[Senate Hearing 105-453]
[From the U.S. Government Publishing Office]
S. Hrg. 105-453
FRAUD ON THE INTERNET: SCAMS AFFECTING CONSUMERS
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HEARING
before the
PERMANENT
SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTH CONGRESS
SECOND SESSION
__________
FEBRUARY 10, 1998
__________
Printed for the use of the Committee on Governmental Affairs
------------
U.S. GOVERNMENT PRINTING OFFICE
46-902 CC WASHINGTON : 1998
_______________________________________________________________________
For sale by the Superintendent of Documents, Congressional Sales Office
U.S. Government Printing Office, Washington, DC 20402
COMMITTEE ON GOVERNMENTAL AFFAIRS
FRED THOMPSON, Tennessee, Chairman
SUSAN M. COLLINS, Maine JOHN GLENN, Ohio
SAM BROWNBACK, Kansas CARL LEVIN, Michigan
PETE V. DOMENICI, New Mexico JOSEPH I. LIEBERMAN, Connecticut
THAD COCHRAN, Mississippi DANIEL K. AKAKA, Hawaii
DON NICKLES, Oklahoma RICHARD J. DURBIN, Illinois
ARLEN SPECTER, Pennsylvania ROBERT G. TORRICELLI,
BOB SMITH, New Hampshire New Jersey
ROBERT F. BENNETT, Utah MAX CLELAND, Georgia
Hannah S. Sistare, Staff Director and Counsel
Leonard Weiss, Minority Staff Director
Michal Sue Prosser, Chief Clerk
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PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
SUSAN M. COLLINS, Maine, Chair
SAM BROWNBACK, Kansas JOHN GLENN, Ohio
PETE V. DOMENICI, New Mexico CARL LEVIN, Michigan
THAD COCHRAN, Mississippi JOSEPH I. LIEBERMAN, Connecticut
DON NICKLES, Oklahoma DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania RICHARD J. DURBIN, Illinois
BOB SMITH, New Hampshire ROBERT G. TORRICELLI, New Jersey
ROBERT F. BENNETT, Utah MAX CLELAND, Georgia
Timothy J. Shea, Chief Counsel and Staff Director
Mary D. Robertson, Chief Clerk
C O N T E N T S
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Opening statements:
Page
Senator Collins.............................................. 1
Senator Glenn................................................ 3
WITNESSES
Tuesday, February 10, 1998
Susan Grant, Director, National Fraud Information Center, Vice
President, Public Policy, National Consumers League............ 5
Tatiana Gau, Vice President of Integrity Assurance, America
Online, Inc.................................................... 9
Barry D. Wise, Certified Public Accountant, Victim of Fortuna
Alliance Internet Pyramid Scheme, Matthews, North Carolina..... 24
Hon. Robert Pitofsky, Chairman, Federal Trade Commission,
accompanied by Jodie Bernstein, Director, Bureau of Consumer
Protection..................................................... 31
Alphabetical List of Witnesses
Gau, Tatiana:
Testimony.................................................... 9
Prepared Statement........................................... 62
Grant, Susan:
Testimony.................................................... 5
Prepared Statement........................................... 45
Pitofsky, Hon. Robert:
Testimony.................................................... 31
Prepared Statement with attachments.......................... 78
Wise, Barry:
Testimony.................................................... 24
Prepared Statement........................................... 75
APPENDIX
Exhibit List
* May Be Found In The Files of the Subcommittee
Page
1. GSlide presentation of Tatiana Gau, Vice President of
Integrity Assurance, America Online, Inc....................... 240
2. GBackground material regarding Fortuna Alliance, including
printout of Fortuna Alliance Web Site as of January 1998,
miscellaneous news releases on Fortuna Alliance, and copy of
FTC v. Fortuna Alliance, et al., FTC Complaint, Temporary
Restraining Order and Stipulated Final Judgment................ 267
3. GSlide presentation of the Honorable Robert Pitofsky,
Chairman, Federal Trade Commission............................. 300
4. GMemoranda prepared by Rena M. Johnson, Counsel, and Dennis
McCarthy, Investigator, Permanent Subcommittee on
Investigations, dated February 5, 1998, to Permanent
Subcommittee on Investigations' Membership Liaisons regarding
Internet Fraud................................................. 312
5. GSupplemental Questions for the Record of The Honorable
Robert Pitofsky, Chairman, Federal Trade Commission............ 351
6. GSupplemental Questions for the Record of Susan Grant,
Director, National Fraud Information Center.................... 355
7. GSupplemental Questions for the Record of Tatiana Gau, Vice
President of Integrity Assurance, America Online, Inc.......... 358
8. GFederal Trade Commission, Bureau of Consumer Protection--
Fighting Crime on the Internet (Material on law enforcement and
consumer and business education.).............................. *
9. GNational Fraud Information Center (NFIC) informational
sheet.......................................................... 360
10. G``Statistics Show Internet Fraud Rising,'' NCL Bulletin,
May/June 1997.................................................. 361
11. GSelected news articles on America Online, Inc.............. *
12. GSelected news articles on Federal Trade Commission (FTC)... *
13. GSelected news articles on Internet fraud issues............ *
FRAUD ON THE INTERNET: SCAMS AFFECTING CONSUMERS
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TUESDAY, FEBRUARY 10, 1998
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 9:35 a.m., in
room SD-342, Dirksen Senate Office Building, Hon. Susan
Collins, Chairman of the Subcommittee, presiding.
Present: Senators Collins and Glenn.
Staff Present: Timothy J. Shea, Chief Counsel/Staff
Director; Mary D. Robertson, Chief Clerk; Rena M. Johnson,
Counsel; Dennis M. McCarthy, Investigator; Lindsey E. Ledwin,
Staff Assistant; Kirk E. Walder, Investigator; Bob Roach,
Counsel to the Minority; Leonard Weiss; Nanci Langley; Marianne
Upton; Lynn Kimmerly; Myla Edwards; Jeff Gabriel; Michael
Loesch; Steve Abbott and Felicia Knight.
OPENING STATEMENT OF SENATOR COLLINS
Senator Collins. The Subcommittee will please come to
order. This morning the Subcommittee begins its hearings on
fraudulent schemes on the Internet. The Internet is emerging as
a phenomenal tool of commerce and communication. One hundred
seventy five countries are connected to the Internet, and
approximately 50 million Americans use the Internet. By the
year 2000, it is projected that there will be half-a-billion
Internet users worldwide.
There is no question that the Internet has been a boon to
business. The remarkable ease and speed with which transactions
can be conducted over the Internet provide businesses of all
sizes with access to millions of customers. For example, I am
familiar with a small, family-owned business in northern Maine
that uses the Internet to market its delicious lobster stew.
Without the Internet, this small business would never be able
to afford the marketing costs in reaching millions of
customers.
For their part, consumers have the ability to engage in a
variety of commercial activities across State and national
borders, including shopping, banking and investing, all from
the comfort, privacy and safety of their own homes.
Unfortunately, those who would use the Internet to defraud can
also work from the comfort, privacy and safety of their own
homes or anywhere else, for that matter.
Because it can be used to transfer text, pictures, and
sounds, as well as money, credit card numbers, and personal
information, the potential for criminal use of the Internet is
infinite. Corresponding
to the explosive growth of the Internet, the number of consumer
complaints of cyberfraud to the National Fraud Information
Center has increased by nearly 300 percent in the past year.
The Federal Trade Commission receives between 100 and 200
Internet fraud complaints per month.
Law enforcement officials are quickly learning that almost
any crime that can be committed in the real world can also be
committed in the virtual world. In fact, by using the Internet,
criminals can target more victims more quickly, more cheaply,
and with much less chance of getting caught.
Through these hearings, the Subcommittee seeks to
accomplish two goals. First, we hope to educate consumers about
the potential for fraud on the Internet. While the Internet
provides limitless opportunities for commerce and
communication, the con artists who roam in cyberspace cause
some consumers to avoid using the Internet to its full
potential, much to the dismay of actual and potential online
businesses.
In order to combat fear of the unknown, consumers must be
armed with the knowledge of how to detect online fraud and how
to avoid becoming a victim. Consumers must also be confident in
the knowledge that there is a sheriff in cyberspace to whom
they can report Internet fraud when they encounter it and who
will investigate their complaints.
Our second goal is to determine Congress' proper role in
the prevention and prosecution of online fraud. Congress must
approach its role with caution. Too much regulation will
hamper, if not destroy, the development of online commerce and
the spirit of the Internet as a society of free and open
communication.
On the other hand, too little regulation or inadequate laws
will erode consumer confidence to the extent that the full
potential of the Internet as a vehicle of commerce and
communication may never be realized. We begin this hearing
keeping in mind the delicate balance that Congress must strike.
This hearing is the first in a series of hearings focusing on
fraudulent schemes being perpetuated over the Internet.
The first thing that strikes you when you begin to examine
Internet fraud is the old adage, ``The more things change, the
more they stay the same.'' There is nothing new or unique about
many of the frauds being committed with the Internet. Instead,
what is happening is that such old-fashioned frauds as work-at-
home scams, pyramid schemes, fraudulent sweepstakes promotions
and others have gone high-tech.
Moreover, as the chairman of the SEC testified at a
previous hearing held by this Subcommittee, the Internet
provides the appearance of legitimacy at a far lower cost. In
such cases, the type of fraud being committed is not new;
rather, it is the use of the Internet as the means of
commission that is new and that poses obstacles to law
enforcement and traps for the unwary Internet user.
In addition to these very traditional types of fraud, we
will examine some not-so-traditional frauds that have spawned a
new vernacular in Netspeak, with such labels as ``Trojan
horses'' and ``sniffers.'' What is particularly alarming is
that the inexperienced Internet user may not even realize that
he or she has been targeted as a victim until well after the
crook has absconded with the victim's money.
We will hear today from three panels of witnesses. Our
first panel will consist of the Director of the National Fraud
Information Center of the National Consumers League and the
Vice President of Integrity Assurance at America Online. These
witnesses will describe the types of fraud prevalent on the
Internet and give us some helpful advice on how consumers can
protect themselves from becoming Internet fraud victims. Our
next witness will be a victim of Internet fraud who lost
thousands of dollars to a pyramid scheme that was ultimately
investigated and shut down by the Federal Trade Commission.
Finally, I am pleased that we will hear this morning from the
chairman of the Federal Trade Commission, the lead Federal
agency charged with protecting consumers from this type of
illegal activity. The chairman will describe Federal efforts to
combat Internet fraud.
It is now my pleasure to recognize the Ranking Minority
Member of the Subcommittee, the senior Senator from Ohio,
Senator John Glenn, for any statement that he may wish to make.
OPENING STATEMENT OF SENATOR GLENN
Senator Glenn. Thank you, Madam Chairman, and I want to
commend you for holding this hearing. The tremendous expansion
of the Internet as a vehicle of communication and commerce
raises an array of important security, consumer and legal
issues that need to be addressed if we are to tap the full
potential of this new technology. I think it is important that
this Subcommittee keep on top of the important issues in this
area.
Two years ago, the Subcommittee held a series of hearings
about security in cyberspace. And today we look at a different
but no less important topic, and that is consumer fraud over
the Internet. The movement toward electronic commerce is a true
cyberspace revolution. It has the potential to change the
nature of the way people and firms conduct business. It can
link millions of consumers and businesses, speed transactions,
lower entry costs for new businesses.
Already a majority of banking and security transactions are
conducted electronically. Now more and more private citizens
are buying, selling and banking over the Internet. One study
reported that the Internet market exceeded $1 billion in 1995,
and that is expected to grow by the year 2000 to more than $23
billion. From $1 billion to $23 billion in just a 5-year
period.
However, a technological breakthrough that brings new
opportunities often creates new vulnerabilities. The same
characteristics that make the Internet a convenient medium for
commerce also make it an attractive vehicle for con artists and
illegitimate businesses. In December, 1996, a task force of
Federal, State and local agencies, led by the FTC, surfed the
Internet and identified 500 likely pyramid schemes. How long
did that search take? They did that in just 3 hours. These were
not proven cases, but they appeared to be cases where some sort
of fraud or wrongdoing was underway. And that was in 3 hours.
One can only imagine how many more were out there then and how
many more have come online since.
We will hear today from the National Consumers League
reports of possible online and Internet fraud have increased
from 32 per month in 1996 to 100 per month in 1997. If
businesses and consumers lose confidence in transacting
business electronically, the Internet's commercial potential
will never be realized. Unfortunately, even a relatively small
percentage of fraudulent activity can taint the entire medium
and discourage its use among the general public.
To maintain business and consumer confidence in electronic
commerce, we must be able to effectively police the medium for
illegal behavior. Today we will hear about the proliferation of
fraud and the types of fraud being perpetrated. Some of them
are the conventional schemes that are committed through the
mail and over the telephone, and some are unique to the
Internet. All of this begs the question of what can be done by
regulatory and law enforcement agencies to prevent this fraud
and apprehend and punish the perpetrators.
Today we will hear what private and governmental agencies
are doing to alert and educate consumers and what our
regulators and law enforcement personnel are doing to apprehend
and to punish the perpetrators. Do we need new legislation? We
do not know. That is one thing we would like to determine from
these hearings. Unfortunately, there are not a lot of easy
answers. We cannot assume the traditional mechanisms used to
control fraud in other communications media will be effective
against Internet fraud.
Control of Internet fraud raises some complicated,
technical, jurisdictional, even constitutional issues. The
Internet makes it easy for con artists to remain anonymous. The
international nature of the Net facilitates international
criminal activity which impairs prosecution even if the
perpetrators are identified. Moreover, efforts to regulate and
control conduct at the front end can often run up against
constitutional issues of privacy and speech.
And we are up against something here, too, in that--I want
to emphasize the international nature of things. Even if we
have constitutional problems in our own country here, it may
not be against the constitution in some other country where
some of this fraud is taking place. And how do we deal with
that? So it is a very, very complex situation.
