Written Statement of Richard H. Walker Director, Division of Enforcement United States Securities and Exchange Commission Concerning Securities Fraud on the Internet U.S. Senate Permanent Subcommittee on Investigations Committee on Governmental Affairs United States Senate Washington, D.C. -- March 23, 1999 Chairman Collins, Ranking Member Levin, and Members of the Subcommittee: I appreciate the opportunity to appear before this Subcommittee on behalf of the Securities and Exchange Commission (“Commission„) to address securities fraud on the Internet and the Commission’s efforts to combat such fraud. The Commission commends the Chairman, the Ranking Member, and the Members of the Subcommittee both for holding hearings in September 1997 on the important issue of microcap securities fraud and for convening these hearings on the related issue of on-line securities fraud. I. Introduction The Internet has dramatically changed how participants in the securities markets interact. In particular, it has provided new opportunities for investors to obtain a wide array of real-time information. However, at the same time, it has opened new avenues for securities fraudsters to swindle the investing public. By providing a medium for cheap, quick, and easy access to vast numbers of potential investors, in relatively anonymous fashion, the Internet has become a favorite haven for many con artists. The Commission is well aware of the potential use of the Internet to perpetrate frauds, and we have been vigilant in developing pro-active and flexible responses to those abuses. This testimony is designed to inform the Subcommittee of the types of securities frauds the Commission has witnessed on the Internet, to discuss the actions the Commission has taken in response, and to comment on future regulatory challenges in the wake of the recent proliferation of on-line brokers and day trading firms. II. The Internet: A Revolution for the Investor Although still in its formative stages, the Internet has already changed the way investors approach the market. Internet usage continues to swell at a ferocious pace, resulting in a surge in the quantity and quality of information available to investors and rapid growth in trading on-line. At present, a reported 147 million people use the Internet worldwide, with approximately 77 million of them in the United States. Approximately 21 percent of all domestic households have access to the Internet.[1] Predictions are that there will be 300 million users worldwide by the end of the year 2000, and 720 million by the end of 2005.[2] The Internet has brought significant benefits to investors, in terms of both cost savings and access to information. On-line brokerage firms generally charge a flat fee per trade, which today averages $15.75 per on-line trade.[3] These low trading costs were virtually unthinkable only a few years ago. Full-service firms, whose fee is generally based on the size of the transaction, often charge more.[4] Retail investors are increasingly taking advantage of these low transaction fees.[5] According to one recent source, nearly 14 percent of all trades are conducted on-line.[6] This number understates the impact on the small investor; nearly 37 percent of all individual investor trades are done on-line, up from 17 percent in 1997.[7] Predictions are that half of all retail trades will be executed over the Internet by 2001.[8] Currently, there are approximately 5 million on-line trading accounts, and predictions of as many as 14 million accounts by 2002.[9] The Internet also provides investors with enhanced access to information. At all times, investors can obtain market information over the Internet from virtually any locale. The Internet places information at investors’ fingertips previously available only to Wall Street professionals. With only a home computer, a modem, a phone line and an Internet service provider account, the investor can gather a wealth of investment information free of charge. For example, the Internet links investors to a growing number of services that provide immediate access to current stock quotations, price/earnings ratios, historical price and volume information, and company press releases. In addition, the Commission makes issuers’ annual and quarterly filings available to investors free of charge from its Edgar database. Moreover, with the growing popularity of bulletin board systems, news groups and other on-line discussion forums, investors can communicate with other interested persons: existing and former shareholders, short-sellers, analysts, brokers, venture capitalists, and just about any other market participant. Further, some companies have begun to broadcast their analyst conference calls over the Internet,[10] an encouraging development in our fight against selective disclosure of significant corporate developments to the marketplace.