The Seedy World of Online Stock Scams
STOCK FRAUD IS ONE OF THE NET’S FASTEST-GROWING INDUSTRIES. HERE’S WHAT YOU NEED TO KNOW TO PROTECT YOURSELF.
John Famularo was playing around on his home computer one day last July when he came across some message-board threads discussing a company called Uniprime Capital. The firm had recently made the astounding announcement that it was successfully developing a cure for AIDS. True believers were posting glowing comments about it on message-board sites like Raging Bull at a furious pace. Within two days, Uniprime’s over-the-counter shares had spiked from around $1.50 to a midday high of just under $8. More than 5.2 million shares changed hands on the stock’s busiest day, vs. a typical daily volume of well under 100,000 shares. It was into that buying frenzy that Famularo, a 37-year-old air-traffic controller at the Dallas/Fort Worth airport, called in his market order for 1,000 shares. It was filled at $5 apiece. An active trader, Famularo says he didn’t bother to research Uniprime. He just believed no company could be allowed to lie about having a cure for AIDS if it didn’t. “I got suckered in and fell for it hook, line and sinker,” he says today. “I got into that mental state that it had to be real, and I couldn’t get out, so I just watched it. Then I got to that point where you feel you got suckered. Screw it! Go crawl under a rock.” Uniprime shares were recently trading at just 3¢ each, making Famularo’s $5,000 investment worth $30.
» One-year return Of the Dow Jones industrial average as of Dec. 15,1999: 29%. Return of the Nasdaq 100: 101%.
Uniprime, it turns out, was no healthcare company but a Las Vegas car dealership — a fact that went unnoticed by many investors. According to fraud charges filed in related civil and criminal cases, Uniprime and Alfred Flores, a major Uniprime shareholder and president of its New Technologies & Concepts subsidiary, lied about the company in a series of false press releases in order to pump up the price of its stock. Not only was Flores not the medical researcher he claimed to be, according to court papers, but he had actually been convicted of conspiracy to commit murder and was in prison in Colorado when the research was supposedly done. Both Uniprime and Flores are contesting the charges. In a collect call from jail, where he is being held without bail until trial, Flores told us: “I never lied to nobody, and I didn’t sell stock. I don’t even know how the market works.”
The case would be funny if it weren’t so serious — and so common. Age-old money frauds of all types are flourishing on the Internet. No longer do con men need rooms full of cold-calling brokers. Now, with just an e-mail address list and a chat-board alias or two, penny-stock promoters can spam tens of thousands (if not millions) of investors, run up a stock’s price and sell their shares to unwitting buyers — only to disappear into cyberspace. The cost to pull off such a fraud: less than one-tenth of a cent per name for the e-mail addresses; most everything else is free. “You just need one person, and they just need to have access to a computer somewhere,” says John Stark, head of the Securities -and Exchange Commission’s office of Internet enforcement. And while there’s no question that the Internet can be a powerful tool for investors, the great bull market has created a lot of gullible — or perhaps just lazy or overly optimistic — Web-enabled investors. “People don’t have a good perspective about probabilities,” says Terry Odean, a behavioral-finance professor at the University of California-Davis. “They have unrealistic expectations, and then they see these ads about truck drivers who own islands, and they think, ‘It must be my turn.’ ”
ONLINE AND OFF, INVESTORS GET SCAM MED OUT OF $10 BILLION A YEAR-THAVS MORE THAN $1 MILLION AN HOUR
The combination of that mind-set and the huge numbers of people now investing online have made cyberscamming the three-card monte of the new millennium. Online and off, investors get ripped off to the tune of an estimated $10 billion a year — that’s more than $1 million an hour — according to the North American Securities Administrators Association (NASAA), While there are no good figures on cyberfrauds, let alone for how many investors have been fleeced in them, regulators and attorneys say that both numbers are on the upswing. So pervasive has the problem become that it’s drawn the attention of the Department of Justice, the Federal Trade Commission, the U.S. Attorneys’ offices, and even the FBI. Since the SEC first set up its online unit five years ago, it has brought more than 100 Internet-related lawsuits, involving tens of millions in ill-gotten gains; and a number of con men have been sent to the slammer in related criminal actions.