Finally, the implementation of controls requires a delicate
balancing act. Too much regulation could discourage electronic
commerce and waste the tremendous potential offered by the
Internet. Too little regulation could leave millions of
consumers and businesses victimized by fraudulent schemes and
erode confidence in electronic commerce.
We need to explore how our law enforcement and consumer
protection system can effectively react to this new type of
crime within the legal and technical parameters that it must
function. We should also discuss what responsibilities can and
should be placed upon the Internet service providers, who are
really the gatekeepers to the Internet. Do we need changes in
current laws, rules or regulations? Are they adequate, but just
inadequately enforced? How do we get into this and what kind of
monitoring devices do we set up?
The Governmental Affairs Committee has two responsibilities
normally in a hearing like this; one is just vent this and let
it be known so the publicity will let people be more aware of
the problems and take their own methods of protection; and the
second role of this Committee, of course, is to see if we need
additional legislation or, if existing rules and regulations
under existing law are inadequate, then we need to take action
in that direction, also. So we will be investigating all these
this morning.
Madam Chairman, thanks again for having this hearing. I
think it is much needed.
Senator Collins. Thank you very much, Senator Glenn.
I would now like to call our first panel of witnesses. I
would like to welcome Susan Grant, the Vice President of Public
Policy for the National Consumers League, and Tatiana Gau, the
Vice President of Integrity Assurance for America Online, Inc.
Ms. Grant is also the Director of the League's National Fraud
Information Center and Internet Fraud Watch projects, which
provide advice to the public concerning Internet fraud and
reports of suspected fraud to appropriate law enforcement
agencies.
Pursuant to Rule 6, all witnesses who testify before the
Subcommittee are required to be sworn. So at this time, I would
ask you to stand and raise your right hand. Do you swear that
the testimony you are about to give before the Subcommittee is
the truth, the whole truth, and nothing but the truth, so help
you, God?
Ms. Grant. I do.
Ms. Gau. I do.
Senator Collins. Thank you. Because of time limits, I am
going to ask each of you to limit your oral testimony to 15
minutes, but any other materials you want to provide will be
included in full in the hearing record.
And, Ms. Grant, we will start with you, if you will please
proceed?
TESTIMONY OF SUSAN GRANT,\1\ DIRECTOR, NATIONAL FRAUD
INFORMATION CENTER, VICE PRESIDENT, PUBLIC POLICY, NATIONAL
CONSUMERS LEAGUE
Ms. Grant. Thank you, Madam Chairman, Senators. On behalf
of the National Consumers League, America's pioneer consumer
organization, I am pleased to provide you with information
about the newest frontier of consumer fraud, the Internet. Some
of the scams that we see, such as pyramid schemes, are as old
as the league, and we will be celebrating our 100th birthday in
1999. Others are new, as advanced technology has created new
opportunities for legitimate marketing and, unfortunately, also
for fraud.
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\1\ The prepared statement of Ms. Grant with attachments appears in
the Appendix on page 45.
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The National Consumers League has a bird's-eye view of
Internet fraud through our Internet Fraud Watch program.
Created in 1996, the Internet Fraud Watch operates in tandem
with our National Fraud Information Center, which was
established in 1992 to fight telemarketing fraud.
The Internet Fraud Watch and the National Fraud Information
Center are unique programs that provide advice to consumers
about telephone and Internet solicitations and relay reports of
possible fraud to law enforcement agencies. Consumers can call
our toll-free number, 1-800-876-7060, or they can visit our Web
site at www.fraud.org for information that helps them size up
telemarketing and Internet solicitations and avoid fraud.
We receive an average of 1,500 telephone calls a week and
an equal number of E-mails. We also receive dozens of letters
from consumers every week, mostly asking for advice. By
offering that advice in English and in Spanish, our trained
counselors help to prevent consumers from becoming fraud
victims.
Another important function of our Internet Fraud Watch and
National Fraud Information Center programs is to relay
consumers' reports about fraud to law enforcement agencies. We
submit those reports daily to the electronic database
maintained by the Federal Trade Commission and the National
Association of Attorneys General. Our own data system also
automatically faxes consumers' fraud reports to over 160
individual Federal, State and local law enforcement agencies
according to criteria that those agencies have set for what
they wish to receive. This alerts those agencies to scams that
they may not even yet know about and provides them with the
documentation that they need to shut down illicit operations.
Our free consumer and law enforcement services are
supported by the members of the National Consumers League and
by contributions from concerned businesses and trade
organizations that are concerned about telemarketing fraud and
Internet fraud. We would welcome government support for the
vital services that we provide. As has been alluded to before,
fraud reports to our Internet Fraud Watch have tripled since
its inception in 1996, averaging about 100 per month by the end
of 1997.
While this is probably just the tip of the iceberg, it
enables us to provide you with a snapshot of the emerging
problem of Internet fraud. In 1997, the top 10 subjects of
Internet fraud reports were: (1) Web auctions: items bid for,
but never delivered, value of items inflated, shills suspected
of driving up prices; (2) Internet services: charges for
services that were supposedly free, payment for online or
Internet services that were never provided or were
misrepresented; (3) general merchandise: sales of everything
from T-shirts to toys, calendars to collectibles, goods never
delivered or misrepresented; (4) computer equipment and
software: sales of computer products that were never delivered
or falsely advertised; (5) pyramids and multi-level schemes in
which profits are really made from recruiting others, not from
sales of goods or services to the end users and benefits of
participation misrepresented; (6) business opportunities and
franchises: empty promises of big profits with little or no
work by investing in pre-packaged businesses or franchises; (7)
work-at-home plans: materials or equipment sold with false
promises of payment for piece work performed at home; (8)
credit card issuing: false promises of credit cards, usually to
people with bad credit on payment of an up-front fee; (9)
prizes and sweepstakes: requests for up-front fees to claim
winnings that never materialize; and (10) book sales,
genealogies, self-improvement books and other publications that
are either never delivered or misrepresented.
Bogus investments, empty offers of travel, scholarship-
search scams, health fraud, and other abuses also abound on the
Internet. I should hasten to add that there are obviously many
legitimate offers for goods through auction sites, for multi-
level distributorships, for Internet services and other
products and services on the Net. And that is precisely why it
is so important to be aware of Internet fraud and to deter it.
Con artists are lurking everywhere on the Net, in flashy-
looking Web sites, in classified ad sections, in unsolicited E-
mail, and even in chat rooms and news groups. In our written
testimony, we provided some examples, including a magazine
sales scam that involved E-mail solicitations disguised as
testimonials from fellow members of news groups.
We also described the technologies that have enabled new
types of scams to emerge, like the Moldova case, in which
consumers who downloaded a free viewer program to see pictures
were unwittingly disconnected from their regular Internet
service providers and reconnected to the Internet through a
phone number in Moldova, resulting in huge international
telephone charges.
There is no limit to the creativity with which crooks seek
to use new technologies to snare their victims. Those crooks
are located everywhere on the Net. If we could have the chart
of the company location,\1\ you will see that these are the top
20 locations. They are in many States but also in other
countries. The category of locations outside of the U.S. and
Canada is at number 12, tied with Arizona. Ontario is number 13
and British Columbia is number 20.
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\1\ Charts submitted by Ms. Grant appear in the Appendix on pages
57-61.
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It is easy to hide who you are and where you are on the
Internet, because you can supply false information to register
a Web site and you can mask your return address for E-mail.
Moreover, the Internet makes geographic boundaries meaningless
in terms of the ability for consumers and sellers to
communicate with one another. But geographic boundaries are
still relevant to jurisdiction for prosecution, a fact that is
well understood by con artists who take advantage of the fact
that it is difficult or more difficult for law enforcement
agencies to go after them if their victims are one place and
they are located in another.
Another difference between the physical world and
cyberspace can be seen in the problem with auctions. Sellers
can offer their wares to millions of potential buyers for a
very low fee. But unlike physical auctions where consumers can
actually touch the merchandise and actually verify that it
exists before they bid on it, you cannot do that in a Web
auction, nor can the auctioneer necessarily verify that the
goods exist or that they are authentic.
And there are also numerous private sellers that are
selling through these Web sites, which raises several issues,
including the fact that private sales are not regulated in the
same way as sales by businesses. While the Internet opens the
doors to honest individuals and small companies for low-cost
entry into this new marketplace in cyberspace, it also provides
ready access to people who are either inexperienced in business
or who have fraudulent intent.
Victims of Internet fraud can also be found in every State
and other countries, as well. These are the top 20 locations of
the victims. Obviously, we hear from victims not only in the
United States, but number 8 is the category of outside of the
U.S. or Canada. In general, victims can be found predominantly
in the states that have the highest populations, not
surprisingly.
No one is immune to Internet fraud. We hear from consumers
of all walks of life and of all ages. If we could have the age
chart, please. While people in their thirties, forties and
fifties are most likely to report Internet fraud to our
Internet Fraud Watch, we also have received reports from
youngsters of 17 and seniors of 78.
Consumers pay for goods and services promoted through the
Internet in a variety of ways. Alarmingly, cash is the fourth
most frequent method of payment reported to our Internet Fraud
Watch in 1997. This is dangerous because it leaves consumers
with no documentation of the transactions and it obviously also
allows crooks to avoid their tax obligations.
Though consumers are more likely to pay with checks, money
orders and cash than with credit cards, we generally encourage
people to use credit cards whenever they are making substantial
advance payments for products or services because of their
ability to dispute the charges for non-delivery or
misrepresentations.
As more and more people go online, more consumer education
is obviously needed to make people aware of the danger signs of
Internet fraud and help them take advantage of what is on the
Net without being victimized. Through our Web site and through
other fora, various methods of public education that we
conduct, the National Consumers League is leading the way in
this effort. We also work with government and the private
sector to get the word out to both consumers and to businesses
about the proper use of the Internet as a tool for
communication and commerce.
And as more needs to be done on the educational front, so
must law enforcement's ability to go after the cybercrooks be
made easier. Cross-border cases pose especially difficult
challenges to investigators and prosecutors because of the
legal restrictions of information sharing between different
countries, the expense of transporting witnesses and the
complications of using different legal systems.
Congress can help by removing any information constraints
between the U.S. and other countries that still exist, setting
up a fund to aid in cross-border actions, and supporting
consumer and law enforcement services such as ours. We also
believe that the Federal telemarketing sales rule should be
expanded to cover the Internet. Many of the same disclosure
requirements and prohibited acts could be tailored to fit
Internet and online promotions. State law enforcement
authorities would be able to go into Federal courts to obtain
injunctions and judgments that would protect consumers in every
State, as they can now for telemarketing fraud. And if the
statute was amended to provide jurisdiction where either the
victims or the perpetrators are located for State consumer
protection authorities, it would enable them to go after crooks
that are based in their backyards but are targeting consumers
in other States, an occurrence that we see frequently.
The promise of the Internet as a means of communication and
commerce is dimmed by the presence of fraud. The National
Consumers League is committed to working with Congress and
others to ensure a brighter and safer future for the
marketplace in cyberspace.
Thank you.
Senator Collins. Thank you very much, Ms. Grant.
Ms. Gau.
TESTIMONY OF TATIANA GAU,\1\ VICE PRESIDENT, INTEGRITY
ASSURANCE, AMERICA ONLINE, INC.
Ms. Gau. Thank you, Madam Chairman and Senator Glenn. My
name is Tatiana Gau, Vice President of AOL Integrity Assurance.
Founded in 1985, America Online is the largest Internet service
provider and has over 11 million members. I appreciate the
opportunity to appear before you today to discuss how the
industry is working to promote online safety and security and
fight Internet fraud and abuse. Thank you for providing this
forum to bring these important issues to the public.
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\1\ The prepared statement of Ms. Gau appears in the Appendix on
page 62.
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At AOL, we are focused on preventing fraud on many fronts.
To give you some insight into these initiatives, let me explain
to you my department's mission. From log-on to log-off, AOL
Integrity Assurance manages all of the company's safety and
security measures in order to ensure the integrity of our
member experience.
The prevention of Internet fraud and the promotion of
online security are critical to cyberspace. It is also critical
to the future development of all interactive media. We believe
that the principles of education, prevention, and cooperation
are key to these efforts. Identifying and tackling Internet
fraud and educating all consumers on how to protect themselves
and enhance their online experience is our goal.
We need to inform consumers how they can protect themselves
and prevent purveyors of fraud and promote cooperation of the
industry and with law enforcement. The vast majority of those
who utilize the online medium are contributing positively to
this vibrant community. Like any environment, however, the
unfortunate reality is that there are individuals who aim to
harm.
As more and more new Internet users come online, combating
fraud becomes even more important. These new users are not
familiar with the technology and they require special
protection and attention. Fulfilling the enormous promise of
the interactive medium depends on consumers and families being
safe and secure online. Online integrity, therefore, is a top
priority both at AOL and across our industry. All of us with a
stake in cyberspace security are focused on this issue, both
pursuing their own strategies and working together.
The Subcommittee has asked that I speak to you about the
types of fraudulent scams that exist online. While it is
difficult to provide you with a comprehensive list of these
frauds, as the dynamics of the scams are constantly changing
and evolving. I can provide you with a sampling of those that
are most common. There are several different kind of scams that
I am going to speak about. These include password scams, credit
card scams, Web-based frauds and junk E-mail, commonly known as
``spam.'' So let us begin with password scams.
As you will see on the slide,\1\ there are two categories
of password scams. There is overt password solicitation, which
basically consists of social engineering tactics to lure a user
into providing their password, and the concealed variety, where
the user is not necessarily aware of the fact that what they
are about to do is going to compromise their password.
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\1\ See Exhibit No. 1, slide presentation of Tautiana Gau, America
Online, appears in the Appendix on page 240.
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The first example is a password ``phishing'' attempt via
instant message. First of all, the term ``phishing'' has been
developed in the Internet industry, P-H-I-S-H, kind of a
takeoff on that, and it is now used quite widely.