[11] Internet-based communication will soon serve as vital a role for investors as communication by the telephone or fax machine does today. Unfortunately, however, as investors explore the Internet for information and guidance to improve their investment decisions, they may also encounter some of the fraudulent scams being conducted on the Internet. As the Internet revolutionizes the way we communicate, fraud perpetrators have found it to be a convenient tool to communicate with investors. As a result, the Commission in general, and the Division of Enforcement in particular, have spent considerable resources in recent years surveilling and fighting securities fraud on the Internet. III. Internet Fraud -- Same Scams, New Medium The Commission began surveilling the Internet to detect fraud and other securities law violations in 1995, when the Internet first began to grow. While many indicia suggest Internet fraud is on the rise, the precise amount of such fraud cannot be quantified. Since 1995, we have brought 66 Internet-related cases, the majority during the last year. Last year, there was a substantial increase in the number of enforcement cases we brought that included an Internet component. This marks a trend we expect to continue. Our four years experience patrolling the Internet leads us to conclude that securities frauds conducted on the Internet are the same basic frauds that have long plagued our markets. The cyber-scams we have seen break down into essentially three categories: offering frauds, market manipulations, and touting. While these scams are nothing new, the Internet facilitates their perpetration by virtue of its speed, low cost, and relative anonymity. A. Offering Frauds These cases generally involve either phony or misleading offerings of equity, debt, and other securities. The securities involved run the gamut from the simple to the complex and esoteric. In some instances, unbeknownst to investors, the securities they think they are purchasing are non-existent. In other instances, the offering involves false and misleading statements concerning the issuer, e.g., exaggerated business prospects, inflated assets, etc. Often, these scams involve the theft of investor funds by the offering’s promoters. To date, we have brought 22 cases involving Internet offering frauds. This category of cases includes the following subsets: Exotic Offerings — The Internet tends to lend an air of credibility to offerings, no matter how far-fetched. This point is exemplified by one of our earliest Internet cases in 1995, involving the fraudulent offer and sale of shares in two Costa Rican coconut plantations.[12] The promoter falsely claimed that one of the plantations had a major distribution contract with an American supermarket and that a bank had guaranteed investors’ principal and 15 percent interest. Shortly thereafter, in another matter, we took action against a promoter who was using mass electronic mailing (i.e., “spam„) to solicit investors for a proposed eel farm.[13] The promoter promised investors a “whopping 20 percent return,„ claiming that the investment was “low risk.„ The promoter also distributed fabricated endorsements of the investment from fictitious investment advisers. Fraudulent exotic offerings continue. In August 1998, we charged two defendants with fraudulently raising approximately $2 million from 152 investors nationwide for purported investment in a virtual casino web site.[14] We alleged that only a portion of the funds raised were used to build the web site for the casino, the remainder went to undisclosed and undetermined expenses, including salaries, payments to family members, and to the purchase of a Mercedes Benz sport utility vehicle. In January 1999, both defendants were permanently enjoined by a federal court from violating the law and ordered to disgorge a total of $288,892. We have also witnessed over time that these schemes tend to offer more complex securities. It appears that fraud artists believe that the more exotic or complex the security, the more likely they are to pique investor interest. For example, last month we secured emergency relief -- including a preliminary injunction and an asset freeze -- against a Dallas company and its president who we claim engaged in a foreign currency trading scheme.[15] We allege that the defendants raised at least $3.7 million from at least 40 investors by selling investments in foreign currency transactions designed to achieve very high rates of return with limited risk. The Internet was used to market the investments. We further allege that only $600,000 was so invested, while the remainder of the funds were misappropriated. Pyramid and Ponzi schemes — These two classic fraudulent schemes have found their way onto the Internet. In a “pyramid„ scheme, participants attempt to make money solely by recruiting new investors to the program. When new investors and capital can no longer be found, the scheme collapses, with those not fortunate enough to have cashed out suffering the loss. In a “Ponzi„ scheme, funds from new investors are secretly used to pay prior investors, with promoters skimming off the top for themselves. The Internet played a major role in one of the largest pyramid schemes ever uncovered by the SEC. In March 1998 we obtained emergency relief against several defendants who had raised more than $150 million from approximately 150,000 investors.[16] We allege the defendants used an Internet web site and postings on several different discussion forums to sell interests in what was in fact a pyramid scheme. While the company claimed that it was product driven, the primary way sales representatives made money was by recruiting other sales representatives. The company concealed the fact that it was being operated as a pyramid scheme, while profiting by requiring each new sales representative to purchase a “business kit„ for $100. In March 1998, we obtained injunctive relief in a case which illustrates an on-line Ponzi scheme.