[Senate Hearing 106-137]
[From the U.S. Government Publishing Office]
S. Hrg. 106-137
SECURITIES FRAUD ON THE INTERNET
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HEARINGS
before the
PERMANENT
SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
MARCH 22 AND 23, 1999
__________
Printed for the use of the Committee on Governmental Affairs
U.S. GOVERNMENT PRINTING OFFICE
57-616cc WASHINGTON : 1999
_______________________________________________________________________
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
WILLIAM V. ROTH, Jr., Delaware JOSEPH I. LIEBERMAN, Connecticut
TED STEVENS, Alaska CARL LEVIN, Michigan
SUSAN M. COLLINS, Maine DANIEL K. AKAKA, Hawaii
GEORGE V. VOINOVICH, Ohio RICHARD J. DURBIN, Illinois
PETE V. DOMENICI, New Mexico ROBERT G. TORRICELLI, New Jersey
THAD COCHRAN, Mississippi MAX CLELAND, Georgia
ARLEN SPECTER, Pennsylvania JOHN EDWARDS, North Carolina
JUDD GREGG, New Hampshire
Hannah S. Sistare, Staff Director and Counsel
Joyce A. Rechtschaffen, Minority Staff Director and Counsel
Darla D. Cassell, Administrive Clerk
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PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
SUSAN M. COLLINS, Maine, Chairman
WILLIAM V. ROTH, Jr., Delaware CARL LEVIN, Michigan
TED STEVENS, Alaska DANIEL K. AKAKA, Hawaii
GEORGE V. VOINOVICH, Ohio RICHARD J. DURBIN, Illinois
PETE V. DOMENICI, New Mexico MAX CLELAND, Georgia
THAD COCHRAN, Mississippi JOHN EDWARDS, North Carolina
ARLEN SPECTER, Pennsylvania
Timothy J. Shea, Chief Counsel and Staff Director
Linda J. Gustitus, Minority Chief Counsel and Staff Director
Mary D. Robertson, Chief Clerk
C O N T E N T S
------
Opening statements:
Page
Senator Collins.............................................. 1, 43
Senator Levin................................................ 3
Senator Edwards.............................................. 17
WITNESSES
Monday, March 22, 1999
Galen O'Kane, Ellsworth, Maine................................... 6
Kristin Morris, Berryville, Virginia............................. 8
Tom Gardner, Head Fool, The Motley Fool, Alexandria, Virginia.... 20
Howard M. Friedman, Professor of Law, The University of Toledo,
Toledo, Ohio................................................... 22
Richard J. Hillman, Associate Director, Financial Institutions
and Markets Issues, General Government Division, U.S. General
Accounting Office, Washington, DC.............................. 24
Tuesday, March 23, 1999
Richard H. Walker, Director, Division of Enforcement, U.S.
Securities and Exchange Commission, Washington, DC, accompanied
by John R. Stark Chief, Office of Internet Enforcement,
Division of Enforcement, SEC................................... 45
Peter C. Hildreth, President, North American Securities
Administrators Association, Inc., Washington, DC............... 49
G. Philip Ruthledge, Deputy Chief Counsel, Pennsylvania
Securities Commission, Harrisburg, Pennsylvania................ 51
Alphabetical List of Witnesses
Friedman, Howard M.:
Testimony.................................................... 22
Prepared statement........................................... 92
Gardner, Tom:
Testimony.................................................... 20
Prepared statement........................................... 79
Hildreth, Peter C.:
Testimony.................................................... 49
Prepared statement........................................... 179
Hillman, Richard J.:
Testimony.................................................... 24
Prepared statement........................................... 102
Morris, Kristin:
Testimony.................................................... 8
Prepared statement........................................... 76
O'Kane, Galen:
Testimony.................................................... 6
Prepared statement........................................... 73
Rutledge, G. Philip:
Testimony.................................................... 51
Prepared statement........................................... 219
Walker, Richard H.:
Testimony.................................................... 45
Prepared statement........................................... 139
Exhibits
1. Memoranda prepared by Elliot S. Berke, Counsel, Smokey
Everett and Wesley Phillips, Investigators, Permanent
Subcommittee on Investigations, dated March 16, 1999, to
Permanent Subcommittee on Investigations' Membership Liaisons
regarding ``Securities Fraud On The Internet''................. 265
2. PowerPoint presentation by Richard H. Walker, Director,
Division of Enforcement, U.S. Securities and Exchange
Commission presented March 23, 1999............................ 318
3. PowerPoint presentation by G. Philip Rutledge, Deputy Chief
Counsel, Pennsylvania Securities Commission presented March 23,
1999........................................................... 323
4. ``The Scary Rise of Internet Stock Scans'' by Katrina
Brooker, Fortune, October 26, 1998............................. 331
5. ``Cybercop'' by P.B. Gray, MONEY.COM, Fall 1998............. 336
6. For These Day Traders, Stock Market Is One Big Casino'' by
Ianthe Jeanne Dugan, Washington Post, February 25, 1999........ 339
7. CPA Web Trust Fact Sheet prepared by the American Institute
of Certified Public Accountants................................ 343
8. Cyberspace Fraud And The Small Investor, pamphlet prepared
by the North American Securities Administrators Association,
Inc............................................................ 347
SECURITIES FRAUD ON THE INTERNET
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MONDAY, MARCH 22, 1999
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 1:31 p.m., in
room SD-342, Dirksen Senate Office Building, Hon. Susan
Collins, Chairman of the Subcommittee, presiding.
Present: Senators Collins, Levin, and Edwards.
Staff Present: Timothy J. Shea, Chief Counsel/Staff
Director; Mary D. Robertson, Chief Clerk; Lee Blalack, Deputy
Chief Counsel; Elliot Berke, Counsel; Kirk E. Walder,
Investigator; Smokey Everett, Detailee/Secret Service; Wesley
Phillips, Detailee/GAO; Linda Gustitus, Minority Chief Counsel;
Bob Roach, Counsel to the Minority; Butch Burke (Senator
Stevens); Michael Loesch (Senator Cochran); Felicia Knight
(Senator Collins); Seema Singh (Senator Specter); Judy White
(Senator Cochran); John Elliot (Senator Specter); Julie Vincent
(Senator Voinovich); Nanci Langley (Senator Akaka); Maureen
Mahon (Senator Edwards); and Peter Ludgin (Senator Lieberman).
OPENING STATEMENT OF SENATOR COLLINS
Senator Collins. Good afternoon. The Subcommittee will
please come to order.
Today, the Permanent Subcommittee on Investigations begins
hearings concerning securities fraud on the Internet. The
investigation that led to these hearings is the logical union
of two earlier inquiries conducted by this Subcommittee.
In September 1997, this Subcommittee held hearings on fraud
in the micro-capital markets, which explored market
manipulation, such as ``pump and dump'' schemes, intended to
bilk unwitting investors out of their hard-earned money. Then,
in February of last year, the Subcommittee held hearings which
examined various Internet scams and detailed the numerous ways
in which consumers have been swindled by con artists using
computers.
As more and more investors turn to the Internet as a
resource for obtaining financial information, not to mention
actual on-line trading, it made sense for the Subcommittee to
explore the connection, if any, between securities fraud and
the Internet. What we have found is that swindlers have
embraced the new technologies of the Internet in order to prey
on Web-surfing investors. In fact, securities frauds have moved
from the boiler rooms of yesterday to the Internet chat rooms
of today.
Over the next 2 days, we will hear testimony from victims
of Internet securities fraud, from Federal and State
regulators, the General Accounting Office, the founder of a
popular on-line financial forum, and the author of the book
``Securities Regulation in Cyberspace.'' Their testimony will
examine the types of fraud perpetrated in cyberspace. They will
also discuss what it is about this new medium, the Internet,
that dramatically accelerates the commission of fraud and how
perpetrators of fraudulent schemes infiltrate on-line bulletin
boards, chat rooms, and newsletters, as well as using mass E-
mails to seek out unwary investors.
I want to emphasize that we are not holding these hearings
as a means of killing the messenger, so to speak. The Internet
has proven to be a remarkably beneficial and revolutionary
technology. It offers consumers substantially greater access to
financial information and investment opportunities previously
available only to industry professionals. Moreover, the
securities industry has experienced notable growth due to the
surge in on-line activity.
The Web, the Internet's interactive multi-media side,
provides an inexpensive and convenient method for placing buy
and sell orders, obtaining market information, discovering
investment opportunities, and reviewing personal stock
portfolios. Unlike traditional information providers, the Web
does not close down at the end of the business or trading day.
Recent studies suggest that nearly one-third of the 30 million
American households now on-line use the Web for researching or
investing in securities. In addition, studies report that some
3 million people now have on-line trading accounts, a number
which is anticipated to reach 14 million people by the year
2001. Let me repeat, generally, this is good news. It is good
for investors, it is good for the securities industry, and it
is good for our economy as a whole.
That said, however, I am concerned that the Internet
appears to be providing cybercrooks with equally profound
avenues for committing financial fraud. Indeed, as USA Today
recently reported, ``1998 stood out not so much for the nature
of the investment frauds as for the way that they were
delivered, the Internet.'' The Internet often gives some
consumers a false sense of security, credibility, and control
regarding their investments. Some people, unfortunately, seem
to believe that if they see something on the Internet, it must
be true. Technology, in some cases, is mistaken for truth.
Micro-cap and penny stocks have become attractive vehicles
for Internet-based scams because of their low prices and their
``get rich quick'' appeal. One SEC official has compared
investments in micro-cap stocks to gambling. Yet, while
investors might not be willing to gamble with their life
savings at a Las Vegas casino, too many appear willing to place
their family's nest egg in the hands of an on-line con artist
illegally touting a penny stock that is ``sure to become the
next Microsoft or America on-line.''
It is my hope that these hearings will demonstrate to what
degree the Internet has changed the nature and the extent of
securities fraud. We will also discuss the best way for
consumers to protect themselves against these on-line scams and
determine whether or not adequate consumer education programs
are in place. Finally, we will explore whether Federal and
State law enforcement efforts to combat securities fraud on the
Internet have been effective.
I would note as part of our consumer education effort
today, these hearings are being broadcast live on the Internet
today and tomorrow on the Governmental Affairs Committee's home
page.
It is now my pleasure to recognize my distinguished
colleague and friend, Senator Levin, for any opening remarks
that he might have.
OPENING STATEMENT OF SENATOR LEVIN
Senator Levin. Madam Chairman, thank you and thank you for
calling these very significant hearings.
The growth of the Internet as a medium for communication
and commerce is revolutionizing the way that business is
conducted in this country and the securities industry is no
different. Today, an investor with a computer and an Internet
connection has immediate access to vast amounts of information,
such as company earnings, stock performance, industry trends,
Securities and Exchange Commission filings, and up-to-the-
minute market information. As Madam Chairman said, some
opportunities that were previously reserved for professionals
are now available to the average investor. That is a positive
consequence of the Internet.
But along with its unprecedented volume of information and
access for the average investor come concerns and problems
related to fraud and market stability. The Internet is a
target-rich environment for old-style frauds and for new scams.
As a spokesman for the State securities regulators said, ``If
you are a con artist and you are not on the Internet, you
should be sued for malpractice.''
Using scams that have been committed through the mail and
over the phone have existed for many years, scams such as
``pump and dump'' with con artists using those scams, and they
found in the Internet a cheaper and easier way to access
millions of potential targets in a very short time. It costs
only about $100 to send bulk E-mail, known as spam, to one
million people. Messages can be sent in ways that disguise or
hide the identity of the sender. Unscrupulous individuals can
easily operate across international borders, from places where
it is more difficult for enforcement officials to reach them
and shut them down. Con artists can cheaply design fancy Web
sites and even illegally copy authentic sites to add an air of
legitimacy to their schemes.
Holding the line against fraud in a medium like this is a
difficult job. Programs to combat these frauds are just getting
underway, and as we will hear today from the General Accounting
Office, enforcement agencies face a number of obstacles that
could limit their long-term effectiveness in this area.
Policing a whole new medium will put more demands on agencies
that are already short-staffed. As con artists exploit the
Internet to commit international crimes, apprehension and
prosecution will become even more difficult and time consuming.
We need to learn whether there are additional authorities
or new strategies that might enhance enforcement efforts, such
as increased penalties or criminal prosecutions of
perpetrators, expanded authority to bar chronic offenders from
all sectors of the industry, or improved technology that would
allow more comprehensive monitoring programs.
At the same time we have to address the use of the Internet
for securities fraud, we also have to face the daunting
challenges the Internet is creating with the use of on-line
trading and day trading. With instant access to information
about price fluctuations and instant access to the trading
floor through the Internet for all Americans with a computer
and a phone line, we face the real possibility that our stock
exchanges will become more like Las Vegas and less like Wall
Street. The term ``blue chip stock'' will have an ironic
meaning, as many stocks will become chips in a poker-like
trading world, where long-term investment and company
development will be concepts relegated to history and minute-
by-minute price changes in a virtual stock gambling casino will
move the market.
There is a growing concern about the U.S. stock market as a
whole, where more and more dollars are chasing a limited number
of shares, where the price-to-earning ratios of stocks have
risen dramatically, where the number of shares traded on a
daily basis has grown exponentially over the last few decades,
and where the bulk of the public's retirement accounts reside.
A certain degree of market volatility is expected, of
course, but with the changes that are sweeping over the stock
markets today, a significant part of which is the result of the
Internet, our regulators need to move swiftly to anticipate the
twists and turns that these new elements create, and on-line
trading and day trading are two practices which I believe need
particular attention and where we are just starting to see the
problems on the horizon.
It is estimated that 7.5 million investors have on-line
accounts today, and the number may grow to 18 million by 2002.
The ease and lower price of on-line trading can bring more
people into the market who have little or no experience and a
misunderstanding of the risks involved.
But it is day trading, making dozens, perhaps hundreds of
trades in 1 day, sometimes with the same stock, hoping to make
profits by capturing small increases in stock prices, that
raises even more troublesome issues. There are now about 40 day
trading firms, with a total of 70 offices around the country,
and they now account for 12 to 15 percent of the daily volume
of the NASDAQ market. As this sector has grown, so have
concerns about its impact on market volatility. Day traders do
not buy and sell on the basis of value or growth potential of a
stock. They are betting on momentum, rumor, and anything else
that might enable them to capture a small rise in the price of
a stock. Then they can dump it and start all over again. They
are turning the most trusted market in the world into a virtual
gambling casino.
If anyone thinks that this is an overstatement, I refer
them to a recent article in the Washington Post that profiles a
casino gambler who has opened a chain of day trading firms.\1\
One of the traders at that firm put the practice of day trading
this way: ``Wall Street is not about investments any more, it
is about big numbers. Who cares whether it is a car company or
a chemical company? Who cares what they are going to be doing
in the year 2000?''
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\1\ See Exhibit No. 6 in the Appendix on page 339.
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Well, I do, and investors do. I know our Chairman does,
because she has been taking the lead in a very large number of
areas that involve consumer protection. The people who have
their retirement savings in the stock market of those companies
surely do, and the future health of our economy does. We have
to be paying attention to this new and growing phenomenon so we
do not wake up one morning and sift through the debris of a
broken economy and ask, what happened?
Madam Chairman, again, I thank you for your important work
in this area and so many other areas of consumer protection and
I look forward to today's witnesses.
Senator Collins. Thank you very much, Senator.
I want to welcome the students who have joined us in the
back of the room. I have a feeling that as on-line trading
becomes more and more popular, that your generation will use it
even more often than mine and I hope that you will learn today
from the testimony you hear of some of the pitfalls if you are
investing on-line or if your parents are investing on-line to
help you save for your college education. So I hope today will
be educational for you, as well.
I want to welcome our first panel of witnesses this
afternoon. They are two on-line investors who, unfortunately,
fell victim to sophisticated Internet securities fraud scams. I
would note that both of them are very bright individuals. They
are well educated. Each of them had considerable experience
using the Internet, and I think that their experience
demonstrates that even those with experience, those who are not
first-time investors, for example, can be preyed upon by con
artists using the Internet.
I want to thank them. I thanked them personally, but I want
to thank them publicly for their willingness to come forward
and share their experience. I know it is very difficult when
you have been the victim of a scam to come forward publicly and
share your story, but by doing so today you will help so many
others avoid being ripped off as you were. So I thank you for
your courage in coming forward and sharing your experience.
Our first witness is going to be Galen O'Kane. He is a
constituent of mine from Ellsworth, Maine, where he lives with
his wife and two sons. He is an electrical engineer by
training.
Our second witness will be Mrs. Kristin Morris. She works
for a computer company from her home in Berryville, Virginia,
where she resides with her husband and daughter. I would note
that as part of her work, working at home, she uses the
Internet every day to do her job. So both of our witnesses are
experienced in using the Internet.
Pursuant to the Subcommittee's Rule 6, all witnesses who
testify are required to be sworn in, so I would ask that you
just rise and raise your right hand. 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?
Mrs. Morris. Yes.
Mr. O'Kane. I do.
Senator Collins. Thank you. Again, I very much appreciate
your willingness to be here today. Your written testimony will
be made part of the official hearing record. We are going to
ask that you limit your oral presentation to no more than 10
minutes each. The lights that are in front of you will help
give you guidance as to when your time is expiring. When you
have 2 minutes left, the yellow light will go on and that will
give you some indication that it is time to wrap up your
remarks.
We are going to start with you, Mr. O'Kane.
TESTIMONY OF GALEN O'KANE,\1\ ELLSWORTH, MAINE
Mr. O'Kane. Madam Chairman and Members of the Subcommittee,
thank you for inviting me to testify before you today. My name
is Galen O'Kane and I am pleased to be here to testify about my
recent experiences concerning a shell company portrayed as an
up-and-coming technology of the future.
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\1\ The prepared statement of Mr. O'Kane appears in the Appendix on
page 73.
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I am 38 years old and presently employed by Able Custom
Yacht in Trenton, Maine. I graduated from the University of
Maine with a degree in electrical engineering. My wife is also
a University of Maine graduate, with a degree in mechanical
engineering. We moved to Boston, Massachusetts, after I could
not find an engineering job close to home.
My interest in investing in stocks began while I was
working in Boston. I worked with a lot of older people that
were getting ready for retirement and listened as they talked
about their investments. Taking a commuter rail to work each
day, I developed a habit of being the last one off the train so
that I could gather up discarded newspapers like the Wall
Street Journal, Investors Daily, and occasionally, a Barrons.
Sometime in 1989, I tied into Prodigy, which is an on-line
service for E-mail access and news updates. I soon discovered
that I could track a list of stocks. Once I became comfortable
with my knowledge of the market and after obtaining my wife's
approval, I began to invest approximately ten percent of my
income in stocks. I did most of my investing through the local
Quick and Reilly office and was doing OK. Most of the stocks
that I invested in were blue chip or well-known companies.
With the addition of our two sons, my wife and I decided
that the country would be a far better place to raise a family.
We knew what living in a small Maine community was like, the
``Mayberry of Andy Griffith'' life, and missed it dearly. So we
moved to Maine, because that is the way life should be. In
1993, my son was diagnosed with dermatomyositis, a rare form of
muscular dystrophy. I began to focus all my energy and
resources into fighting and managing this terrible disease. By
1995, I could not keep a job because of all the medical
attention my son required.
In 1997, we got on the Web to gain medical information
about my son's illness and this got me more involved with
stocks again on a day-to-day basis. I was buying and selling
stocks more and sometimes on-line. I did this in an attempt to
offset my son's medical expenses. I continued to use my
discount broker, Quick and Reilly, which had been my broker
from the beginning.
One day, while using Yahoo! Finance, I saw an advertisement
for an Internet newsletter, ``The Future Superstock,'' which
was operated by an individual named Jeffrey Bruss. The site
promoted a company called Electro-Optical, which developed and
produced low-cost, high-quality fingerprint identification
devices small enough to be placed on a computer mouse. ``The
Future Superstock'' promoted Electro-Optical as its stock pick
of the month, and a few weeks later as its stock pick of the
year.
I was impressed with the engineering and low unit cost of
Electro-Optical's technology and envisioned the product being
used as a security device on everything from ATMs to door locks
to computer mouses. I invested approximately $5,400 in Electro-
Optical, purchasing 900 shares through my Quick and Reilly on-
line account at slightly less than $6 a share.
Based on the stock's performance, I felt it was behaving
normally for market conditions. In January 1998, I spotted a
press release about Electro-Optical on Yahoo! announcing a huge
purchase order. After reading the press release, I became
convinced that Electro-Optical and its product had tremendous
growth potential. I immediately purchased 3,000 more shares at
approximately $6 per share. By this time, I had put in over
$23,000 in the company.
An article which ran in the Bangor Daily News in January
1998 entitled, ``Computers to Send Fingerprints: New Technology
Will Cut Identification Time for Maine Police,'' further
validated my belief in Electro-Optical's product and the
incredible possibilities it offered.
In February 1998, while surfing the Internet, I came across
a Barrow Street Research press release that discussed Electro-
Optical. In the fine print, Barrow Street disclosed that it had
been paid to promote the Electro-Optical stock. I had never
noticed such a disclaimer on any of the prior press releases or
Web sites that I had used to make my investment decisions.
In March 1998, I had to take my son, James, to the New
England Medical Center in Boston for treatment. Before
returning to Maine, I decided that I should stop by Electro-
Optical's office, which was located just outside of Boston. I
was surprised when I was blocked from entering the building by
the one employee that I saw. I looked into the building and was
shocked to find that the building was completely empty. I
expected to see an assembly line, equipment, employees, but
there was nothing. I felt that Electro-Optical had completely
misrepresented the nature of its apparently nonexistent
operation. I immediately sold 1,900 of my shares for $1.10 per
share. Presently, my total loss is over $20,000.