Senator Collins. I thought it was a band. [Laughter.]
Ms. Gau. Instant messages are real time, one-on-one
communications that can be transferred between one user to
another, and they are private communications that only go to
the designated recipient and they are real time. What scam
artists often employ is a technique where they impersonate
either a billing service representative of the Internet service
that that user is accessing the Internet with, or they might
take on the guise of a phone company representative coming up
with some type of claim that there is trouble with your phone
line, please provide your password. One of the things that AOL
has done to try to raise awareness of this issue is on the
window of the instant message, when it comes to you, there is
actually a warning in red letters that states, ``AOL will never
ask you for your password or billing information.''
The next example via E-mail is very similar to the previous
example I discussed in that they employ similar tactics, either
as a billing service representative or a phone company rep or a
security rep for the company, but they send it via E-mail. And
these can sit in an E-mail box, can get mixed up with other
personal mail, and when a user goes to read it, they may not be
as vigilant as they should be in deciding whether or not they
really should believe this and send in their password.
A first example of concealed password scams is what is
called the ``Diag.dat'', phishing via instant message.
``Diag.dat'' is a file where the password is recorded on your
computer, and different services have different names for that
file. And what scams artists will do is they will send you an
E-mail under the pretext that they have malfunctioning software
and could you help them out and send them a copy of your file
so they can get their software working again. And, again, the
rule of thumb to follow here is not only do not accept things
from strangers and if it sounds too good to be true, it
probably is, but also do not give out things to strangers
unless you really know what you are giving.
The second example of concealed password solicitations are
Trojan horses. Trojan horses are programs that come in
attachments to E-mail that are sent to you under the guise of
some type of beneficial offer for free: ``Here is a great new
animated video. Download it and enjoy.'' And they take
different approaches to try to entice the user to download it.
And when the user does download it, in fact, at that point,
they have become infected and have the potential of either
having their password compromised or even having files deleted,
a variety of different things, depending on the Trojan.
This slide actually shows the area on America Online where
we have posted safety tips for our members to understand what
Trojan horses are and the telltale signs of Trojan horses, as
well as linking them to an area where they can get special
antivirus software that protects against Trojan horses.
This is an example of a scam using a screen-saver approach.
It states, ``Hey, this is cool. It's the latest coolarama
screen saver. Download it and enjoy.'' Here the rule of thumb,
of course, is to again be careful who you receive information
from and do not download things from people you do not know.
A second example of an approach to provide a Trojan to
someone is to take on the guise of a software company. And in
this situation, the scam artists will impersonate software
companies and will send a message stating, ``This is the
upgrade you have requested,'' or ``This is the upgrade that you
need. Please download as soon as possible.''
I will discuss three more areas of password
vulnerabilities. All of these scams that I have mentioned via
instant message and E-mail can also occur on Web sites. Fake
log-in procedures can be posted on Web sites to try to entice
you into entering your password and other information that they
might be requesting. There are also Web sites that take on the
appearance, say, of an Internet service provider billing or
registration page where, in fact, they are asking for the
member to provide their registration information along with
their password.
Password guessing is becoming more frequent in that recent
studies have shown that approximately 60 percent of users on
the Internet have insecure passwords in that they are either
names of their spouses or words in the dictionary or names of
their pets, whatever the case might be. And if a scam artist
chooses to target one particular person, they can, in fact,
just through raw attempts try to guess the password, entering
and entering until they finally get in.
Password cracking is a higher level of that kind of
guessing in that scam artists use an automated program to
actually, through brute force, continue to prompt a password
field in order to try to get into the account. This is why, of
course, it is so important for users to choose safe passwords
for their E-mail accounts. In fact, the password is the key to
the E-mail account. And this is an area where education on the
part of consumers is greatly needed.
Credit card and billing scams, there are two categories in
this section. There are those scams that affect users and those
scams that affect the services. Here is an example of a billing
service scam, and this takes a similar approach as taken in
password phishing in that this time it might say that the
database is contaminated and your full name, address and credit
card number and expiration date is needed in order to make sure
your account will stay alive; if not, it will be turned off
within 24 hours, usually taking some guise of that sort.
A slightly more complex version of that is when the E-mail
that is received by the user then links the user to a Web site
where, as I mentioned previously, a Web site has been put up
mimicking that service provider's design and layout to confuse
the user so that they think, in fact, that this might be a
legitimate site. And again, to prevent users from falling for
these types of scams and to avoid their falling victim to them,
AOL has posted warning messages on the E-mail screens, as well,
again stating that AOL staff will never ask for personal or
billing information.
There is also another example of a billing scam that I will
quickly mention, and that is an approach where you receive an
E-mail that says you have won a prize, whether it is a laptop
or a stereo or whatever the case might be. And the E-mail goes
on to describe how wonderful this prize is. And then at the
bottom of the E-mail, it says, ``So please reply back to us
with your name and mailing address and include your credit card
number to cover shipping and handling.'' And, of course, at the
other end, the scam artist never sends the supposed prize and
has the user's credit card number, and name and address, in
their hands.
Subscription fraud is the first example of scams that
affect the services. Scam artists can obtain on the Internet
programs that are called credit card generators, and what these
programs do is create fake credit card numbers that can be used
to sign up with online services. They can also forge their name
and address and a variety of other things, and that is why it
is so important for services to have strong registration
processes, as well as them being real-time verification
processes.
In a lot of the business on the Internet, oftentimes the
verifications are not done in real time; rather, they are done
in 24 to 72 hours. And at that point, you have let the scam
artist onto the service and have allowed him to spend 24 hours
wreaking havoc on that service. This particular slide shows
some of AOL's checks during the registration process.
A second example of fraud that affects services or, rather,
merchants, is transaction fraud. And here, again, scam artists
are using the credit card generator numbers that they get from
the Internet or using stolen credit card numbers. And, of
course, in those cases, the user or the owner of that credit
card may not realize that their credit card has been stolen
until they receive the next monthly bill.
One thing to keep in mind in both of these frauds is that
these are not unique to online. These frauds occur in the real
world, as well, whether it is signing up for a service or
registering with a membership club or whatever the case might
be--or making a purchase at a store. And, as we all know, in
stores now they run immediate checks on your credit card
number, and that is what needs to be done in the Internet, as
well, to ensure that no fraud is undertaken.
There are a number of other Web frauds. Fake store fronts--
those are transaction frauds that affects users, where they
enter a credit card number and the site is actually a fake.
Virulent active content, Trojan horses, are different types of
things that can be pushed onto your computer, and thus all
users should be sure to have antivirus software and browser--
setting their browser security alerts.
I am going to run through this very quickly, given the
limit on time--just to move through, I have a number of
examples of scams, the marketing scam, which is a weight-loss
program in this case. And, again, typically in these
situations, the product does not live up to its claims. Here is
a get-rich-quick scam, make a million dollars from home, or in
this case, make $800,000 from home. And, also, there are
varieties of pyramid schemes, as well.
Forged headers are what I call a category of identity fraud
in that the sender of the E-mail has chosen to disguise their
identity by using forged headers and thus making it difficult
to identify that user. One important item that I would like to
stress is that users are not without protection. AOL
fundamentally believes that a combination of education and
technology tools that we make available to our members are the
answer to solving the fraud problem as it exists today. We also
believe fundamentally that law enforcement needs to play an
important role in this, and we have an ongoing relationship
with law enforcement to cooperate on cases that come up.
What I will run through here quickly are some of the tools
that are available. Mail controls actually allow a user to
designate who they can receive E-mail from in their account and
who they cannot receive E-mail from, who they do not want to.
It also allows them to block instant messages, and this is
particularly useful for families that have children who are
using the Internet, where they do not want their children
exposed to these kinds of things.
The file download alert is a warning against Trojan horses.
This message pops up any time a member goes to download a file
attached to E-mail that contains a Trojan horse. The
Neighborhood Watch is both an educational area on America
Online, but is also a centralized point to link to all the
different tools that are available by AOL to their members, to
customize their online experience.
Notify AOL is our notification mechanism. Members send in
reports of fraud that they either witness or fall victim to,
and we have staff that monitors those reports 24 hours, 7 days
a week, and will take action, such as terminating the account
of the offender if appropriate and, if illegal, referring the
matter on to law enforcement.
Spam tools include AOL proprietary blocking technology
against spam, as well as the mail controls that I discussed
previously. Parental controls--this is a one-stop shopping for
parents to set up again these accounts for their children that
are customized so that their children are not exposed to things
believed to be beyond their age level.
And finally, in summary, I would just like to reiterate
some of the safety tips that I mentioned through the
presentation: Choosing a safe password and making sure you
protect that password by not giving out the information to
anyone. Similarly, do not give out personal information. Just
like in the real world, you would not give out your Social
Security number, you should not be doing it online. Do not
download files from strangers or, as I like to call it, do not
take candy from strangers. If a Web site is unfamiliar, look
into the company's background before you do business with them.
And perhaps most importantly, do not believe everything you
read; if it sounds too good to be true, it probably is.
Thank you.
Senator Collins. Thank you very much, Ms. Gau.
Ms. Grant, I would like to start with some questions to
you. It was very helpful for us to have the list of the top 10
Internet frauds that have been reported to you, but as you
pointed out, legitimate businesses are also included in each of
those categories. A lot of people order books through the
Internet with very satisfactory results. Are there any warning
signs that you can give the public for when it is likely that
an offer is fraudulent within those top 10, because the
difficulty is in distinguishing between legitimate online
offers versus the fraudulent schemes?
Ms. Grant. That is really difficult for consumers, and that
is one thing that we try to help them with when they contact
us. First, offers of things for free or for ridiculously cheap
prices ought to be suspect. The Trojan horses that were
referred to are one example of something that somebody is
supposedly giving you as a gift. And you have to ask why; there
is usually a string attached. If someone is trying to get you
to buy expensive computer equipment for a very low price, you
have to wonder why that is. Promises that you can make money in
business very easily with little or no work have to be suspect.
Promises that you can get huge returns on an investment with
little or no risk are also suspect.
Many of the same pieces of advice that we give for
telemarketing fraud, we also give for Internet fraud, that it
is illegal for somebody to ask you for a fee up-front to get a
prize. That is an illegal lottery and something that should be
a red flag to you. Some other warning signs are promises of
loans or credit cards to people with bad credit because
legitimate lenders and card issuers generally do not extend
credit to people with credit problems. So we try to warn people
that if someone is promising you that, it is probably not true.
Senator Collins. My impression is that consumers who never
would have fallen victim to a fraudulent solicitation if it had
come in the mail or via the telephone will nevertheless be
sucked in by one that is offered on the Internet, that somehow
consumers are under the false impression that if something is
on the Internet, it has been screened or it somehow conveys an
aura of legitimacy.
What makes consumers--first of all, would you agree with
that? And, second, what makes consumers so susceptible to
fraudulent schemes on the Internet?
Ms. Grant. I agree with what you have said and I think that
consumers also are under the same misconceptions with magazine
and newspaper and television advertising, where they think that
there is more screening than actually exists in most cases. But
another part of this is that I think that consumers are seduced
by the novelty and excitement of being on the Net and that they
are not necessarily looking at these promotions with the same
cold eye that they need to and that they would if somebody was
knocking at their door and offering them something.
Senator Collins. Despite all our best efforts to educate
consumers, what should a consumer do if they feel they have
been a victim of Internet fraud?
Ms. Grant. Report it to our Internet Fraud Watch program,
for one thing. They may also want to contact their own State
attorney general or State securities commission, or whatever
would be the appropriate agency locally for their problem. But
the most important thing is to report it, because that is the
only way that these kinds of fraudulent operations can
ultimately be shut down.
Senator Collins. Ms. Gau, does AOL encourage its customers
to report fraudulent activities to you, and if so, what do you
do if you get a complaint of that nature?
Ms. Gau. We do indeed try to encourage our members to do
that, and one of the ways in which we accomplish that is by
putting promotion buttons on the welcome screen, which is the
first screen that AOL members see when they sign on. And that
button takes them to the Notify AOL area and provides them with
guidelines on how to report frauds or different types of
problems they may come across online.
On the question of how do we respond to them, as I
indicated previously, we do have staff that is there 24 hours,
7 days a week, to respond to the reports. If appropriate, they
will terminate the account of the offender, and if it is
illegal, they will refer it on to law enforcement.
Senator Collins. One reason consumers can get trapped in a
fraudulent scheme is that a Web site looks so elaborate and
looks so legitimate. Could you explain, as part of our efforts
to educate consumers, how easy it is to set up a Web site and
whether or not it is difficult to dismantle one once the fraud
has been perpetuated?
Ms. Gau. Yes. And perhaps in that regard I would like to
quickly provide a response to one of the questions you asked
Susan, in terms of is it because people are on their computers
in the safety of their home that they fall victim to some of
these scams? I would add to that the fact that in effect there
is this false sense of security, of users who are on the
computer in the safety of their home. Not only are they
thrilled by this new medium and all the technologies that it
offers, as Susan Grant mentioned, but also they believe that
they are untouchable because the computer has been something
that has been very familiar to people for many years, where you
wrote your documents that nobody else could read. And so there
is an assumption that that continues along, as well.
Now, to answer your question directly, Web sites can be set
up relatively inexpensively. It can cost as little as a couple
of hundred dollars to set up a Web site. As far as dismantling
Web sites, it all depends on who is the host provider for that
Web site. In the case of certain domain names that are
registered and where Web sites pop up on frequently, they even
disappear themselves within a couple days because they do not
want to stay up too long and they move around.
If one needs to dismantle a Web site, like in some cases we
have been alerted by our users that there is an Internet site
out there that is collecting information under the guise of
being an AOL billing page, we then contact the service provider
that is hosting that Web site and ask them to take it down,
obviously under the due diligence procedures and in legal
compliance.