[17] A Central District of California court enjoined four defendants for operating a Ponzi scheme involving investment contracts for the sale and leaseback of automated teller machines. The defendants offered the ATM program over the Internet and raised over $3.49 million from 132 investors. Defendants were ordered to disgorge over $595,000 in ill-gotten gains and to pay a civil penalty in a like amount. Affinity Frauds — These are frauds targeted at specific racial, religious, or ethnic groups. Here, too, we have witnessed the migration of similar type of fraudulent conduct to the Internet. For example, in July 1998, we obtained injunctions and a $4 million disgorgement order in an Internet fraud targeted at African-Americans.[18] Defendants raised $4 million from approximately 2,000 investors through false claims that they were operating a bank when, in fact, no bank existed. An Internet web site was used to solicit investors. The Internet offers a variety of ways to conduct affinity frauds, such as by advertising on a web discussion forum dedicated to a particular racial, religious, or ethnic group. Prime Bank Fraud — In recent years, the incidence of so- called “prime„ bank schemes has been on the rise.[19] These instruments purportedly take the form of notes, debentures, letters of credit, and guarantees. The schemes involve promises or guarantees of unrealistic rates of return. Typically, no such securities exist and the names of well-known domestic and foreign banks are improperly used to add credibility to the offering. Our early days of Internet surveillance detected this type of fraud as well. For example, in August 1995, we obtained emergency relief against defendants who raised $4 million in a “prime„ bank scheme which took advantage of the Internet.[20] Defendants used various methods to advertise the offering, including postings in the classified section of a major on-line service provider. B. Market Manipulation Market manipulation most often involves attempts to drive up a stock’s price in the secondary trading market by creating demand through the dissemination of false and misleading information. The manipulator normally owns shares in the company’s stock and sells out after the price is artificially inflated. When the manipulation is complete, the share price normally collapses, victimizing those who purchased during the scheme at higher prices. This form of manipulation is commonly referred to as the “pump and dump.„ Since a key element of a manipulation is widespread dissemination of false and misleading information, the Internet has proven to be a vehicle of choice for those who would manipulate the market. With a few keystrokes and a click of a mouse, information can be widely distributed over the Internet through postings to web sites, postings on electronic bulletin boards, via spam, as part of chat room discussions, or through multiple other avenues. While the Internet offers important benefits to investors, unfortunately, it does not come with a built-in mechanism that separates the tainted information from that which is truthful and reliable. In addition, investors often do not know the identity and background of the person with whom they are communicating. The cost of disseminating information over the Internet is less than running a traditional “boiler room,„ which entails the cost of office space and numerous salespeople and telephone lines. The speed and efficiency of the Internet also allow information to be disseminated much more broadly and quickly than conventional boiler room methods. Accordingly, the Internet could soon replace the boiler room as the primary mode for conducting market manipulations. We have brought 18 cases involving manipulations taking place on the Internet. The typical Internet manipulation involves “microcap„ stocks.[21] As discussed during this Subcommittee’s September 1997 hearings on microcap fraud, these stocks are particularly susceptible to manipulation due to the confluence of their low price, lack of reliable and current issuer information, and relatively small number of shares trading in the market. A classic example of an on-line manipulation is our case against Comparator Systems Corp. The company and several of its officers and directors disseminated misleading information on the Internet regarding the financial status of the company as well as the company’s purported proprietary interest in a fingerprint identification device. Comparator had, in fact, stolen the fingerprint technology. Comparator was the subject of tens of thousands of Internet bulletin board postings where the misleading information was discussed. During the time of the manipulation, Comparator stock, normally trading in nominal amounts, broke the Nasdaq one-day trading volume record with 123 million shares traded. At its height, the company’s market capitalization was inflated to over $1 billion. Defendants sold millions of dollars of Comparator shares through accounts in the names of other persons. To date, the Commission has obtained a trading suspension, permanent injunctions, and officer and director bars against several defendants. We also sanctioned Comparator’s accounting firm. The litigation and our investigation is