This experience reminds me of the old saying, if it is too
good to be true, then it probably is. If one is looking to
invest in a risky start-up stock, then he or she should go
visit the company first. The other advice that I would offer is
to acquire advice from a reputable stock advisor. Many bulletin
boards on the Web are full of information from sources that are
not looking out for your best interests. I listened to a
newsletter that appeared to be professional to me because they
had a Web site, published a letter on a regular basis, had Web
links to the stocks that they recommended, had other firms'
recommendations, which I never heard of, like Barrow Street
Research, and appeared to know what they were talking about.
Being an engineer, knowing a little bit about the technology,
and feeling that Electro-Optical had a viable product with
countless uses intrigued me.
This was my first attempt at investing in a stock promoted
on the Internet and it will be my last. I have continued to
invest on-line, but I now turn to an investment advisor for
advice on all of my investments. The Internet provided my
family with invaluable information regarding my son's
condition, and today he is much better because of it. However,
I also discovered the darker side of the Internet. Even after
this experience, I still believe that the Internet does far
more good than bad.
That concludes my oral testimony. Thank you again for
allowing me to come here today to tell my story. Hopefully, it
will help prevent others from falling into the same situation.
Senator Collins. Thank you very much, Mr. O'Kane.
Mrs. Morris.
TESTIMONY OF KRISTIN MORRIS,\1\ BERRYVILLE, VIRGINIA
Mrs. Morris. Madam Chairman, Members of the Subcommittee,
good afternoon to you all. I would like to thank you for
allowing me the opportunity to share my experience with you
this afternoon.
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\1\ The prepared statement of Mrs. Morris appears in the Appendix
on page 76.
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My name is Kristin Morris. I am a 34-year-old Washington,
DC native. I have been married for almost 4 years and had my
first child in October 1998. I am and have been an employee for
7 years with a small business, Advanced Computing Solutions,
and we are resellers to the Federal Government, selling
computer parts, components, and systems.
I have always felt that I am very knowledgeable about
computers and the Internet. At the time of my original purchase
of stock on the Internet, I felt very comfortable with the
process. I first came upon Interactive Products and Services
sometime in April 1997. At the time, I was losing money in the
utility stock which I had owned for several years prior and
thought I needed to get out of that investment and try to be a
little bit less conservative with my money.
While surfing the Internet, I located a Web page through
the ``Webcrawler'' search engine that maintained a list of
different initial public offerings being offered over the
Internet. I was attracted to IPS because of its products and
its claims.
What enticed me were several main items. One, the products
being offered by IPS made sense to me. These products were an
Internet telephone and a hand-held keyboard/mouse that would
work with Web TV and other like products.
I agreed with the owner of IPS, Mr. Bowin, and his
suggestion that many people will purchase products like Web TV
because of its cost. Computers are extremely expensive and are
often more than the average person needs. Mr. Bowin went into
this subject in detail. He discussed within the prospectus that
many service-oriented and blue-collar workers would be more
likely to purchase Internet television products before
investing in costly computers because of the cost savings to
them.
Third, Mr. Bowin included a link within his Web site
containing an IPS press release announcing that they were in
the process of working directly with companies such as
Microsoft, Sun, Apple, and to integrate his IPS products to
work with their software and their Internet TV hardware. These
press releases stated that a deal was imminent and that he
expected the stock to be worth somewhere around $500 per share
within the next 5 years. Of course, I saw this and I figured I
could not go wrong. I thought I was getting in on the ground
floor of something big.
Last, Mr. Bowin also included links within his Web site
prospectus of camera-ready color photographs of the actual
products themselves. These pictures were very impressive in
their design. The prospectus gave detailed instructions on the
products and how to use them. He even went on to claim in his
description of the keyboard that the design was so innovative
and so easy to use that it would change the way we type in the
future.
Though the Web site looked very impressive, I did not rush
immediately to buy the stock. Instead, I printed out the
prospectus and had my husband read it over. We later agreed to
sell my utility stock and invest $1,000 in IPS. The minimum
purchase of the stock was $250. We knew, of course, we could
lose this money if IPS did not succeed, but I never dreamed it
was an elaborate scam and my money would be stolen.
Because the initial offering deadline was 2 weeks away when
I first came across it, I only took two steps to verify the
company. I called the long distance operator and asked for the
telephone number of the address listed on the prospectus. I
wanted to see if the number given to me by the operator matched
the number in the IPS prospectus. This telephone number did
match, so I then called the number and Mr. Bowin answered the
call.
I asked several direct questions about IPS and its stock
offerings. I asked Mr. Bowin how close he was to meeting his
financial goals. He said he was close but he might need to file
for an extension and told me this information was in the
prospectus. I asked how the talks were going with Microsoft,
Sun, AND Apple. He informed me things looked very good, but, of
course, nothing was signed as of yet and anything could happen.
Last, he said he had filed for a U.S. patent on the keyboard
and the telephone product and this patent would be secured
shortly. This information was also within the prospectus.
Satisfied with these answers, I proceeded to fill out the
application form and wrote my check for $1,000 payable to
Interactive Products and Services. I sent the form and my check
by certified mail. In a little over a week, I received my
certified mail receipt with Mr. Bowin's signature. Actually, I
remember feeling a little bit odd about that. Since my past
experience working in the corporate world, I found it strange
that someone so high up like a president or a CEO would
personally sign for mail. But after my initial suspicion had
passed, I decided it was no big deal.
A couple of months passed and the initial offering was
over, but I still had not heard from IPS or received my stock
certificates. I called the IPS offices and once again reached
Mr. Bowin personally. I inquired as to when these certificates
would be mailed. He informed me that the offering had been
extended through July 1997. He told me to make a duplicate copy
of my application and resend it. My stock purchase would be
verified. I did as he requested.
After this last telephone conversation with Mr. Bowin, I
would never again be able to reach him and no one from his
office would return my messages. After several months, I gave
up. I knew I had been scammed. Out of sheer embarrassment, I
never spoke of my experience to anyone. I wrote the money and
experience off as a lesson learned the hard way.
Then, after many months had passed, I received a letter
from the California State District Attorney informing me that
Mr. Bowin had been arrested for fraud and I had been identified
as one of his victims. I received another letter in December
1998 from the District Attorney stating that Mr. Bowin had been
sentenced to 10 years in a California State prison and the case
was concluded.
My advice to anyone looking to purchase the stock over the
Internet is just do not. It is not worth the risk. An average
investor like myself has no way to verify whether the stocks
they are interested in are fraudulent or not. Until there is a
solid, verifiable way to confirm the legitimacy of a stock, I
just say, do not do it.
Today, I get an average of two E-mails a week offering
stocks and ``get rich quick'' schemes. Many of these E-mails
arrive without a return E-mail address, so even if I wanted to,
I could not report them. These E-mails usually direct the
recipient to a Web site announcing a stock purchase plan, and
like the IPS Web site, many are extremely sophisticated and
professional. I believe most of these stocks appeal to the
small investor because they stress knocking out the stockbroker
commissions and they play on past successes of Internet stocks.
Anyone who even remotely follows the stock market knows the
incredible gains these types of stocks have made in the recent
past.
I consider Internet Web pages to be a much more
sophisticated approach to fraud than the overzealous
stockbroker who calls you at your home or your office. Whereas
you can always hang up on the stockbroker, a Web page can be as
professional and legitimate as any legitimate prospectus out
there. These Web sites can even fool the most experienced of
consumers.
I have no way to recover my money in which Mr. Bowin stole
from me, but I would like to close by offering my opinion,
better yet, my advice, which might help the average small
investor like myself. I suggest that the SEC provide an
authorized banner to any legitimate stock offering to post on
their Web page. This banner could provide a central telephone
number the consumer can call to verify an offering by either
the stock name or by its registration number. One quick phone
call to an SEC operator to check the name or the registration
number and the consumer would immediately know if this was a
legitimate security. I also believe this would inhibit any
potential criminal activity, due to the fact that their stock
would, of course, not be registered within the SEC. If I had
been given this option, I know I would not be sitting in front
of you today.
Again, thank you very much for allowing me to tell my
story. I hope in some way your Subcommittee will find it
useful. I appreciate what you are trying to do and I know it is
a very difficult job you have ahead of you. Thank you.
Senator Collins. Thank you very much, Mrs. Morris.
I just want to get a few more of the facts of your two
experiences before the Subcommittee.
Mr. O'Kane, how long had you been investing prior to
stumbling upon the scam in which you lost your money?
Mr. O'Kane. I had been investing for about 10 years. I
would consider myself a seasoned investor and I felt I
understood the market at the time that I bought it.
Senator Collins. Mrs. Morris, how about you? How long had
you been investing?
Mrs. Morris. About 5 years, mutual funds, IRAs, things like
that.
Senator Collins. So neither of you were first-time, brand
new at this. Each of you had considerable investment
experience, which I think is an important point.
The other common thread that I noticed in listening to both
of you tell your stories is that each of you were attracted to
products that you thought you knew something about, and that
is, of course, common investment advice that we are all given
by the professional, is to invest in something that you
understand.
Mr. O'Kane, how important was it to you that the
engineering of the product that this company supposedly was
producing made sense to you? Did that influence your decision,
that being an engineer, you were able to bring your own
expertise and it made sense to you?
Mr. O'Kane. It did affect the decision quite a bit. The
write-up that they gave was, as far as the technology goes,
realistic to me. I felt that they had a viable product because
of my background, and yes, I think it did make a--carry a heavy
part.
Senator Collins. And Mrs. Morris, I noticed in your case it
was something related to computer products, and again, that is
the industry that you are in.
Mrs. Morris. Right.
Senator Collins. Was that part of your comfort level, that
it made sense to you?
Mrs. Morris. Yes, because when people come in--I sell to
the Federal Government, but when Joe Public comes into our
offices and wants to buy a computer, they nickel and dime you,
and I knew that computers are very expensive and my first
question to someone who walks in the door is, what do you want
to do with it, and most of the time, they want to surf the
Internet or they want to do E-mail, or they want to play games.
This is why I thought the idea of having an Internet television
product would suit the general public much more than a computer
would and it is less expensive.
Senator Collins. And again, these appeared to be legitimate
products based on your own personal expertise, and you each
have a lot of expertise in this area.
Mrs. Morris. Yes.
Senator Collins. Mr. O'Kane, Mrs. Morris mentioned that she
lost $1,000. I understand that your loss was considerably
greater. Can you tell us how much money you lost and give us
some idea of was this a great deal of money to you, or put it
in context for us.
Mr. O'Kane. It really was a great deal of money for me
because it was part of my retirement and investment account I
was using to generate income to live on. It was a considerable
amount of my savings.
Senator Collins. How much did you lose?
Mr. O'Kane. It was--I try to forget--it was over $20,000.
Senator Collins. So it was more than $20,000. Have either
of you received any restitution? I know in Mrs. Morris's case,
at least you have the comfort of knowing that the person went
to jail, and I believe, Mr. O'Kane, in your case, the SEC has
some pending action. But to date, have either of you received
any restitution? Mr. O'Kane, we will start with you.
Mr. O'Kane. No, I have not, not yet, but I have hope.
Senator Collins. Mrs. Morris.
Mrs. Morris. No. I will not receive--I received a letter
from the District Attorney in the State of California stating
that chances were very slim to none. But I do have the
satisfaction that he is in jail, which most of the time is not
the case.
Senator Collins. That is exactly right. One of the lessons
that I took from your testimony is it appears that you put more
trust in this scam in each of your cases because it came to you
over the Internet. Mrs. Morris, could you expand on what it was
about the professionalism of the scam that you uncovered, or
the fact that you uncovered it yourself, this investment
opportunity, that made it seem more credible to you?
Mrs. Morris. Well, I found it listed among many different
IPOs that were being offered over the Internet. I chose that
one because, like you said, it was in my field. I could
understand it. It made sense to me. The prospectus itself was
extremely sophisticated, down to the links and attaching itself
to different Web sites, its own links with its own press
releases. To me, it was not somebody calling me on the phone--
buy this stock, buy now, buy now, buy now, where you do not
believe a word they say. This was a very passive, where I took
control, and I printed it out. I took my time. I made the phone
calls and nobody was telling me what to do. So I had much
higher hopes for it.
Senator Collins. So the fact that the Web page for the
stock offering was a passive solicitation made it more credible
to you?
Mrs. Morris. Yes.
Senator Collins. Because you found it as opposed to someone
calling you at dinnertime?
Mrs. Morris. Exactly.
Senator Collins. What about you, Mr. O'Kane? Do you think
if you had gotten a cold call at dinnertime with exactly the
same information presented over the telephone that you would
have invested?
Mr. O'Kane. I think I would hang up and finish my lunch.
Senator Collins. So the fact that these offerings were on
the Internet gave them a credibility that they would not have
had if you had received a call from an aggressive salesman at
dinnertime, is that correct in both your cases?
Mr. O'Kane. That is correct.
Mrs. Morris. Correct.
Senator Collins. Mr. O'Kane, you said in your opening
statement that when you first came across the information about
Electro-Optical, that it was through an on-line newsletter
called ``The Future Superstock'' and that you found this on
Yahoo! and that the Yahoo! site then linked you to ``The Future
Superstock'' Web site, which touted the fortunes of the company
that you invested in. Had you ever heard of this newsletter
before or used it before?
Mr. O'Kane. Never
Senator Collins. And did you rely on this on-line
newsletter which promoted this stock to make your decision to
invest? Was it influential to you?
Mr. O'Kane. It was very influential. It appeared to be
professional. It had all the appropriate links and it looked
just like a blue chip-style company format.
Senator Collins. And at that time, were you aware that
there is a problem with some of these on-line newsletters
touting stocks that they are being paid to promote, or were you
under the impression this was some sort of objective source of
information?
Mr. O'Kane. No. I was not aware that they were paid for
that.
Senator Collins. You subsequently learned that both ``The
Future Superstock'' newsletter and the Barrow Street press
release were, in fact, paid to promote this stock, is that
correct?
Mr. O'Kane. Yes, it is.
Senator Collins. When did you first become suspicious?
Mr. O'Kane. It was after I already had my shares and I was
looking at a press release from Barrow Street and the fine
print on the very bottom said something to the effect that it
was paid for by EOSC, and that is when I smelled a rat.
Senator Collins. So you saw the disclosure in this
particular case. Would your decision to invest in Electro-
Optical have been affected if you had known that the company
paid this newsletter to promote its stock? Would you have still
gone ahead?
Mr. O'Kane. It would most definitely make a difference, and
whether I went ahead, I am not sure. I do not think so. I would
have to seek the advice of somebody else. Someone is paying for
that. No. I would not do it.
Senator Collins. Mrs. Morris, I was struck in your
testimony that you did take some steps to try to verify the
company rather than just immediately writing off your check for
$1,000. Now, as I understand it, for example, you knew to look
through a prospectus and to request a prospectus, is that
correct?
Mrs. Morris. Yes.
Senator Collins. And you also matched up the telephone
numbers. Were there any other steps that you took?
Mrs. Morris. Well, I did call and I did speak with Mr.
Bowin, who was the person who was president, CEO, the person
offering the stock.
Senator Collins. And again, were you influenced by the
press release you found on-line touting the stock?
Mrs. Morris. Yes, definitely. When I saw the names
Microsoft, Sun, Oracle, or Apple, working closely, deals are
imminent type of thing, and then him actually verbally saying
these things to me also, yes, I was very satisfied.
Senator Collins. So in both cases, your decision to
purchase the stock was greatly influenced by information in on-
line newsletters, by press accounts that appeared to you to be
legitimate, is that correct, Mr. O'Kane?
Mr. O'Kane. Yes.
Senator Collins. Mrs. Morris.
Mrs. Morris. That is correct, yes.
Senator Collins. And in both cases, it was the
professionalism of the Web site, the links, the graphics, that
it made it seem much more credible than if you had received
just a solicitation by mail or the usual aggressive cold call
at dinnertime, is that correct?
Mrs. Morris. That is correct.
Mr. O'Kane. That is right.
Senator Collins. Mrs. Morris, you said that your final
advice, and I can certainly understand it, based on your
experience, would be simply to not invest over the Internet.
If, in fact, we were able to do the kinds of disclosures you
talked about, having perhaps a third party verification of the
Web site or other disclaimers put up front, would you feel more
comfortable in making investments over the Internet?
Mrs. Morris. Yes.
Senator Collins. Is it really the lack of a way that you
found to verify the information as opposed to the Internet
itself?
Mrs. Morris. Yes. Right now, since there is no way to
verify, they are not regulated. They can say whatever they want
and there is nobody to tell the consumer, like myself, who
comes upon their page, that it is not. Yes. The Internet is not
a bad--it is a great place to find information about stocks. I
can go out and I can research it, but I would not purchase it
over the Internet right away. I would definitely take it to a
reputable broker, someone who I would pay some money to direct
me in the right direction. But no, I would not buy it over the
Internet right now until there is a definite verifiable way.
Senator Collins. Mr. O'Kane, do you still invest on-line?
Mr. O'Kane. Oh, yes, I do.
Senator Collins. And you have had better experiences than
the one before, I trust?
Mr. O'Kane. That is correct. I am using the widely-known
stocks at this point.
Senator Collins. One of the purposes of these hearings are
to educate consumers about what the resources are out there,
and tomorrow, we are going to hear from both Federal and State
regulators who have very good on-line tips for investing on-
line that would be helpful to investors such as yourselves.
Senator Levin.
Senator Levin. Thank you, Madam Chairman.
When you say that you continue to buy stocks on-line, Mr.
O'Kane, you do that, I take it, following your own advice that
you now check out the stocks as reputable brokers or
investing----
Mr. O'Kane. Yes, I do. I have an investment advisor that I
check with.
Senator Levin. There was an article in the Fortune magazine
that went into some of these stock scams and your experience
was covered there and I am just wondering whether or not it was
accurate when it said, for instance, that even after your
experience and the visit to the company, you still felt there
could be some value left in that stock. Is that accurate?
Mr. O'Kane. That is correct. I still have a few shares in
the company.
Senator Levin. If you say that you should visit a company
before you invest, you visited the company, but you still felt
even after the visit that the stock might really be----
Mr. O'Kane. My stock is worth so little that it is like
peanuts at this point and it made no sense to sell the whole
thing.
Senator Levin. Was it immediately after your visit to the
company that you decided to sell the stock?
Mr. O'Kane. Yes. I tried to get rid of it and I realized
that my value was down to almost nothing at that point. I
wanted to leave a little in so that I would still hear what the
company is doing. It was a total loss, but we have some in
there, so at least I get on the mailings.
Senator Levin. That article still says that you still surf
the Web every day looking for hot stock tips, is that correct?
Mr. O'Kane. Oh, yes, I do that. I do, indeed.
Senator Levin. When you think you have got something that
might be real, you then check that with your advisor, is that
correct?
Mr. O'Kane. Right, and they usually tell me no. [Laughter.]
Senator Levin. I wish everybody who surfs the Internet for
hot stock tips would check with an advisor and follow the
``no'' advice.
Mr. O'Kane. They should.
Senator Levin. It is not no advice, it is advice to not
buy.
Mr. O'Kane. Right.
Senator Levin. I wish people would do that based on your
experience, because I do not know how many people get burned
every day by these kinds of hot stock tips. We checked one of
these today, one of these hot stock tips, and I almost cannot
believe that people can buy this stuff.
Here is one that came out Friday in one of these stock tip
forms and it said, if you ever want a sure thing, and you push
that one, and here it is. If you ever want a sure thing, it
says here, buy GARM. The company was acquired by the largest
recycling company in the world. This is a sure thing, by the
way. The only thing is, nobody from that big company that
bought it was allowed to buy so much as one share until after
the shareholders meeting. In other words, this is inside
information and no one else can buy that except you millions of
folks reading this out there. It says here, the shareholders
meeting is later on today. In other words, buy it quick, while
you can, before this information becomes public.
When you take a look at what happened to that stock from
Friday, when that tip was on the Web at 12:17, if you ever
wanted a sure thing last Friday at 12:17--Bob is holding that
up--do you see where that spike goes up in that second-to-last
column there? That spike jumped up on Friday right after this
hot stock tip. Well, someone got suckered into that. That last
column is this morning, right back where it was. That spike
represents a victim.
Mr. O'Kane. I defer that back to, if it is too good to be
true, then do not do it.
Senator Levin. Yes. I was just learning how these kinds of
scams were perpetrated today, and I was going through it and
just picked one by random and that is one we picked. But
somebody believed this tout, if you ever wanted a sure thing,
you million people out there, a sure thing. A few folks, at
least, thought that, somehow or other, there was something for
nothing, and bought it. Then this morning, that sure thing
looked like it was dust and someone lost a lot of money between
last Friday and this morning because they believed this kind of
a come-on.
Hopefully, your testimony this morning and this afternoon
and tomorrow's testimony will help other people resist these
kind of temptations, because it is nothing more than just
throwing dice on a table, and usually the dice are loaded
against you.
Let me just ask Mrs. Morris a question, as well. You did
get a telephone call?
Mrs. Morris. Yes, I did.
Senator Levin. So you were not just conned by the Web site
being attractive and the information being put together
professionally. You were skeptical and actually called the guy.
Mrs. Morris. Yes. I was conned by him personally.
Senator Levin. You were called by him?
Mrs. Morris. Conned by him personally.
Senator Levin. Oh, conned by him personally. So you were
told that this stock was going to be going up, what, 500
percent in 5 years?
Mrs. Morris. Within the next 5 years after the initial
product offering.
Senator Levin. Five hundred percent?
Mrs. Morris. Yes.
Senator Levin. Did that make you suspicious?
Mrs. Morris. Yes, because--I mean, I never expected it to
jump. I knew, of course, that they over-hype it, but I did see
that there could be some serious initial gains due to the
product that they were offering, which I believed to be very
viable. And the fact that they were dealing with Microsoft was
a whole another issue. I just thought that alone, Microsoft--he
touted the whole product as working with their software,
Microsoft Home. Soon, his product will integrate with his
software, Microsoft's software, be able to open your garage,
turn off the lights, remote your TV, everything from that.