Senator Collins. Ms. Grant, does the National Fraud
Information Center follow up on the complaints that it refers
to law enforcement agencies?
Ms. Grant. No, we do not, and in fact we tell consumers who
are contacting us that we will provide their information to law
enforcement agencies, that we do not investigate it ourselves,
and not to contact us again to find out the status of their
report because we do not have that information. We really do
not have the resources to follow up.
We find out sometimes what agencies are doing with those
reports because they will contact us to ask for more
information or we will receive a press release saying that an
enforcement action has been taken against a company that is
very familiar to us.
Senator Collins. Have you found that law enforcement
agencies have--I realize you do not do actually follow-up--but
in general, are they receptive to the complaints that you
forward? Do you have an impression that they are investigated?
My concern is that I think it is very confusing for consumers
who are ripped off to figure out where to go and to figure out
what is the right agency.
As Senator Glenn pointed out, we have an unusual
jurisdictional issue involving the Internet. We may be dealing
with a fraudulent company that is not even located in the
United States.
Ms. Grant. Yes. Actually, last summer we surveyed the law
enforcement users of our system to find out what they thought
about our services in providing them with reports about
telemarketing and Internet fraud. They said that the
information was extremely valuable to them, not only to tip
them off about things that they may not have even been aware
of, but to give them information about victims and witnesses
that could help them make their cases.
So they are very appreciative of these services.
One of the most difficult aspects of Internet fraud is that
you have victims scattered so far, that it is often hard for an
agency to find out about everything that is going on when
consumers are most likely to contact their own local agencies
about their own problems. If the perpetrator is located in one
State, but the victims are all in another State, then the
attorney general's office in the State where the perpetrator is
located may not be hearing about that. The consumers may be
complaining to the attorneys general in their own States.
Senator Collins. Ms. Gau, how do the con artists that use
spam as their weapon get the addresses, the E-mail addresses,
of their victims?
Ms. Gau. They do so in a variety of ways. They can obtain
programs on the Internet that are called harvesting programs,
and they can go into a chat room and, in effect, harvest or
copy all of the screen names or the E-mail names of the people
in that room. They can also use this tool to collect names off
of message boards, off of member directories for different
service providers, and collect a mass of names to which they
can send their E-mail.
Senator Collins. I would like to now turn to what may be
some additional remedies to this problem. Ms. Grant, in your
testimony, you suggested that the FTC's telemarketing sales
rules should be made to apply to online and Internet
promotions. And we have the chairman of the FTC here today, so
I am going to ask him about your suggestion. Could you please
explain a little bit more to us about what the rule provides
and how expanding its scope would help combat Internet fraud?
Ms. Grant. The rule basically has two parts; one is a set
of required disclosures and the other is prohibited practices.
Just to use sweepstakes and prize offers as an example, there
are certain disclosures that are required concerning the odds
of winning and the values of the prizes and so on, which would,
I think, be properly applicable to Internet promotions that
involve prizes and sweepstakes.
There are also a host of prohibited practices, for
instance, asking for a payment up-front to extend credit or a
loan. Again, I think that such a prohibition for Internet and
online promotions would make sense. A lot of the same types of
scams that we see on the Internet are things that have been
long-time abuses in telemarketing fraud and that the
telemarketing fraud rule was promulgated to prevent and to give
law enforcement agencies more tools to prosecute.
Senator Collins. Do you believe, Ms. Grant, that online
providers such as AOL should also be doing more to educate
consumers up-front about the possibility of fraud and to do
more referrals to law enforcement? Is there an obligation that
they should undertake, as well?
Ms. Grant. I think there is. I think that most of the major
Internet service providers are stepping up to the plate, as AOL
is, and doing that through the educational messages that were
demonstrated here today and reporting those problems when they
hear about them to law enforcement agencies. There are, of
course, a vast number of providers out there and not everybody
is stepping up to the plate and helping to become part of a
solution here.
Senator Collins. I appreciate very much the specific
regulatory and law changes that you both included in your
testimony. I am going to turn now to Senator Glenn for his
questions.
Senator Glenn. Thank you very much. Senator Durbin could
not be here this morning. He has done a lot of work in this
area and is very interested in it. He is on Judiciary, and they
are having some hearings or meetings on the tobacco situation,
and so he could not be here this morning.
But his staff gave me something a moment ago that I was not
even aware of. We now even have magazines out, Internet
Shopper, that I had not seen before, and I was just leafing
through it here. I was not reading a cowboy story or something
up here. I was looking through this. [Laughter.]
And I am amazed at some of this stuff. I was not aware
until this moment about the extent of some of this. We have 50
national companies and thousands of Internet service providers
listed in here State by State. I count 65 in my own State of
Ohio, and 50 national. Illinois has, I think, more than that. I
did not count them, but probably 80 or so in Illinois, where
Senator Durbin is from, of course.
And I am going back to the office and click in on one of
these. It says, ``Click and win 1,000 roses, Valentine's Day
coming up, www.,'' and I will not give the rest of it. But this
has gone beyond anything that I was even aware of, even with
the briefings that I received for this hearing. I had not seen
that particular magazine before and I am not recommending
everybody go get a subscription.
These things, you know, ``Click and win 1,000 roses for
Valentine's Day, detail and registration at,'' and gives it.
That is it, that is pretty seductive.
Ms. Grant. That could be legitimate.
Senator Glenn. Could be.
Ms. Grant. But I do not know as I would smell those roses
yet. [Laughter.]
Senator Glenn. Could be. But if everybody who clicks in is
expected to win 1,000 roses, they have a lot of roses going
out. And Annie is going to like that once I get back to the
office and click in on that. But we knew this was big stuff,
and it is even bigger than I realized it was when the Chairman
planned these hearings.
Do we need stiffer civil and criminal penalties on these,
Ms. Grant?
Ms. Grant. I am always in favor of stiffer civil and
criminal penalties. I think you need to hit white-collar crooks
in the pocket.
Senator Glenn. But you have to get a balance here.
Someplace you get into personal rights and constitutional
rights and things like that. Are we at the point where we
shouldn't go further, or are we way short of that point and
need more legislation?
Ms. Grant. Even in telemarketing, there are ongoing
discussions about enhanced penalties for targeting certain
vulnerable populations or for certain really egregious
violations. And I certainly think, especially if we are talking
about fraud, if we are talking about intentionally robbing
people of their money, that those people ought to be put in
jail.
Senator Glenn. Now, Ms. Gau, you look at it from an
industry standpoint. Do you think we need more regulation? I
know the industry has preferred to look at this that they can
self-regulate, and yet the record has not been very good in
that regard.
Ms. Gau. We do, in fact, believe that education and
technology tools are the way to provide consumers with real-
time information that can allow them to protect themselves when
they go online.
When it comes to the role of the government, we believe the
government does need to play a role, just as they do in the
real world, the off-line world, in protecting consumers against
fraud. And Congress should thus appropriate the necessary
resources to the agencies that are charged with enforcing anti-
fraud statutes.
We would agree that enhancing penalties would be a
beneficial way to deter other criminals from conducting such
activities, but we also believe that one needs to take a look
at the juvenile issue, because a number of the scam artists
that are perpetrating these frauds are, indeed, juveniles.
Senator Glenn. Well, OK. The Internet service providers
have been termed as being the gatekeepers, and many consumers
who use the Internet will form their opinions of the medium
through the relations that they have with the ISP's. And I
guess you folks have about as much control about what goes on
the Internet as anyone, and yet the track record hasn't been
all that good for the industry.
I don't know when you came with America Online, but it is
discouraging to read that three of the largest ISP's, including
America Online, were charged by and settled with the FTC for
engaging in practices that I would look at as being similar to
the consumer scams we are talking about here today.
Let me just run through them real quickly here:
Offering free trial subscriptions and not adequately
disclosing that consumers would be billed as subscribers after
the trial period unless they affirmatively canceled their
membership. I wouldn't want to be treated that way, and I don't
think you would either. In mail, years ago, some businesses
would send a gift through the mail and then they billed you for
it unless you paid the postage to return it. Well, we have
corrected that through the years, and that is not done now.
Another one was debiting checking accounts before receiving
authorization to do so. I don't want anybody debiting my
checking account, and you wouldn't either, unless I gave
specific permission to do it.
Failing to give consumers advance notice of the amounts to
be transferred from their accounts.
Now, America Online was also cited for failing to
adequately inform consumers that 15 seconds of connection time
was added to each session. Well, I don't know how major these
things are. I know that they were settled somehow with FTC. I
don't know how they were settled or what the penalties were.
And maybe this didn't happen on your watch. But when the
leaders in the industry are being hauled up for things like
this, we have got a major problem. What are we going to do
about it?
Ms. Gau. Well, my first comment would be to say that we
have, indeed, corrected those problems in that we are providing
more disclosure on exactly the policies. And I think that that
is very dissimilar from the fraud that is occurring on the
Internet where it is strangers that approach you----
Senator Glenn. Well, it is a different level. I will grant
you that.
Ms. Gau. You may recall that one of my safety tips was not
to do business with a Web site or a service, even, if you don't
know that company's background. And there, really, I do believe
that, in fact, we were not adequately, perhaps, disclosing all
these specifics to our consumers, but we have rectified that at
this point.
Senator Glenn. Well, this showed a mind-set of what they
were trying to do, maximize the money coming in and don't worry
about whether the person was being treated fairly or not, it
seems to me. Has that mind-set been changed now so that you are
looking at it from the consumer's standpoint? You are a
consumer, too.
Ms. Gau. Yes.
Senator Glenn. If you call and you get a service from
somebody, you don't want to be treated like that. Has this all
been corrected now? And how are we handling this?
Ms. Gau. Absolutely. This is being corrected, and it
actually was one of the reasons for my appointment at America
Online in late 1996. It was to create the position of integrity
assurance in that area----
Senator Glenn. Very good.
Ms. Gau [continuing]. As part of the assurances to members
that they are being looked out for and actually acting as
somewhat of an ombudsman for members.
Senator Glenn. Well, I hope your being brought on has
corrected all this, and I hope you are keeping them on a mind-
set that looks at it from the consumer's standpoint. Because if
this goes on like this, I can guarantee you we are going to
have tough new regulations and tough new standards, and we will
have to set up a big enforcement group, we will expand FTC, and
we will do all sorts of things, whatever we have to do, because
this is the wave of the future. This is not a little thing
where we are going out on the Internet momentarily and all the
Internet stuff will pass away in a year or two. We are just at
the beginning of the Internet way of doing business and
financial transactions.
So if the companies don't police themselves, they are going
to get policed. I will tell you that right now, and you can
carry that back. If the same people are in charge that let this
stuff happen to begin with, then bringing you on as one person
down below in the hierarchy isn't going to correct the problem,
if the mind-set of everybody else is that they are out to skim
what they can off the people. And that is from one of the
biggest companies in the business.
Ms. Gau. I would again like to reiterate that those issues
have been corrected, and, indeed, moving forward, they are
situations that are not going to happen again.
Senator Glenn. Just those three or four things that I read
off, were estimates ever made or did FTC prepare any estimates
of what consumers lost as a result of these practices? Because
as I understand it, no recompense was made, no payback was made
to people that were dealt with unfairly. Is that correct?
Ms. Gau. My understanding is that, in fact, there were
settlements made, but I don't know the specifics of them.
Senator Glenn. Did FTC make an estimate of that, do you
know?
Ms. Gau. I don't know.
Senator Glenn. OK. We will ask and see if they have any
estimates on that later when they testify.
Recently, America Online went to court to stop a junk
mailer that threatened to publicize the addresses of all 5
million customers of American Online if your company did not
allow it to send junk mail. That sounds like the worst kind of
extortion, with the customers as the innocent victims. Luckily,
it sounds as if you were successful in stopping the firm.
Could you tell us about that case and explain how the
company was able to obtain the E-mail addresses? And I would
like you also to address, once it had them, did it in turn sell
them to others? Is this a scheme where one company sells to
another, to another, to another, and so the fact that you have
corrected it with one company, the horse is out of the barn,
and it may have gone to half a dozen companies eventually? Is
that correct?
Ms. Gau. Yes. The site collected the names of AOL members
through harvesting techniques, as I explained previously.
Senator Glenn. Yes.
Ms. Gau. Not only do they pass them on to other spammers,
but they also sell them via spam. In those cases, you will
receive an E-mail, saying, ``Want to grow your business? Send
$25, and we will send you 5 million screen names you can send
your promotion material to.''
So, in fact, there is this constant continuing circle of
spammers to spammers, and then also selling those lists to
individual users as well.
Senator Glenn. Do all the ISP's have a policy or do most of
them have a policy of selling their customer list to others?
Ms. Gau. I am not familiar, no.
Senator Glenn. How about America Online? Do they sell their
customer list to others or rent them?
Ms. Gau. No.\1\
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\1\ See Exhibit No. 7 for clarification of this answer which
appears in the Appendix on page 358.
---------------------------------------------------------------------------
Senator Glenn. Either one?
Ms. Gau. Not anything providing the actual identity of the
user in terms of their screen name on AOL.
Senator Glenn. I am not sure what you mean by that. Say I
am going into business, could I contact America Online and
could I get a list of people? Or how would I do that? Would I
buy them?
Ms. Gau. No, you could not.
Senator Glenn. I could not. Could I rent them?
Ms. Gau. No, you could not.
Senator Glenn. From the accounts I have read, it sounds
like an ISP already has the authority and technical capability
to refuse to send out unsolicited E-mail and to enable its
subscribers to block it. Is that correct?
Ms. Gau. That is correct.
Senator Glenn. What standards do you apply when deciding
whether or not to send out unsolicited commercial E-mail? What
is the criteria?
Ms. Gau. What is the criteria for AOL in deciding to send
out?
Senator Glenn. What standards do you apply when deciding
whether or not to send out unsolicited commercial E-mail?
Ms. Gau. We apply the concept of a previous existing
business relationship or, in fact, that if we have to send mail
to our members, it is because we have a member relationship
with them.