continuing. A second massive market manipulation conducted on-line involved the stock of Systems of Excellence (“SOE„), a company purportedly in the business of manufacturing and distributing video teleconferencing equipment. The mastermind of the scheme, Charles Huttoe, secretly distributed millions of SOE shares to family members and entities he controlled. Huttoe then made corrupt payments to the publishers of an on-line newsletter, SGA Goldstar, to recommend the stock and proceeded to sell his shares at an inflated price. The scheme allowed SOE to obtain a market capitalization of $350 million without ever selling a product. The Commission brought 11 enforcement actions charging 19 defendants and 12 relief defendants. We also worked closely with the U.S. Attorney’s Office for the Eastern District of Virginia to prosecute Huttoe and others involved in the scheme. In January 1997, Huttoe was sentenced to 46 months in federal prison. In total, six guilty pleas have been entered in the case.[22] **FOOTNOTES** [1]: PR Newswire, Feb. 10, 1999 (reporting statistics provided by the Computer Industry Almanac Inc.). [2]: Id. [3]: Pop?, U.S. News & World Report, Jan. 25, 1999 at 42. [4]: Who Needs a Broker?, Business Week, Feb. 22, 1999 at 113 (stating that it would cost between $8 and $29.95 to buy 200 shares on-line, while the same trade would cost $116 at a full service firm). We caution, however, that investors should consider factors in addition to cost when selecting a broker, including the need for research and advice. [5]: In turn, more brokers are setting up shop on the Internet. Today, approximately 100 firms offer on-line brokerage, up from 33 in 1997, 20 in 1996 and a mere 12 in 1995. [6]: Who Needs a Broker?, Business Week, Feb. 22, 1999 at 113. [7]: Lynnley Browning, The Rise of E-Wall St., The Boston Globe, March 7, 1999 at G1. [8]: Julie Forster, Online Trading Jars Full-Service Brokers, Corporate Report Wisconsin, January 1999 at 1 (citing stats supplied by Forrester Research). [9]: Jon Birger, On-Line Brokerage Fights for Attention: Outspent, NBD Taps Novice Investors, Crain’s New York Business, Dec. 21, 1998 at 4. [10]: See Internet Calls Can Reach the Ears of Small Investors, Bloomberg.com, Feb. 26, 1999. [11]: See Arthur Levitt, A Question of Integrity: Promoting Investor Confidence by Fighting Insider Trading, SEC Speaks, February 27, 1998 (expressing concern about a process whereby some companies release material information to analysts before the rest of the market). [12]: SEC v. Scott A. Frye, Lit. Rel. No. 15139, 1996 SEC LEXIS 3016 (Oct. 29, 1996). [13]: SEC v. Daniel Odulo, Lit. Rel. No. 14616, 1995 SEC LEXIS 2186 (Aug. 24, 1995). [14]: SEC v. Internet Casino Sports Gaming, LLC, Lit. Rel. No. 16025, 1999 SEC LEXIS 112 (Jan. 13, 1999). [15]: SEC v. Forex Asset Management, LLC, Lit. Rel. No. 16055, 1999 SEC LEXIS 262 (Feb. 8, 1999). [16]: SEC v. International Heritage, Inc., Lit. Rel. No. 15672, 1998 SEC LEXIS 434 (March 17, 1998). [17]: SEC v. Western Executive Group, Inc., Lit. Rel. No. 15134, 1996 SEC LEXIS 2999 (Oct. 23, 1996). [18]: SEC v. First Zurich National USA, Lit. Rel. No. 15634, 1998 SEC LEXIS 169 (Feb. 3, 1998).. [19]: See SEC Office of Investor Education and Assistance, Investor Alert, So-Called “Prime„ Bank and Similar Financial Instruments (available at www.sec.gov.). [20]: SEC v. Gene Block, d/b/a Block Consulting Services, Lit. Rel. No. 14711, 1995 SEC LEXIS 3006 (Nov. 2, 1995). [21]: Although “microcap„ is not a term defined in the federal securities laws, microcap companies are generally thinly capitalized companies whose securities trade in the over-the-counter market, primarily on the OTC Bulletin Board or in the pink sheets. [22]: For other significant cases where we alleged on-line market manipulations, see: SEC v. Electro-Optical Systems Corp., Lit. Rel. No. 39750, 1998 SEC LEXIS 751(Apr. 21, 1998); SEC v. Environmental Chemicals Group, Inc., Lit. Rel. No. 15183, 1996 SEC LEXIS 3351, (Dec. 11, 1996); and SEC v. Remington Hall Capital Corp., Lit. Rel. No. 15493, 1998 SEC LEXIS 2289 (Oct. 22, 1998). C. Touting Investors presented with information and analysis concerning a potential investment have a right to know whether that information and analysis is the product of objective and independent research, or whether, in reality, the issuer simply “bought and paid for„ it. The average investor would find the fact that the information or analysis was “paid for„ to be highly significant, because he or she would be likely to consider such information less reliable than independent, disinterested analysis. Section 17(b) of the Securities Act is the antifraud provision that directly addresses this concern. Section 17(b) makes it illegal to tout any security for compensation received from an issuer, underwriter, or dealer, without fully disclosing the nature, source, and amount of that compensation. Illegal touting on the Internet (and elsewhere) is a major concern of the Commission. The wealth of information available over the Internet aids investors and the markets only to the extent it is credible and reliable. Our surveillance of the Internet, particularly during 1998, made clear that numerous promoters were flouting the requirements of Securities Act Section 17(b). Our Office of Internet Enforcement[23] directed and oversaw a coordinated surveillance effort that resulted in our identification of numerous situations where there was either non-disclosure or inadequate disclosure of compensation received by the touter.