» Number of Web pages created daily: 3 million. Amount of time it takes a search engine to add a new site: 6 month
In spite of the cops’ best efforts, however, the complaints just keep pouring in. The SEC’s Internet complaint hotline (e-mail address: email@example.com) gets up to 300 messages a day, a thirtyfold increase since its June 1996 founding. NASAA gets another 500 a week. The No. 1 complaint: spam e-mail touting stocks, typically little-known and illiquid ones, often with false or inflated claims. Some come from the companies themselves, others from unaffiliated spamming groups. While not all spam stock e-mail messages are frauds, it’s a rare one that turns out to be a good deal for investors. A typical spam, one of many coming to this reporter’s personal e-mail address in recent weeks, promotes a money-losing CD-ROM and website producer called Digs Inc. with a “Strong Immediate Buy Recommendation.” It then claims that Digs’ stock (recently at $9) would hit $15 within two months. (An attorney for Digs says the company had nothing to do with the email and had forwarded information about it to federal regulators.) Another recent tout came from the Stock-Tipper cybernewsletter (“Growth stocks featured daily!!”). This one promoted NELX Inc., which it claimed was negotiating to buy a private oil-and-gas company with reserves potentially worth more than $1 billion. Though NELX hadn’t turned a profit, its bulletin-board-traded shares certainly have soared this year, rising 225% to a recent 12¢ apiece. And then there’s the July 19 spam about Uniprime (forwarded later to MONEY by a large Uniprime investor) that claimed the company had found the cure for AIDS, that it was working on interviews with Time, 20/20 and 60 Minutes and that the stock — so undervalued it was “like buying Microsoft now at a nickel” — was headed for $50.
WHO FALLS VICTIM TO SUCH SCAMS? “IT CAN BE ANYBODY WITH ACCESS TO THE NET, ANYBODY CAPABLE OF RECEIVING E-MAIL,” SAYS A REGULATOR.
»Total in Net mergers and acquisitions in the first half of 1998: $1.5 bil. In the first half of 1999: $33.4 bil.
Who falls victim to these promotions? The money losers represent the broad range of American investors of all ages, locales, occupations and net worths. “It is anybody who has got Internet access and is following these message boards or is capable of receiving email,” explains Cameron Funkhouser, vice president of market regulation at the National Association of Securities Dealers. “With all this information on the Internet, people are doing their own research and getting sucked into these schemes.”
Look, for example, at who fell for the Uniprime story. In addition to Famularo (the Dallas air-traffic controller), the stock’s investors included Quentin White, 33, a full-time stock trader in Denver (invested $1,375, worth around $30 now); Rob Abrams, 46, an environmental consultant near Trenton (invested $5,000, planned to sell for tax purposes before year-end); and a 43- year-old real estate developer in California, who spoke on condition of anonymity (invested a whopping $65,000 and cashed out for just over $1,000).
What is it that allows a stock like Uniprime to attract more than 13,000 posts on Raging Bull alone (55% more messages than Microsoft garnered) since the beginning of 1999? And what accounts for investors’ suspension of disbelief about a Las Vegas car dealer with a $1.50 stock discovering a cure for AIDS? Says White, the burned trader: “It’s greed, and in this situation, it was stupidity.”
It’s a laissez-faire world on the Net, with no brokers to read you suitability requirements and few of the other safeguards that might protect you offline. And though the securities cops are beefing up their enforcement efforts, the best way to avoid getting taken in a cyberscam is to protect yourself before you plunk down your hard-earned cash. Get hold of financial documents, read them, find out about the people behind the investments, and learn more about what you’re planning to get than you would to, say, buy a car. (For a handy list of 10 questions to ask yourself before investing, see the box on page 146.) If, despite your best efforts you do get burned, don’t be embarrassed. You’re surely not alone. Save all your documents and alert the securities cops at the SEC (www.sec.gov), the NASD (www.nasdr.com) or NASAA (www.nasaa.org). You may not get your money back, but at least you’ll clue others in to the problem.
