Online investment scams: Coming to a screen near you

Online investment scams:
Coming to a screen near you

Armed with the cheaper and faster technologies of the Internet, crooks are recycling old schemes. Here's how to avoid falling for one.

By Dennis Murray
Senior Editor

"This stock is a winner. I'm a subscriber to this newsletter. I'm not sure if I'm allowed to send this out, but I thought it was really interesting. I bought some of the stock and decided to share this with everyone."

—e-mail sent anonymously to a Medical Economics editor

With junk mail proliferating on the Internet, you may have already received a message similar to the one above. If you haven't, you can bet your kid's college fund that you will. Crooks are always looking for new ways to reach into your pocket, and they're aiming their latest loaded gun—the Internet—right at your computer screen.

Think you can easily spot an online investment scam? Don't be too sure. Accountants, attorneys, and stockbrokers are among the white-collar professionals who have colluded to bilk investors out of millions of dollars. They typically use well-written e-mails, online newsletters and bulletin boards, and flashy Web sites—complete with audio, video, and links to legitimate sites—to perpetuate their schemes.

"These guys no longer need a boiler room with 100 people phoning during the dinner hour," says Richard H. Walker, director of enforcement for the Securities and Exchange Commission. "They can send thousands of e-mails with a single keystroke."

They can also post anything on the Internet—cheaply, quickly, and without disclosing their identity and location. That means it's up to you to separate truth from fiction.

Recognize these scams

Most electronic swindles are essentially high-tech versions of longstanding scams, like the "pump and dump." In this infamous setup, a crook hypes the thinly traded stock of a tiny company, hoping that eager investors will run up the price. The promoters either own shares themselves and hope to sell them at an inflated price, or they're paid a flat fee for touting the stock and possibly a bonus based on how high its price rises.

When the price jumps, as can happen quickly when word of a "hot" stock circulates on the Internet, a sell-off by the perps can cause it to drop back down just as fast. When investors complain about their losses, the promoters often encourage them to hang on until the price rebounds—which rarely happens, because of some longstanding, intractable problem with the company or its products.

"Because of the speed and reach of the Internet, these people can pump up a stock's price from 4 to 8 or 10 in no time," says Alexander Novak, a securities-arbitration attorney with Novak & Juhase, of New York City. "They make money by trapping people who invest relatively small amounts in the stock—say, $1,000 or less for a few hundred shares. Multiply that small investment by hundreds of people, and you're talking big money."

In a 1998 Internet pump-and-dump scheme, swindlers raised more than $10 million in three months by hyping Electro-Optical Systems. According to the SEC, the defendants caused the stock price to soar more than 1,000 percent in one day. In a similar case involving PairGain Technologies, a huckster issued a report that said the company was being acquired. The report initially appeared on an electronic bulletin board and then spread to other sites where investors share stock tips. Adding to its apparent credibility was a link to another page seemingly from Bloomberg.com, a popular personal finance site. PairGain shares rose 30 percent in early trading, then settled back after the takeover hoax was discovered.

Perhaps even more alarming, hackers last February broke into the corporate Web site of Aastrom Biosciences and posted a false announcement of a merger between Aastrom and its rival, Geron. The fake release was exposed fairly quickly, but not before some investors acted on the "news." As a result, both companies' share prices zoomed in early trading. Those who bought right away were left with sizable losses after the prices fell back to earth.

Conversely, scam artists can lead a campaign to badmouth a stock, to drive down its price. The cons profit by selling the stock short—in essence, betting that it'll drop. "They visit online chat rooms and spread rumors that the SEC and other authorities are investigating the company for serious offenses," says Novak.

In another type of sting, victims are invited to join in some exotic-sounding investment, sometimes through a "matchmaker" Web site that offers to find them a financial product that reflects their interests. Among the carrots that have been dangled are stakes in gold mines, cable projects, "prime bank" securities, eel farms, and Turkish hospitals.

Sometimes, the investment opportunity is fabricated: Prime bank securities—which supposedly wouldn't risk a penny of investors' initial outlays—don't exist. Nevertheless, two schemers were able to collect $3.5 million from naive investors before the SEC froze their assets.

Offshore schemes, too, have proliferated on the Internet, because con artists can make their pitches without having to pay for postage or long-distance phone calls. In 1996, the SEC filed a complaint against IVT Systems, which used the Internet to help finance construction of a purported ethanol plant in the Dominican Republic. The perps were promising a minimum return of 50 percent. According to the SEC, their literature "contained lies about contracts with well-known companies and omitted other important information for investors."

How to avoid being duped

First, be skeptical. Don't believe anything you read—on your computer or elsewhere—about deals with "guaranteed" returns, unless the promoters provide proof. Second, ask questions, and print any messages, statistics, or other information, so that you have a record of the sender's e-mail or Web site address. If the sender's e-mail address is something generic, like "stock@boom.com" or "friend@public.com," chances are good that you've received a bogus mass-mail solicitation.

"I've gotten a few of these e-mails, but I ignore them," says Sunita Puri, a family practitioner and emergency medicine specialist in Decatur, AL. "I invest only in reputable companies, and only after studying their prospectuses and talking with people who work for them." Donald C. Faust, a New Orleans hand surgeon, follows this cardinal rule: "I never invest in anything I can't research using Morningstar, Value Line, or a major publication like The Wall Street Journal. If I use the Internet, it's in dealing with Fidelity or Vanguard—companies I already know and trust."