[24] Because the problem appeared to be widespread, we believed a strong enforcement response in this area was required. Accordingly, we decided that a “sweep„ approach would work best, coordinating multiple investigations to culminate in the filing and announcement of numerous cases on the same day. This approach maximizes the visibility and deterrent effect of our enforcement efforts. The “Sweep„ The Commission's first nationwide Internet fraud sweep (the “Sweep„) was announced October 28, 1998. We filed 23 enforcement actions against 44 defendants and respondents across the country for committing fraud over the Internet and deceiving investors around the world. The Sweep involved actions filed by the SEC’s home office in Washington, D.C., as well as ten of our 11 regional offices. The Sweep cases primarily concerned unlawful and fraudulent touting of microcap companies. The cases involved a range of Internet conduct including fraudulent spams, on-line newsletters, message board postings, and Web sites. We alleged that the promoters unlawfully touted more than 235 microcap companies, by either: (1) making misrepresentations about the companies; (2) making misrepresentations about their own "independence"; or (3) failing to disclose adequately the nature, source and amount of compensation paid by the touted microcap company. Purporting to provide an unbiased opinion in their recommendations, the creators of these Internet touts received a total of almost $7 million and almost two million shares of cheap insider stock and options for touting services. In five cases, the touters sold their stock or exercised their options immediately after a price increase in response to their recommendations, a deceptive practice commonly referred to as "scalping." A chart providing details of each of the 23 Sweep cases is attached as an exhibit to this testimony. To illustrate the fraudulent conduct encountered in the Sweep in greater detail, however, we discuss three representative cases below. 1. Touting. The allegations in the action we brought against Jeffrey Bruss and his company, the Future SuperStock, Inc. (“FSS„)[25] demonstrate a Section 17(b) touting violation. Beginning in the spring of 1996, a newsletter published by Bruss and FSS recommended to more than 100,000 subscribers the purchase of approximately 25 microcap stocks. The recommendations were also displayed on FSS’s web site. The standard prediction was that the stock price would double or triple within the next three to twelve months. We allege, among other things, that neither Bruss nor FSS disclosed the receipt of compensation from nearly every issuer profiled. Our allegations also include that FSS and Bruss represented that they performed independent research and analysis in evaluating the issuers profiled when, in fact, they conducted little, if any, research. 2. Scalping. The allegations in our action against StocksToWatch.com (“STW„) provide an example of touting combined with scalping.[26] STW touted five microcap issuers to over 200,000 subscribers of its on-line newsletter. The touts also appeared on its web site and in millions of spams. STW issued a buy recommendation for one of the microcap issuers on April 21, 1998. We alleged that, at that time, the issuer’s stock traded at 96 cents per share and STW predicted it would reach $20 per share within 18 months. Two days later, the stock surged from 96 cents to $3.13. At this time, STW began selling its shares of the issuer. By July 6, STW had sold all of its shares reaping a profit in excess of $570,000. We allege that STW made an additional profit of approximately $600,000 by scalping shares of the other issuers. 3. Touts Coupled with Misrepresentations. Our action against Princeton Research exhibits how touts may contain misrepresentations hyping the issuer’s stock.[27] Princeton touted five issuers through the use of more than 6 million spams e-mailed worldwide. Princeton received almost 300,000 shares and 75,000 options from those issuers. We alleged that Princeton made misrepresentations about two of the issuers. Princeton claimed that one of the issuers, IRT Industries, had a casino in Costa Rica making weekly profits of $10,000. We alleged that no IRT casino had ever made a profit. Princeton also claimed that a second issuer, Energy Optics, would soon more than double in value because of acquisitions. At the time of the Sweep, Energy Optics traded at $2.50 per share and Princeton claimed it would climb to between $6 and $7. We alleged that this prediction was baseless because Energy Optics’ financial statements showed no acquisitions and a history of losses. Energy Optics now trades under a new name at less than a dollar per share. Princeton and its president have consented to the entry of a permanent injunction and to payment of a $40,000 civil penalty. Aftermath of the “Sweep„ Reaction to the Sweep has been overwhelmingly positive. Investor sensitivity to on-line fraud was heightened by the widespread media coverage. Prior to the Sweep, our on-line complaint center, designed to receive enforcement referrals from the public, received approximately 120 messages per day. In the days immediately following the Sweep, it received four