-AMY FELDMAN firstname.lastname@example.org
University of Florida
► Journal of Finance
“It has links to various finance sites, both academic and nonacademic.”
“They make specific commentary and predictions on upcoming initial public Offerings.”
“United uses the Internet Travel Network, so I can book flights there through other airlines as well.”
University of Chicago
►Social Science Research Network
“Many professors post their early research on the site.”
“It aggregates a variety of economic and finance journals that I can search for published papers.”
“I grew up in Indiana, so I’ve got to follow college hoops.”
-COMPILED BY ADRIENNE CARTER
10 QUESTIONS BEFORE YOU INVEST
Found a hot investment tip online? Consult this checklist before buying.
- Is the investment registered with the Securities and Exchange Commission and your state’s securities agency?
- Have you read audited financial statements about the investment? (Find public company filings at the SEC’s website, www.sec.gov, or at FreeEDGAR, www.freeedgar.com.)
- Is the person recommending this investment a registered broker? If so, have you seen his or her Central Registration Depository (or CRD) regulatory record? CRD records are available from the National Association of Securities Dealers (www.nasdr.com) or your state securities regulator. (Find yours at www.nasaa.org, the North American Securities Administrators Association’s website.)
- What does the person promoting the investment have to gain? It is not illegal for a promoter to receive cash or securities if the payment is disclosed, but consider it a big red flag. The Stock Detective (www.stockdetective.com) keeps tabs on many paid Web promoters.
- If the tip came from an online bulletin board or e-mail, is the author identifiable or using an alias? Is there any reason to trust that person?
- Are you being pressured to act before you can check an investment out?
- Does the investment promise you’ll get rich quick, using words like “guaranteed,” “high return” or “risk free”?
- Does the investment match your objectives? Could you afford to lose all of the money you invest?
- How easy would it be to sell the investment later? Stocks with few shares are easy for promoters to manipulate and hard for investors to sell if the price starts falling.
- Does the investment originate overseas? If yes, beware: it is tougher to track money sent abroad, and harder for burned investors to have recourse to justice.
► Demystifying Finance
www.andrewtobias.com Think of Andrew Tobias’ home-grown website as you would a page-a-day finance calendar. Every day, the author pens a short, quirky column on topics that careen from the sober to the whimsical. One day he might write about the best strategies for employee stock-purchase plans; the next, he may share his recipe for frozen grapes. (Buy grapes. Freeze. Eat.) The site’s most useful attraction: its mutual fund cost calculator, which lets you evaluate how much of a toll taxes and expenses are taking on your funds’ returns.
► Dismal Scientist
www.dismalscientist.com Whether you could use a refresher on what the consumer price index actually measures or you’re a data hound hunting for the latest Japanese jobless figures, head to the Dismal Scientist. The site is chock-full of economic data, definitions, calculators and forecasts. One tool lets you plug in any zip code to receive a complete economic profile of the area, from median household income to demographics.
ONLINE CONS: A FIELD GUIDE
A glossary of popular Internet securities scams
Illegal touting. When a promoter praises a stock without disclosing that he is being paid to do so.
Pump-and-dump. Touts drive up demand in a stock by lauding it on bulletin boards or using e-mail. When the price soars, the touts dump their shares at the inflated price. Newer investors take the hit when the stock inevitably collapses.
Pyramid schemes. A marketing ploy in which promoters claim you can profit by sending in small sums of money for signing up, and then get paid to recruit new participants. Later investors eventually get stuck with losses.
Exotic frauds. Solicitations that offers an “opportunity of a lifetime” to invest in obscure vehicles like ostrich farms or so-called prime bank securities thrive online. Sometimes, the investments don’t exist. Other times, they wind up being worth almost nothing. —A.F.