Senator Levin. I think both of your testimonies are
important in terms of the credibility which some people
apparently attribute to these stock touts on the Internet. They
obviously do have credibility in the eyes of some people, and
hopefully, people will be an awful lot more skeptical of these
touts and these come-ons after your testimony than before.
There is only so much regulation we can do. We have talked
to some of the regulators who say they get so many thousands of
complaints of this, they cannot possibly catch up to them. For
instance, in your testimony, Mrs. Morris, you indicated that we
ought to have a quick phone call to an SEC operator to check
the name or registration number and the consumer would
immediately know. That is one way of doing it, but there is
apparently a Web site that the SEC does have where you can
check a stock registration number already.
Mrs. Morris. I did not know that.
Senator Levin. I think, and we are going to double check
that to make sure I am not giving out bum information here. But
I believe that that is accurate. If so, it would be useful
along the lines----
Mrs. Morris. That would be very useful, but it would only
be useful if someone knows to look for it.
Senator Levin. But somebody would have to know to call an
SEC operator, as well.
Mrs. Morris. That is what I was saying. You should put it
at--like IPS should have had that banner on their Web site,
along with their offering.
Senator Levin. We could, for instance, perhaps figure out a
way to require people to put down the Web site of the SEC----
Mrs. Morris. True.
Senator Levin [continuing]. On any stock tip.
Mrs. Morris. Sort of like a warning label on a pack of
cigarettes. You have to have it there.
Senator Levin. Right. This stock is dangerous to your
health.
Mrs. Morris. Exactly.
Senator Levin. Yes. Too many of them are.
In addition to the SEC, whether through a Web site or an
800 number or both, there is also this reputable stock broker
or this financial advisor that people really should rely on
more, and that is what your experience has taught you both, and
again, thank you for coming forward. It will be, hopefully,
helpful in having other people avoid your kind of losses and
your kind of suffering, in the case of some of you. Thank you.
Senator Collins. Mrs. Morris, before I yield to Senator
Edwards, I just want to ask you one final question, and that
is, do you know how many other investors sent money to IPS?
Mrs. Morris. I believe 160 lost about $190,000 all
together.
Senator Collins. There was a substantial amount of money in
the aggregate that was lost?
Mrs. Morris. Correct.
Senator Collins. Thank you. Senator Edwards.
OPENING STATEMENT OF SENATOR EDWARDS
Senator Edwards. Thank you, Madam Chairman. Good morning.
Mrs. Morris. Good morning.
Mr. O'Kane. Good morning.
Senator Edwards. Mrs. Morris, let me ask you this question.
Did you, prior to your purchase, did you know what a direct
public offering was?
Mrs. Morris. Yes, I did.
Senator Edwards. Maybe you mentioned this earlier, and I
apologize I was not here----
Mrs. Morris. That is OK.
Senator Edwards. What kind of research did you do on
Interactive Products and Services?
Mrs. Morris. When I first ran across the Internet site, I
just basically read the prospectus. I called the long distance
operator. The company was located in California. I called the
long distance operator and used their address given on their
prospectus as their corporate headquarters and verified that
the number they gave me for them matched the number given on
the prospectus. I then called the number and I reached Mr.
Bowin, who was the president, I guess, directly and spoke with
him and asked him several questions about the offering, its
products, and made my decision from that.
Senator Edwards. What kind of information would have been
helpful to you in making a thoughtful decision about this
investment?
Mrs. Morris. What I asked him, I thought was pretty
thoughtful. I asked him, one, where he was in reaching his goal
financially. I asked him about the products and his dealings
with the other companies where his hardware would work with
their software, the Microsoft, the Apple, the Sun, the Oracle,
which he had stated. He also--we discussed a U.S. patent
pending on his products, he said was basically coming down the
line. It was imminent. Just several items like that.
Senator Edwards. Mr. O'Kane, let me ask you a couple of
questions, if I can. Can you give me some idea of, from your
perspective as an investor or potential investor, I gather that
you had felt some comfort with using the Internet prior to
making your investment, is that right?
Mr. O'Kane. Yes, I did.
Senator Edwards. Did you feel comfort in buying other kinds
of goods over the Internet?
Mr. O'Kane. Yes, I did.
Senator Edwards. Tell me, knowing what you know now about
the company that you invested in, or the lack thereof, can you
tell me what kinds of disclaimers, information, would have been
useful for you that would have alerted you to the potential
problems you were confronted with?
Mr. O'Kane. Well, the number one thing I look for now is I
scan down to the bottom of the newsletter or the press release
or whatever and see if it is paid for by the stock that they
are talking about. I check that first, look at the fine print.
Senator Edwards. What else? Is there anything else that you
need to know?
Mr. O'Kane. Beyond that, I do not think there is anything
they can offer me other than the SEC connections that I would
go to now that I did not know about.
Senator Edwards. Thank you, Madam Chairman. Thank you both
for being here.
Mrs. Morris. Thank you.
Senator Edwards. Your testimony is very important for what
we are doing here today.
Mr. O'Kane. Good.
Senator Collins. I just have one final question for each of
you. Were either of you aware that you could have called your
State Division of Securities or Bureau of Securities for
advice, to run this investment by them to see whether they had
had any previous complaints, to see whether the investment
opportunity was registered with the State? Were either of you
aware of the State role in regulating securities? Mr. O'Kane.
Mr. O'Kane. No, I really was not.
Senator Collins. Mrs. Morris.
Mrs. Morris. No, not at all.
Senator Collins. Thank you. The States do do a good job----
Mrs. Morris. I know that now.
Mr. O'Kane. We know that now, yes.
Senator Collins [continuing]. In this area, but obviously,
if investors who have been in the market as long as each of you
have been, in one case 10 years and in one case 5 years, were
unaware of the State role, that suggests we need to do a lot
more to make people aware that help is out there. Thank you.
Mr. O'Kane. You need to have some of those banners posted
on the sites.
Senator Collins. I think you are right. Thank you very much
for sharing your experience and being here today. We have
learned a lot from your experience. Thank you.
Mrs. Morris. Thank you.
Mr. O'Kane. Thank you.
Senator Collins. Our second panel will provide the
Subcommittee with a broad overview of Internet securities fraud
and describe Federal, State, and private sector efforts to
combat this growing problem.
Our first witness is going to be Tom Gardner of The Motley
Fool, which is a free on-line financial forum that is available
over the Internet. The Motley Fool reaches millions of
investors each month and provides financial information and
investment strategies in several different mediums, including
its Web site, books, radio programs, and newspaper columns.
Our second witness will be Howard Friedman, a professor of
law at the University of Toledo. Professor Friedman has taught
securities law for more than 30 years with a special focus on
securities regulation and the Internet over the past several
years. Last year, he published a book entitled Securities
Regulation in Cyberspace.
Our final witness this afternoon will be Richard Hillman.
He is the Associate Director with the Financial Institutions
and Markets Issues Group of the U.S. General Accounting Office.
He will summarize the findings of a GAO study that I initiated
to determine the extent of Internet securities fraud and to
discuss the efforts to detect these frauds by the Securities
and Exchange Commission and State regulatory agencies.
Again, I welcome all of you and I would ask, pursuant to
Rule 6, that you stand and raise your right hand so I can swear
you in. 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. Gardner. I do.
Mr. Friedman. I do.
Mr. Hillman. I do.
Senator Collins. Thank you. We very much appreciate your
willingness to join us today. I would ask that you each limit
your oral presentation to about 10 minutes and we will put your
prepared testimony into the record.
Mr. Gardner, you may proceed. I want to tell you that I did
go on site today on The Motley Fool Web site and had a great
time. It was really very interesting.
Mr. Gardner. Thank you.
Senator Collins. So please proceed.
TESTIMONY OF TOM GARDNER,\1\ HEAD FOOL, THE MOTLEY FOOL,
ALEXANDRIA, VIRGINIA
Mr. Gardner. Thank you, Senator Collins. I would like to
thank you, Senator Levin, Senator Edwards, and the other
Members of the Subcommittee for holding these important
hearings today and tomorrow.
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\1\ The prepared statement of Mr. Gardner appears in the Appendix
on page 79.
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My name is Tom Gardner and I am a co-founder of The Motley
Fool, Incorporated, based in Alexandria, Virginia. It is a
great honor for me to address the Senate Permanent Subcommittee
on Investigations. After all, fools do not often get a chance
to speak in the U.S. Senate.
Senator Collins. Some would disagree with you on that.
[Laughter.]
Mr. Gardner. I am pleased to have the opportunity to
address the problem of securities fraud on the Internet today.
I believe that the main factor that permits Internet securities
fraud, indeed, all consumer fraud, is financial ignorance, and
this sort of ignorance is exactly what we founded The Motley
Fool to combat.
We founded The Motley Fool in 1994 to educate, amuse, and
inform the individual investor. Starting with a little
newsletter, we now have internationally syndicated newspaper
columns, books, a syndicated radio program, and on-line areas,
all meeting with popular demand because we believe, and many
do, that individuals should take as much charge of their
financial lives as they can.
The Motley Fool today recognizes that technology,
especially the Internet, allows people across the world to do
just that, by obtaining information that once was the exclusive
property of the financial services industry. The general
inaccessibility of critical information, coupled with the lack
of financial education in America's schools, has delivered an
ignorance that is the very reason we are meeting here today.
As this Subcommittee has previously learned, one of the
worst examples of fraud that takes place on the Internet
apparently involves micro-cap or penny stocks. Penny stocks are
the shares of small companies that do not qualify for listing
on any of our major exchanges but trade over the counter. These
stocks generally trade at less than $5 per share. Statisticians
have noted that 75 percent of all the companies whose stocks
trade for less than $5 per share go bankrupt over any 10-year
period.
These are the obscure diamond miners in Zaire. I have seen
all of these come by, by the way. These are the obscure diamond
miners in Zaire, the meat packing business that just launched
an Internet service, the fingerprint technology company at 10
cents per share that claims it will provide the foundation for
all transactions in the century ahead, all ludicrous, but many
of them gathered a following.
Now, because these companies do not trade on the major
exchanges, they often do not need to make comprehensive
electronic or hard copy filings with the SEC. Further, because
of their relative obscurity, many of these public corporations
lack liquidity. In many instances, the majority of the shares
in a penny stock company are held by company insiders and/or
promoters.
But why, when they present such little opportunity to long-
term investors, do penny stocks still attract attention?
Inexperienced investors are certainly attracted by the fact
that they can buy a ton of shares with very little money. To
take an extreme example, $3,000 could buy you only one share of
Warren Buffett's Berkshire Hathaway Class B stock today, but it
could buy you 6,000 exciting shares of, say, Marginal
Technology Systems, Incorporated, at $.50 per share.
The combination of the opportunity to hold large share
positions and that appearance of unlimited upside draws scads
of new investors into this most highly speculative form of
equities ownership. After all, if the micro-cap stock goes up
just $.50, the stockholder would double his or her money. on-
line con artists take advantage of this gambling mentality of
untrained investors today. Indeed, penny stocks are the public
market's own brand of lottery ticket, the engine of financial
dissolution among those who have not been educated about their
money.
For this and numerous other reasons, The Motley Fool abhors
the dreaded penny stock. Penny stock ownership is not
beneficial for newcomers to our public markets. It is generally
absurdly comic to experienced investors and, thus, is not
reported on or covered at The Motley Fool on-line.
The question remains, though, what can we do about this?
Our company's answer is education. If people knew enough not to
make investment decisions based upon tips, rumors, and touts
but to do their own homework, they would not fall for most
stock frauds. The SEC has played an active role in trying to
educate investors. In truth, though, they have a gigantic task
ahead of them. They face massive financial illiteracy in this
country, though not nearly so substantial as that across the
world, because a great number of Americans are never taught the
basic principles of personal finance and investing in school or
at home. If we as a country are concerned about citizens'
ability to control their own financial futures, to avoid
fraudulent offerings, to sidestep poor investment vehicles, and
to rely less on Government in the decades to come, then this
ignorance is collectively our greatest obstacle.
At The Motley Fool, we coach a few common sense principles
to help individuals make sense of the money world. We advise
that they do their own homework, understand what they own, not
act on tips, and not instinctually believe the conventional
wisdom that professionals in the financial services industries
always know what they are doing and always have their clients'
best interests at heart. If something sounds too good to be
true, it probably is. If someone implies that you must act now
to win big, skip it.
It is clear to us that the only sure fire way to get rich
is to be patient, to learn more about investments, to
understand the role of money in the world, and to know thyself.
Though unoriginal, these are principles that have served us and
our community well.
Thank you again for inviting me to be here today and I will
be happy to answer any questions you have later.
Senator Collins. Thank you very much. Professor Friedman.
TESTIMONY OF HOWARD M. FRIEDMAN,\1\ PROFESSOR OF LAW, THE
UNIVERSITY OF TOLEDO, TOLEDO, OHIO
Mr. Friedman. Thank you, Madam Chair, Members of the
Subcommittee. I am Howard M. Friedman, Professor of Law at the
University of Toledo. My book, ``Securities Regulation in
Cyberspace,'' and my recent research focus on the impact of
Internet technology on securities regulation. I appreciate the
opportunity to testify before you today. My written statement
explores additional issues beyond those which I am able to
cover in my 10-minute oral statement.
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\1\ The prepared statement of Mr. Friedman appears in the Appendix
on page 92.
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The Internet revolution is an information revolution. The
securities markets are natural early adaptors of new
technologies that make information more accessible. The
Internet is young. Important experimentation to find its most
effective uses is still underway.
Despite occasional problems of system capacity, a major
success story of the Internet is on-line trading. An outgrowth
of on-line trading and low commission rates, however, is the
troubling explosion of day trading which creates excessive
volatility in the price of shares.
For at least a significant number of day traders, their
activities more closely resemble on-line gambling than on-line
investing. Many of the dangers of gambling, including the
addictive element, are present in unrestrained day trading.
Therefore, it is important for brokerage firms to have in place
appropriate criteria to screen investors who are permitted to
engage in day trading on-line.
Currently, when a brokerage firm makes an investment
recommendation to a customer, the recommendation must be
suitable in light of the customer's investment objectives and
financial circumstances. However, now clients increasingly
trade on the basis of their own research. A critical regulatory
question is whether the suitability obligations now imposed on
broker-dealers should be expanded in an on-line environment.
Should broker-dealers be required to monitor the on-line
trading of their clients? Should they not be required to
intervene when clients use trading strategies that are vastly
out of line with their investment goals and financial
situations, even though the trading has been undertaken without
any recommendations from the brokerage firm? Imposing
responsibility on brokers seems appropriate, since it is the
brokerage firm's trading facilities that permit the customer to
engage in inappropriate trading strategies.
Since the Internet revolution, information previously
available only to investment professionals now is available to
everyone at the click of a mouse. However, excessive data can
result in information overload. Many investors, understanding
this, welcome the newly available information but continue to
rely on investment professionals to assist them in interpreting
it. However, others do not. They, instead, use the Internet to
seek out investment recommendations and stock tips. They rely
on postings from often unknown sources who seem to have
filtered through the mass of available information. In this
way, they may become victims of securities fraud.
A famous cartoon in the New Yorker portrayed two dogs
sitting in front of a computer screen with one saying to the
other, ``On the Internet, nobody knows you are a dog.'' Well,
similarly on the Internet, Web sites that are ``dogs'' can
easily look as professional as those of the most established
firms. Moreover, at least in its early years, the Internet
fostered a culture of community and trust that further
encourages undiscriminating reliance by investors on all sorts
of on-line investment recommendations.
The various sorts of Internet securities fraud have a
single common thread. In each case, the victim relies on
exaggerated recommendations or false information transmitted
on-line by a person who will profit from the victim's reliance
on the information. The profit may come from secret payments by
others to the person promoting the stock or may be realized
when the stock price rises and shares secretly held by the
person engaging in the promotion are dumped on the market.
Many so-called Internet stock frauds are traditional
garden-variety scams which have merely migrated to the
Internet. Other frauds, while resembling traditional ones, have
taken advantage of the special capabilities of cyberspace.
While much information on the Internet is accurate, the
Internet is also an effective instrument for disseminating
false investment information because it permits simultaneous
transmission of information to thousands of investors around
the world; it permits and even encourages information to be
transmitted anonymously; and it discourages qualitative
differentiation between different on-line sources of
information.
Bulk E-mailing, called spamming, permits promoters to reach
thousands of persons at an extremely low cost. For less than
$300, software is available that will harvest thousands of E-
mail addresses from Internet files and create mailing lists
from them. Similarly, bulk E-mail address lists can be
purchased. One Web site offers a list of 10 million names for
$10,000.
Perhaps the most common on-line frauds are ``pump and
dump'' schemes. Using Web sites, on-line newsletters, or
Internet bulletin boards, insiders, brokers, or large
shareholders drive up the price of the stock through posting
false rumors on-line. Often, these rumors are posted
anonymously or under assumed names. Once the market price is
impacted by these rumors, the fraudsters sell off their earlier
acquired shares at inflated prices. Then when the rumors prove
to be untrue, the stock price declines for everyone else.
Existing laws seem sufficient for prosecution of most
Internet securities fraud. In some ways, Internet securities
fraud is easier to detect and to prove than fraud carried out
through high-pressure telephone sales. E-mail leaves a trail on
disks. Enforcers can often discover fraudulent representations
on Internet bulletin boards and Web sites by surfing the
Internet searching for words associated with fraudulent offers.
on-line complaint centers make it easier than ever for
investors to alert enforcers to problems.
The international reach of the Internet, however, does
create enforcement hurdles and continued strengthening of
international enforcement cooperation will remain critical.
While prosecution is important, prevention is even more
critical. In examining what additional preventive efforts are
needed, we must remember that risk inheres in our securities
markets. Innovation requires risk. Our securities laws,
however, are designed to assure that investors understand the
risks they are assuming.
To summarize, I would suggest three approaches that may
help prevent future victimization of investors. First,
securities professionals, broker-dealers and investment
advisors, are gate keepers at the entrance to the securities
markets. They should have heightened duties to screen out on-
line investors who are pursuing investment strategies that are
clearly too risky for their financial situations and investment
goals.
Second, inexpensive software can make a fly-by-night
financial Web site indistinguishable from those of well-
established firms. Some type of third-party verification is
needed to vouch for the legitimacy of particular sites. An
accounting industry program for commercial Web sites issues a
special seal to home pages that have passed an audit. A similar
program might be instituted for financial Web sites. When we
move from Web sites to E-mail and bulletin board postings,
anonymous messages may be a source of fraud. Securities
regulators and industry groups should encourage the use of
digital signature technology to permit accurate identification
of those posting financial information.
Finally, we need to ask why investors are willing to
believe on-line promises of quick wealth and on-line rumors
posted by unknown informants. Publicity campaigns have alerted
consumers to all sorts of physical health risks. Similar
techniques should be used to alert investors to risks to their
financial health posed by unsafe investment practices. A start
has been made in this direction with programs designed to
increase personal finance instruction in American high schools.
Educational materials are widely available on-line, including
through the SEC's Web site. However, more significant
investments in educational campaigns through the media will be
required for the message to be disseminated effectively.
Thank you.
Senator Collins. Thank you very much, Professor. Mr.
Hillman.
TESTIMONY OF RICHARD J. HILLMAN,\1\ ASSOCIATE DIRECTOR,
FINANCIAL INSTITUTIONS AND MARKETS ISSUES, GENERAL GOVERNMENT
DIVISION, U.S. GENERAL ACCOUNTING OFFICE, WASHINGTON, DC
Mr. Hillman. Thank you, Chairman Collins and Members of the
Subcommittee. I am pleased to be here this afternoon to discuss
Internet securities fraud and the challenges it poses to
regulators and investors.
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\1\ The prepared statement of Mr. Hillman appears in the Appendix
on page 102.
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The Internet is providing the basis for a rapid
transformation of the securities industry. As the Chairman
said, in her opening remarks, although there are several
benefits that the Internet provides to investors, such as
immediate access to price quotes on stocks or mutual funds and
readily accessible stock market research data, the Internet
also provides a new medium for fraudulent operators to bilk
investors out of millions of dollars. Attractive features of
the Internet to fraudulent operators include the ability to
anonymously communicate with millions of potential victims at
far lower costs than traditional means and the ability to do so
quickly from virtually any location in the world.
This afternoon, I would like to briefly touch on the three
areas you requested information on in your letter announcing
this hearing. These are, first, the incident rate and types of
Internet securities fraud violations that the SEC and others
have identified; second, a discussion of the steps that SEC and
State securities regulators have initiated to combat Internet
fraud; and third, a description of the enforcement actions
taken to deter fraudulent conduct. I would like to close my
oral remarks with a discussion of some of the challenges that
regulators face in combatting this problem.
Currently, there are no comprehensive statistics available
on the incidents or types of securities frauds committed over
the Internet. However, State, SEC, and other Federal agency
officials we have contacted said that the Internet securities
fraud is an emerging problem which is likely to grow as the use
of the Internet continues to expand worldwide. One rough
indicator of the growth of Internet securities fraud is the
number of public E-mail complaints that are submitted to SEC's
Internet Web site. According to SEC officials, the number of
such E-mail complaints, many of which allege the potential
Internet securities frauds, soared from about 10 to 15 daily in
1996 to between 200 and 300 daily in early 1999.
The types of securities frauds reported to be occurring
over the Internet are generally not new. The Internet seems to
be providing a new medium to perpetrate traditional investor
frauds, such as stock price manipulation schemes. However, some
securities frauds appear to be unique to the Internet
environment, such as the illegal copying of broker-dealer Web
pages.
One illustrative incident occurred in California in May
1997. A broker-dealer in California reported that its Web site
had been copied and the company name, address, and telephone
numbers slightly altered. The perpetrator used the new but
bogus Web site to dupe foreign investors into sending funds to
addresses listed on the new Web site. This scam went on for
about 10 months, until perpetrators moved on and copied another
company's Web site to repeat the same scam.