Senator Glenn. Well, what is your business relationship?
What does a business relationship consist of, then?
Ms. Gau. I am sorry? Excuse me.
Senator Glenn. Define business relationship.
Ms. Gau. A pre-existing relationship in which either a
transaction has occurred or there is an ongoing business
relationship.
Senator Glenn. Well, OK. So if anybody had come in online,
if anybody had tapped in and used your service at all, then
they could be the subject of having unsolicited E-mail sent to
them in the future because you have had a business relationship
with that person. Is that correct?
Ms. Gau. Perhaps I would like to make a clarification. What
I am discussing right now is mail that AOL might send to its
members. I am not discussing mail that comes from the Internet
which is of a spam nature, and junk E-mail. Mail that AOL sends
to its members consists of advisory notices about different
things relating to the service, letters from Steve Case, the
chairman and CEO, and materials of those sort that are meant to
enhance the member experience, but they are, if you want to
call them, unsolicited.
Senator Glenn. There have been some recent articles about
AOL subscribers being the targets of E-mail scams to steal such
things as account numbers, passwords, credit cards. In one scam
to obtain credit card numbers, a perpetrator pretended to be
AOL's Member Services Department and had a fake letter from
AOL's chairman.
Do you know how the con artists were getting your
subscribers' addresses? And how do you guard against that?
Ms. Gau. The example you just mentioned was one of the
examples that--types of examples I illustrated in my
presentation. The scam artists harvest names, again, for these
types of scams, collecting names from people in chat rooms,
member profiles, message boards, whatever the case might be,
and then, in fact, target the individual.
Senator Glenn. Let me address this to both of you. Should
there be a requirement in law or by regulation that requires
ISP's to screen commercial sites more carefully, to set some
criteria and make them screen for those criteria?
Ms. Gau. At AOL we do, indeed, engage in screening
processes with the commercial sites that are allowed to be set
up within the AOL environment. As far as the Internet is
concerned, when users go out onto the Internet, they, in fact,
are entering areas where AOL does not have control over those
sites.
Senator Glenn. Ms. Grant, do you think there should be
requirements, certain criteria set by government, that they
would have to adhere to in screening commercial sites more
carefully?
Ms. Grant. We have long advocated that newspapers and other
forms of media that have advertising do a better job of
voluntary screening. I am not sure how feasible it would be to
actually screen everything on the Net except perhaps things
that are just within a certain proprietary service, like AOL.
But I think that if a better job of self-screening isn't done,
maybe that is something we should look into in the future.
Senator Glenn. Should the ISP's be required to report
customer complaints to the FTC?
Ms. Grant. I think with the consumer's permission they
should. When consumers report fraud to us, we tell them that,
with their permission, we will report this information to law
enforcement agencies.
Senator Glenn. Ms. Gau.
Ms. Gau. I would absolutely agree that we would need the
member's consent to forward the message on. But we do, indeed,
refer any illegal activity to law enforcement, so I think that
the combination of both of those would be a good step.
Senator Glenn. Well, there were already two pieces of
legislation introduced that deal with unsolicited commercial E-
mail, and given the proliferation of this activity and the
technical and consumer problems it creates, there is likely to
be even more legislation proposed unless the problem is
controlled.
You people are more familiar with this than I am,
certainly, and I presume the Chairman, also. But what do we
need to do? What do you suggest at this point? Ms. Gau.
Ms. Gau. Unfortunately, spam is constantly changing in
terms of the techniques that they use to attack Internet
service providers. They are using ever-changing techniques,
whether it is changing the source addresses from which the spam
is coming or forging headers to disguise where the message is
actually coming from, that make it extremely complicated not
only to create effective blocking software that would, in fact,
prevent any spam from getting through, but also poses problems
for some of the legislation currently being proposed as the
dynamics are continually changing and they will continue to
change, and next week we probably will have one more problem to
deal with.
Senator Glenn. Could ISP's levy extra fees on those who
want to send unsolicited commercial E-mail? Would that control
it?
Ms. Gau. We are not in favor of unsolicited commercial E-
mail, so that is not something that we are looking at right
now.
Senator Glenn. Well, just to sort of summarize here--and I
know I am probably over my time, Madam Chairman--let me just
say that the issues are how much we are going to regulate to
protect those interests, who will regulate, and are we moving
fast enough. Two big concerns are consumer protection and
individual privacy. And I don't know whether we ought to
require opt-in systems so businesses can't collect personal
information unless the consumer first gives his or her
permission. Maybe we are coming to that one of these days. I
don't know. And children, we haven't dealt with that one at
all, didn't even question on that. Kids have far more computer
knowledge than I have, I can guarantee you that, and they are
into these things all the time. And what happens if someone
says go get daddy's credit card and do whatever? How do we deal
with children? That is another big one here.
I don't know how long the FTC wants to wait on self-
regulation by the industry before we step in with other
regulations, but that is what is coming if the industry doesn't
do it itself.
Thank you.
Senator Collins. Thank you, Senator Glenn. I want to
commend you for your probing questions on this very important
issue.
I just want to second your comments about the need for the
ISP's to set a very high ethical standard. If they are going to
be the ones that are helping to educate consumers about fraud,
certainly their own activities have to be above reproach, and I
think that is an excellent point.
Senator Glenn. I have to leave early. I am going back to
get those thousand roses for Annie. [Laughter.]
Senator Collins. Could I have a few?
I just have one final question for Ms. Grant. Ms. Grant, we
had hearings last year on fraud in the securities industry, and
we are starting to see the Internet used as a medium for that
kind of fraud. And I know that you have a long history, the
league, in this area.
I propose to the industry as well as the Chairman of the
Securities and Exchange Commission that there be adopted what I
call a zero tolerance policy so that if a licensed individual
in the industry commits a serious breach of ethical standards
or a fraud, that that individual be banned from the industry
forever, because what we have seen is rogue brokers going from
firm to firm.
Do you think that such an action would be helpful in trying
to curb the use of the Internet for securities fraud?
Ms. Grant. I think it probably would. I think that more
action has to be done to keep repeat offenders from victimizing
consumers both in the physical world and in cyberspace.
Senator Collins. I want to thank you both very much for
your testimony today and your cooperation with our
investigation. We very much appreciate your being here.
Ms. Grant. Thank you.
Ms. Gau. Thank you.
Senator Collins. Our next witness is Barry Wise, a
certified public accountant and a certified fraud examiner,
from Matthews, North Carolina.
Mr. Wise unfortunately was a victim of a pyramid scheme
conducted over the Internet. I very much appreciate his
willingness to share his experience with us. It shows that even
an individual with financial training can become a victim of
cyberspace fraud. So we very much appreciate your being here.
As I explained earlier, pursuant to Rule VI, all the
witnesses who testify before us are required to be sworn in, so
I would ask that you stand and raise your right hand. Do you
swear that the testimony you will give to the Subcommittee will
be the truth, the whole truth, and nothing but the truth, so
help you, God?
Mr. Wise. Yes.
Senator Collins. Thank you.
We look forward to hearing your testimony today. Because of
time constraints, including an upcoming vote, I would ask that
you limit your testimony to 10 minutes, and we will put your
prepared statement as part of the hearing record.
Please proceed.
TESTIMONY OF BARRY D. WISE,\1\ CERTIFIED PUBLIC ACCOUNTANT,
VICTIM OF FORTUNA ALLIANCE INTERNET PYRAMID SCHEME, MATTHEWS,
NORTH CAROLINA
Mr. Wise. Actually, I have already learned a lot from what
I have heard.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Wise appears in the Appendix on
page 75.
---------------------------------------------------------------------------
Madam Chairman and Members of the Subcommittee, my name is
Barry Wise, and it is my pleasure to be here today to share my
experiences with you of being defrauded by a company known as
Fortuna Alliance.\2\ I am currently employed by the Duke Energy
Corporation as a senior internal auditor. I am also a certified
public accountant and recently became a certified fraud
examiner. Obviously I wish I had become a certified fraud
examiner when I was considering my investment with Fortuna
Alliance.
---------------------------------------------------------------------------
\2\ See Exhibit No. 2 for background material on Fortuna Alliance
which appears in the Appendix on page 267.
---------------------------------------------------------------------------
I am also a husband and a father of two young children. The
intention of my investment with Fortuna was meant to benefit my
children's future, not the financial heartache that resulted
instead.
I would also like to express my appreciation to the Federal
Trade Commission at this time for the help that they have given
with this case.
In April of 1996, I was told by a colleague that a company
known as Fortuna Alliance was advertising on the Internet. The
company was supposedly offering a good investment opportunity
with a high rate of return. My associate informed me that he
knew of a person who had already received some return on the
investment, so it must be legitimate. I later discovered that
this person had some type of relationship with the founder of
Fortuna Alliance and the return on investment probably was
nothing more than bait money to create an air of legitimacy to
the scheme.
I visited the Fortuna Alliance Web site as well as numerous
other individual sites that had been created by its members.
These members were people who had already invested with Fortuna
and were actively recruiting new investors which would be
directly to their benefit. The Fortuna Alliance site explained
that each membership would pay out a maximum of $5,000 per
month when a matrix of approximately 300 was filled with names
of new investors. The matrix was supposedly based on their
``unique mathematical formula: The Fibonacci Sequence.'' The
Web site informed that Fortuna was about to begin a massive
advertising campaign to solicit new members; therefore, I would
not have to recruit anyone or do anything to get a return on my
investment. I would not have to work at filling up the matrix
because Fortuna Alliance's advertising campaign would
accomplish that for me. However, the recruitment of new
investors was encouraged because that would fill up the matrix
faster, which in turn would initiate a flow of money to Fortuna
Alliance members.
Another part of the Fortuna Alliance business was a co-op
through which products and services would be sold in the
matrix. I understood that a commission would be paid to me for
any purchases made in the co-op by people in my matrix. It
should be noted I never received any literature from Fortuna
that explained what goods were for sale and how to purchase
them. Fortuna stated there was a money-back guarantee of my
entire initial investment if after 90 days I was not completely
satisfied for any reason. The offer really made me feel that I
had nothing to lose with this potentially lucrative investment.
In late April of 1996, after carefully studying the Fortuna
Alliance Web site and several of the individual member sites, I
decided to make an investment. I purchased 15 elite membership
at $250 each and two premier memberships which cost $600 each.
My total investment was $4,950 which I hoped would result in a
monthly income check from Fortuna Alliance. Fortuna insisted
that I pay this investment by money order or certified check
only. When I received a very elaborate package of investment
information from Fortuna for each of my memberships, I read
this information carefully and continued to understand I did
not have to actually do anything to receive a return on my
investment.
Shortly after purchasing these memberships, I tried to call
Fortuna Alliance several times in order to verify my investment
was properly recorded in their computer system. My telephone
calls were always answered by an automated voice system that
never connected me to an actual person.
In late May 1996, I was roving the Internet while working
on a project with the search word ``fraud.'' During this
search, I came across a notice by the Federal Trade Commission
that Fortuna Alliance had been shut down for operating an
illegal pyramid scheme and making false claims. I immediately
sent a letter to Fortuna Alliance requesting a refund of my
money. They never refunded any of the $4,950 initial
investment. I also filed a claim with the Federal Trade
Commission.
Upon discovering that I had been the victim of a fraud via
the Internet, I started to do some investigation on my own. I
determined that in order to be a legitimate multi-level
marketing company, commission needs to be paid on actual goods
and services sold. Fortuna Alliance was supposedly going to pay
commissions only based on one-time fees paid to purchase a
membership--in other words, money was just being funneled to
people at the top of the pyramid. During my research, I noted
several other companies on the Internet which appeared to be
operating illegal pyramid-type schemes.
In the spring of 1997, I received a letter from Gilardi &
Company in San Rafael, California. Gilardi & Company had been
appointed by the Federal Trade Commission to be the claims
administrator for Fortuna Alliance. The correspondence I
received from Gilardi & Company indicated that my account
consisted of only three elite memberships, when I had actually
purchased 15 elite membership and two premier memberships.
Evidently, Fortuna Alliance's records of my purchases did not
properly account for my entire investment. I subsequently filed
a claim of $4,950 with proper documentation to Gilardi &
Company. In a telephone conversation with representatives of
Gilardi & Company, I determined that my claim of $4,950 was
accepted and verified by them as accurate.
Shortly after my dealings with Gilardi & Company, I
received a letter from Fortuna Alliance which stated they had
been cleared of all charges and were continuing to do business
as Fortuna Alliance II. They also encouraged me not to request
a refund and continue to invest with Fortuna Alliance II. I
disregarded this letter and its message as being completely
bogus.
It is my understanding that the Federal Trade Commission
has collected enough funds from Fortuna Alliance thus far to
cover 60 percent of investors' claims. On January 6, 1998, the
court issued a compliance order that would allow over 8,600
Fortuna Alliance members to begin receiving partial refunds
which would cover approximately 60 percent of their individual
claim amounts.
I appreciate this opportunity to share my story. This
concludes my statement. I would be pleased to answer any
questions.
Senator Collins. Thank you very much, Mr. Wise.
Let me start by just clarifying some of the facts in this
case. This essentially was a pyramid scheme--is that correct?
Where there was an effort to recruit a lot of investors and
eventually it was going to collapse?
Mr. Wise. That is right.
Senator Collins. Did you ever recover the nearly $5,000
that you invested?
Mr. Wise. No, but it is my understanding per a conversation
with Gilardi & Company that on February 11, 60 percent of that
money will be mailed to me. And it should be on its way
shortly.
Senator Collins. So you hope to recover about 60 percent of
your initial investment due to the action taken by the FTC?
Mr. Wise. At least at this time. I am not sure what the
outcome is going to be between them and the Federal Trade
Commission as far as recouping the other 40 percent. But I do
know that the Federal Trade Commission is aggressively pursuing
that remaining 40 percent.