times that amount from concerned investors. Numerous message board postings and chat room discussions focused on our actions and the conduct we had uncovered. In addition, our Internet surveillance leads us to believe that disclosure by touters has improved. Continuing our crackdown on Internet fraud, we announced a follow-up Internet sweep in February 1999. We brought four enforcement actions against 13 individuals and companies for committing fraud over the Internet. Three of the actions involved allegations of illegal touting; the fourth involved allegations of a “pump and dump„ manipulation scheme. The alleged creators of the touts purportedly provided unbiased opinions in their recommendations, while at the same time receiving more than $450,000 in cash and approximately 2.7 million stock shares and options in exchange for their services. A chart providing details of each case in this sweep set forth as an exhibit to this testimony. We anticipate future sweeps as a way to continue making strong deterrent statements against fraudulent Internet offerings and manipulative Internet trading. Despite the tremendous growth of the securities markets, and the Internet’s role in that growth, the Commission's resources have remained relatively constant. We must therefore rely increasingly on innovative and efficient ways of minimizing fraud and of maximizing the deterrence achievable with the Commission's limited resources. Both our October 1998 and February 1999 sweeps proved effective in achieving these goals. IV. The Commission’s Response to the Rise in Internet Fraud -- Creation of an Office of Internet Enforcement and “Cyberforce„ The Commission’s program to address the rise in Internet securities fraud has evolved considerably since our initial efforts in 1995. To centralize operations, the Commission created an Office of Internet Enforcement in July 1998. The Office regularly surveils the Internet, refers matters to the entire Division of Enforcement staff, as well as to other agencies and self-regulatory organizations, engages in special projects, and trains staff of the Commission and of other governmental authorities. The Office, part of the Division of Enforcement, is specifically charged with executing a five-prong program to counter Internet-related securities fraud. The five prongs are defined below. 1. Vigilant and Flexible Surveillance As communications technology and markets have evolved, the Division’s practices in surveilling for potential securities frauds have responded in kind. In particular, as the Internet has grown in importance, the Division and other areas of the Commission have increased surveillance, assigning staff members to monitor the Internet, especially the web and message areas like news groups, bulletin boards, and web discussion forums. The Division has all the necessary commercial on-line access accounts, employs the latest browsing software for viewing the Internet, and maintains designated high speed phone lines for direct Internet access. The surveillance program has grown increasingly sophisticated since its early days. Given the vastness of the Internet, and its constant expansion, no surveillance program can guarantee complete coverage. Aiding our detection efforts, however, is the fact that Internet fraud artists face a double-edged sword. The characteristics of the medium that make their promotions accessible to investors also often place their activities in plain view of our Enforcement Division. Moreover, despite efforts to conceal their identities and location, the fact remains that, at some point, they must surface to collect funds. The Enforcement Division has enlisted a group called the “Cyberforce,„ a specially trained nationwide corps of approximately 125 of the Division’s attorneys, accountants and analysts. Cyberforce members spend some time each week “surfing„ the web in search of securities law violations and also conduct targeted operations to locate specific types of Internet fraud (e.g., a bogus on-line newsletter) or participating in joint operations with other agencies (such as the “Surf days„ carried out by the Federal Trade Commission). Surfing for fraud has become more effective as the web has become more organized. Emerging Internet devices have begun to catalog services, such as investment offerings, investment newsletters, and Internet trading facilities. Even search engines designed to organize the results of other search engines have cropped up. This greater organization of information has made the Internet somewhat easier to police. Moreover, navigation has also become far simpler and more comprehensive, and will continue to improve in the future. 2. Aggressive prosecution Of course, the most effective deterrent of fraud on the Internet and elsewhere is a track record of aggressive enforcement actions. Such actions not only halt ongoing frauds and punish violators, but the credible threat of potential prosecution serves to deter other potential transgressors. As discussed in detail above, the Commission has brought 66 Internet-related securities fraud cases to date. To protect investors, we have been quick to suspend trading where there is inaccurate information in the marketplace or other indicia of manipulation.