Another frequent scheme involves perpetrators touting false
information on small companies through Internet spam, Web
sites, on-line newsletters, or other means in order to increase
investors' purchases of securities, thereby raising share
prices. The fraudulent operators already own large numbers of
these securities and are able to make quick profits by selling
the securities as prices increase, while others face
significant losses when artificially inflated share prices
drop.
The sale of unregistered securities on the Internet is
another type of fraud being reported among the States we
visited. In addition, other State securities regulators have
reported the illegal sale of securities over the Internet
involving offshore gambling enterprises, time travel
technology, Hollywood movie theme restaurants, and air
conditioning and helicopter production companies.
Financial losses suffered amongst victims of fraudulent
schemes on the Internet have ranged from $18,000 to over $100
million.
SEC has responded to the growing Internet fraud problem by,
among other things, creating the Office of Internet Enforcement
to coordinate the agency's efforts to combat Internet fraud,
providing training to SEC investigative staff on monitoring the
Internet, and preparing guidance for SEC staff who are
investigating potential Internet frauds. The Internet Office
has three full-time staff and about 125 volunteer staff in SEC
headquarters and regional offices who work on a part-time basis
to identify Internet fraud-related activities.
In addition, SEC has established programs to educate
investors about the risks associated with Internet securities
frauds. SEC has posted investor education information on its
Web site, sponsored town meetings, and produced pamphlets on
the risks associated with Internet securities investments.
Their primary message to individual investors is that given the
potential for fraud, investment decisions should not be based
solely on information obtained over the Internet.
Rather, investors should perform a number of independent
steps to ensure the accuracy of Internet information. These
steps include reviewing financial information about a company
that may not be available off the Internet; determining whether
a company is, in fact, developing a technology as advertised
and contacting companies that are alleged to be in the process
of signing contracts with the company in question. Unless
investors are willing to take such steps, the SEC suggests that
investors may want to avoid using the Internet as a basis for
making investment decisions.
At the State level, nearly half of the State securities
agencies we surveyed had developed programs to deter securities
fraud on the Internet. These programs generally consisted of
monitoring the Internet for fraud, which varied widely from
about a half-hour daily to one time per month. We note that the
North American Security Administrators Association contributes
significantly in this area. The organization provides investor
education and serves as a clearinghouse for investor
complaints.
Regarding enforcement actions, SEC has initiated 66
enforcement actions since 1995 against individuals and
companies for securities fraud. As of February 1999, 32 of the
66 cases had largely been concluded, with violators generally
required to pay civil monetary penalties or refrain from
further violations of the securities laws. The civil monetary
penalties that SEC imposed range from $5,000 to $4.4 million.
In two of these cases, Federal and State law enforcement
agencies also obtained criminal convictions or prison sentences
for seven individuals.
According to SEC officials we contacted, the agency has
limited staff and other investigative resources and it is not
able to pursue every credible allegation of securities law
violations, including Internet frauds. Thus, SEC officials said
that the agency investigations often focus on what they call
message cases that have a high degree of public notoriety.
According to SEC officials, message cases are intended to
punish wrongdoers for egregious offenses and send a broader
message to deter would-be violators.
Collectively, State regulatory agencies have initiated
about 190 enforcement actions against persons and companies
accused of violating State securities laws. Nearly all of these
enforcement actions resulted in warning letters, informal
agreements, or the issuance of cease and desist orders.
State criminal enforcement agencies have pursued criminal
cases, as well. However, State and regulatory agency officials
report that State enforcement actions are not effective across
other States. That is because an enforcement action brought by
one State may deter persons or companies from committing
fraudulent acts in that State, but it does not necessarily
prevent persons or companies from committing the same scam
through the Internet in other States.
Although SEC and State agencies have initiated programs to
combat Internet securities fraud, these programs are new and it
is too early to predict their long-term effectiveness. On the
basis of our work, however, we have identified several
potential challenges that could limit the ability of these
programs to protect investors from Internet scams. In
particular, the potential exists that the rapid growth in
reporting Internet securities frauds could ultimately place a
significant burden on the regulators' limited investigative
staff resources and thereby limit the agency's ability to
respond effectively to credible fraud allegations.
Another ongoing challenge is coordinating oversight amongst
international, Federal, and State securities regulators so that
fraudulent operators are deterred from taking advantage of the
fact that Internet frauds can be initiated from virtually
anywhere in the world.
A final challenge involves reaching a broad audience to
educate the investing public about the risks associated with
Internet securities frauds. Since regulatory resources are
limited, preventing investors from falling into Internet
securities frauds in the first place may be our best way to
contain this problem.
Madam Chairman, I commend you for holding this hearing and
thank you for inviting our observations on Internet securities
fraud and regulatory efforts to combat this growing problem.
Hearings such as this are particularly useful because they
provide a public forum for educating large numbers of investors
that while the Internet has much to offer, there are also
potential risks, as well. We look forward to working with you
and your staffs in this important area.
Senator Collins. Thank you very much, Mr. Hillman.
Mr. Gardner, knowing of the dangers of penny stocks, I want
to commend you for the efforts that you have taken at The
Motley Fool to monitor your chat rooms and your bulletin boards
to make them inhospitable to penny stocks. I would note that
the actions that you take are unusual, that the Subcommittee
has done some investigation in this area and most of the major
on-line financial forums, such as Yahoo! or Silicon Investor,
do not police their chat rooms or their bulletin boards, or at
least not in an aggressive way. That raises the question in my
mind of what responsibility do on-line financial forums have to
aggressively monitor and police their bulletin boards and chat
rooms.
Mr. Gardner. I am not really sure what responsibility they
have, because I believe that in a free market system, over
time, individuals and consumers will come to recognize where
the value resides in different pockets. The earlier that we can
identify that and the earlier that we can get the message out
that monitored chat rooms and message boards are a great
benefit because they set a context, they give people an
understanding of what kind of community they are coming into.
It is my great wish that all financial sites had monitors. It
is an expense that we have to shoulder, but it is an expense
that is worth it because, again, it sets the tone for the
entire community. But I am not sure about placing regulations
or responsibilities on sites automatically to do a certain
amount of monitoring of their pages.
Senator Collins. Professor Friedman and Mr. Hillman, what
do you think of this idea? How much responsibility do you think
that on-line financial forums have to monitor or police their
bulletin boards and chat rooms? No one wants to interfere with
the flow of free information on the Internet. No one wants to
impose vast new Federal regulation on the Internet. And yet, we
clearly have a problem here, as we have heard from our previous
witnesses. Is self-policing the answer? Are steps such as The
Motley Fool has taken the answer, Professor?
Mr. Friedman. Well, there is always the danger of too much
censorship when you put liability on bulletin boards and other
providers. I should add that there is a provision in the 1996
Communications Decency Act which, while it was directed at
defamation and obscenity and not at fraud, probably shields
bulletin boards from a good deal of liability, at least in
civil actions, in this area.
Senator Collins. Mr. Hillman.
Mr. Hillman. I believe some form of monitoring or policing
of chat rooms would be something worth looking into. Such
practices already take place in certain broker-dealer firms,
where you have the broker-dealers' disciplinary records showing
a history of unscrupulous actions. There are audio tapes of
calls that are being made by these brokers and some similar
form of oversight in the Internet industry would be worth
looking into.
Senator Collins. Mr. Gardner, it is my understanding that
The Motley Fool created a fictitious stock and then hyped it to
show how easily investors can be sucked into the hype and to
make investment decisions. You mentioned it in your written
testimony, but because of time constraints did not in your oral
presentation. Could you tell us a bit about that and what
lessons you think can be gained from that experience?
Mr. Gardner. Certainly. When we started on-line in the
early 1990's, we walked into an environment where there was a
lot of loud promotion of what we consider to be very low-grade
investment opportunities, again, unlisted stocks in the United
States, over-the-counter stocks, or Vancouver Stock Exchange
securities. Unfortunately, Vancouver is a lovely city, but
their stock exchange stands out in my mind as a haven of very
low-grade businesses, or a number of them.
We tried, as best we could, as earnestly as we could, to
teach people about the very spike that we saw on the graph
earlier presented, and that there were small brokerage firms
and individuals and companies participating in the promotion of
their stock in an attempt to get a 30-cent share stock up to $2
over the next 2 weeks, and then they would turn and move to a
new company. As outrageous as some of the claims of the
companies were, there were enough inexperienced investors that
these were successful scams.
What we tried to do in teaching people was totally overrun
by, again, a very creative and very critical move against
education on-line at the time. So what we did was we created
our own penny stock, our own foreign exchange, the Halifax
Canadian Exchange----
Senator Collins. Which does not exist, correct?
Mr. Gardner. Which does not exist. We created this whole
scenario on April 1, 1994, and walked through it over about a
6-day period, and during that period, we probably got 1,000 E-
mails, a number of them from people saying, I cannot buy the
stock. Where is this exchange? I have asked my broker to locate
it. Then about 6 days later, we collapsed the entire story of
Zeigletics, and we did so to really show step by step what
happens when a thinly-traded micro-cap stock is promoted.
I think Senator Levin has correctly found one, and I also
agree that there are hundreds of examples, if not thousands of
examples, of this over the last 5 years. And if there is one
corner of the overall market to pinpoint to shed more light on
for greater clarity to guide individual investors on, it is
those companies that have the capitalization under $50 million
that are not listed on our exchanges for which there is not a
lot of public information.
But we created that April fool's joke. We believe that is
our national holiday at The Motley Fool, and we did so to
really educate people about why these investment options really
are options to be avoided.
Senator Collins. And Zeigletics sold what? What was the
product?
Mr. Gardner. Zeigletics was selling linked sewage disposal
systems around the world, and one can infer what we thought of
their product based on that description.
Senator Collins. With a concentration in Chad, as I
understand it.
Mr. Gardner. Exactly, and that is actually a critical
component of so many of these scams, is that they are a
business that is happening internationally that one could not
verify. You could not travel down to the company headquarters
very easily because they were doing business abroad. They were
located abroad. They were listed on a foreign exchange. That
kind of far-away nature and that remote, obscure business is
something that I think untrained investors who have a belief
that the way to make money off their savings is to gamble, and
that has been reinforced in a number of places in our society,
then think that they need inside information and a secret sauce
investment approach to do well, and, therefore, those are the
most attractive first options to them, unfortunately.
Senator Collins. The language you used also was very
typical of what you see with the hyping of these penny stocks,
saying that if you have not bought the stock yet, you are no
player at all, a lot of times implying that someone is going to
miss out on this exciting opportunity to, as our previous
witness said, to get in on the ground floor. It is stunning to
me that, given what you portrayed, that you had over 1,000 E-
mails from people who were unhappy they could not find this
fictitious stock. I think that suggests we have a long ways to
go on consumer education in this area.
Mr. Gardner. We certainly do.
Senator Collins. Mr. Hillman, Professor Friedman and Mrs.
Morris made a suggestion that there be some sort of third-party
verification to give, say, a seal of approval to a Web site
that it is legitimate, and the professor mentioned a program
that I believe it is the American Association of Certified
Public Accountants has that has that seal of verification.
How practical do you think that is, given the vast number
of stock offerings that we are dealing with and Web sites? I
mean, it is millions and millions of Web sites out there now.
Mr. Hillman. And there are hundreds more being developed
every day. I think that one of the better ways of perhaps
tackling this problem is through investor education, tapping
investors' knowledge at the source so that they do not fall for
these types of frauds to begin with.
Senator Collins. Professor Friedman, another one of your
suggestions was extending the suitability requirements to on-
line trades that would otherwise apply in a normal relationship
that an investor would have with his broker. Could you expand
more on your proposal in that regard?
Mr. Friedman. Yes. Right now, the suitability requirements,
the requirements that brokers limit sales to securities that
are suitable for an investor's financial situation, apply where
brokers are making recommendations. But in today's on-line
environment, very often, brokers are not making recommendations
at all. People are doing their own research, sometimes from the
broker's Web site, sometimes from elsewhere. But, nevertheless,
a monitoring of the customer's activity would show the broker
that this customer is trading in ways that are very unsuitable,
and expanding brokers' obligations to that, I think, might well
cut off some fraud, or at least some losses, that investors are
now suffering.
Senator Collins. Thank you. Mr. Gardner, many of us are
concerned, as I know that Professor Friedman is and you
mentioned in your written testimony, about the growth of day
trading. Do you think that the explosive growth of day trading
presents the opportunity for more of the kinds of market
manipulations, particularly ``pump and dump'' schemes, that we
are seeing?
Mr. Gardner. Certainly. I think any time you have a number
of investors focusing on the short-term performance of stock
prices rather than the intermediate or long-term success of a
business, you are going to have opportunities and attempts at
trying to manipulate the movement of those prices in the short
term.
The simplest solution came out of Omaha, Nebraska, a number
of years ago when Warren Buffett said, let us just create--it
should make the government happy, as well. Let us create the
100 percent short-term capital gains tax. That is, if you trade
out of your position within a year, you pay your entire profits
to the government, and that will encourage people to look at
the public markets as the mechanism that they were created for,
ownership of public companies and financing for those
businesses.
But short of that, increased education, and I do not think
this is a sustainable problem because the economics of day
trading are so unattractive and the lifestyle of the day trader
is also so unattractive that I think, over time, we are going
to see this gleaned out.
Senator Collins. Thank you. My time for this round has
expired.
Senator Levin.
Senator Levin. Thank you, Madam Chairman.
I want to get back to the question of responsibility,
suitability obligation of brokers. I take it that the day
trading firms also have that responsibility now, but your point
is that that responsibility is limited now to the occasions
where they are recommending the specific purchase of a stock
and does not go to the strategy which a customer might use to
engage in day trading. Is that generally correct?
Mr. Friedman. That is right.
Senator Levin. All right. So is the suitability obligation
that we place on brokers done by law, by regulation, by self-
regulation? Where does that suitability obligation emanate?
Mr. Friedman. It comes primarily from the rules of the NASD
and the New York Stock Exchange, although courts have also read
it into common law fiduciary duties. But the most direct
obligation is from the NASD and New York Stock Exchange Rules.
Senator Levin. So we have not through SEC regulations or
through legislation been the source of that obligation?
Mr. Friedman. There is a limited SEC suitability obligation
in the penny stock area, but beyond that, it is in the self-
regulatory organization rules, although those are all rules
that the SEC has to approve. The SEC oversees those rules and
coordinates its own regulation with those of the NASD and the
stock exchanges.
Senator Levin. But this is the penny stock area, basically,
that we are most concerned about, is it not, so-called penny
stock?
Mr. Friedman. Some of it is. Some of the trading, some of
the day trading goes beyond things that are within the
definition of penny stocks, however.
Senator Levin. We can take this issue up tomorrow with our
witnesses, but let me ask a few questions of our witnesses
today. Do either of you, Mr. Gardner first, Mr. Hillman second,
have any reaction or comment to the suggestion that the
suitability obligation be extended, in effect, to a customer's
investment strategy, where they are engaged in day trading, to
make sure that that strategy is suitable to that customer's
investment goals and financial circumstances? Do you have any
reaction to that?
Mr. Gardner. I have some reservations about applying
guidelines that brokers have to follow or discount brokers have
to follow. I believe the recommendations and strong
recommendations and the opportunity for those discount brokers
to promote that they are following those recommendations and
use it in their promotional material, it is a great idea.
Basically, when it comes down to the sort of speculative
side of the public markets, I think the single best combatant
to that is education because there is simply, numerically,
there is no support of trading that way for your long-term
benefit.
Senator Levin. Maybe not for each individual's long-term
benefit, but there are more new individuals coming along all
the time.
Mr. Gardner. That is true, and unfortunately, day trading
also benefits a lot of brokerage firms. It was not started on
the Internet. We all know that. Right now, the commission-
driven compensation at the firms does reward that sort of
active trading. But again, I am a strongest advocate of making
sure that the new investor that comes in has set materials and
reads through stuff and then has an understanding what they are
doing.
Senator Levin. Thank you. Mr. Hillman, do you have any
reaction to the proposal of Professor Friedman?
Mr. Hillman. We have not looked into the day trading
phenomenon itself. We have been pretty much focused on Internet
securities fraud. However, day trading activity is something
that deserves some additional attention. I have concerns about
whether day traders who trade stock through these niche
brokerage firms actually are aware of the risks associated with
this trading activity and would therefore recommend that more
could be accomplished in the disclosure area to determine
whether or not day traders are being made aware of their risks.
Senator Levin. Should anybody who uses electronic means to
buy stock be required to be a recipient of the message as to
what the SEC Web site address is? In other words, one of our
earlier witnesses said she was not aware that there was a Web
site of the SEC where stocks are registered. She could have
checked it out. Should any electronic dissemination of a stock
tout or suggestion that somebody buy stock be required to be
accompanied by the Web site address of the SEC? That is my
question. I guess, let me start with Mr. Hillman.
Mr. Hillman. I think that is an interesting idea and
something that probably ought to be looked into.
Senator Levin. OK.
Mr. Friedman. I think that many of these are offerings that
are made under an SEC exemption from registration, so it really
would not do all that much good. Many of these are sold under
Rule 504 as offerings of under $1 million. Where it is a
registered offering by the company, present law requires that
the prospectus itself be delivered either electronically or in
paper form before the person purchase? So when we are talking
about the company itself offering securities, many of these
offerings are made, or at least supposedly made, under
exemptions.
Senator Levin. OK.
Mr. Gardner. I am in support of any materials that are
released that give people more information about the shadowy
parts of our public markets, which I think are activities off
the major exchanges. We require so much of our public companies
in terms of their disclosure, if they are to be listed on the
NASDAQ, the NYSE, or the AMEX, and I think a lot of those
disclosure requirements should extend to any company that is
selling stock to investors.
Senator Levin. Let me ask each of you about the practice of
day trading firms aggressively recruiting inexperienced people
that take courses and become day traders. We have seen
examples. They are very expensive, some of these courses, too.
It could be many hundreds of dollars to take a course as to how
to become a gambler, or a day trader. I am just wondering if
you think there is anything that can or should be done about
those aggressive marketing tactics to try to train you to--and
the more inexperienced, the better, by the way, some of these
ads run. The less you know about the firms, the better off you
are in terms of becoming a day trader. It is ultimately touted
that way.
But at any rate, any suggestions from any of you as to
whether there ought to be any control, regulation over those
kinds of aggressive recruiting practices? Mr. Hillman.
Mr. Hillman. Again, I think disclosure is something worth
looking into. For example, to what extent have these firms
disclosed to these new day trading investors the number of day
traders that have made money and the number that have lost
money? If they provided information over a 3-month period of
time of the number of investors who had lost money during such
activities, perhaps that would give them some information to
think about.
Senator Levin. Are you contemplating such a requirement by
Federal regulation?
Mr. Hillman. The General Accounting Office has done no work
in the day trading area. I am speaking from personal knowledge
and considering best practices.
Senator Levin. I would be particularly interested as to
whether or not any of you think that there is a role for
Federal regulation or Federal law in this or any other area,
for that matter. Professor Friedman.
Mr. Friedman. I think that kind of disclosure obligation
under Federal law might make sense. I think probably some of
those ads already violate anti-fraud provisions, depending on
what they say. I think, unfortunately, this attraction of day
trading is part of a broader notion in our society. People
think that if they invest in good, old-fashioned, safe, low-
return kinds of investments, that somehow they are fools for
doing it, excuse the pun.
Mr. Gardner. With a small ``f ''. It was a small ``f '',
Mr. Friedman, I am sure. [Laughter.]
Senator Levin. That was a commercial, as a matter of fact.
Mr. Friedman. It is.
Mr. Gardner. Spell the name right. That is all that counts.
Mr. Friedman. Day trading is just another example of the
prevalent idea that ``I have to get rich quick.''
Mr. Gardner. I think to the extent that we can start by
applying the existing guidelines for advertising, that we could
probably clean up a lot of the stuff that is going on out there
today. I do know that one individual, who, for legal purposes I
will not put his name in the record, but I believe that his
radio advertisement was suggesting that individuals using his
stock option strategy could expect 20 to 40 percent growth per
month.
So what do we do at our on-line site? Rather than read
through all the materials and figure it out, we simply took
$1,000 and said, if it grew at 20 percent a month, how much
would you have after 15 years, and the answer is, you would
have more than $100 trillion. So either this individual is
going to be master of the universe or we are going to begin to
educate people more about what is happening out there, and I
think there are some advertising guidelines that could be
applied and there could be ones that are introduced anew to
make sure that the message of what the real service is, if
there is any, is out there.
Senator Levin. A final question. Mr. Hillman, I think it
was your testimony which indicated that the SEC's Office of
Internet Enforcement in 1996, I believe you said, got 10 to 15
E-mail complaints a day and that now that is 200 to 300?
Mr. Hillman. That is correct.
Senator Levin. That means that the SEC's Office of Internet
Enforcement is now receiving complaints about fraud or
misstatements to the tune of 50,000 a year, roughly, the way I
multiply. I do not know if that fits your----
Mr. Hillman. An awesome number.
Senator Levin. The Chairman corrects me, because it is 7
days a week, so you are right. I was just multiplying 5 days a
week. I am old fashioned. But it is more like 70,000 a year.
How many people do they have in their office to handle that?
Mr. Hillman. The Office of Internet Enforcement has three
full-time staff and 125 volunteer staff within SEC's
Enforcement Division and regional offices.
Senator Levin. Well, we can ask the SEC this tomorrow, but
there is no way that is anything other than overwhelming. They
cannot possibly come close, even with all the volunteers, to
handling that kind of a crush of complaints. So I think we are
going to need to do a lot of education, but we are also going
to need to do an awful lot of shoring up our enforcement
mechanisms and maybe look at the penalties, as well, in order
to get at the frauds and the scams which are swamping the
Internet these days, so thank you.
Senator Collins. Thank you, Senator Levin.