Senator Collins. How much experience did you have using the
Internet prior to your dealings with Fortuna Alliance?
Mr. Wise. I think prior to that I had had Internet service
for about a year, but not a whole lot of experience using the
Internet.
Senator Collins. Had you had experience with investing via
the Internet prior to your dealings with Fortuna?
Mr. Wise. No, I had never invested on the Internet. And I
never will, also.
Senator Collins. Did it cause you--were you more concerned,
did you have a higher level of wariness that you were dealing
through the Internet rather than in person with a financial
advisor, for example?
Mr. Wise. Not really, because an individual had told me
about it and plus they had one Web site of their own and
probably numerous other Web sites that were out there by some
of your individual investors, which sort of added a legitimacy
to what was going on.
Senator Collins. You have mentioned that there were these
other Web sites.
Mr. Wise. Right.
Senator Collins. It is my understanding that Fortuna
Alliance instructed its investors to create their own Web
sites. Is that correct?
Mr. Wise. That is my understanding.
Senator Collins. And that was a means of soliciting new
members to try to sustain the pyramid a little bit longer. Is
that correct?
Mr. Wise. Yes. At the time, I pulled up all the individual
Web sites, just did a search word ``Fortuna,'' and I think
there were probably three or four complete pages that would
come up. When a search engine would pull up Fortuna, you would
see page after page of just nothing but Fortuna, Fortuna,
Fortuna. And you would go to another page, and you would see
more lines of Fortuna. So there were numerous Web sites out
there.
Senator Collins. Did the existence of all these other
related Web sites confer to you a certain legitimacy of the
enterprise? Did it reassure you that it must be legitimate or
otherwise why would there be all these Web sites?
Mr. Wise. Yes, that did, plus they also had a 90-day money-
back guarantee, which I guess at that time added some
legitimacy. But in hindsight, money-back guarantees really
don't mean anything.
Senator Collins. That certainly seems to have been the
case.
You discovered that you were a victim of fraud really by
chance. Is that correct?
Mr. Wise. That is right. I don't think if I had searched--
had been on the Internet with the search engine ``fraud, I
don't even know if I would have ever known about it.
Senator Collins. What did the FTC statement say that you
chanced upon when you were browsing on the Internet?
Mr. Wise. I can't recall the exact--what the FTC said. I
just know once I hit that search engine, there was a big alert
that came up, and it gave a lot of details of what the Federal
Trade Commission did as far as what they had. They had raided
their complex. They had been shut down, could not do business
anymore, and they were in the process of legal action against
Fortuna.
Senator Collins. So the FTC site specifically identified
Fortuna Alliance as a fraudulent enterprise that it was taking
action against?
Mr. Wise. That is right.
Senator Collins. And had it not been for your stumbling
across the FTC's fraud Web site, do you think you would have
discovered that you were a victim of fraud as quickly?
Mr. Wise. No.
Senator Collins. You stated that you received a letter from
Fortuna Alliance indicating that they had been cleared of all
charges and urging you not to request a refund. And it is my
understanding that this letter was written after action was
taken against the company by the FTC.
Did you report that additional letter that you received to
the FTC?
Mr. Wise. I did not. In hindsight, I probably should have,
but the reason I didn't, because I know that the FTC at that
time was aggressively pursuing Fortuna and had already one
legal action against them.
Senator Collins. As a consumer, did you find it troubling
that Fortuna Alliance could make such claims and so quickly
could emerge with a new identity as Fortuna Alliance II?
Mr. Wise. Yes. I would have had more concern if they would
have set up business in the realm of the United States. But
when they set up Fortuna Alliance II, they did that outside of
the country, which really makes----
Senator Collins. So this was an offshore enterprise?
Mr. Wise. Right, which really makes it difficult to do
anything with anybody that does something like that.
Senator Collins. Again, I see a parallel with the hearings
we held on securities scams where a rogue broker will go from
one firm to another, set up a new base of operations, and it
becomes difficult to track and catch these individuals.
Did you try to use the information resources of the
Internet to do some background research on Fortuna Alliance
prior to or at the time of your investment?
Mr. Wise. No. I will have to plead ignorance to that.
Senator Collins. Given your experience--and, again, I would
emphasize that you are much more sophisticated than a lot of
people who are doing investments via the Internet. You are a
CPA. I know how prestigious a designation that is. And yet you
got trapped.
I guess I have two final questions for you. One, why do you
think you did get taken in? And, second, what advice would you
have for other consumers so that they can avoid the kind of
fraudulent investment that you made?
Mr. Wise. I was mainly taken in with the 90-day money-back
guarantee, which, like I said earlier, I now know means
absolutely nothing. They were obviously offering a good return
on the investment. Probably greed comes into play, which in
turn clouds your thinking ability to a certain extent.
As far as the normal investor or anybody on the street, as
long as they know that to be legitimate, especially in a multi-
level marketing scheme like this, commissions need to be paid
solely on goods or services that are sold. If they knew that,
that would probably eliminate at least some of the people that
would get involved in an illegal pyramid scheme.
Senator Collins. Thank you very much, Mr. Wise.
Senator Glenn.
Senator Glenn. Thank you very much, Madam Chairman.
I was interested in some of the material that Fortuna
Alliance sent out where even an educated person like yourself,
an auditor, who is familiar with accounts and how these things
work, you could be drawn into something like this. And the
company has all the things down there, ``no recruiting
necessary, no investment, no''--a whole bunch of things, just
on and on and on here. And then its latest publication talks
about how the FTC came in with armed people and so on, and the
company says down here it has made some changes ``to protect it
from interference by governmental agencies of any country,''
and so on.
The gist of this is these people are so brazen, they have
now set up Fortuna Alliance II.
Mr. Wise. That is right.
Senator Glenn. It is offshore, I guess. Where is it based
now?
Mr. Wise. I have no idea. I have sort of disconnected
myself from them. [Laughter.]
Senator Glenn. You are not a new investor----
Mr. Wise. I would like to add one other thing that I
thought was, to me, almost amusing at the time that the Federal
Trade Commission went in and raided Fortuna. Based on my
knowledge, there was a good percentage of Fortuna Alliance
memberships that were so--became so, I guess, sucked in with
Fortuna that they were actually, I guess, mad at the Federal
Trade Commission for shutting down Fortuna and were sending, I
guess, letters and complaining about the Federal Trade
Commission as being a tyrannous-type organization, which in
hindsight that was far from the fact in this particular case.
Senator Glenn. Well, they say here that Fortuna Alliance
offices in the United States were ``raided by armed members of
a U.S. regulatory enforcement agency known as the Federal Trade
Commission.'' I didn't know the Federal Trade Commission went
around packing guns, but maybe they do now. [Laughter.]
Maybe we will get some testimony on that a little bit
later. Fortuna Alliance was forced into receivership by order
of a Federal judge and so on. But they have opened up again
offshore. That is the point I am making.
Mr. Wise. Right.
Senator Glenn. They have opened up again. They are still
going, and I guess they are back on the Internet and didn't
even change their name except they now make it Fortuna Alliance
II. And, ``The new Fortuna Alliance II will be similar to the
original Fortuna Alliance in most ways. It was very good as it
was, and the primary reasons to change any part of it are, one,
to protect it from interference by governmental agencies of any
country; and, two, to take advantage of all the founder, Augie
Delgado''--that sounds great--``and executive team learned from
this most devastating experience at the hands of a brutal U.S.
regulatory agency, the Federal Trade Commission,'' and so on.
And the one that I like, too, is they have--this is in
their quotes, ``a unique mathematical formula: The Fibonacci
Sequence.'' At least the first syllable is right, the ``fib''
part, anyway.
Mr. Wise. That is right.
Senator Glenn. We know that. So, anyway, these things, you
squash them here and they pop up somewhere offshore, I guess.
We are on five lights up there, and I know we have got to
vote, Madam Chairman, but this is very interesting, and I hope
it gets enough publicity that people are not subscribing to
things like this.
Senator Collins. Mr. Wise, I do want to thank you very much
for sharing your experience. It certainly is a cautionary tale
for all of us, and we appreciate your willingness to come
forward.
Thank you very much.
Mr. Wise. All right. Thank you.
Senator Collins. We are now in the middle of a vote, and I
expect a second vote back to back. So I regret to inform our
next witness, with great apologies, that we are going to need
to take a 15-minute recess. But we will resume in 15 minutes.
Thank you.
[Recess.]
Senator Collins. The Subcommittee will be back in session.
I apologize for the delay. We were on Senate time, which I have
yet to get used to, and the vote was held for a couple of
Senators, so I apologize for the delay.
Our final witness this morning is the Hon. Robert Pitofsky,
the chairman of the Federal Trade Commission. The chairman's
testimony will provide the Subcommittee with an overview of the
roots of Internet fraud from the Federal perspective, as well
as a discussion of the FTC's civil enforcement action and
consumer education efforts.
I would note that the FTC's enforcement led to the
dismantling of the pyramid scheme about which the previous
witness just testified. It is my understanding that the
chairman may wish to have an individual accompany him, and I
would at this time introduce Jodie Bernstein, the Director of
Consumer Protection, and anyone else that you would like to
have, Mr. Pitofsky, we would welcome their participation.
As I have explained, pursuant to the rules of the
Subcommittee, all witnesses who testify are required to be
sworn, so I would ask that you stand and raise your right
hands.
Do you swear that the testimony you are about to give to
the Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
Mr. Pitofsky. I do.
Ms. Bernstein. I do.
Senator Collins. Thank you.
Again, Mr. Pitofsky, my apologies for the unavoidable
delays. I know you have a busy schedule, and I appreciate your
willingness to participate in these important hearings. And I
would ask that you proceed with your statement.
TESTIMONY OF HON. ROBERT PITOFSKY,\1\ CHAIRMAN, FEDERAL TRADE
COMMISSION, ACCOMPANIED BY JODIE BERNSTEIN, DIRECTOR, BUREAU OF
CONSUMER PROTECTION
Mr. Pitofsky. Thank you, Madam Chairman. I am delighted to
be here, and I want to compliment the Subcommittee for holding
hearings on this important and, I think, sometimes somewhat
neglected subject, and that is, marketing fraud on the Internet
and in this country generally.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Pitofsky and additional copy
submitted for the record appears in the Appendix on page 78.
---------------------------------------------------------------------------
With your permission, I would like to submit my full
testimony for the record and just summarize it this morning.
Senator Collins. It will be included in the record in its
entirety. Thank you.
Mr. Pitofsky. And may I introduce Jodie Bernstein, who is
director of our Bureau of Consumer Protection, and who is in
charge of enforcement in this area, and also very active on the
consumer education front.
As you know, the FTC is the primary agency at the Federal
level authorized to challenge fraud and deception. We do so
under Section 5 of the Federal Trade Commission Act, which
outlaws unfair and deceptive acts and practices in commerce.
Section 5 gives the Commission the authority not only to combat
fraudulent activity by issuing administrative cease and desist
orders, but also by going directly into Federal court to seek
injunctive relief and consumer redress.
We have noted several times already this morning that the
Internet is growing by leaps and bounds.\2\ Fifty-eight million
potential consumers are already online, and we expect Internet
commerce to grow exponentially over the next few years. Online
advertising is expected to grow to $4.35 billion by the year
2000, and as Senator Glenn's reference to the Internet Shopper
pointed out, online commerce is growing. We think it might be
as much as $220 billion by the year 2001.
---------------------------------------------------------------------------
\2\ See Exhibit No. 3, slide presentation of the Honorable Robert
Pitofsky, Chairman, Federal Trade Commission which appears in the
Appendix on page 300.
---------------------------------------------------------------------------
In this expanding marketplace, consumers often will receive
new goods and services faster and at lower prices. They will
receive more information to make informed decisions. In
general, I think of the Internet as a pro-competitive, pro-
consumer opportunity.
We also know, however, that the growth of the Internet will
generate an increase in fraud and deception. To combat these
problems, we will combine traditional law enforcement with new
types of consumer and business education.
The Commission has already brought over 25 Federal actions
against deceptive and fraudulent activity on the Internet. That
has just occurred in the last year and a half or so. Most of
these cases have involved old wine in new bottles, traditional
types of scams that have migrated to cyberspace. For example,
we have seen credit repair scams and business opportunity
schemes, that look very much like the traditional programs that
we have seen in telemarketing and elsewhere.
It has also given new life to a kind of fraud that we
thought we had virtually wiped out 10 or 15 years ago, and that
is the pyramid fraud. In one of the largest Internet cases,
which has been discussed, the Commission sued Fortuna Alliance
to halt an alleged pyramid scheme that took more than $7
million from consumers.
We have also pursued more sophisticated schemes on the
Internet, and you heard about the Audiotex case where the
Commission sued a Web site operator that allegedly hijacked
consumers' computer modems and silently placed very expensive
international telephone calls to a Moldovan telephone number.
That is a former republic of Russia. And, of course, consumers
ended up with very large telephone bills at the end of the
month.
In addition to law enforcement, the Commission has fought
Internet fraud through aggressive consumer education because,
in the long run, consumer education really is the best way for
people to protect their own interests. The Commission has used
technology on the Internet to establish informative Web sites
and teaser pages. The Commission home page receives over
100,000 visitors per month and provides consumers with access
to everything from fraud alerts to Federal court pleadings. The
public can easily find information either by clicking into a
category like Consumer Line or by placing simple key words into
our search engine.
The Commission also has established another Web site with
other Federal agencies. This site provides one-stop shopping
for people with consumer questions about automobile recalls,
drug safety, other topics. And we have tried to reach out to
consumers through educational teaser pages.
The ``Ultimate Prosperity Page'' is an example of a teaser
site posted by the Commission. It mimics an online business
opportunity scam promising high earnings for little or no
efforts. Clicking through this site, a consumer will eventually
arrive at the last page, which states, ``If you responded to an
ad like this, you could get scammed.'' This page warns
consumers about fraudulent business opportunities and provides
a link back to the ftc.gov Web site for more information.