[28] 3. Coordinated Liaison work The jurisdiction to address securities violations on the Internet is not limited to the Commission, but stretches across federal, state, and local law enforcement lines. The activity may also violate laws administered by other federal agencies. Historically, the Commission has succeeded in coordinating its efforts with other law enforcement authorities, and the Commission's policing of the Internet follows a similar path of cooperation and joint action. In the context of its Internet program, the Commission has cooperated, formally and informally, with the United States Department of Justice, the Federal Bureau of Investigation, the Federal Trade Commission, the United States Secret Service, and a range of other civil and criminal law enforcement authorities. These coordinated efforts began as early as December of 1996, when the Commission teamed with the FTC, the FCC, the Postal Inspection Service, and 70 state and local law enforcement officials from 24 states on “Surf Day,„ which resulted in the identification of more than 500 possible Internet scams. The Commission has enjoyed particular success in joint investigations with the Department of Justice and local criminal prosecutors. For example, as described above, the Commission coordinated its efforts with the United States Attorney’s Office for the Eastern District of Virginia in a blatant market manipulation case -- Systems of Excellence. In that case, the Commission brought civil and administrative proceedings against thirty-two individuals and entities while the U.S. Attorney convicted six defendants of criminal violations, including the CEO of the company and the publisher of an Internet-based investment newsletter. In another notable example, the Commission and the Santa Cruz California District Attorney’s office coordinated efforts against the promoter of an on-line direct public offering of a company called Interactive Products and Services.[29] A jury recently found the owner of Interactive Products and Services guilty of 54 felony counts and a judge sentenced the owner to 10 years in a California state prison. The Division also works closely with self-regulatory organizations, such as the New York Stock Exchange and National Association of Securities Dealers Regulation, Inc., as well as state regulatory authorities and the North American Securities Administrators Association. The SEC will continue such cooperative operations with other law enforcement agencies to counter unlawful conduct on the Internet. Staff from our Office of Internet Enforcement also travel throughout the country conducting training for law enforcement and regulatory authorities. These efforts include training sessions at seminars sponsored by NASAA, the U.S. Department of Justice, and the FBI Academy at Quantico. 4. Investor Education. The best defense to any securities scam is an informed and wary investing public. The Office of Investor Education and Assistance has worked closely with the Enforcement Division in producing several brochures telling investors how they can invest wisely on-line and avoid becoming the victims. The publications, Internet Fraud and Microcap Stock: A Guide for Investors, are found on the Commission's web page . They provide checklists 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 if offered over the Internet. On the day of the Sweep announcement, Internet Fraud received more than 10,000 visits. While we do not have a budget to pay for advertising these publications, we take every opportunity to promote these publications with the media. The SEC also posts relevant information on Internet forums (such as commercial on-line providers, Internet discussion forums, and news groups) where such information is available to actual and potential investors in a specific security. For instance, in several recent instances where the SEC obtained trading suspensions of certain public companies, the Commission posted press releases concerning the trading suspensions and a copy of the actual suspension order in discussion forums dedicated to discussing those particular stocks. 5. Fostering Self-policing Complaints and tips from members of the public have historically provided an important source of investigative leads for the Enforcement Division. To increase accessibility, the Commission opened its on-line Enforcement Complaint Center (“ECC„) on June 14, 1996. The ECC expanded the ways members of the public can contact the Enforcement Division to report any potential securities violations over the Internet (or any other potential violation of the federal securities laws). The ECC includes an email box, toll-free telephone number, fax number, and mailing address, and also provides a user-friendly form to ensure that the complainant sends a complete report of the suspicious activity. The success of the ECC has been extraordinary. From its first day of operation, the ECC began to receive about 20 complaints each day and now receives between 200 and 300 complaints each day. Not only does the ECC generate leads about specific entities and persons, but the ECC also allows the Enforcement Division to remain apprised of the latest trends and tactics of on-line fraud. More than 50 percent of the complaints relate to, and often advance, existing SEC investigations. IV. A Look Towards the Future In addition to the challenges the Internet presents to our enforcement program, the growing use of technology in the securities markets -- and in particular the proliferation of on-line brokers and day trading firms -- require the Commission to examine how these firms are regulated. The Commission, together with the self- regulatory organizations, is currently looking into the practices of on-line and day trading firms to ensure that they are complying with the securities laws, and will consider whether there is a need for new or modified rules. As part of this effort, Commissioner Unger is conducting a series of roundtables composed of various industry and market participants to discuss issues relating to on-line trading. The first of these roundtables was held on February 22, 1999 in San Francisco. 