General. In that case, the Attorney General alleged that the bank gave detailed information on millions of credit card holders to telemarketers in exchange for a cut of any commissions generated. Also, the New York Times recently reported that certain consumers who refused to divulge their social security numbers were asked to post substantial deposits to obtain cell phone service.

Investor Education

One of the most important challenges for the Commission and the industry is how to educate online investors. We have heard the stories about how the Internet has empowered investors but we have also heard about how the Internet has emboldened investors. What do online investors need to know and when? Investors who are empowered and emboldened would probably benefit from resources that provide information on how to analyze financial statements, the difference between a limit and a market order, the true cost of margin trading, the options in execution venues, and the benefits of diversification, just to name a few.

In a market in its 107th month of growth, most investors online and off are not digging too deeply before making investment decisions. I recently read about a Money magazine columnist who visited an investment club last spring and found that club members based their investment decisions on the stockís 52-week high and low and the number of analysts with buy ratings on the stock. Given that over 98% of analystís recommendations are either "buy" or "hold," investors would do well to consider more than just one source.

Much of this "so-called" advice may even be coming from less reputable sources on message boards. For example, the Commission recently sued a popular sponsor of message boards who charged a subscription for his stock tips. In that case, the Commission alleged that the sponsor, Tokyo Joe: 1) fraudulently inflated past performance results, 2) traded ahead in securities that he recommended, and

3) recommended a particular stock without disclosing that he had been compensated by the issuer.

As regulators, the Commission should understand how investors online make investment decisions. In my report, I recommend that we develop some basic information about investor behavior online. I am particularly interested in knowing who is investing online and how online investors analyze investment risk and potential return. What factors do they consider when they decide to invest? Where do they get their information?


Although I have covered a number of issues here today, there are two basic messages I want to convey. In case I was too subtle, the first is to read my online trading report. The second is that technology does not require a sea change in how the Commission approaches regulation.

We are all in the midst of changes wrought by technology. It will continue to impact how we conduct ourselves as individuals and certainly as investors. While the Internet Age will change many things, it will not change the underpinnings of the federal securities laws.

In fact, in many respects the Internet will make carrying out the Commissionís regulatory role easier. It will facilitate our mandate of providing full and fair disclosure and it will help us track fraud online. While we do not have to rethink the foundation of the law, we face the challenging but exciting task of applying these principles in cyberspace. As we consider the issues I have touched upon today, I at least would benefit from more input from the online investor community.