The Commission also fights Internet fraud by reaching out
to businesses, especially new entrepreneurs who may be entering
the marketplace for the first time and may not know the basic
principles of consumer protection law. We have pursued
partnerships with private industry, asked Silicon Valley
executives for assistance in working with us, and we have
developed road shows and seminars to present to small business
and their lawyers.
The Commission also educates businesses through projects
that it calls surf days. During a typical surf day, the
Commission and its law enforcement partners surf together for a
few hours, searching the Internet for a specific type of
problem, and after compiling a list of potentially deceptive
sites, the Commission sends the operators at those sites a
message. The message discusses the problem targeted by the surf
day and outlines the law in that particular area.
Looking ahead, the Commission expects that old-fashioned
types of fraud will continue to plague the Internet. At the
same time, the Commission expects that new high-tech schemes
will present new challenges. Combatting Internet fraud will be
a daunting task, but we will continue to attack it with law
enforcement and education, always looking for ways to turn new
technology to our advantage and ways to boost consumer
confidence in this emerging marketplace.
Finally, we must consider the question of how many
resources we have to deal with this problem, and the chart
demonstrates something along that line. As you will see, the
tall block on the screen is total consumer protection resources
each year during the last 3 years. They haven't changed much at
all, but our resources committed to challenging fraudulent
behavior on the Internet have gone from 4 percent to 11 percent
to 16 percent. Something like 53 people at the Federal Trade
Commission are now working in this area.
I think we are doing as much as ought to be done. On the
other hand, in order to come up with these resources, we really
did have to reduce resources in other areas of our consumer
protection mission. And I have no doubt that this is not the
end of the growth of Internet fraud or of our response to it.
Thank you, and I would be glad to answer your questions.
Senator Collins. Thank you very much, Mr. Chairman.
One of the complaints that the Subcommittee has heard from
consumers is there is a perception that there is, as I put it,
no sheriff in cyberspace. Consumers feel that if their fraud
involves only a few hundred dollars that nobody is going to pay
attention to it, that Federal agencies or law enforcement
officials are only interested in the big-dollar frauds.
What would be your response to that concern? Can consumers
come to you if they have lost, say, under $500? Which may be a
great deal to that particular consumer.
Mr. Pitofsky. Of course. Absolutely. Let me start by saying
that I think the perception that the Internet is a wild west
frontier and there is no law and there is no regulation, that
is one of the things that needs to be combatted, because we
want consumers to have confidence in the Internet in order to
see that constructive and useful marketplace grow.
Now, it is true if we see something like Fortuna, where we
are talking about millions and millions of dollars of fraud, we
are going to be quicker off the mark than we would be for
smaller-scale frauds. But we have brought actions where
relatively modest amounts of money have been defrauded away
from consumers.
Jodie, do you want to add to that?
Ms. Bernstein. In fact, the first five cases, I think, that
the Commission brought early on were against small companies
with small amounts of losses per consumer. But in total, it
added up to a lot of money. That means that there was a lot of
loss involved.
We did that in part to establish the Commission's
jurisdiction to attack fraud and deception in this particular
marketplace and because we wanted, as the Chairman said, to
establish that there will be protection for consumers in this
new medium.
Senator Collins. I would like to talk a little bit more
about the Fortuna Alliance case. What is the present status of
the FTC's actions against Fortuna Alliance?
Mr. Pitofsky. We challenged their behavior, and later
settled the case. We are trying to get restitution for
defrauded consumers. Restitution did not occur promptly, and
with the help of the Department of Justice, we have pursued
these people to Antigua. That is where they are located now.
And we were able to get the court to enforce an order which
would require very substantial restitution to consumers.
I understand that tomorrow is the date when they are
committed to pay back to consumers 60 percent of the monies
that they have committed to pay back, which I think is in the
range of about $6 million. But I must tell you, until that
money is in the hands of consumers, I am not prepared to
declare victory here.
This is a very difficult enforcement process. They have
made it difficult for us. But we are pursuing it, and we will
continue to pursue it and get the money back if we can.
Senator Collins. It is very troubling to me that this
company could pop up with the same name with just ``II'' after
it and move its operations offshore. Does the company's ability
to move offshore make it more difficult for the FTC to pursue
this kind of fraudulent activity?
Mr. Pitofsky. Absolutely, and we have often seen this
business of people who are caught in one place moving to
another jurisdiction, changing their names, and going right
back into business. We have seen that a lot in telemarketing.
This is not all that unusual.
What is unusual is going across a national border because
the Internet respects no borders, and when you get to these
foreign jurisdictions, sometimes they have no comparable
consumer protection law or it is very difficult to enforce your
judgment in a foreign country. It just makes our job all the
more difficult, and yet we know that that is what is going to
happen more and more as time goes on.
Senator Collins. Isn't the company essentially violating at
least the spirit if not the letter of the agreement that it
reached with the FTC?
Mr. Pitofsky. We have moved for contempt against the
company on grounds that they are violating the previous order.
Senator Collins. In a case like this, does the FTC, Mr.
Chairman, consider a referral to the Justice Department for a
criminal prosecution? I know you can't comment on a specific
action, but----
Mr. Pitofsky. I can't. The general policy is we are
increasingly thinking about these kinds of fraud, telemarketing
and Internet, as deserving criminal enforcement. Some of these
frauds are extremely raw. People are taken advantage of. They
are injured very badly. And some of these people engaged in the
fraud deserve to be treated criminally.
Ms. Bernstein. Madam Chairman, in this case, we can also
disclose because it is public that a Federal grand jury in
Seattle has issued subpoenas to individuals associated with
Fortuna, and the FBI is also conducting interviews.
Senator Collins. Ms. Bernstein, I notice that the victim we
had who was testifying today talked about some of the customers
of Fortuna Alliance actually being angry at the FTC for closing
down what clearly was a fraudulent pyramid scheme. Were these
customers who got in at the ground level and thus made some
money before the whole pyramid collapsed? Or could you tell us
a little bit about that? I thought that was just fascinating. I
would think they would be grateful to you.
Ms. Bernstein. Well, not only were they complaining about
our conduct, I believe they complained to various Members of
Congress that the FTC was interfering with their ability to be
winners in this scheme.
I think the voices that were heard were people who really
believed if we, the FTC, had held off for a little while
longer, they would be among the early winners, and they weren't
too concerned, I think, about the downstream potential victims.
We believe that is what happened in that situation, and it
often does in pyramid schemes.
Senator Collins. I noticed that you provided to the
Subcommittee some terrific consumer brochures and sort of
warning tips. But I have to say this is the first that I have
seen these materials, which I think are excellent.
What do you do, Mr. Chairman or Ms. Bernstein, to make sure
that consumers get hold of these kinds of very useful warning
publications? What is your plan for distributing them?
Ms. Bernstein. The first thing that we have done, obviously
we have tried to move away from what used to be called
government brochures that were not very readable and not very
intriguing to people. We have tried to use new techniques.
Second, we formed partnerships with legitimate companies
who were anxious to assist us with our consumer education.
Various companies have taken on the task of distributing
materials very broadly. We have over 100 companies as part of
our consumer education partnership that we established some
time ago.
And, third, and perhaps I should have said this first, we
are on the Web with these materials. Our home page allows you
to know what is available, how to get it, and you can print it
out directly from the Web page.
So we are trying to use, as best we can, every technique
that these fraud operators are using to get to consumers. We
hope the teaser pages, particularly, are very specific, and
like our previous witness said, it was one of those pages and
one of our alerts that caused him to be suspicious of his
investment in Fortuna.
So we are using every technique that we know of and that
experts in dissemination and communication have helped us with.
Senator Collins. I was wondering whether it would be
worthwhile trying to get some of the service providers, the
Internet service providers, to include some of your
publications when they sign up a new customer. For example, the
``Don't get scammed'' publication, the little bookmark, would
be very easy to stuff in as a mailer, it seems to me.
Have you pursued that sort of idea?
Ms. Bernstein. We have, and they have been very
cooperative, the service providers we have worked with, AOL and
the others, to be of assistance on that. And some have actually
included some of our consumer education material in the billing
notices. I hope it doesn't turn people off from the message
when they have to pay the bill, but it is a very good device.
You are absolutely right. It is a very good device for having a
consumer see it at the time they are thinking about the
service.
Senator Collins. Both Senator Glenn and I in our opening
statements talked about the importance of striking the right
balance here, because the Internet really is a tremendous means
for small businesses in particular, which don't have the money
for large advertising budgets, to reach consumers. Yet, on the
other hand, that same ease of transactions and speed and low
cost are an invitation to the fraudulent person as well.
I am interested--and I will start with you, Mr. Chairman--
in what specifically you would recommend that Congress do as
far as new legislation in this area. Is there new legislation
that is needed to make it easier for you to police the Internet
or to discourage this kind of fraud? Are our current penalties
tough enough? What would your recommendations be to us?
Mr. Pitofsky. Well, let me start by saying how much I agree
with what you say. There are legitimate people who are
marketing on the Internet, and this new marketplace creates a
great opportunity for easy entry, for good service, for
information and so forth.
I think that in the long run it may very well be that
Congress is going to have to act in this area, as it did with
respect to telemarketing fraud so very effectively.
On the other hand, I think maybe we are just a little bit
premature at this point in looking to legislation, for several
reasons. One is this whole Internet marketing phenomenon is
only a few years old. We are just beginning to learn about how
it works, what the frauds are, who is vulnerable and so forth.
I think it is a good idea, before we move too quickly into
legislation or rulemaking by an agency like this, to get a
better fix on where the problems are. Also, some of these
problems are unique to the Internet, like the password thefts
that we talked about before.
We held several sets of hearings bringing consumer groups,
industry groups, and academics together to talk about what the
problems are on the Internet, and we received some pretty clear
promises from the industry that, through technology or self-
regulation, they thought they were capable of cleaning up a lot
of the problems on the Internet.
We are going to surf the Net very broadly next month. That
was a commitment we made to Congress some time ago, and we will
be filing a report to Congress before the end of June of this
year in which we evaluate self-regulation, in which we look
carefully at what has been done and what hasn't been done, and
we may be making legislative recommendations.
I heard Senator Glenn say earlier that if self-regulation
doesn't happen, Congress should and likely will act, and I
think that is exactly right. In that event, Congress should
act. It is up to the industry at this point. They have made a
lot of promises. Some people have come through in excellent
fashion in proposed self-regulation programs, but we have got a
long way to go. And we will be ready to report to the Congress
by the end of June of this year.
Senator Collins. One of our witnesses earlier today, Susan
Grant of the National Consumers League, made a specific
recommendation with regard to the FTC's telemarketing sales
rule, and she proposed that it be expanded to cover promotions
via the Internet and online services so that Federal and State
prosecutors can go into Federal court to take action on
interstate violations.
Do you agree with that recommendation? What is your
reaction to that specific proposal?
Mr. Pitofsky. Two reactions. One is, again, I think we are
a little ahead of where we ought to be. The telemarketing sales
rule, first of all, wouldn't fit exactly for some of the
Internet problems that we see. On the other hand, my second
reaction is the best thing about the telemarketing sales rule
is the way Congress adopted the rule--or adopted a law,
authorized us to promulgate a rule, and then allowed not only
the Federal Government but State officials to go into Federal
court to enforce that rule. That has led to an extraordinary
level of cooperation, and I think some success in challenging
telemarketing fraud.
So I think if there is to be legislation, it ought to be
along that model. As to what the exact provisions ought to be
in dealing with Internet fraud, I think we ought to allow a
little more time to pass to see how self-regulation works and
have a little more experience with what the frauds are.
Senator Collins. Thank you.
Senator Glenn.
Senator Glenn. Thank you, Madam Chairman. Sorry I was a
little late getting back. I got tied up over there on the
floor.
Do you think the ISP's should be required to screen
commercial sites more carefully? I presume you believe that
that is a starting point, at least.
Mr. Pitofsky. I do, and we have urged them to do so.
Senator Glenn. Should they be required to report customer
complaints to FTC?
Mr. Pitofsky. I don't know about--well, require. They do
now. We received many of our complaints from the service
providers. I think they are well advised to do that. But I
think for the most part they are doing that.
Senator Glenn. There are two pieces of legislation that
have been introduced that deal with unsolicited commercial E-
mail. I have not looked in detail at those. Have you looked at
those? And do you favor either one of them, or do you have some
suggestions how we could either use those as a basis for
legislation or should we be putting in separate legislation or
let well enough alone right now?
Mr. Pitofsky. Well, I think spam, unsolicited E-mail, is a
real problem, in part because we--there are probably certain
kinds of spam that are injurious, and yet we can't reach it
under our statute.
We can challenge the kind of unsolicited E-mail that
contains some deceptive count to it: False return address,
false claims within the four corners of the presentation. But
if it is just straight spam, I am not at all sure that we can
get at it. And unless self-regulation--again, we have had all
these promises that self-regulation and technological fixes
would do the job. Unless it does, I think Congress would and
will become involved. But I haven't looked at these two bills.
Senator Glenn. Is this akin to junk mail that we get in our
mailbox every day? And we haven't learned how to regulate that.
We do have laws for truth in advertising that cover that. Now,
should those same laws be extended here, or do they already
apply?
Mr. Pitofsky. Oh, they already apply, and we would enforce
that law. But, yes, it is junk mail raised to a higher power.
We are talking about a million people who may get this kind of
unsolicited E-mail at a very cheap cost to the sender.
Senator Glenn. Could the ISP's levy extra fees on those who
want to send unsolicited E-mail?
Mr. Pitofsky. I think they could. I heard the testimony
earlier that they have no intention of doing do. I don't know
exactly where that stands as far as what their policies are.
Senator Glenn. What do you need to more effectively fight
Internet fraud? Do you need more people? Do you need more
resources? You need what?
Mr. Pitofsky. Well, I am glad you asked me that question,
Senator.