Before investing with someone unfamiliar, find out whether the seller and the product have registered with the SEC. You can do this by visiting the SEC's EDGAR database (www.sec.gov/edgarhp.htm), where you'll also find the company's prospectus, offering circular, or most recent annual report. Even companies that raise less than $1 million, which are often tough to research, must file a Form D with the SEC. This discloses the names and addresses of the company's owners and promoters. Dig elsewhere in the SEC's site (www.sec.gov), and you'll discover alerts on the latest scams, updates on enforcement, and the complete text of many SEC publications. If you don't have Internet access, call the SEC at 800-732-0330.

Contact your state's securities agency, too. It can tell you whether a person or company is licensed to sell investments in your state or has faced any disciplinary actions. The phone number should be in the state government section of your phone book, but if you have trouble finding it, call the North American Securities Administrators Association at 202-737-0900 or visit its Web site (www.nasaa.org). On the Web site's home page, click Find Your Securities Regulator.

Even if all the required paperwork has been filed, the investment may not be a good one for you, or the company and individuals selling it may not be beyond reproach. Protect yourself by asking the promoters a lot of pointed questions. If the e-mail or Web site asks for money without listing a contact you can speak with, consider it a bad sign.

Some questions to ask:

• How did you get my e-mail address?

• Why do you think this investment makes sense for me?

• How much are you being paid to promote it?

• What risks are associated with this product?

• What must happen for it to increase in value as much as you claim it will?

• How much would this investment have to increase in value for me to break even, after subtracting all the fees to buy, hold, and sell it?

• How successful has the company been in managing this type of investment?

• How easy would it be to sell if I needed my money right away?

• Where can I get the latest annual reports and financial statements?

Take notes during the conversation, and tell the person you speak with that you're doing so. This will indicate that you're a serious investor and establish a paper trail that may help if you decide to invest and something goes wrong later. Your notes may be admissible before an arbitrator or a jury. Never give anyone your Social Security number, bank account information, or credit card number before you're satisfied that the offer is legitimate.

And, of course, it couldn't hurt to ask your accountant, attorney, or financial planner for an opinion. These professionals will likely be able to evaluate the investment faster than you can and determine whether it's appropriate for you.

What to do if you suspect fraud

The SEC received 3,313 reports of online investment fraud from Oct. 1, 1998, through Sept. 30, 1999—nearly three times more than it received during the previous 12 months. In response, the SEC has assigned a team of investigators to handle only these complaints. So if you smell a rat or think you've been taken, contact the SEC right away. By acting early, you could prevent someone else from being similarly swindled, and you'll have a better chance of recovering any money you may have lost.

You can send an e-mail to enforcement@sec.gov, a fax to 202-942-9570, or call the SEC at 800-732-0330. Or send a letter to the following address: SEC Division of Enforcement, Enforcement Complaint Center, 450 Fifth St. NW, Washington, DC 20549-0710. Another alternative is to complete the SEC's online complaint form and submit it electronically at www.sec.gov/enforce/con-form.htm. If the SEC receives enough complaints from other investors, it may decide to file a case before an administrative law judge or, depending on the circumstances, a civil suit in federal court.

Don't be content with alerting the SEC. It's also smart to contact your state's consumer protection agency and the local Better Business Bureau. It's a safe bet that the swindlers aren't bureau members, but many of the bureau's offices have online databases, and your report could help alert other investors to a similar ruse.

If you think you've lost more than $10,000, contact an attorney. Federal securities laws, which most states also follow, say you must initiate a lawsuit within a year of the date when you should have reasonably discovered the scam, and no later than three years from the date the ripoff occurred. However, some states allow you up to six years to file a claim, depending on the type of infraction, according to securities attorney Alexander Novak. If the amount in dispute is less than $10,000, check with your state's securities administrator to see whether you can try to recover your money without a lawyer's help, by stating your case in writing.

Cases of suspected broker fraud, whether or not they're perpetrated online, are almost always heard before a panel of arbitrators, but they can take as much time and expense to prepare for as a trial. For this reason, many attorneys who prosecute investment fraud won't take cases that involve less than $50,000, says Novak. "The time and work a lawyer puts into a $50,000 case is similar to what goes into one involving 10 times that amount or more."

To find an appropriate lawyer, call the Public Investors Arbitration Bar Association (888-621-7484) or visit its Web site (www.piaba.org), which lists 300-plus attorneys who have represented at least one person in an investment dispute. Most of these lawyers offer a free consultation, either in person or by phone. If you can't find someone on PIABA's roster to work with, ask your local or state bar association for a list of lawyers who handle investment-fraud cases.

Unfortunately, it's not always easy to triumph over an Internet thief. Although arbitrators are supposed to be impartial, some find it hard to sympathize with someone who's well-educated and well-paid. "The arbitrators," Novak says, "take the position that most doctors and other professionals can afford to pay an adviser to review their investments, so they expect them to be a lot more savvy and better-informed than a typical investor."

Even when an investor does win a decision, collecting the award isn't a sure thing. The defendant often declares Chapter 11. "Bankruptcy courts almost always discharge an arbitration award," Novak says. "Worse, in many states, including New York, filing for bankruptcy doesn't prohibit a dishonest broker from going back into the securities industry. Some will just pick up and move elsewhere—overseas, if necessary."

Certainly, if you win a dispute with a reputable online brokerage or a registered investment firm that conducts some of its business over the Internet, the odds that you'll recover your money are excellent. Not so if you deal with the shady characters who lurk on the Net, trolling for suckers—which is just one more reason to approach any online investment opportunity with caution and skepticism. If a voice in the back of your head says "don't do it," you probably shouldn't.

Dennis Murray. Online investment scams: Coming to a screen near you.

Medical Economics

2000;7:184.