To follow up on a point that Senator Levin made, we asked
the SEC how many of those E-mail complaints relate to Internet
fraud schemes as opposed to other kinds that are just being
conveyed, and the estimate was that it was about 70 percent
did. So it is a substantial and growing number.
Senator Edwards.
Senator Edwards. Thank you, Madam Chairman.
I have just made a list of the broad categories that I have
heard the three of you talk about. I am going to go back and
ask you a couple of questions about these, but what I have got
are fraud, day trading, penny stocks, micro-cap stocks, ``pump
and dump'', and I guess to some extent, anonymity contributing
to those things. Have I left out some broad category of
problems that you all are seeing? What have I left out? Is that
it?
Mr. Gardner. When we can nail those, we are on the road.
Senator Edwards. All right. And I think I have heard at
least Mr. Gardner and Mr. Hillman say, particularly when you
were pressed about some specifics about potential regulations
and so forth, that investor education, you think, is critical,
and Mr. Gardner, I know you said that in your opening comments.
Professor Friedman, do you agree with the two of them about
that?
Mr. Friedman. I agree that investor education is critically
important. I am not sure that it alone is enough.
Senator Edwards. OK. I want to come back to that in just a
minute. Mr. Hillman, since you are one of the people who talked
about that, can you give me some notion in your mind what the
components of investor education need to be, and also, second,
the practical way of getting that information to people, to
potential investors, to make sure that they have got it?
Mr. Hillman. I think to avoid scams, education needs to be
put forth that tells individual investors to think twice before
investing on information learned solely over the Internet and
to get the facts. Get financial statements and analyze them.
Verify claims about new product developments. Call suppliers or
customers of the company.
There are a number of ways that this information could get
out. The SEC has a Web page containing investor education
information, including warnings on investment recommendations
over the Internet. They also produce pamphlets and they host
town meetings.
Senator Edwards. Can I interrupt you there just a moment?
Do not lose your place, but I want to ask you about that. Do
you have any notion of how many investors who participate in
purchasing the kinds of things that we have been talking about
over the Internet actually go to those places to get
information now?
Mr. Hillman. I do not have the numbers of the hits that
have been made on their Web page, and I am sure the SEC could
provide that to you.
Senator Edwards. Do you have any sense of it?
Mr. Hillman. I am sorry, I do not.
Senator Edwards. You do not know? OK. Again, back to that
list of things that you talked about as being critical, in the
ideal world, where would you put that information to make it
most obvious and most accessible to the investor? Instead of
making him go somewhere else, I mean, you are talking about
going to some SEC Web site, instead of going somewhere else,
where would you put it to make it most obvious and most
accessible?
Mr. Hillman. In my opinion, I would put that information
right in the investor's face while that individual is
attempting to make investment decisions, and that is why I
think Senator Levin's comment about providing information on
the Web sites as to where to go in the SEC to get information
on prospective investments is something that we ought to
consider.
Senator Edwards. Do you have any idea, Mr. Gardner, how
many Web sites, or does anybody do that now, what Mr. Hillman
just talked about?
Mr. Gardner. We are doing our darndest at The Motley Fool.
Senator Edwards. Besides you.
Mr. Gardner. I generally think that if you can place it in
the application for a brokerage account. Obviously, placing it
at the high school level as a core requirement to graduate
would almost guarantee that things like, if I may list a few
educational items that would be wonderful if everyone knew.
Today, $6,000 in credit card debt is the average for an average
American household, $6,000 in credit card debt at 18 percent
interest rates, which is just terribly unfortunate. Ninety
percent of mutual funds charging eight times more than an index
fund, 90 percent of them do worse than the market's average in
the 1990's. And brokers today are still paid on commission,
many of them entirely on commission, and that is something a
lot of individuals do not do going into the game of planning
for their retirement.
So to the extent that we can get these items out, as well
as information about how to use the on-line medium to their
maximal benefit, I do concur that we have to make sure to
explain the Internet, a new medium and the most powerful medium
in our world's history. However, so much of this has existed in
some form or another before the Internet. So we have to
recognize we have been unable to address it in advancing the
Internet. To the extent we can with this--but let us also make
sure to focus on the schools.
Senator Edwards. Mr. Hillman, I interrupted you. Could I go
back and let you finish, or did we cover what you intended to
say?
Mr. Hillman. No, I pretty much covered everything that I
intended to cover. The SEC has provided a number of pamphlets.
They have hosted town meetings. They have their own internal
Web site which provides information on how individual investors
are being scammed and how to avoid such scams. To the extent
that that information can be made more readily available to the
investing public, the better off we will be.
Senator Edwards. Professor Friedman, I did not miss it in
your testimony. You believe that this investor education is
important, but also apparently believe that there may be other
steps that are necessary.
Mr. Friedman. That is right. I mentioned there is a high
school program that the Investor Protection Trust and the NASD
and NASAA have begun. I think getting students at high school
age is certainly a good starting point.
Senator Edwards. Did I not also hear you talk about some
sort of heightened broker-dealer responsibilities?
Mr. Friedman. Yes.
Senator Edwards. Talk to me a little bit more about that,
because I want to get these other gentlemen's comments about
whether they think that is realistic or not.
Mr. Friedman. To some extent, that goes to the day trading
issue, of making certain that customers who are engaging in day
trading are only doing it if it is suitable to their financial
needs and their investment goals. But also more broadly,
broker-dealers and investment advisors should have to monitor
customers' trading to make sure that it is consistent with the
customers' goals and objectives. This would extend suitability
obligations beyond just the situation where brokers make
recommendations, which is now the case.
Senator Edwards. Which you talked about with Senator
Collins.
Mr. Friedman. Yes.
Senator Edwards. Mr. Hillman, is that practical from your
perspective?
Mr. Hillman. In my opinion, intermittent monitoring is
something that ought to be looked into. As I indicated before,
broker-dealers who have a track record of providing improper
information to investors are now required to have their
telephone conversations with investors taped to better
understand the extent to which proper information is being
provided.
Senator Edwards. Mr. Gardner, how about your comment on
that?
Mr. Gardner. I am hesitant, again, to try and place
guidelines on investment strategies, what works and what does
not and to cookie-cut the way people can invest. I think at
some point you might have a broker saying to Bill Gates, you
can no longer hold 99.9 percent of your wealth in a single
stock. So I am not sure----
Senator Edwards. Can I interrupt you for just a minute? You
see, my concern is, as much as I--and I very much want to
protect investors, particularly elderly investors and people
who are being taken advantage of--Professor and Mr. Gardner, I
just worry about the practicality of it. These guidelines sound
very subjective and very amorphous to me, and trying to enforce
them with broker-dealers seems like an awfully hard thing to do
to me.
Mr. Gardner. I think it would be extremely difficult, but I
have sympathy with the intent. But I think the execution of
that idea would be very difficult. I do think that you have to
try and shed as much light on this industry as possible, and to
the extent that the SEC is doing that, we are going to see a
greatly improved marketplace in the years ahead. But we are on
the cusp here of a new medium that has been created and there
may be a need for more requirements in terms of disclosure and,
again, making sure that these sites shed light on what their
activities are.
Senator Edwards. Professor Friedman, I want to give you a
chance to respond to the concern I just expressed.
Mr. Friedman. There is one distinction we have to keep in
mind that I think maybe we are running together. One problem is
the pure fraud situation, where someone is just misrepresenting
information.
Senator Edwards. Right.
Mr. Friedman. A second issue is trading opportunities,
trading strategies, investments which are legitimate but high
risk, and----
Senator Edwards. Day trading, for example.
Mr. Friedman. Yes, day trading or start-up companies, and
those may be perfectly legitimate investments for some
investors but not for others. I think we have to deal
separately with those two kinds of issues, the legitimate
investment that is too risky for some people versus the
fraudulent investment that nobody ought to be getting into.
I think the enforcement is always a problem, but that is a
problem now with suitability obligations. That enforcement
problem is limited to some extent by being handled largely
through arbitration when there is a violation so that it does
not give rise to some of the proliferation of lawsuits that we
might otherwise have.
Senator Edwards. One thing I have not heard any of you
mention, and I may have just missed it in your testimony, have
there been any problems with computer hacking in this area?
Mr. Gardner. We have not encountered any, but certainly
security is always an issue. So we have not run across that.
Senator Edwards. You have not seen it, but there is always
the potential for that, obviously.
Mr. Gardner. Sure.
Senator Edwards. How about you, Mr. Hillman?
Mr. Hillman. We have asked some of the on-line firms that
we interviewed during the course of our study whether or not
they have been penetrated and the answer so far has been no.
Senator Edwards. OK. Professor Friedman.
Mr. Friedman. I do not know of any situations.
Senator Edwards. Thank you all very much. It has been very
helpful.
Senator Collins. Thank you.
Senator Edwards. Thank you, Madam Chairman.
Senator Collins. Thank you. Mr. Gardner, this morning when
I accessed your Web site, I read your very lengthy and complete
disclaimer where you make very clear to people that you are not
acting as investment advisors and you tell people that,
essentially, they are acting on any tips that they hear at
their own risk and they should do further research and you
really go to great pains to make sure that people are not
confused by the role that your on-line financial forum is
playing.
Some have suggested that perhaps chat rooms, the sponsors
of chat rooms, should be registered as investment advisors.
That strikes me as being regulatory overkill and not a very
practical solution. But what about requiring on-line financial
forums to have the kind of disclaimer that you have where they
make very clear that they are not acting in that capacity?
Would you support that kind of move?
Mr. Gardner. Do we get a licensing fee? [Laughter.]
No. I certainly would support requirements of disclosure
about the service, the responsibilities of those people
providing the service, and I hope we have set a good example. I
mean, in all of this, I always feel that there may be a need
for regulation up front, but I would only position that
regulation as something that gets peeled away over time, in
other words, not denying ourselves the responsibility that we
have to educate people to do this as much as possible
themselves.
So any sort of requirements that are placed, I would hope
that they would only be placed because we had already applied
the existing law that we had as best we could, that we had
enforced it, that we had seriously penalized those who had
violated it, and then if there was a need for additional
regulation, I would hope that education could supplant it over
time.
Senator Collins. Professor Friedman, you mentioned in your
written testimony a new kind of spam that I had not been
familiar with which I want to get on our hearing record so that
others can beware of it, and that is the so-called misdirected
E-mail spam. This struck me as much more sophisticated than the
normal spam. Could you explain how this works?
Mr. Friedman. It is. It leads the person who receives an E-
mail message to think that he or she has been the lucky
recipient of inside information that was intended for someone
else that got misdirected to that person. It is, of course,
sent out to millions of people, but it looks like an internal
memo from a brokerage firm or some message that has inside
information in it.
Senator Collins. So rather than being a direct pitch to buy
or to invest, in fact, this gives the impression that, somehow,
the E-mail recipient is the lucky recipient of inside
information that will give them an advantage if they act now.
Mr. Friedman. That is right, and it plays on this idea
that, gee, that is how people make money, by using inside
information.
Senator Collins. Which is an interesting point, because I
think there is a common perception about that among investors,
and that, somehow, if only they had the inside information,
they, too, would make a lot of money.
Mr. Friedman. That is right.
Senator Collins. Is this a growing kind of spam?
Mr. Friedman. I do not know. I think this has been fairly
limited so far. I only have heard of a few instances of it. So
I think it is a little more sophisticated than the schemes
carried out by most of these fraudsters have done. In fact, a
lot of these schemes are pretty simple, straightforward frauds
and not nearly that sophisticated.
Senator Collins. Mr. Hillman, I want to turn back to the
issue that Senator Levin touched on as far as the adequacy of
the SEC resources and efforts in this area. I have been
impressed by the proactive response of the SEC to crack down on
Internet fraud. It is, however, a growing problem and the
question is whether the resources, no matter how well
intentioned the SEC may be, are keeping pace with the problem.
What is your assessment of that? Are the resources adequate?
You mentioned there are only three full-time SEC staff people
who are dedicated full-time to Internet fraud, though they are
supplemented by 125 volunteers.
Mr. Hillman. It is clear to me, as well, that the SEC is
trying hard to combat Internet securities fraud, but you have
to wonder, while they are fighting a good battle, are they
winning the war? At this early stage, it seems that the
potential for Internet securities fraud is unlimited, while we
know the SEC's resources are not. With the rapid growth of the
Internet, it is constraining the agency's ability to respond,
and as a result, they are having to focus on what they call
message cases as opposed to looking into every investigation,
as they probably should.
Senator Collins. One step that the SEC has taken, and it
goes along with Mr. Gardner's theme about consumer education,
is sponsoring town meetings. I was pleased to host one in
Maine. The overriding message that was conveyed by the SEC
Chairman was to not give money to people you do not know. I am
wondering if one of the lessons that we should take from these
hearings is that that basic rule has not changed and that even
if it is an investment opportunity over the Internet, if it is
a company you have never heard of and someone you do not know,
that you ought to really think twice. Mr. Gardner, what do you
think of that advice?
Mr. Gardner. I entirely agree, although I would have to add
somewhat foolishly that we have had a lot of people come into
our forum and contribute to our ``my dumbest investment''
discussion, which is a single folder that we have that is very
popular and rich with education for anyone who wants to sit
down and read through it, that there are a lot of people who
work with people that they do know, that are their college
friends. Ed McMahon came on our radio show about a month and a
half ago and said that he lost $1.4 million investing in a
psychedelic paper design company run by a college buddy of his.
Senator Collins. Maybe he will enter one of those
sweepstakes that he is always promoting and win it all back.
Mr. Gardner. I will not go into any detail there.
[Laughter.]
But one thing that did strike me about the testimony of the
two individuals that had been victims of scams is that to the
extent that we can show the different sorts of investments and
teach people how to read financial statements, even though it
can appear to be somewhat boring, that would have tipped them
off right away that the promise of owning the world by a tiny
little company is so unlikely relative to everything else that
goes on in the business world, that I think that would have
helped them avoid that.
Senator Collins. Professor Friedman.
Mr. Friedman. I am sorry. You were asking me----
Senator Collins. What advice do you have as far as is it a
mistake for people to invest in a product they have never heard
of with a company they cannot verify and with someone they do
not know? I mean, does it really come down to that being the
bottom line?
Mr. Friedman. Well, that is certainly a lot of it. That has
been the case even before Internet fraud, that fraud carried
out through the telephone, carried out in other ways, often
involves exactly that same thing. That is a very basic
proposition. You are right. Much of that is what we have here.
Much of it is, again, just convincing people that there is no
such thing as getting rich quick without huge downside risk.
Senator Collins. Mr. Hillman.
Mr. Hillman. I think the bottom line is, get the facts.
Senator Collins. Thank you. I want to thank the three of
you for participating in our hearing today. You have greatly
added to our understanding of this problem. Tomorrow, we are
going to hear from State and Federal regulators.
As we approach this issue, we are mindful of the many
benefits of the Internet. In many ways, I think it is helping
to democratize our markets and make them more accessible to the
average person, to the person who did not previously have
access to the kinds of information that only securities
professionals would have. And so in many ways, that is a very
positive development that has been brought about through the
Internet.
On the other hand, we have also seen the dark side, as Mr.
O'Kane so aptly called it, of people investing through the
Internet in a venture that they never would have invested in
had it been through a cold call from an aggressive broker or
even through a solicitation in the mail.
We have heard examples of how the perpetrators of
securities scams in some ways seem to have simply packed up
their operations and moved to the Internet frontier, and
indeed, the Internet offers many advantages over the
traditional means of communication. It is much cheaper. You can
reach many more people than you could through calling from a
boiler room, for example. So instead of cold calling families
one at a time as they are sitting down to dinner, now these
fraudsters can with the click of a mouse instantly communicate
with hundreds of thousands of people via the Internet.
As we address this issue, I am convinced that, as Mr.
Gardner has said, that consumer education is front and center,
but I also think we need to look at questions such as whether
the SEC has adequate resources, whether penalties need to be
increased, whether suitability requirements need to be
toughened, as Professor Friedman suggests, and we need to look
at the whole panoply of possible solutions.
I very much appreciate your joining us today as we explore
this very interesting issue, and with that, the hearing will
now be in recess until 9:30 tomorrow morning.
[Whereupon, at 3:41 p.m., the Subcommittee was adjourned,
to reconvene at 9:30 a.m. on Tuesday, March 23, 1999.]
SECURITIES FRAUD ON THE INTERNET
----------
TUESDAY, MARCH 23, 1999
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 9:31 a.m., in
room SD-342, Dirksen Senate Office Building, Hon. Susan M.
Collins, Chairman of the Subcommittee, presiding.
Present: Senator Collins.
Staff Present: Timothy J. Shea, Chief Counsel/Staff
Director; Mary D. Robertson, Chief Clerk; Lee Blalack, Deputy
Chief Counsel; Elliot Berke, Counsel; Kirk E. Walder,
Investigator; Smokey Everett, Detailee/Secret Service; Wesley
Phillips, Detailee/GAO; Bob Roach, Counsel to the Minority;
Butch Burke (Senator Stevens); Seema Singh (Senator Specter);
and Peter Ludgin (Senator Lieberman).
OPENING STATEMENT OF SENATOR COLLINS
Senator Collins. Good morning. The Subcommittee will please
come to order. This morning, we continue our investigation into
securities fraud on the Internet.
Yesterday, we heard troubling testimony from two
unfortunate investors who have firsthand knowledge of Internet
securities fraud. We learned that even computer-literate,
experienced investors can be bilked out of thousands of dollars
through investment scams perpetrated over the Internet.
We also received testimony yesterday from the General
Accounting Office, the law professor who wrote Securities
Regulation in Cyberspace, and the founder of an on-line
financial form.
Today, we will turn our attention to the efforts undertaken
by both Federal and State securities regulators in response to
escalating Internet securities fraud. Both the SEC and many
State regulators have been inundated with consumer complaints
alleging securities fraud. The SEC's Office of Internet
Enforcement receives between 200 and 300 complaints via E-mail
every day, of which an estimated 70 percent allege Internet
securities fraud.
One question the Subcommittee will explore this morning is
whether the SEC has sufficient resources to combat this
burgeoning problem.
For 5 years, I served as Maine's Commissioner of
Professional and Financial Regulation, with jurisdiction over
the State Securities Division.
I well remember how hard our staff worked to obtain
restitution for elderly consumers who had invested in penny
stocks and other unsuitable investments. The Internet greatly
extends the reach of con artists creating many more potential
victims.
Given my experience at the State level, I am particularly
interested in learning what State regulators are doing to fight
Internet fraud. I look forward to hearing from our witnesses
this morning as they offer the Subcommittee their perspectives
on how the regulators are approaching securities fraud on the
Internet and how investors can best protect themselves from
falling prey to on-line securities schemes.
I do want to explain the absence of other Subcommittee
Members this morning. Many of the Subcommittee Members who have
a particular interest in this issue, such as Senator Levin,
Senator Specter, and Senator Lieberman, are at the White House
for a briefing on Kosovo that the President scheduled last
night, and we did not have the opportunity to move the hearing.
I hope that some of them will be able to join us later in the
hearing, but I know all of them will look forward to reviewing
the hearing record with great interest.
Today, we are pleased to have a panel of distinguished
witnesses who will discuss Federal and State regulatory efforts
to combat Internet securities fraud and to educate consumers
about the risks associated with investing over the Internet.
Our first witness this morning is Richard H. Walker, who is
the Director of the Division of Enforcement with the Securities
and Exchange Commission.
It is my understanding that John Stark, who is the Chief of
the SEC's recently created Office of Internet Enforcement, is
also available to respond to questions.
Our next witness will provide a perspective on State
regulatory efforts to combat Internet securities fraud. Peter
C. Hildreth is the President of the North American Securities
Administrators Association, or NASAA as I have always known it
as, and he is also the Director of Securities Regulation for
the State of New Hampshire--a fine New England State.
Mr. Hildreth is accompanied by Philip Rutledge, who is the
Deputy General Counsel of the Pennsylvania Securities
Commission, and I do want to thank Mr. Rutledge also for being
here. He has 20 years of experience in the field of securities
regulation, and I know that Senator Specter will be reviewing
your testimony with great interest.
Pursuant to Rule 6, all witnesses who testify before the
Subcommittee are required to be sworn in. So, at this time, I
would ask that you stand and please raise your right hand.
Do you swear that the testimony you are about to give the
Subcommittee will be the truth, the whole truth, and nothing
but the truth, so help you, God?
Mr. Walker. I do.
Mr. Hildreth. I do.
Mr. Rutledge. I do.
Senator Collins. Thank you.
We will make your complete written testimony, which in some
cases is quite extensive, part of the complete hearing record.
I am going to ask that you limit your oral presentations to no
more than 10 minutes each. However, if you do need a little
extra time, feel free to take it, and as I mentioned, your
prepared testimony will be printed in its entirety in the
hearing record.
Mr. Walker, thank you for being here today, and I will ask
that we start with you.
TESTIMONY OF RICHARD H. WALKER,\1\ DIRECTOR, DIVISION OF
ENFORCEMENT, U.S. SECURITIES AND EXCHANGE COMMISSION,
WASHINGTON, DC, ACCOMPANIED BY JOHN R. STARK, CHIEF, OFFICE OF
INTERNET ENFORCEMENT, DIVISION OF ENFORCEMENT, SECURITIES AND
EXCHANGE COMMISSION, WASHINGTON, DC
Mr. Walker. Thank you, and good morning, Chairman Collins.
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\1\ The prepared statement of Mr. Walker appears in the Appendix on
page 139.
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I am Richard Walker, the Securities and Exchange
Commission's Director of Enforcement. We commend you, Chairman
Collins, and this Subcommittee for holding today's hearing. The
hearing focuses on one of the greatest challenges that we
regulators face today, and that is policing the Internet.
It is a problem that has grown in magnitude and promises to
command ever more of our time, resources, and ingenuity in the
years ahead, and we are pleased to share with you what we have
been doing in this area. We are very proud of the
accomplishments that we have made so far, and we would be happy
to respond to your questions.