Amy Feldman discusses online stock scams and how to avoid them in a live chat on Jan. 25 at 6 p.m. ET. Go to MoneyLive Chat Center at chat.yahoo.com.
» Forrester Research’s estimate of 1999’s online holiday sales: $4 billion. Ernst & Young’s estimate: $15 billion.
FULL-SERVICE BROKERS HIT THE WEB
Wall Street finally gets the Net, but not all brokers offer great prices.
AFTER YEARS of denial and dithering about the Internet, full-service brokerages have finally caught the online trading bug. Although a few firms continue to drag their heels completely, most now offer their clients some sort of trade execution on the Web, even if they still charge the full commission.
More recently, the industry’s biggest names have begun rolling out online trading offerings designed to take momentum and market share back from online discounters like Schwab, Fidelity and E*Trade. The high-profile marketing campaigns accompanying some of these rollouts imply that the full-service firms now offer their clients the best of both worlds: personal attention and discount pricing. But do they? The fact is, most full-service brokerages’ offerings are more complicated and expensive than meets the eye, and most have a way to go before they will appeal to anyone but very high net worth clients or those who must have the security of a personal adviser’s second opinion.
Consider the most common new offerings, adviser-assisted plans like Salomon Smith Barneys AssetOne, PaineWebber’s InsightOne, Merrill Lynch’s Unlimited Advantage and Morgan Stanley Dean Witter’s Choice. They typically include assistance from one of the firm’s brokers plus virtually unlimited stock trading and access to proprietary equity research. In return, each charges an annual fee based on your account’s assets rather than a separate commission for every transaction you make. This arrangement, also known as a wrap account, sounds like a pretty good deal—until you do the math. The Morgan Stanley Dean Witter Choice account, for example, sets a standard 2.25% annual fee on equity accounts between $50,000 and $249,999. The benefits of personalized advice and Morgan Stanley’s in-house research may be worth $1,125 to someone with only $50,000 to invest, but that’s the equivalent of nearly 113 trades at Datek. Annual fees do go down to 0.3% for accounts with $10 million in equities, a reasonable charge for comprehensive money management, but many self-directed investors may find even that tariff hard to swallow.
AN ONLINE TRADING FEE FOR ALL
Full-service firms have finally begun offering stock trading over the Internet, but their pricing schedules are often more complicated, and more expensive, than they first appear. Below are the programs currently being offered by five of the largest full-service brokerage companies.
In fact, Merrill Lynch and Morgan Stanley Dean Witter are the only traditional brokerages with low-cost trading options that truly compete with online discounters. If you can meet its $20,000 minimum deposit, Merrill’s is the most attractive combination yet of full-service features at cut-rate prices. (See the table on page 151 for online pricing schedules for five of the largest full-service brokers.) You won’t get a financial adviser at $29.95 a trade with Merrill Lynch Direct, but customers do have unlimited access to analyst stock reports, a perk usually available elsewhere online only to high-net-worth customers. And if Merrill Lynch and Morgan Stanley are successful in distinguishing themselves in the months ahead, many of the old stalwarts could follow their lead within the next year, according to Dan Burke, an analyst at Gomez Advisors, an ecommerce research firm in Lincoln, Mass.
Online brokers, of course, aren’t sitting quietly while brick-and-mortar competitors move into their territory. Schwab, Ameritrade and TD Waterhouse recently announced plans to form an investment bank, demonstrating that the distinction between full-service brokerage and online brokerage may soon become meaningless. — Adrienne Carter email@example.com
MOST FULL-SERVICE BROKERAGES’ INTERNET OFFERINGS SOUND LIKE GOOD DEALS—UNTIL YOU DO THE MATH.
Q. Where can I check the stability of an insurance provider?
A. All of the major ratings services that track the stability of insurance companies offer free online information for consumers. Check the ratings from a few different ones; if all deem an insurer’s health as poor or middling, you should stay away. Start with Moody’s (www.moodys.com/repldata /insurance/ratings/insfs.html) and Standard & Poor’s (www.standardandpoors.com/ratings/insurance).