1. On-Line Brokerage In many cases, on-line brokerage merely the substitutes of the Internet for the telephone as the means for customers to send their orders to their brokers. A broker’s obligations to its customers does not change just because it receives its customers’ orders through the Internet, rather than over the telephone. Nevertheless, on-line brokerage does raise some new issues. The combined market strength and lower cost of trading has contributed to more individuals trading more often. This increased trading activity heightens the importance of investor education efforts. For this reason, Chairman Arthur Levitt recently stressed the need for on- line investors to be knowledgeable about the risks of investing in securities generally, and to understand the limitations -- not only the advantages -- of on-line trading.[30] Our Office of Investor Education and Assistance also has posted tips for on-line investors on our web site. In addition, as brokers and investors increase their reliance on technology, the reliability of these systems becomes critical. The Commission recently proposed new rules that would specifically require registered broker- dealers to have sufficient operational capability.[31] The Commission continues to discuss with the NASD and the industry how existing requirements apply in the new on-line world and what, if any changes, may be appropriate. 2. Day Trading Firms In general, the Commission considers a day trading firm to be one that provides individuals -- referred to as “day traders„ -- with powerful hardware and software so that the traders have immediate or real time access to stock exchanges and the Nasdaq market. Day trading firms also provide their traders with access to real time market information, with systems that analyze and chart this market information. Day trading firms encourage traders to buy and sell particular stock during the day, often within minutes, with the goal of profiting from intraday swings in share prices. These firms’ activities raise different regulatory issues than does the growth of on-line brokerage. In particular, day trading firms raise questions regarding compliance with margin, short sale, and broker-dealer registration requirements, as well as supervision of associated persons of broker-dealers. Firms’ on-line brokerage services generally do not raise significant issues in these areas. V. Conclusion Despite its great potential to benefit the investing public, the Internet has proven to be an irresistible target for certain fraud artists. By continuing to implement a vigilant Internet program, the Commission intends to deter Internet fraud, and protect investors in this medium, as in others. Our greatest problem will likely be one of resources, as the size of our staff has remained relatively constant while the Internet has grown by leaps and bounds. The Commission and its staff will be pleased to assist the Subcommittee as it goes forward. **FOOTNOTES** [23]: For a discussion of the work of this Office, see pages 18 - 23 below. [24]: A typical example of inadequate disclosure is: “From time to time we may receive compensation from some of the featured companies.„ In cases where the touter features only companies that have in fact paid compensation (as is typical), this disclosure is misleading because it suggests that receipt of compensation is not a regular business practice. [25]: SEC v. The Future SuperStock Inc., Lit. Rel. No. 15958, 1998 SEC LEXIS 2345 (Oct. 27, 1998). [26]: SEC v. StocksToWatch.com, Lit. Rel. No. 15956, 1998 SEC LEXIS 2343 (Oct. 27, 1998). [27]: SEC v. Jon Wesley Savage and Princeton Research Inc., Lit. Rel. No. 15954, 1998 SEC LEXIS 2341 (Oct. 27, 1998). [28]: See Green Oasis Environmental Inc., 1997 SEC LEXIS 1014 (May 9, 1997); Interactive Multimedia Publishers, Inc., 1996 SEC LEXIS 3386 (Dec. 3, 1996); International Heritage, Inc., 1998 SEC LEXIS 423 (March 13, 1998); Omnigene Diagnostics, Inc., 1996 SEC LEXIS 3178 (Nov. 16, 1996); Legend Sports, Inc., 1997 SEC LEXIS 1891 (Sept. 15, 1997); and Midland, Inc., 1998 SEC LEXIS 1752 (Aug. 18, 1998). Section 12(k) of the Securities Exchange Act of 1934 authorizes the Commission to summarily suspend trading in a company’s stock for a ten day period if the public interest and the protection of investors so require. [29]: SEC v. Interactive Products and Services, Inc., Lit. Rel. No. 15700, 1998 SEC LEXIS 630 (Apr. 8, 1998). [30]: Statement by Arthur Levitt, Chairman, U.S. Securities and Exchange Commission, Concerning On-Line Trading, January 27, 1999 (available at www.sec.gov./statements and digests/press releases). [31]: Securities Exchange Act Release No. 41142 (March 5, 1999), 64 FR 12127 (March 11, 1999).