I understand that today's hearing will be broadcast
worldwide on the Web, and with that spirit in mind, we have
prepared a computerized PowerPoint presentation for the
Subcommittee.\1\
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\1\ See Exhibit No. 2 in the Appendix on page 318.
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I would like to begin with a brief overview of my
testimony. I am going to first talk about the types of
securities frauds that we have been seeing on the Internet.
Then I will discuss briefly the SEC's response to combatting
fraud on the Internet, and finally, I will talk about some of
the current and future regulatory and enforcement challenges
that we are grappling with.
To put things in the proper perspective, I think it is
appropriate to say a few words about the phenomenal growth of
the Internet. There are currently about 150 million Internet
users worldwide. That number is expected to double this year
alone; by the end of the year, there will be about 300 million
users.
Thirty-seven percent of all retail trades are currently
done on-line. That number is up from about 17 percent in 1997.
The Internet has unquestionably provided valuable benefits
to investors. It has enabled Internet users to directly
communicate with all reaches of market participants,
shareholders, officers and directors of public companies, and
other investors.
It has also provided direct and instant access to market
information 24 hours a day, 7 days a week, which is another
terrific benefit for investors.
The Commission itself has made vast amounts of information
available over the Internet through its Edgar database, which
is available on our Web site at www.sec.gov. Unfortunately,
with the rapid growth of the Internet, we have also seen an
increase in fraud on the Internet. This has emerged as a
considerable challenge for our division.
We have brought so far 66 cases since we first began
surveilling the Internet in 1995. Thirty-eight of those cases
were brought last year in 1998. All of the cases allege fraud.
They are serious cases.
Now, what is Internet fraud? There is nothing new on the
Internet. We are seeing the same scams, just a new medium. As a
result, we have seen phony offerings of securities, pyramid and
Ponzi schemes, market manipulations which we call ``pump-and-
dump'' schemes, and unlawful touting.
Now, Internet schemes can often be quite exotic, as
witnessed in some of the first cases that we brought. For
instance, we saw a scheme involving a partnership to sell eel
farms. Another one involved coconut plantations which
manufactured Coco Loco Chips.
I think as both Chairman Collins and Senator Levin
indicated yesterday in their opening remarks, the Internet
provides an aura of legitimacy and credibility which allows
these schemes to take place.
One of the more recent schemes that we saw was the
exploration of near-earth asteroids in a case called SEC v.
Spacedev. Now, not only can Internet schemes be exotic, they
are also quite complex.
One recent case involves a foreign currency trading scheme
which raised $3.7 million from over 40 investors. Another
involved the sale of prime bank securities, which raised $4
million from another small group of investors.
One of the favorite tools for those now engaged in market
manipulation is the Internet. We have seen at least 18 market
manipulation cases on the Internet raising billions of dollars.
The SEC has adopted a five-pronged approach to combatting
fraud over the Internet. The first prong is aggressive
surveillance, principally through our cyber force of volunteers
throughout the country. We also engage in vigorous prosecution.
Investor education is another key prong of our program. Liaison
with other law enforcement officials at both the Federal and
the State level is the fourth prong. We have worked closely
with the FBI, the Secret Service, the States, and increasingly
criminal prosecutors. And finally, self-policing, principally
through our Enforcement Complaint Center. We have operated our
Enforcement Complaint Center since 1996, and it is available on
our Web site.
We currently receive, as Chairman Collins noted, between
200 and 300 messages a day. About half of the messages that we
receive relate to existing investigations, and those are
quickly transmitted to the staff that is handling those
investigations. Overall, about 70 percent relate to fraudulent
conduct on the Internet.
Now, the Enforcement Complaint Center provides a user-
friendly complaint form for people to fill out or people can
make their own messages and E-mail them to us. This is an
example of our enforcement complaint form.
Our Web site also contains valuable investor education
materials, such as this cyber alert which contains tips for on-
line investing.
Another investor education posting offers valuable advice
regarding investing in micro-cap stocks, which is, I know,
another concern and interest of this Subcommittee.
At the SEC, we have been patrolling the Internet since
1995. Recently, we created an Office of Internet Enforcement to
focus, coordinate, and expand our internal enforcement efforts.
The office was formed in July 1998. I believe that there
has been some misconceptions about exactly what this office
does.
The office is currently staffed by three individuals who
are all Internet experts, and we intend to grow that staff over
the years ahead. But the three people that staff this office
are not the sum and the total of the SEC's commitment of
resources to fighting fraud on the Internet.
We have an enforcement staff of approximately 850
nationwide who bring all kinds and manner of cases, including
cases involving Internet fraud. It is the duties of the Office
of Internet Enforcement to coordinate the activities and to
provide assistance to our larger staff throughout the Nation.
In addition, the Office of Internet Enforcement oversees
our 125-person cyber force, also located throughout the
country, that conduct surveillance. And finally, it manages our
Enforcement Complaint Center, where it receives, attends to,
and promptly dispatches the complaints that we receive.
Now, one of the first dividends of establishing this office
occurred this past October when we brought a coordinated sweep
of cases on October 28, 1998. The sweep was the first
systematic operation by the SEC to combat Internet fraud. It
was coordinated by the Office of Internet Enforcement, but
involves a nationwide attack with cases brought by our
headquarters office and all of our regional offices throughout
the country.
The focus of the sweep was on illegal touting. Now, what
makes touting a security illegal? The law provides that it is
unlawful to publicize a security if you are being paid to do
so, unless you disclose three things. The first thing is the
nature of the compensation you are receiving, whether it is
cash or whether it is stock. The second thing is the amount of
compensation, and the third is the source of the compensation,
presumably from the company that you are touting.
Our sweep was highly productive. We filed 23 cases on the
same day against 44 different respondents and defendants. The
respondents and defendants included all major participants in
the Internet--authors of spam or junk E-mail, on-line
newsletters, message board postings, and Web sites.
The totals were quite eye-opening. The touters received
from micro-cap companies more than $6.2 million in cash alone,
plus more than 1.8 million shares of stock and options which
had potentially unlimited value. Touters also touted more than
235 micro-cap companies.
The sweep achieved the intended results. It sent a powerful
message which was heard loud and clear and which has resulted
in substantially improved disclosures. We have checked the
disclosures very carefully subsequent to the sweep, and we
found that people have heard the message that we have sent and
they have improved substantially the disclosures. The
disclosure is not at the point that we would like to see it,
but it is better. We continue to be vigilant.
We also received a record number of visits to our Web site
when we announced the sweep, particularly to our consumer and
investor alert on on-line investing.
We also got a surge in messages to our Enforcement
Complaint Center. Before the sweep, we were receiving about 120
a day. In the few days following the sweep, the number went to
800 to 900, and it has now settled back to 200 to 300.
The sweep also created a very positive buzz among Internet
users. They were aware of what we did, and I think that they
learned from the message we were sending. That is evident from
the following message, which is an example of one of the
messages we received after the sweep.
Notwithstanding improved disclosure in this area, our work
is not done, and we are going to continue to be vigilant. The
best proof of that is a follow-up sweep which we announced just
recently on February 25. We brought four more cases involving
unlawful touting against 13 defendants and respondents who had
touted 56 different companies without making proper
disclosures. The kinds of frauds I have discussed so far are
not new. They have been around for many, many years.
In addition, we are looking at existing and currently
evolving types of conduct to which we call the new frontiers.
Those include things which have been widely discussed in the
press--on-line trading and day trading.
We have identified approximately 100-plus firms that are
engaged in on-line trading, and we define on-line trading as a
situation where the Internet simply substitutes for a
telephone. Rather than telephoning in an order, an investor
uses the Internet to transmit the order to a broker, who
executes the order.
We have several concerns in this area. The first concern is
operational capacity. Are the firms capable of handling the
orders that they receive? The second is the quality of
disclosure that the firms are providing. Are investors alerted
not only to the benefits, but also to some of the limitations
of on-line trading? And third is investor education. Do
investors know what they are doing? Are they at risk of losing
their money simply because they do not understand how on-line
trading works?
Distinct from on-line trading is a phenomenon called day
trading. By day trading, we refer to firms that do one of three
things. Either they provide direct access to markets, they
train people, or they make recommendations to individuals who
are engaged in what we call day trading. Day trading is a
strategy of rapid buying and selling to take advantage of small
price movements during the course of a particular day. Most day
traders buy and sell during the day and do not carry overnight
positions.
We have a number of concerns which we have identified with
respect to day trading. They include: Are the margin
requirements of the law being satisfied? Are borrowing limits
being exceeded? Second is disclosure and suitability. Are
recommendations complete and consistent with an investor's
ability to bear risk? And third, finally, are registrations to
provisions requirements being met? Should any of these entities
that are engaged in this kind of activity be required to
register with our agency and be subject to the protections of
the Federal securities laws?
I see that I have exceeded my time, but at this point, I
will----
Senator Collins. You are free to finish.
Mr. Walker [continuing]. Conclude, and I appreciate the
opportunity to respond to any questions that the Subcommittee
has.
Thank you very much.
Senator Collins. Thank you, Mr. Walker.
If you did have some additional points you wanted to make
right now, please feel free to do so.
Mr. Walker. That concludes my opening remarks. Thank you.
Senator Collins. Thank you. Mr. Hildreth, welcome.
TESTIMONY OF PETER C. HILDRETH,\1\ PRESIDENT, NORTH AMERICAN
SECURITIES ADMINISTRATORS ASSOCIATION, INC., WASHINGTON, DC
Mr. Hildreth. Thank you, Chairman Collins.
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\1\ The prepared statement of Mr. Hildreth appears in the Appendix
on page 179.
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I am Peter Hildreth, Director of Securities Regulation for
the State of New Hampshire and President of the North American
Securities Administrators Association.
I am pleased to have the opportunity to present the States'
perspective as you examine the issues related to securities
fraud on the Internet, as well as on-line trading issues, and I
am especially happy that you also have a representative from
one of our more active States in that area. I am sure Phil
Rutledge will do a good job for us.
As you pointed out yesterday, the legitimate business
opportunities for financial services on the Internet are
unlimited. At the same time, however, the risks for fraud are
great. With a click of a mouse, con artists can reach tens of
thousands of people via E-mail literally for pennies. They can
hide their identities and locations through fictitious names,
multiple aliases and remailers. Because the Internet is so
cheap and reaches so many people, truly any con artists not on
the Internet should be sued for malpractice.
Given the size and growth of the Internet, regulators
cannot police it alone. It is like expecting one precinct house
to patrol all of New York City. State and local governments
have limited resources and defined jurisdictional boundaries.
That is why we have asked investors to become partners with us
in the fight against securities fraud on the Internet.
When I became NASAA President last fall, I announced NASAA
would create a new E-mail address for investors to report
suspected Internet securities fraud. The address is cyberfraud
at nasaa.org.
In just 4 months, we had received over 4,700 unsolicited E-
mail messages, or spams. The two messages that you have before
you today are typical, and they contain uncanny similarities.
An informed investor would be very skeptical about such
hyperbole. Both messages contain claims that are not supported
with data. Who is recommending the stocks? Who is rating the
stocks? There is no disclosure of such information, but these
messages are on the Internet with a link to Yahoo!, the leading
search engine, which lends them an air of credibility.
State securities regulators have been policing Internet-
based investment scams for years. One great advantage of State
securities regulators is their authority to use an undercover
operation to detect fraud on the Internet.
My written testimony elaborates on various actions brought
by a number of States since 1994, but last fall, NASAA and 30
State and provincial jurisdictions participated in the Internet
Investment Opportunities Surf Day looking for suspicious or
fraudulent investment opportunities. Also taking part in the
Surf Day were regulators from the FTC, the CFTC, and the NASD.
Just 2 weeks ago, NASAA joined with other Federal, State,
and local law enforcers to announce 33 law enforcement actions
against 67 defendants promoting Internet pyramid schemes.
My advice to investors going on-line is ask yourself, if it
is such a great money-making idea, why is someone telling
100,000 of their closest friends about it on the Internet.
Never make a decision to buy or sell an investment product
based solely on information you read on the Internet.
There will never be enough regulators to keep the on-line
world free of fraud and abuse. Investor education is the key to
protecting investors on the Internet.
Here are some tips that we offer. Do not expect to get rich
quick. Do not buy thinly traded, little known stocks on the
basis of on-line hype. Do not get suckered by claims about
inside information, and certainly, call your State or
provincial securities agency.
Turning briefly to on-line investing, an estimated 5
million investors have on-line brokerage accounts, and that is
expected to top 10 million by the year 2000.
Not surprisingly, the on-line brokerage industry is
experiencing growing pains. Regulators have been bombarded with
complaints from investors stemming from outages and computer
glitches at major on-line brokerage firms.
On February 7, the State of New York announced an inquiry
into on-line trading firms to find out about their computer and
network capacity, contingency plans, customer complains, and
how orders are processed and executed.
State regulators have also issued the following tips for
investors venturing on-line, and they are included in a
brochure that we have distributed. I think there are copies in
the back.
First, call your State securities regulator to see if the
firm is properly registered or has a disciplinary history.
Carefully read the customer account agreement. Know your
rights. Learn how the software works before you make your first
trade. Know where to go if you make a mistake or have a
problem. Remember that technology can fail. In volatile
markets, your order could be delayed, and you may not get the
price you want. Consider using limit orders instead of market
orders.
In conclusion, State securities regulators are committed to
protecting investors and preserving the integrity of the U.S.
capital markets. NASAA appreciates the interest you have
demonstrated in exploring all of these issues, and we are
committed to working with you as your fact-finding continues.
I, of course, will be willing to answer any questions.
Senator Collins. Thank you, Mr. Hildreth.
Mr. Rutledge, welcome.
TESTIMONY OF G. PHILIP RUTLEDGE,\1\ DEPUTY CHIEF COUNSEL,
PENNSYLVANIA SECURITIES COMMISSION, HARRISBURG, PENNSYLVANIA
Mr. Rutledge. Thank you. Madam Chairperson and Members of
the Subcommittee, my name is Philip Rutledge, and I serve as
Deputy Chief Counsel to the Pennsylvania Securities Commission.
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\1\ The prepared statement of Mr. Rutledge appears in the Appendix
on page 219.
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The Subcommittee is to be commended on the timeliness of
these hearings on securities frauds on the Internet, and I am
grateful for the opportunity to comment on Pennsylvania's
experience.
Nineteen-hundred-ninety-five also was a watershed year for
the PSC because we became involved in our first three
securities fraud cases where Internet was used to solicit
investors. Those cases dealt with fraudulent and misleading
statements posted on Internet to solicit investors in purported
coconut groves in Costa Rica, nonexistent offshore hard-
currency bonds, and allegedly patented therapy to treat AIDS.
These early cases, investigated jointly by PSC and SEC,
also serve to highlight the cooperation necessary between State
securities regulators and SEC to combat securities frauds on
Internet.
Actions related to securities frauds on the Internet now
account for approximately 20 percent of our enforcement
caseload. I expect this percentage to continue to increase as
more persons obtain personal computers and Internet access.
More recent PSC Internet-related cases have involved pure
contract trusts paying 70 percent annual interest, purported
investments in electric utility licenses, and secured notes
paying 30 percent annual interest.
We also have secured State court injunctions against
entities using Internet to solicit investments in an offshore
virtual casino and in an organization promising investors a
100-percent return of their money through offshore transactions
and investments in diamond fields, gold mines, and oil wells.
To combat securities fraud on Internet, I believe
regulators need to focus on several areas; first, regulatory
and statutory changes. A new Pennsylvania law now automatically
treats violations of PSC enforcement orders as civil contempt
with penalties of up to $10,000 per violation, and we have used
this new law in an Internet-related case. This same law also
provides special punitive administrative assessments for people
who use telemarketing which we believe includes Internet, and
we also have the ability to bar individuals from the securities
business, including being promoters of new issuers. These bars
may be temporary or they may be permanent.
Second, dedication of resources. PSC has dedicated full-
time legal, investigative, and importantly, information
technology staff to Internet cases, and have substantially
upgraded its computer capabilities, including high-speed
Internet access.
States have the right to conduct undercover surveillance in
the securities areas, as they do in other areas, and we adhere
to guidelines established by the courts to conduct these
operations.
Third, investor education. On the PSC Web site, we
disseminate investor alerts, and there is a handout which shows
some of these, but I will just briefly scroll through them. The
first is an investor alert concerning warning seniors about on-
line investing. That was issued in July 15, 1998. These are all
available on our Web site at www.psc.state.us.
We also publicize recent enforcement actions. So, when we
take an enforcement action, we immediately put it up on our Web
site. Here is our recent enforcement actions, and there is a
cease-and-desist order which we issued against Reliable
Electric and Power, which was using the Internet to solicit
investors in Pennsylvania.\1\
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\1\ See Exhibit No. 3 in the Appendix on page 323.
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We also provide links from our Web site to other investor
protection Web sites such as the National Fraud Information
Center, the National White Collar Crime Center, the SEC, NASAA,
and the Investor Protection Trust, which provides investor
protection information. So, from our site, you can link to
other sites.
Importantly, we also have a mailing list where you can sign
up to register with us, and we will send you an automatic E-
mail when we have updated our Web site. So, if you are looking
for new enforcement activities, or whether you are looking for
investor protection information, you will be automatically
notified.
Fourth, regulatory cooperation. PSC participates in
regularized Internet sweeps with SEC and other State securities
regulators, as well as the Federal Trade Commission. This
cooperation must be broadened to include industry and foreign
regulatory authorities.
One of the most important actions, however, which can be
taken now to help protect investors from securities fraud on
the Internet is making the information maintained in the
central registration depository accessible to public investors
via a Web site. Investor protection would be well served if
investors had this information available to them at a click of
a mouse while they are surfing the Internet. The best way to
counteract a fraudulent investment scam on Internet is to
provide a quick and easy way for an investor to perform a
baseline check with CRD of the company or individual promoting
the stock or investment.
Unfortunately, public access to CRD information via the Web
appears in jeopardy because the National Association of
Securities Dealers, which operates CRD, believes that current
Federal law relating to civil liability for public release of
CRD information does not apply to dissemination of the same
information via a Web site. I would urge Congress to enact as
quickly as possible whatever statutory amendments NASD believes
necessary to give investors access to CRD information via the
Web as soon as possible.
Internet is coming into the homes and businesses of
millions of Americans at a time of a booming stock market and
economy fueled by consumer spending and a shifting of
responsibility for retirement saving from employer to employee.
Internet is changing the way Americans approach investing.
We need to be alert to these changes and the ramifications they
have on investor protection.
Thank you very much for the opportunity to testify before
the Subcommittee.
Senator Collins. Thank you very much, Mr. Rutledge.
First, I want to start by commending both the SEC and NASAA
for the actions that you have taken to try to get a handle on
this burgeoning problem. It is evident from the testimony we
had yesterday and from your descriptions of some of the scams
that you have taken action against that there is no end to the
ingenuity of the con artists who are preying on people via the
Internet.
My concern is that their reach is so much further and it is
so much less expensive than it used to be in the old-style
scams of filling up a boiler room with telephone operators who
are calling families one on one at dinner time; that now we
have a situation where, with the click of a mouse, a scam
artist can reach literally millions of potential victims.
Mr. Walker, in the hearings that the Subcommittee held on
micro-cap fraud in 1997, in the fall of 1997, the SEC's
chairman testified that the SEC's enforcement staff was
severely strained in its effort to detect and prosecute micro-
cap securities fraud. Since that time, we have seen an
explosion of Internet fraud that seems to be taxing the SEC's
resources still more.
Another issue that the GAO testified about yesterday is the
problem of attrition among the experienced enforcement staff. I
believe, for example, in the SEC's New York office that half of
the attorneys who are experienced attorneys have left for more
lucrative private-sector employment.
The combination of the chairman's testimony back in 1997
and the GAO's testimony to us yesterday raises the concern in
my mind about whether the SEC's resources are adequate to deal
with this new medium for perpetrating fraud and also the
related question of whether they can ever be adequate, no
matter how many more resources we give you.
Could you commend on that issue and whether there are steps
other than additional resources that the SEC could take to try
to keep up with this problem?
Mr. Walker. Certainly, Chairman Collins.
We are certainly challenged, if not strained, by the
increase in fraud on the Internet. I believe that we have been
highly effective through the use of leverage. We try to use the
resources that we have to the greatest possible advantage. We
have done that by trying to bring ``sweep'' type of cases where
we have been able to have a large impact and really send a
strong message at one time, but, unquestionably, as Internet
use continues to grow, I expect that fraud will also continue
to grow on the Internet as well. We are certainly going to have
to assign, and we intend to assign, more resources to fighting
fraud over the Internet.
What this means is that we have to rob Peter to pay Paul
and take resources away from other areas, unless, of course, we
do have staff increases, which I am hopeful that we will be
able to do through the appropriations process with Congress.
But, certainly, we do have to use our staff very effectively.
We have to leverage every single resource that we have to the
maximum extent possible.
We have also found very great success in working with our
fellow regulators, both at the State level and the Federal
level. Through sharing information, oftentimes with criminal
prosecutors who really have the biggest clubs of all of us, we
have been able to, I think, achieve some real deterrence.
Certainly, it has been my experience in the micro-cap area that
the greatest deterrence that we have achieved has been through
the threat of criminal sanctions to people who oftentimes are
undeterred by the prospect of an injunction or a cease-and-
desist order.
Unquestionably, going forward, we are going to have to see
what we can do to enhance our staff in this area because I
expect the problem will continue to grow.
Certainly, there are some legislative possibilities that
could be of great assistance to us and could help us in terms
of the remedies that we have available to us. Too often, we see
some of the same people coming back into the industry who we
have sanctioned in other capacities. One of the things that we
have no jurisdiction over is people who act as promoters. The
promoter population has been growing rapidly. It is also
probably a pretty bad gene pool. Many people in this area have
been previously sanctioned. Some have even been thrown out of
the industry in terms of being associated with the broker-
dealers and other entities.