Senator Glenn. We did not have that arranged in advance, I
would add. [Laughter.]
Mr. Pitofsky. There is a chart that I mentioned earlier in
my testimony. The red block is our appropriation across the
board for consumer protection. The green block shows that we
are now spending four times as much of our resources, 16
percent of our total consumer protection resources, on Internet
monitoring and regulation, and we know that that block is going
to continue to grow.
I think we can cover our responsibility right now, but the
way things are going, two things are happening. One is we are
robbing Peter to pay Paul. We are taking resources away from
other valuable activities in order to cover the Internet. And,
second, that block is going to grow, and I think if we are to
address Internet problems, we are going to need more people and
more money.
Senator Glenn. You heard us earlier--I know you were in the
room--when we talked about America Online and some of the other
companies that were hauled up and after due course made a
settlement of some kind with the FTC. They were three of the
largest and supposedly most reputable ISP's.
Do you have any estimate of how much the consumers lost
because of improper practices of either of those three or in
general across the board?
Mr. Pitofsky. I don't. And, incidentally, that case is not
yet final, so let me--I would be limited in what I can say
about it. But let me make two points about that.
One is that we jumped into that matter very early in the
game. I don't think that behavior was going on too long before
we learned about it from a very wide variety of consumer
complaints. And, second, my recollection is that the companies,
as soon as we started our investigation, abandoned the
practices. They didn't wait for us to complete our enforcement
action.
And so we settled with an order that required them to
discontinue the four practices that you mentioned earlier this
morning and also commit some money for consumer education. But
as to getting money back for consumers, I don't have an
estimate as to how much money was involved there.
Senator Glenn. Have we made any effort--the Fortuna case is
one that just sort of pops out at me, Mr. Wise--Barry Wise is
still in the room and let me just say for the record here,
Barry, I admire your coming forward, and I hope that your
company gives you full credit when you get back home for being
honest enough to come up here and I think they are to be
commended for letting you come up here and testify on these
matters today, because it is too easy to get a scam and say I
am ashamed of what I did in this and just clam up. And you have
got guts enough to come up and testify before a Senate
Committee and say where you got scammed and admit it and
hopefully prevent this from hurting other people. And your
company was willing to let you come up and make that kind of
testimony, and I think both the company and you are to be given
a lot of credit for being willing to do that. If we had more
people willing to come forward instead of just covering up
things like this, why, it would be a big help toward getting
some eventual solution to this. So I want to compliment you for
coming up this morning.
But what happened with Fortuna that Mr. Wise testified
about was the company got whacked, and so they just go
offshore, and they have got the same thing going again and
didn't even change the name, now Fortuna Alliance II, and even
the parentheses, ``TM,'' which I guess means trademark, which
is the ultimate insult, I guess. I presume that is what it
means. I don't know.
But how are we going to get into this? Because we have got
people on the Internet now from all over the world, you can
have people operating out of any little country that has no
regulation whatsoever. They could be set up in some place that
doesn't even have much business law or whatever. And yet they
are just as much a scam on the international Net as anybody
else.
How are you going to address that? Are there any plans to
hold some international organization or conference that
addresses this and tries to get agreements with other nations?
It is a very tough problem you are up against here. How are you
going to deal with the international aspects?
Mr. Pitofsky. It is one of the most serious problems, and
it is going to grow as time goes on.
I think long term--I am going to ask Ms. Bernstein to
address this because she has negotiated with some of these
foreign countries. But I think long term we are going to need
bilateral agreements with countries like Canada and the E.U.,
Australia, Mexico, and so forth. The kind of agreements that we
have begun to develop in the antitrust field, we are going to
have to expand that to consumer protection so that we can get
some help.
The problem isn't identifying the crooks. The problem is
when you have identified them and you know what they have done,
bringing an enforcement action that can be enforced in a
foreign country is where the difficulty is.
Now, Jodie, do you want to add to that?
Ms. Bernstein. Yes. At least in connection with our
relationships with Canada, we have had a good deal of success
in establishing bilateral relationships already, sharing data
with them, pursuing joint actions and so forth. We really have
a very good working arrangement with them because the first
sign of movement was initially into Canada or Canadians coming
here in order to escape either country's laws. And that sets a
good model for us, at least initially, because we are part of a
joint law enforcement initiative, in addition to which a
committee, an international committee, has been set up--I think
it was a couple years ago, maybe a year and a half--called the
International Marketing Supervisory Network, in which we were
trying to work as other international organizations have, to
extend that international--extend the law enforcement Network
to other countries as well so that we can quickly alert each
other and work together to try to pursue this.
It certainly is a long way from being in completion, but at
least we have an organization that we have been participating
in with other countries at the same time.
Senator Glenn. Fortuna, though, is a good example. I
understand they are operating now out of Antigua. Is that
correct?
Ms. Bernstein. Right.
Senator Glenn. Well, that would just show they could be in
Antigua, they could be in Burma, they could be on an island, in
Diego Garcia. They could be anywhere in the world, almost.
Ms. Bernstein. Well, we did have some success in working
through the Justice Department in Antigua, and the courts down
there, after we, through the Justice Department, had local
counsel retained, which is required by law down there, to be
able to pursue them there. The courts down there have been
quite--very supportive of reaching them in Antigua.
Senator Glenn. Just as a last statement, Madam Chairman, I
am not quite as optimistic about this self-regulation as you
indicated you might have hopes for. It hasn't worked with
banks, SEC, auto dealers, doctors, lawyers, you name it. We
have laws all over the place. In fact, our whole body of
regulatory law in this country is based on the fact that people
are not operating under the golden rule, not operating under
fairness, and so we have to have some sort of regulation.
This is such a tough one to get your arms around that I
don't know where you go with it. But I will pledge you my
support for what time I have left in the Senate here the rest
of this year. Mr. Pitofsky, I don't know whether it is possible
to do this or whether you people at the FTC are over there like
the little Dutch kid with the finger in the dike. You are just
waiting for the dam to burst in some way over there and that we
are at that stage of this whole thing right now. I think you do
need more resources than you are probably going to get to deal
with a problem of this magnitude. But it is a tough one, and I
hope we can be working with you on this and that you will keep
us advised on what you think is necessary so that we can give
you the maximum support possible.
It is never pleasant to have to come up and appear at a
hearing and answer a lot of questions. I know that. But we are
really all working together on this thing, and we have one part
of the puzzle here. If we can put it together to help you, that
is what we want to do.
Thank you.
Senator Collins. Thank you, Senator.
Mr. Pitofsky. May I just----
Senator Collins. Yes.
Mr. Pitofsky. I don't want to be misunderstood here. I
completely agree with you that self-regulation is going to be
difficult here. We have heard many promises. We have had some
constructive evidence of moving forward, but not a great deal.
My own view is that if self-regulation doesn't work after
all those promises, that is all the more reason for Congress to
step in aggressively in this area.
Ms. Bernstein. The Chairman has also made clear that any
self-regulatory mechanism that they propound will have to have
a strong enforcement mechanism so that we can monitor it and
the public can monitor what the effects of self-regulation are.
Senator Collins. Mr. Chairman, in one of my previous
incarnations, I was a commissioner in State government in
charge of the department that had a broad consumer protection
mandate and included securities regulation. As I am listening
to the testimony today, it strikes me that there are a lot of
cross-jurisdictional issues right within our own country, and I
am interested in whether or not there is good cooperation with
State and local law enforcement officials, but also whether you
have considered some sort of interagency task force. The SEC
obviously has a role in the area of securities fraud being
perpetrated over the Internet.
What is the status of cooperative efforts such as those?
Mr. Pitofsky. On the Federal-State front, I would say the
cooperation is better than anything we have seen before. It is
outstanding. We work constantly together. Congress, as I said,
made a very good call here by allowing States and the Federal
Government to enforce laws in this marketing fraud area.
Now, we are all short of resources, but we certainly
maximize our resources and leverage our resources, I should add
that the FBI, the Department of Justice, the SEC and others are
active in this area.
At the Federal level, you are absolutely right. There are
some overlaps here. There is some gray area. There are some
cross-lines. In specific areas, there are groups that are
working together. For example, we hardly have mentioned privacy
considerations today, and yet they are going to influence
profoundly the willingness of consumers to buy products on the
Internet.
We have a good working group going with respect to privacy.
I think we have a ways to go, and I think more coordination at
the Federal level will occur as time goes on.
Senator Collins. Finally, I want to turn to one aspect that
we haven't discussed today, and that is, we have talked a lot
about the cyber crooks, if you will, the people who are
deliberately, intentionally defrauding individuals. But I
suspect there is also a category of online fraud that occurs
that is undertaken by people who are just ignorant of the law
or who are very unsophisticated, think that they have come up
with a scheme that is legitimate, when, in fact, it is
downright illegal.
When you do your surveillances and visits to Web sites, how
much is that a problem, of an unsophisticated person putting
together a scheme that is, in fact, illegal and yet the person
is unaware of that?
Mr. Pitofsky. They don't have a large law firm and a
general counsel to advise them. That is exactly right. We see a
lot of it. And I think what we are trying to do is to get back
to some of these people and let them know that they are on thin
ice, they are in an area where they may be approaching or have
stepped over the line with respect to fraud.
I am going to ask Ms. Bernstein, again, because she is
responsible for developing a program of advising the small
business community about this. I will ask her to develop the
point.
Ms. Bernstein. Thank you. We have actually conducted what
we call surf days, eight surf days on different fraud topics
over the last couple of years, and the purpose of it, Madam
Chairman, really was to do exactly what you have referred to,
because we know there are a lot of small entrepreneurs and
others who aren't--some of them, we think, have never heard of
the FTC, leave alone that there is a law against deception or
false advertising.
So what we do is join together with States and other law
enforcement folks, look at the surf in a block of time, say,
for example, the first one we did was on pyramid sites, gather
them up, and then those that we believe have violated the law,
we send warning letters to saying: You may not be aware that
your practice here violates Federal law, etc., and we are going
to give you a chance to basically clean up your act. And then
we go back and surf after 30 days.
On the very first one, we found when we went back that 18
percent of the sites had improved or had taken them away
entirely in 30 days. Others in business opportunities, almost
25 percent either disappeared or had cleaned up what they were
proposing and so forth.
We have done eight of them, one on credit repair, get-rich-
quick schemes, and the last one we did was what we called our
false spam harvest. We sent out 1,000 letters to fraudulent,
unsolicited E-mail communicators with the same purpose in mind.
We just did that last week. Interestingly enough, they didn't
give us their E-mail address, so we had to send it by ``snail''
mail. But we will be following through on that, and that was a
very aggressive kind of program that we have put in place to
try to get that, to clean up that part of a new type of
business.
Senator Collins. Senator Glenn, do you have any further
questions?
Senator Glenn. I just have a couple to wrap up, Madam
Chairman, if I could.
In your testimony I believe you testified that you have
brought about 25 civil cases, I think.
Mr. Pitofsky. That is right.
Senator Glenn. Let me just run through this. You had 25
civil cases. Were those all done within the FTC itself, or did
you refer those to Justice?
Mr. Pitofsky. Oh, no. These are FTC cases, although in most
instances we went to court. We didn't enforce it within the
administrative process.
Senator Glenn. OK. But you have your own counsel and your
own staff of people there to do this on civil cases.
Mr. Pitofsky. We do.
Senator Glenn. I presume that on criminal cases you have to
go through Justice; is that correct?
Mr. Pitofsky. We refer those to the Justice Department.
Senator Glenn. And have you done any of that? Have you
referred criminal cases to Justice?
Mr. Pitofsky. Well, this Fortuna case----
Senator Glenn. That was a criminal case.
Mr. Pitofsky. Yes. I don't think we have had any other
criminal cases with respect, narrowly, to Internet fraud thus
far.
Senator Glenn. Do we have any extradition agreements with
other countries that cover this?
Mr. Pitofsky. I think we do not, but I would have to check
on that and find out.
Senator Glenn. Do you know?
Ms. Bernstein. I don't know, Senator.
Senator Glenn. And my follow-up to that was going to be has
it ever been exercised. If so, how many have we extradited?
That may be an area where we could help out some on this.
Since the con artists are moving, shuffling off to other
countries when they have a problem in this country, that may be
an important area that we could help on as far as getting
extradition agreements and things like that. So if you could
furnish that for the record, we would appreciate it.
Thank you, Madam Chairman. I think it has been a good
hearing this morning.
Senator Collins. Thank you very much, Senator Glenn.
Each of the witnesses that we have heard from today have
emphasized a common theme, and that is that we need to do more
to educate consumers so that they can distinguish more easily
between fraudulent offers on the Internet from legitimate
offers. We don't want to stifle legitimate commerce, and yet we
do want to take steps to protect the consumer who may be out
there with very little guidance on what is a fraudulent scheme.
We also need to make certain that consumer complaints in
this area are vigorously pursued and that agencies like the FTC
have the tools needed to do the job. In that regard, I would
invite you, Mr. Pitofsky, and your staff to continue to work
with the Subcommittee on legislative or regulatory reforms when
the appropriate time comes and to share with us the report that
you mentioned that will be available in June.
I also want to echo Senator Glenn's commendation of Mr.
Wise for coming forward today. It is never easy to come forward
and concede that you were ripped off, but it was his testimony
that allows us to understand that even a sophisticated consumer
can be taken advantage of. And he has done, indeed, a great
public service.
Finally, I want to thank Susan Grant and America Online and
other witnesses today for sharing their information as well. We
hope to build on these hearings to further the consumer
education efforts we are all involved in and also to identify
legislative reforms that may be needed.
I finally want to thank my staff for their hard work on
this hearing. Rena Johnson, Tim Shea, and Kirk Walder all
worked very hard, as did the rest of the staff and the minority
staff as well. We will be continuing hearings into this area,
and we look forward to continuing to work with you.
Senator Collins. The Subcommittee is now adjourned.
[Whereupon, at 12:27 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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