Fraud detectors at the US Securities and Exchange Commission knew him as ‘The Phantom’. His real name was Roland Baughman of Cuyahoga Falls, Ohio, a sleepy little hamlet near Cleveland and 800 miles from the hurly-burly of Wall Street. SEC officials had been watching Baughman and his cohorts for years.
They weren’t eyeballing him from a black sedan parked outside his house, or tapping his phone from a van down the block. Instead, this unit of the SEC was keeping tabs on Baughman online over the internet via a ‘cyberstakeout’.
This relatively new form of investment scam espionage entails 100 or so SEC investigators patrolling internet chat rooms and investment-oriented web pages looking for unscrupulous con artists. The SEC suspected Baughman and his cronies of artificially pumping up the stock of a company called Interactive Multimedia Publishers in 1996. Baughman’s crime? Chatting up the stock on the internet without revealing that the company was paying him to do so – a big no-no in the eyes of federal regulators.
IMP president Joseph Vertucci and Bruce Straughn, a Wilmette, Illinois stockbroker, had hired Baughman and two other associates in January 1996 to help them ‘pump and dump’ by talking up the stock through internet chat rooms like Prodigy’s Money Talk bulletin board. Baughman posted 49 messages on the Prodigy board in February 1996, suggesting that he’d researched the company and its stock price was about to climb even though investigators said that wasn’t the case. When IMP’s stock rose as a result of the postings, the SEC says Vertucci and Straughn sold shares in the company at a hefty profit.
In February and March 1996, shares of IMP shot through the roof, leaping 1,322 percent from 56 cents per share to $8 per share. At the time, Wall Street fell for the scam hook, line and sinker, with some industry analysts citing IMP as ‘the Microsoft of multimedia’. During that period, more than 1.7 mn shares of IMP stock changed hands, even though only 200,000 were available to the stock buying public. In addition to the fat fee Baughman extracted from IMP to lure investors online to the stock, he also made at least $38,000 in profits himself from the stock. The company’s value when all was said and done? About $40 mn – over 400 times its sales the previous quarter.
After three years of putting the case together, including piecing together the Prodigy chat room missives after investors there complained, the SEC had its case. In February 1999, Baughman, Vertucci, Straughn, and two other accomplices were indicted in US District Court in Akron, Ohio. ‘In a lot of ways, it was a meat-and-potatoes scam,’ says Richard Sauer, assistant director of the SEC’s enforcement division in Washington, DC. ‘The bizarre element of the company is that it was masquerading as a public entity when it wasn’t. Its commission filings were fraudulent. It inflated the value of its assets. And it said marvelous, exciting things were happening when they weren’t.’
The indictments also signaled a seismic shift in the way the agency goes after crooks. Now, the PC is one of the SEC’s most powerful tools. ‘These actions demonstrate the SEC’s commitment to cleaning up the internet, and prove that through vigilant surveillance and preemptive strikes, the SEC can catch internet thieves in the early stages of investment frauds, sometimes even before they’ve stolen from a single investor,’ says Richard Walker, director of enforcement at the agency. ‘We want cyber-scammers to know, If you’re trying to cheat investors on the internet, we’ll be watching you’.
New direction
Patrolling cyberspace was barely on the SEC’s radar screen only five years ago, but the agency is ramping things up in a hurry as more investors go online looking for sure things and quick profits. Unfortunately, just as many scam artists are logging on to take advantage of this new wave of do-it yourself investors.
Walker says the use of paid internet ‘touters’ in the IMP case harkens back 70 years ago to the infamous boiler-room touts of the 1920s, who worked the phones lobbying brokers and investors on the merits of a given stock. While Congress passed an anti-touting law in 1934, the SEC says touting is back again in a big way because of the vast, unfiltered audience unscrupulous brokers and companies have via the internet. ‘The internet has made it so easy and cheap to communicate with investors that nobody needs a boiler room anymore,’ adds Sauer. Nobody needs to man a phone bank or get hold of a ‘sucker’ list. They can just write what they want and push a button.’
The IMP indictments were the second prominent crackdown since July 1998, when the SEC’s Office of Internet Enforcement was launched. Last October the agency nabbed 44 companies and individuals, including stock promoters, web site operators, and online newsletter publishers, for illegally touting a collective 235 small companies’ stocks over the internet. Here’s a sampling of the charges:
- Stockstowatch.com, an internet newsletter, touted Electronic & Gas Technology which was trading at $1.50 per share. Said the web site, ‘Don’t be surprised to wake up and hear on CNBC that the stock reached $50 per share.’ Despite its best efforts to flog the stock, it dropped to $1 per share days later.
- Future Superstock, an internet newsletter from Chicago, wrote to its 100,000 subscribers touting about 25 microcap stocks, saying the issues would ‘double or triple’ in value in months. Nowhere in the newsletter was the admission that Future Superstock was paid $3 mn from the companies involved.
- Sloane Fitzgerald, a New York-based PR company, fired off 6 mn spam messages to investors to drum up enthusiasm for two microcap companies from which it allegedly received payment. This time, investors grew suspicious and reported the company to the SEC. The company settled with the agency, paying out $15,000 and agreeing to a permanent injunction from touting stocks online. In return, the company admitted to no wrongdoing.
This May, the SEC launched its third sweep, shutting down a band of ‘prime bank’ web sites, where operators peddle low-risk, high-return investments to affluent investors. The SEC indicted 14 companies trafficking in offshore investment deals which promised returns of up to 800 percent. The SEC found the investments to be bogus and the web sites were shut down before any serious damage was done.
All three rounds of indictments shared similar characteristics. Each involved the sale or marketing of securities via the web and each focused on outrageous or baseless promises, sometimes guaranteeing annual profits exceeding 100, or even 2,000, percent of the initial investment. In addition to the fraud claims, the SEC charged several individuals for acting as unregistered broker-dealers and selling unregistered securities.
Around the clock
The National Association of Securities Dealers is getting in on the act too, with a new search engine called ‘NetWatch’ that actively seeks out investment fraud. The software is ‘trained’ to look for tell-tale phrases like ‘guaranteed moneymaker’ or ‘the next Microsoft’ and identify offenders. And last October, the North American Securities Administrators Association (NASAA) rolled out a new e-mail address called [email protected] where investors can report suspected investment scams.
But it’s the SEC that is taking on the primary watchdog role on the net, a role that the agency says will steadily increase in the months and years to come. ‘I think we’re well positioned to stop a lot of these online scams,’ explains Duncan King, deputy director of public affairs and spokesperson for the SEC. ‘We know that web fraud is no different than what we’ve seen in the past – it’s just being used on a different medium. But what crooks don’t know is that the web’s ability to attract lots of investors to their sites works against them as well. Not only are they reaching investors faster, but they’re reaching federal regulators faster as well.’
King adds that investors, companies and the financial community in general can help regulators track down and nab securities shucksters:
- Call your securities regulator or (in the US) check the SEC’s Edgar site at www.sec.gov to determine whether an investment is legally registered.
- Ask your securities regulator whether the person or firm selling the investment is licensed to do business in your market and whether they have a record of complaints or fraud.
- Assume investments offered through the internet are scams until you have done your homework and proven otherwise.
Also, to report suspicious internet activities pertaining to securities fraud, the SEC encourages contacting its enforcement complaint center through its web site or by e-mail at [email protected].