To the extent that we could get and obtain remedies that
would bar them from acting as promoters in micro-cap type of
offerings, that would be a very effective remedy.
Another thought--forgive me for going on, but since you
asked for a Christmas list, it is a good occasion to do so. We
do not currently have the authority to use State law
enforcement decrees and remedies at the Federal level. We can
access the State's files, and that is very effective and very
useful, but then we have to do our own investigations and bring
our own cases. If we have the authority to use findings by a
State securities administrator as a basis for a disciplinary
proceeding, that would really help us be able to bring cases
much faster and cut out a lot of the intermediate levels.
I might say that it has been very successful when it has
worked the other way. Oftentimes, State securities
administrators can take temporary restraining orders or
preliminary injunctions that we obtain and immediately suspend
someone from doing business in the State. That is a highly
effective remedy. I think if we had greater authority to use
State court and State securities regulator decrees, that would
be very helpful as well.
So those are some of the things I think that would really
enable us with the resources that we have to enhance our
ability to deter fraud in this area.
Senator Collins. That was a very helpful summary of some of
the issues that I would like to get into and in more depth.
I do invite you, and it is rare for a Member of the Senate
to invite you to give us a wish list on your appropriation
needs, but I am doing that as well, and also whether there is
an issue of the pay and classification of the attorneys
because, if you cannot keep your experienced staff, that to me
is equally as serious a problem. So I would welcome your
suggestions in that area as well, as we seek to put together a
legislative package to deal with some of the issues in this
area.
I want to go back to the issue you raised of what I call
rogue brokers who go from one firm to another. I saw this when
I was working at the State level and the frustration that it
caused my securities regulators, and also the regulators in the
other financial areas in my department, insurance, for example,
where we would have someone who would be barred from selling
securities, switch over and sell life insurance. So I think
there is an issue there as well.
Just for the record, I want to flesh out this issue. Am I
correct that under current securities law, the SEC can bar a
registered securities professional from serving in that
capacity and from participating in any future penny stock
offering, even as a promoter, or is there a gap on the promoter
part?
Mr. Walker. We have the authority to bar someone under our
penny stock rules and statutes only from participating as a
promoter in connection with penny stock activities. We do not
have the authority to bar someone, for instance, who is
associated with a broker-dealer from also participating as a
promoter for a penny stock entity. So it is only with respect
to penny stock-related cases that we can bar someone from being
a promoter.
Senator Collins. In the previous hearing held by the
Subcommittee focussing on micro-cap stocks, we found that
people who had been barred from dealing with penny stocks were
shifting over and acting as promoters for micro-cap stocks. Is
that correct? Is that a loophole in the current law?
Mr. Walker. Well, that is certainly correct. There has been
a migration. The penny stock rules typically apply to stocks
that sell for $5 or less. So it is very easy for someone that
wants to evade the scope of a penny stock bar to simply promote
a stock for $5.50. So there has been creep in terms of the type
of dollar level in which fraudulent activity has occurred.
Enlarging the scope of the penny stock rules would be another,
I think, very useful possibility for Congress to address.
Senator Collins. Indeed, at least one of the cases in your
February sweep, involved a repeat offender of micro-cap fraud.
Is that correct?
Mr. Walker. That is correct.
Senator Collins. It seems to me that we need to crack down
in this whole area. I suggested to Chairman Levitt that we have
perhaps a zero tolerance rule; that instead of giving people
chance after chance or letting them migrate from one kind of
stock to another or one financial field to another that we have
a one-strike-and-you-are-out rule.
I had asked at that time, and it has been quite a bit of
time since that hearing, whether the SEC would consider
supporting that kind of enforcement action, where we would bar
someone forever for dealing in the securities field. What is
your reaction to that proposal?
Mr. Walker. Well, I would not want to speak on behalf of
the agency with respect to that, but I must say that the agency
has been very tough. I think that the level of sanctions in
this area has been increasing.
The Commission takes this message very much to heart, and I
think has been imposing and expects the staff to seek very,
very harsh and appropriate sanctions to the worst of the
violators. This is so because we recognize that so many people
who are barred and serve their time or who are barred in some
capacities end up coming back into the industry in other
capacities. So it is certainly something that I think we should
give very serious consideration to.
Senator Collins. Mr. Hildreth, do you have a comment on
that proposal?
Mr. Hildreth. Well, I was going to comment that one of the
things that we do in New Hampshire--and we do not have a large
staff, but we have one very capable woman who goes through the
licensing--we keep people out of selling in New Hampshire who
have those kind of disciplinary histories when we check the
CRD.
Occasionally, we let them come in with special supervision,
but usually if there is the rouge broker story in The Wall
Street Journal or the New York Times, Mary will come into my
office with a printout and say, ``Kept him out, kept him out,
kept him out, was not quite enough to keep this guy out, but I
had a bad feeling about him.'' So it goes back. I think, also,
we use that.
Another State took action against him. The SEC took action
against him. It goes back to the comment that Dick Walker made
about using State actions. It is a very effective tool for the
States to use, and I think that the SEC and NASAA would
certainly support it being extended to them, not just in the
Internet area.
Senator Collins. Mr. Rutledge, do you have any comment on
that issue? Has that been a problem in your State where people
pop up from one firm to another?
Mr. Rutledge. Indeed, and we took action with the new law,
effective in January of this year, where the Commission as an
administrative agency has the authority to ban for temporarily
or permanently any person from acting in the Commonwealth as an
issuer; acting as a promoter, officer, or director, or a person
trying to offer to sell securities; from being registered as a
broker-dealer, investment advisor, investment advisor
representative or a registered representative, or as an
affiliate of such person; or relying on any exemption from
registration under State law. This is our response to your zero
tolerance idea.
It is not a statutory mandate that everybody who has an
infraction is out of the industry, but it places the burden on
the regulator because they know best as to how bad this person
was.
We also borrowed a provision from the Federal Penny Stock
Reform Act and put liability on individuals who knowingly
employ barred individuals to act in that capacity.
So, if you are a legitimate person, but then you hire a
person who is banned from being a promoter to promote your next
stock, you also are liable under our statute.
Senator Collins. It seems to me that if we can prevent the
people from being in this field, that that is a lot easier than
trying to chase after the fraud after it has been committed.
I know that in Maine, as well as in New Hampshire, that we
placed a lot of emphasis on the registration and licensing, the
provisions to try to keep people out who did have a history. We
would check the CRD and see if there were other State actions.
Mr. Hildreth. One of the things that the new Web CRD--it is
supposed to come on-line in August--is to allow us to track
people from those bad firms so that we know where they went.
You have seen the charts where they track them, but that is a
lot of manpower. If we can do it with a ``click of the mouse,''
as is the phrase, it is going to help us find those people,
where they went, and if not take action, at least have a flag
there to keep an eye on them.
Senator Collins. Mr. Hildreth, let me follow up on an issue
that Mr. Walker raised, which I think is a very good idea and
something that Congress should give the SEC the authority to
do, and that is, as I understand current law, as Mr. Walker
explained, the SEC cannot make use of State findings when
bringing its own enforcement actions.
If the SEC had the authority to follow up on State actions,
presumably, the SEC could bring quick-hit actions with greater
remedies against violators of securities laws, and it seems to
me that that authority would be very valuable, especially since
in New Hampshire or Pennsylvania, you cannot bar someone from
going to another State. Only the SEC can take the kinds of
national action that is needed.
So I would like to hear from Mr. Hildreth and Mr. Rutledge.
Would NASAA and the State regulators support giving the SEC the
authority to act based on State actions?
Do you see any problem with our changing the law to allow
that, Mr. Hildreth?
Mr. Hildreth. I do not see any problem at all.
As I have mentioned, the States use it very effectively. I
think you may hear from some people that, well, how do we know
that these are going to be real hearings on the State level.
I can tell you from my perspective that when I run a
hearing, I am very careful to watch out for due process rights,
give the people we bring in, the respondents, all of their
rights, but these actions when we revoked--New Hampshire
happened to be the first State that revoked a company called
Investors Associates, I think, as part of the micro-cap sweep.
When we did, we held a full hearing. We revoked them. It
allowed other States to take action with them, who may have had
pending actions or pending complaints, but had not had enough
evidence to do anything, for them to take action and stop them
from selling in their State.
I think and NASAA, I am sure, would be willing to testify
in favor of any legislation necessary to give the SEC that
authority because, as you said, it is very quick and effective.
In this world, there is nothing better than acting quickly.
When they can, as you said, hit that mouse and it goes to
everyone, every day, every hour that goes by, there is another
potential victim there who is going to lose money.
Senator Collins. Mr. Rutledge, do you see any problem with
giving the SEC the authority to act based on State actions?
Mr. Rutledge. I think it is a very common-sense approach to
the use of our admittedly limited resources to have SEC have to
duplicate an investigation when they can rely on a State court
injunction or an administrative adjudication. I just think it
makes plain regulatory sense.
Senator Collins. I also think this issue is of growing
importance, given the use of the Internet, because the Internet
expands the reach of these con artists so much that for one
State to try to tackle the issue, it protects only the
residents of that particular State. So it seems to me that
giving that authority--I will say that when I look at the
enforcement actions taken by the State and the SEC, it only
reinforces my belief of the importance of having both
regulatory systems. I know that has been an issue in the past.
When we are looking at the goal of protecting consumers, it is
very clear to me that we need aggressive actions on both the
State and the Federal level and a lot of cooperation between
the Federal and State level as well.
I would now like to turn to some of the issues that were
raised at our hearing yesterday to get your reaction to some of
the suggestions that were made by our witnesses.
We heard yesterday from the founder of the on-line
financial forum, The Motley Fool, about the extensive efforts
that The Motley Fool undertakes to monitor its on-line chat
rooms and bulletin boards.
In particular, The Motley Fool very aggressively
discourages speculation or talk of--I guess the word is
``chat''--about penny stocks. The Subcommittee's investigation
has found that the efforts taken by The Motley Fool are not
common; that Yahoo!, for example, undertakes virtually no
monitoring or policing of its financial chat rooms or bulletin
boards.
I would like to get all three of you to comment on the
issue of whether or not on-line financial forums should be
responsible for policing or monitoring their chat rooms and
bulletin boards.
Mr. Walker, I will start with you.
Mr. Walker. Thank you, Chairman Collins.
I do think that it is reasonable to have some
responsibility and authority placed at that level. Certainly,
the most effective law enforcement is law enforcement that
occurs at various different levels. I am not suggesting that
they would act as law enforcement, but they are the first
layer, where the rubber meets the road, if you will. It is the
first level of defense for these people to see what comes in
their own chat rooms. So I applaud The Motley Fool for their
efforts to do that, and I think that is certainly very helpful
in terms of providing a sense to others as to what kinds of
things are going on. The earlier that we can find out about
situations like that, the better equipped and better prepared
we are to address those kinds of situations. Time and speed are
sometimes of the essence before investors are injured and
before fraudulent messages and fraudulent information gets
disseminated. So I think that is an excellent idea.
Senator Collins. Has the SEC had any discussions with on-
line financial forums to encourage this kind of monitoring or
policing of the bulletin boards and chat rooms?
Mr. Walker. I am probably not the right person to ask that
question because I guess, when they hear from me, they do not
appreciate it. But I think that those activities are probably
more likely through our Division of Market Regulation, but I
honestly do not know the answer. We would be pleased to provide
you with that information.
Senator Collins. If you would get back to us.
Mr. Walker. Certainly.
Senator Collins. Mr. Hildreth, what do you think the
obligation is of the sponsors of these forums?
Mr. Hildreth. I think there will be a hesitancy on some of
those sponsors. Given the sort of gray legal areas that are out
there, they are going to probably be asking you for some sort
of coverage for liability.
I know there has been some cases. There is a securities
case, and I apologize I do not have it in front of me, that
dealt with someone supposedly defaming one of these micro-cap
companies, and I think it was settled before hearing.
I think that they do have a role to play. I read The Motley
Fool's testimony last night, and he talked about how there is a
role when it is brought up that the Internet citizens, I guess,
will come out and say, ``Oh, do not do that. Make sure you go
do this.'' So there is some self-policing there, also.
My concern would be whether you can--what has faced
Congress before. How do you regulate the Internet? If you have
all of the U.S. providers and you force them to regulate this,
someone sets up who knows where and just connects in and we are
not going to have any jurisdiction over them.
So I think that while it may be something to look at, if
there is a way to get them and maybe just PR forcing them to do
it, it is just so wide open. It is the wild, wild west. If they
cannot get it from Yahoo!, they will go somewhere else, I
guess. That is my gut feeling.
Senator Collins. On the issue of liability, we did receive
testimony yesterday from Professor Friedman, who is a
securities expert from the University of Toledo, who said that
current law makes it clear that there is not liability. I know
that is an issue that has been raised, but perhaps a variation
of this is to have the on-line financial forum disclose if they
are not monitoring or policing the chat rooms. In other words,
that at least there is disclosure one way or another, and so
much of our securities laws are based on disclosure.
I, too, share a reluctance for Congress to be heavy-handed
in regulating the Internet. On the other hand, I am also
disturbed by the fact that people tap into access these chat
rooms, get this hyped information, and think that somehow it is
valid. So it is a difficult balance, and maybe the answer is
that if there is no monitoring or policing of the chat room,
that there be a disclosure up front that that is the case.
Mr. Hildreth. What is interesting to me is that it is not
even, though, the chat rooms. It is sort of like they use other
areas of the Internet to get access to an investor.
The one that was my own experience, I have my own AOL
account. I signed on 1 day, and it said something about spring
and seeds. My wife likes gardening. So I went to their free
shop.
Well, I never got to find out what that offer was because
the first thing that caught my eye was: ``Alaska gold . . .
Texas oil.'' And sure enough, it was unregistered, and I
finally got the person at AOL, their legal department, said who
I was, and to their credit, it immediately came off. I mean
within 30 minutes of when I had called them, it was gone, but
as a result of that, they sold the list to someone else, and I
am sitting at my desk in my office. The secretary says Mr. So-
and-So is on the phone. So I said, ``Oh, OK. Well, put him
through.'' This guy got the list and is trying to sell me
securities, unregistered securities, when they answer the
phone, ``Good afternoon. Bureau of Securities.'' I mean, they
do not care, but they use those lists. They use list serves.
They use bulletin boards, whatever, to get names to send you
mail and contact you. So it is a wild, wild west out there.
Senator Collins. Mr. Rutledge, do you have any comments on
whether you think there is some obligation for the on-line
financial forums to either disclose that they are not
monitoring the chat rooms or bulletin boards or to in fact
affirmatively monitor them?
Mr. Rutledge. I found it interesting from Mr. Gardner's
testimony yesterday, he kind of portrayed it as a public
service as on-line facilities where common folk can come and
discuss things. I think if you are taking that type of public
service approach, maybe as a public service, which The Motley
Fool is doing, where you know of problems or you are or are not
monitoring your chat rooms, that you should disclose that.
Because of the liability issues, it may evolve perhaps into
something of a code of best practices for on-line forum. That
could be developed, and you could link to it or you can say we
subscribe to the best practices which include monitoring, or we
do not subscribe to best practices, you are on your own, it is
a free-for-all.
I would like to ask for some free on-line advertising
banners to expose the regulators' Web sites to people who are
logging on for financial information. I think that would be a
great public service.
Senator Collins. Actually, there was one of the next issues
I was going to ask you about. Two ideas that surfaced at our
hearings yesterday were, one, to require there to be a link to
the SEC or NASAA or State Web pages, which, by the way, I
accessed yesterday and they are excellent. I think if a lot of
on-line investors would read the tips for investing that are on
the SEC or the NASAA Web page, they would save themselves a lot
of heartache and financial ruin.
One proposal is to encourage or require that to be that
link. Another proposal, which I suspect has some practical
problems, was suggested by both Professor Friedman and one of
our victim witnesses, and that was that there be some kind of
third-party verification that a Web page is legitimate.
Professor Friedman referred to an AICPA seal of approval,
if you will, that some Web pages are about to use if in fact
they have been audited and verified.
Are either of those suggestions practical, the link to the
SEC or NASAA Web pages, or having some sort of third-party
verification? The sheer volume is the issue to me.
Mr. Walker.
Mr. Walker. Certainly, first, with respect to third-party
verification, I read Professor Friedman's testimony and found
his idea to be an interesting and very potentially valuable
idea if it could be achieved.
I do not think that it can be achieved by the regulatory
community for the following reasons. First of all, the
authority for overseeing sales of securities is dispersed
between the Federal Government and the States, and no one
authority would be able to oversee all of the different kinds
of securities offerings. Some are registered with the SEC,
others with State, and some exempt from registration.
Also, I think the AICPA model that Professor Friedman
talked about was a situation in which someone actually
conducted some form of audit of the various Web sites before
they gave the seal of approval. That is not currently the way
securities registration at the Federal level occurs. We do not
audit the merits of the registration. We just simply provide
that the statutory requirements have been met. We take no
position on the bona fides of the particular securities being
sold.
It may be the type of service that could be done by the
private sector. It could be, if not a ``Good Housekeeping''
type of thing, somebody from the private sector that would have
the funds and the ability and be able to have the stature and
the reputation to do something like that, which would be a
terrific service for investors. If there was one central
person, even if you paid perhaps a modest fee or maybe the fee
could be achieved through some other sources, it would be a
great benefit for investors.
I am just skeptical as to whether it could happen at the
government level, either Federal or State.
Senator Collins. Mr. Hildreth.
Mr. Hildreth. I think that somehow either requiring or
promoting a link to an investor protection site is a great
idea, and it would seem to me that legitimate chat room
locations, any of those folks, should be more than willing to
do that because that is what they are really in the business
of. It is getting people educated to make educated decisions,
to keep the markets where they are today.
The third-party verification, I guess sometimes I think
like a scam artist. Wouldn't I be able to find someone who is a
good enough computer geek to take--I am not sure I should use
that term. I had better be careful, but to take that
certification and move it to my page, and then wouldn't I be
saying--someone would log on and say this is an OK site, they
have been verified? I do not know if that is technically
possible, but I will bet you somebody could figure out how to
do it. That is my real concern about that.
Once you give a mark that it means something, how do you
protect it?
Senator Collins. Mr. Rutledge.
Mr. Rutledge. Which is exactly our conclusion. We evaluated
using medallions at the Pennsylvania Securities Commission,
where we would issue a medallion to a Web site, because we have
a lot of legitimate small businesses who want to post their
prospectus on a Web site. We rejected it for those reasons.
If you issued it and then the Web page changed, it might
change legitimately, to change the address, or it might be
changed illegitimately to make alterations. It might be copied.
All of those concerns have led us to the conclusion that the
direction we are going is to put on our Web site a link to our
registration system, so that if you are looking at, for
instance, the lady from IPS, if she had been a Pennsylvania
resident, she could have clinked on our Web site, gone to our
registration list, and these companies have been registered
with the Pennsylvania Securities Commission. Depending on what
kind of offering it was in that particular instance, I believe
it was purported to be an exempt offering from registration
with the SEC. It would have to have been registered under
Pennsylvania law. So there would have been affirmative
registration.
Like SEC, we do not pass on the merits, but there is a lot
more substantive criteria that must be met for registration in
Pennsylvania.
So I think in the area of the Regulation A offerings, which
is $5 million or less, or the Rule 504 offerings, which are a
million dollars or less, both of which are exempt from Section
5 registration with the SEC and are registered at the State
level, that that would be a more bona fide check, was it
registered, and that way, the responsibility of the issuer for
keeping their Web page current and not misleading remains on
the issuer. So, if they changed it, we could take action
against them, but at least they know there was at least a first
cut, and they can always call us and say what about this
particular offering, did you register it, what were your
problems with it, or, more importantly, we never heard of these
people.
Senator Collins. It was told to me that both of our victim
investors yesterday were experienced investors, but they had no
idea that they could have called their State securities bureau
for assistance.
Mr. Rutledge. That is why we need banner advertising on
those Yahoo! sites.
Senator Collins. That is why I raised the issue because
both of them--one had been investing for 10 years, one for 5
years, and I remember when I was involved in this area in
Maine, we kept trying to do constant outreach so that people
would know, but it is very difficult to reach every investor.
In the case of Ms. Morris, yesterday, she tried to do some
due diligence steps. Had she called the California Securities
Division, which is where this offering was from, she would have
found that it was an unregistered offering, and would have
saved herself a thousand dollars.
We somehow need to do more, and I think the Internet is an
untapped resource in many ways, to make sure that investors
understand that there is information available, that there is
help available both at the State and Federal levels. In many
ways, I think the Internet, which is being used by these scam
artists, needs to be used more effectively by regulators to
educate investors.
One of the strengths of the Internet, which we keep talking
about, is it can reach so many people, and I would suggest that
is a strength for the regulators to use in educating consumers.
Mr. Hildreth, in your written testimony, you mentioned that
States are making more use of the Internet to try to get
consumer information out to investors. Could you tell us a bit
about the programs? I think that you mentioned that Ohio, in
particular, has a program that is very helpful.
Mr. Hildreth. I think that government has been slower than
the scam artists to use the Internet, and I guess part of that
is just the way governments work and how long it sometimes
takes us to get the technology that we need.
I think the one that you are talking about in Ohio is that
they are listing the bad boys, the ones that are selling in
their State who are not registered there, sort of an
affirmative step instead of having to call California, for
example, and ask, is this a legitimate offering. There is a
list that you can at least cross off. You might not get them
all because the State does not know until they get a complaint
sometimes who is selling in their State, but when they try to
do it, they get a complaint. They say, OK, it is very simple.
It is not registered. It is not exempt. It goes on the list.
I think there are several facets. NASAA, as you know,
probably from your days in the State of Maine, does a lot of
outreach, giving information to State securities regulators as
far as fill-in-the-blank press releases. We have done a lot of
those recently, and a lot of States have used them and local
people have picked them up and run stories on them. So there is
the press side of it, and those States, like Pennsylvania and
Ohio, as the two that come to mind, that very early got
involved in the Internet, probably have progressed further than
a State like New Hampshire who just recently got their Internet
access for their office. I am not sure what Maine is doing.
I do think that we should make more use of the Internet. I
think one idea is the banners. I think the States probably
need--and perhaps the SEC--they may be more restricted, but at
NASAA, we have sort of a nongovernmental site here, might be
able to do some negotiating with sites along those lines, to
cooperate with them.
I think we need to talk to groups like Yahoo!, like AOL,
some of the big-service providers, and work along those lines.
Senator Collins. I think that would be very positive.
What I like about the Ohio example is it names names. It is
very specific.
One example that I have is about an offering called
travelzoo.com, and it says, ``The Ohio Division encourages
investors who are considering obtaining shares in travelzoo.com
to exercise caution. Please consider the following. There may
be no dividend payments. There may be no current value to the
shares, nor may the shares ever be traded publicly or acquire
any future value. This company should not be compared to any
other technology or Internet company. Projected growth in the
use of the Internet will not necessarily result in future value
to the company,'' etc.
Any consumer who read that would be very unlikely to make
an investment in travelzoo.com, or if they did, they would know
what they were getting into, which is fine. The problem is when
investors do not understand the risks that they are
undertaking.
This strikes me as a very valuable proposal, and one that
also is very useful, because the consumer can do it right on
the computer. They do not even have to do the long distance
phone call.
Are other States moving in that area? Do you know, Mr.
Hildreth or Mr. Rutledge?
Mr. Hildreth. I would have to say that I do not know of
other States who have taken that step.
I will say they would probably get, at least in New
Hampshire if they called--they might get the same kind of
information, but as you said, if you are on the Internet doing
your trading, it is more comfortable for you to click that
button and go check it out. It is more my daughters and the
little older generation. They are better Internet citizens
probably than I am, but that is second nature to them, much
more than it is to me. When the investors get on there and do
those things, probably to sign off and call the agency is
almost an anathema. So I think it is a good idea and something
that we ought to talk about to other States, and I am trying to
think if I can get my Web master to work on that myself.
Mr. Rutledge. And they are doing it at 11 o'clock at night.
Senator Collins. Right.
Mr. Rutledge. The children are in bed. Our offices are
closed, but our Web site is open 24 hours a day.
Senator Collins. Exactly.
Mr. Rutledge. I believe there is an obligation on the part
of the regulators, us at this table and our fellow regulators,
to put as much information as possible on our Web site so the
public can access it.
As an example, we took an action against a company whose
executive officer had been banned permanently by the SEC with
any association with any securities dealer, or any securities
association and was subject to a permanent injunction of a
Federal court in New York. It was obviously not disclosed, and
spams sent to a Pennsylvania investor who did call the
Pennsylvania Securities Commission, but had that CRD
information--which is where we got that information--been
available on the Web. That person when he got the spam could
have clicked on the Web site, put in the person's name, and
found that this person was a bad person he should not do
business with.
Senator Collins. Mr. Walker, what is the SEC doing to use
the Internet beyond the investor tips, but as far as specific
people that the investor should be leery of?
Mr. Walker. What we have done in addition to the investor
alerts that I have described previously is, of course, to
publish every single enforcement action that we bring. That
information is available on our Web site--the names, the
companies, and the individuals that are involved in those
actions.
In addition, we have found from time to time that it is
very effective to post those releases in other locations where
the frauds have occurred. So, if there are areas on the
Internet where people have been solicited to buy particular
securities, rather than having them have to find a way to our
Web site, we have gone and posted temporary restraining orders
or preliminary injunctions on other Web sites where some of the
fraudulent activity has occurred. We found that to be
effective, too, because it gets right to the people who have
been victimized. But in all instances in which we bring cases,
the names of the individuals and entities are set forth, and
anyone that visits our Web site can find them going back.
Senator Collins. I think that is a step in the right
direction.
What appeals to me, however, about what appears to be the
Ohio example, which NASAA brought to our attention, is it seems
to be up front before there is an enforcement action. It seems
to be alerting people that if you invest, you are investing in
a very high-risk venture, and be sure you know what you are
getting into. Maybe that is a responsibility that is more at
the State level, but does the SEC do anything that is
proactive?
Mr. Walker. We do require those kinds of disclosures from
time to time with respect to offerings of securities that are
highly speculative and at risk, and those filings are available
also on our Web site through our Edgar database. So it is not
uncommon to see those kind of hair-raising disclosures,
particularly in some of the lower end of the kinds of offerings
where we see perhaps people have been disciplined in the past.
Those kinds of disclosures are made, and I think, are very
effective to let investors know the full risks of what they are
buying.
Unfortunately, we have found that notwithstanding that,
there are people that are still purchasing these kinds of
investments.
I think one other thing I would add is that one of the most
effective remedies we have is trading suspensions and where
there is inaccurate or incomplete information in the
marketplace. We are able to suspend trading in a particular
security for a period of up to 10 days. We do post notices of
trading suspensions in forums so that that information and
knowledge gets out, dispersed widely to some of the people who
have purchased or owned these kinds of securities.
Senator Collins. I would like to turn to another difference
between State and Federal enforcement efforts.
Mr. Hildreth, in your written testimony, you noted that the
great advantage of State securities regulators is their
authority to use an undercover operation to detect fraud on the
Internet. A State agency can establish an E-mail address to go
shopping for fraudulent Internet solicitations to obtain
information to pursue enforcement cases.
Are these kinds of undercover operations a large part of
State regulators' efforts to detect Internet fraud?
Mr. Hildreth. What I like about that is it seems to use the
Internet capabilities the same way the scam artists do. They do
not tell you who they are. They do not tell you where they are.
They use these remailers. They use aliases.
We can do the same thing, and it is simple on the Internet.
It is not like you have to get a phone line and work with the
phone company to get it listed to somebody else, although a lot
of States also do that and it is very lucrative.
Once you get on these lists, it does not take much. You
create a screen name or whatever they want to call it, and you
go to a couple sites, and suddenly, you are getting mail from
everybody and not just the securities scam artists. I guess
they all look for the same pigeons. I do not know if it is
securities or business opportunities or pornographic sites.
They all say, ``Well, we will jump in.'' So it is something
that is very useful to identify before people get taken.
I am sure you saw in Maine the sad cases where people come
in, and if they had just called us or if we had shut this
company down just a week or two sooner--I mean, we had one
woman, and one of the good stories, a half hour before she sent
her certified check off with Federal Express, decided to call
us and ask us about them. If we can get those scam artists and
close them down before they take that woman's total liquid
worth, that is what we need to do.
Senator Collins. We used these operations in Maine as well.
I remember my securities administrator always gave his home
phone number out so that the phone would not be answered,
``Securities Division.'' It seems to the Internet greatly
expands the possibilities. As one of our witnesses said
yesterday, ``No one knows you are a dog on the Internet.''
Well, no one knows you are a securities regulator either.
It is my understanding, Mr. Walker, that the Federal
Government does not use those kinds of undercover operations.
Why not?
Mr. Walker. We are bound by the Privacy Act, which is a
Federal law, which prohibits us from engaging in effect in
undercover operations. We have to identify ourselves and who we
are and what we are doing when we approach people in connection
with investigations. So that is the limitation that we have
confronted.
Outside the Internet, we have provided technical advice and
assistance to others who are engaged in undercover operations,
which has been very effective. Frankly, we are not particularly
well trained, because we have never done it, to engage in these
kinds of operations, though certainly the Internet, if you are
simply just sort of hiding your identity, that raises concerns
of a very different kind than if you are establishing an
undercover broker-dealer, for instance, but currently Federal
law does prohibit us from using aliases when we are on the
Internet and we have to identify ourselves, but I will say that
does not seem to have a limited--or disabled us from finding
ample incidents of suspicious or fraudulent conduct. Location
of illegal conduct, we have not been inhibited by the fact that
we have to approach people, and we actually go onto the
Internet and use our own names and addresses.
Senator Collins. Would it be helpful for you to have that
authority?
Mr. Walker. I think it could be, yes, certainly on the
Internet.
I would be very cautious in seeking to expand it in other
areas because, as I indicated, we are simply not equipped to
engage in other kinds of undercover operations. But certainly
to the extent that it would allow us to participate or engage
in conversations with people over the Internet, where there are
no real questions about physical security or things of that
sort, it could be very useful.
Senator Collins. Mr. Rutledge, does Pennsylvania use those
kinds of undercover techniques or establishing a phoney E-mail
address?
Mr. Rutledge. It is a very integral part of our enforcement
effort, totally with particularity to the Internet, and as
Peter said, our goal is to get the con artists out of the
Commonwealth before he takes the money, and we use it
extensively. We issue our cease-and-desist orders. As soon as
those C&D's are issued, they go up on our Web site, and our Web
site actually has--we have people coming in to tell us, ``I saw
your enforcement Web site. I am glad I did not invest because I
have been called by this person or I had received a spam from
this person.'' Other stories are not so good in that, ``I have
been spammed or I have been the victim, but here is some
evidence you can use against this person,'' when we go to
administrative proceedings. So we use it extensively.
However, the fraudsters are getting a little smarter, and
there are now some sites that are off limits if they detect
that you are coming from a government network. So you have to
be a little more crafty in how you set up your surveillance
operations.
Senator Collins. I would now like to turn to some
concluding issues on day trading and on-line trading.
Yesterday, at least one of our witnesses expressed the
concern that the explosive growth of day trading could make it
much easier for ``pump-and-dump'' schemes, other manipulations
to occur. What steps are being taken at both the State and the
Federal level to deal with day trading and the problems that it
poses for securities regulators?
Mr. Walker.
Mr. Walker. Certainly, we have identified approximately
100-plus firms that are engaged in what we have identified and
defined as day trading activity. Those are firms that either
make recommendations to day traders, provide actual facilities
that give you direct access to markets or promise to train you
in that strategy and that technique.
We are coordinating examinations of those firms with the
NASD, so that we have a presence in the firms. We are trying to
observe the conduct and the activities of the firms firsthand.
We are looking at some of the advertising that the firms
provide. We are looking at regulatory types of issues that are
raised by the operation of those firms, and looking at these
things very carefully.
We have not necessarily seen a nexus or relationship to
``pump-and-dump'' type of manipulations because, for the most
part, these are very short types of positions that day traders
take. They are in and out very, very quickly within the course
of a day. They do not carry positions overnight. They take
advantage of rapid buying and selling in small increments in
terms of price changes. So those are the activities that we are
undertaking right at the present time.
Senator Collins. The problem is if you chart the changes in
some of these penny stocks, for example, that have been hyped
by on-line newsletters, and if you add in the phenomenon of day
trading, it seems to me, you create a very potentially
explosive and exploitive situation, and that is the basis for
my concern.
Mr. Hildreth.
Mr. Hildreth. The States really do not have the resources
to deal with the market manipulations. I mean, we see them. It
is really an SEC need to regulate, although I think, for
example, we in our State statute, have the ability, I guess,
the authority, but it really is beyond us.
I think that the problem--day trading, it depends on how
you define it. I guess there are a lot of day traders who are
just on-line traders, and they send their deals through the
computer Internet, just as if they had called their broker, and
I think that they probably do impact the way the market is
acting.
The day traders, where they go into a location and are
trained to use the computers and place the trades themselves,
the States have been very active in this, and some of you may
have seen ``60 Minutes II,'' the other night, on day trading.
Massachusetts, Texas, and Missouri are the ones that come
rapidly to mind who have taken action. Indiana recently did.
I think those are the States that have done it because that
is where these day traders are located.
Senator Collins. What action did they take?
Mr. Hildreth. They would have been cease-and-desist orders,
but it has been mostly on unregistered activity, unlicensed
activity, being a broker-dealer without getting the license to
do it in the State of whatever, using unregistered agents.
It is really a small--I have heard maybe 8,000 people
nationwide who do that kind of trading. Our concerns on day
trading are more along that, that people are not being given
the proper disclosures. In some cases, they are being told they
are not clients or customers of the firm. They are actually
independent contractors, and they trade on the firm's account.
There is a lot of those kinds of regulatory issues for the
State. I mean, I certainly would not suggest that anyone become
a day trader, but I guess there is a group of people who want
to do that.
I had a friend of mine that I went to law school with ask
me, ``Gee, what about day trading?,'' and I said, ``This is not
what you want to do. You are doing other things. You are not
going to go in and sit at this thing and risk your family's
financial health on these things.'' It was interesting to me
that that was an interest to him.
He read these articles and said, ``Gee, I could do that. I
could make thousands overnight.''
Senator Collins. Well, it is the get-rich-quick appeal,
once again.
Mr. Hildreth. Right, exactly.
Mr. Walker. If I might just add to my prior answer,
Chairman Collins?
Senator Collins. Yes.
Mr. Walker. We have received actually, remarkably, few
complaints from people in connection with day trading. I think
our biggest concern is that people are engaging in this
activity that do not know what they are doing. So, once again,
investor education here is so critical because losses can
happen so quickly and so easily. You can place trades directly
without any intermediary giving you advice or telling you
whether something is good or not good. I think the ``60 Minutes
II'' presentation really made that vividly clear.
There was one individual who had lost money and simply did
not have the knowledge and appreciation of the risks that were
involved. Chairman Levitt has issued a cautionary statement
with respect to both on-line trading and day trading, just
trying to warn people to not overlook the fundamentals of
investing for trading purposes, for the purpose of getting a
quick profit.
You have got to do your homework. You have got to get the
facts, and you have got to know what you are doing, or you can
run every much of a risk of losing money as making money. So it
is a very important thing to get the message out that people
should not be doing this. They should assess and understand
their risk levels. They should not get in over their heads,
which is possible, and, of course, we have to make sure that
they are not induced to do that through fraudulent
misrepresentations of get-rich-quick or false strategies that
simply do not work for these people.
Senator Collins. Mr. Rutledge, do you have concerns from
your perspective as a State regulator about the growth in day
trading?
Mr. Rutledge. Yes, and we have several investigations
underway.
I think there are primarily two. One is licensure, that
these people are licensed as a broker-dealer. They are in
compliance with all the regulatory requirements for
registration, such as margin, etc., and where they are
promising get-rich-quick, anybody can do this--I have even
seen, ``Well, not knowing anything about investing is actually
good. You can even be better at it if you do not know this.''
Senator Collins. Ignorance is an advantage?
Mr. Rutledge. Yes. They are selling: Ignorance is good.
We are concerned about those firms who are basically
touting nirvana to people who maybe have never invested before.
We view them more as customers, rather than agents of the
broker. They are giving them investment advice because they are
making recommendations as to investment strategies when the
people do not know the difference between a market order and a
limit order, and they end up losing a lot of money.
One said, ``Oh, all you need is $25,000 to start.'' Well,
$25,000 taken out of your 401(k) plan does not make you a
sophisticated trader or investor. So we have concerns.
With respect to on-line trading, something we have begun to
discover in our compliance audits of some on-line brokerage
firms is third-party authorizations, where a customer opens up
an account, but also gives authorization to a third party.
Sometimes it is their financial advisor, and the financial
advisor, we are finding out, is actually acting as an
investment advisor that is not registered either with the
Federal Government or with the State government as is required
under Federal law. So that is another area of concern that
people are trading on behalf of customers, using their on-line
brokerage account. We are concerned about that, that there
should be some obligation on the part of the on-line broker
that if they know there is a third party authorized to trade in
an account of one of their customers that they check out to
make sure that the individual is registered either with the
State government or the Federal Government to provide that
investment advice.
Senator Collins. Yesterday, Professor Friedman testified
about possibly expanding the suitability requirements to take
into account the new on-line environment, which follows up with
the point that you just made.
He pointed out that unsophisticated traders can easily
invest in securities that are unsuited for their financial
goals and their risk profiles, and that but for the broker-
dealer's firm's trading facilities, the customer would be
unable to invest in these inappropriate investments.
Do we need to take another look at the suitability
requirements to make sure that they apply in an on-line
environment? Presumably a broker would not recommend--or would
recommend against some of the investments that the customer is
able to do on-line, using the broker-dealer's facilities.
Mr. Walker, what is your reaction to that proposal?
Mr. Walker. I think historically, the suitability rules
have applied where recommendations are being made, and
oftentimes with respect to on-line brokerages, people are not
looking for recommendations. They are simply plugging in orders
which would raise questions as to whether the traditional
suitability rules would apply in those circumstances.
However, in the day trading area, oftentimes
recommendations are being made. Day trading firms recommending
a strategy might be covered by suitability rules, and the NASD
is taking a look at that. We have been having discussions with
them about that.
Oftentimes, they are also recommending actual high-risk,
very speculative securities, and certainly, I think the
suitability rules would attach in those circumstances. So there
is a review underway, and it is important that that take place
because certainly that does provide very important protections
to investors. That is a rule that I think the regulators all
believe is a very important rule.
Senator Collins. Mr. Hildreth.
Mr. Hildreth. It is sort of interesting. Last week, I was
on a panel, a continuing legal education panel of securities
lawyers, and interesting to me that they being the lawyers who
are representing firms who are on-line, rather than wanting to
somehow expand suitability, want to narrow it and say, ``Look,
if people are trading on-line, they are sending it themselves.
They are putting it into our computer system. They are not
talking to a broker. We should not have any responsibility to
them.'' I tend to disagree with that and said so at the panel.
I do think that in some cases, we have to look at our
current rules and say, ``OK, maybe they need to be tweaked a
little for the Internet.'' Pennsylvania took the lead, and I do
not remember what year, on the issue of securities offering. If
you put up a Web site and someone from New Hampshire goes into
it, is that an offer to sell in New Hampshire? That was
something specific to the Internet that it made sense that you
had to tweak things, that you had to change things because of
it.
I am not convinced certainly that we need to narrow the
suitability rule or the know-your-customer rule, but I think
that you are going to hear--or some people will hear from
industry that they want relief, rather than expansion.
I think that there certainly still is a responsibility.
Whether that person is making that sale, trade, through the
computer, you need to know your customer and know whether that
is a good trade. They may want to do it, anyway, but you bear a
responsibility towards your customer.
Senator Collins. Mr. Rutledge.
Mr. Rutledge. I could not agree more. I do not think there
is any difference from walking into the door of a brokerage
firm on Main Street in Maine than opening the virtual door to
an on-line brokerage on the Internet, and if I went in with an
order off of Main Street, I think I would get a different kind
of reception. I would hope I would get a different kind of
reception than I do if I just plug in and order on-line.
You have people who are investing on-line, who do not know
the difference between market orders and limit orders. They are
acting perhaps on tips that they saw in an on-line financial
forum.
I commend the NASD for putting out a recent notice on
volatility. I thought it was well done where examples were
given of these volatile Internet stocks, and these were not
penny stocks. These were bona fide Nasdaq NMS stocks that were
very volatile, and people lost--I should not say lost, but they
put in a market order. They thought the IPO was coming out at
$10 to $12, which is normal, but the time they got their order
executed, it was $90 a share. They did not want it for $90 a
share, but they did not know any better to put in a limit
order.
They can track. They know where the trading is. One company
halted all on-line trading on that particular stock and said,
``No, you have to call the registered representative on the
phone. They could walk you through.'' ``Well, do you really
want this? Do you want to put in a limit order rather than a
market? If it is market, it might take time to execute. It
could be vastly different than what the quote is right now.''
Just, again, educate the consumer. Educate the investor as
to what the alternatives and possibilities are.
Another firm may use pop-ups, ``Are you sure you want to do
this? Right now it is a very volatile stock. It is going up.
You are going to be responsible for what you put in. The
difference between a market order and a limit order is''--``If
you need help, click here or call our customer service line,''
or whatever. I think those are very doable things. I do not
believe that just because you offer an on-line facility, you
can put your head in the sand as to your obligations to your
customers.
A common theme throughout this hearing is the need for more
consumer investor education, and I think that is something we
can all agree on.
For my final question to you today, if you had one piece of
advice to give investors who are going to use the Internet to
make trades, what would your advice be?
Mr. Hildreth.
Mr. Hildreth. I am not sure that it is any different from
the Internet or somewhere else. If it sounds too good to be
true, it probably is.
Senator Collins. Mr. Walker.
Mr. Walker. I would agree with Mr. Hildreth. I would say
the advice that I would give would be the same to people who
are investing, and that is to get the facts and do your
homework before you spend your hard-earned money.
Senator Collins. Mr. Rutledge.
Mr. Rutledge. Investigate before you invest.
Senator Collins. I think that says it very well.
I am reminded of the investors town meeting that I hosted
in Bangor, Maine, and Chairman Levitt's advice was that you do
not give your money to someone you do not know, and I think
that applies whether it is in person or on the Internet.
The Subcommittee looks forward to continuing to work with
you. You have identified today some areas where we need some
legislative changes to tighten, for example, the area of micro-
cap stocks, regardless of whether they are sold over the
Internet or whether they are sold in other ways, to tighten the
regulation and the authority that the SEC has.
We look forward and invite your further participation in
this effort as we go forward. I very much appreciate the good
work that you are doing and the cooperative effort that the
States have established with the SEC.
In particular, what I do believe is the fundamental answer
to this problem, which is to use the Internet just as the
fraudsters are using the Internet, to reach more consumers, but
with information on how they can better protect themselves.
So I thank you very much for your participation in this
investigation and our hearings.
I also want to thank the Subcommittee staff, including Tim
Shea, Lee Blalack, Elliot Berke, Smokey Everett, and Wes
Phillips, as well as our support staff, Mary Robertson and
Lindsey Ledwin. Their hard work in conducting this
investigation and preparing these hearings helped us alert a
lot of consumers, I believe, to the dangers or at least the
perils of Internet investing.
I would also like to thank the minority staff and Senator
Levin for their contributions to this effort.
The Subcommittee's hearing is now adjourned.
[Whereupon, at 11:05 a.m., the Subcommittee was adjourned.]
A P P E N D I X
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