Insure.com (data.insure.com/ratings/sandp.cfm) has an especially easy-to-use interface that uses S&P’s data. With 4,000 companies rated, S&P is second only to A.M. Best (www3.ambest.com/ratings/search.html), which rates 6,000 companies, using a complex methodology that examines capitalization and future growth estimates. Duff & Phelps Credit Rating (www.dcrco.com/groups/finservices/finservmain.cfm?subgroup=INS) gives the ratings histories of the insurers that they cover, making it easy to spot positive or negative trends.
E-mail your questions to firstname.lastname@example.org.
» Schwab’s ad spending increase in the first half of 1999:100%. Decrease in its online market share: 5%.
YOU CAN’T TELL TRADERS WHAT TO DO
When does information become advice? Regulators aren’t sure.
By David Futrelle
YOU DON’T have to be a smug hipster in a Suretrade commercial to know that “modern capitalist mavericks” don’t like to be told what to do — or told what information they can and can’t see. That’s one reason why regulators have had such a hard time coining to terms with the Web and with the culture of do-it-yourself investing.
Securities regulations were designed for a world that’s come to seem quaint, one in which investors relied solely on their brokers for advice. To prevent the pitching tech stocks to investors who can’t withstand heavy short-term losses.
Are such suitability requirements suitable online? Until now, brokers and regulators have said no. It’s one thing to protect investors from lazy or sleazy brokers; it’s quite another to protect them from themselves. If you want to while away your days (and your life savings) day-trading dotcoms, hey, that’s your business.
It’s hard to argue with that — so long as your online brokerage is merely taking orders, not encouraging reckless behavior. But online brokers are starting to bundle information and advice alongside stock trades, and regulators have begun to wonder if the hands-off policy can really continue much longer.
» Clients who stopped trading stocks online in the past year: 3%. Those who stopped banking online: 50%.
The opening salvo in what may become a protracted struggle was fired in November by SEC Commissioner Laura Unger. In a 115-page report, Unger suggested that the SEC may step in to protect investors from unsuitable electronic advice from online brokers. Many online brokers already offer rudimentary customization features that allow them to tailor the information they present to an investor’s specific interests. But, Unger suggests, that’s just the beginning: Online brokerages are busily adapting what’s known as data-mining software to enable them to uncover patterns in the stocks you buy or the research you look at.
Armed with this information, the software can start brainstorming stock ideas for you, in the manner of Amazon.com’s book recommendations. Like Cisco? Then you’ll love Lucent!
To Unger, these turbocharged customization features look a lot like advice, and that’s the sort of thing that regulators monitor. A recommendation is a recommendation, Unger tells me, “whether it’s coming through a computer or a person.”
It’s easy to understand her concern. If brokerage firms look upon their datamining technology as little more than a marketing tool—or a way to spur customers into making more trades than perhaps they should—such technologies have the potential to do a lot of harm. Steering a newbie investor, Amazon-style, toward more of the sorts of stocks he seems to like, for example, is not the route to a well-diversified portfolio.
Whatever advice the brokers give needs to be bundled with the appropriate disclaimers, and not just in the fine print. Already, firms like Schwab and DLJdirect monitor accounts and step in with phone calls or e-mail messages if they notice customers doing anything rash; this approach could easily be supplemented by online “warning labels” that, for example, remind investors how dangerous it is to enter market rather than limit orders for volatile stocks.
So it’s probably a good thing that the brokers know the SEC is watching them; it’ll help encourage whatever inclination they have toward doing the right thing. (Having absorbed hundreds of hours of brokerage ads over the past year, I know that most aren’t exactly forthcoming about the risks of active trading.)
If the SEC decides to move beyond jawboning, though, things could get tricky. Overzealous policing could discourage
brokerages from offering their customers useful tools like asset-allocation calculators and gizmos that can help them better understand various investing risks. Generally, the more information, the better, so long as investors recognize that computer-generated stock picks from online brokers may not necessarily be any better than tips from the message boards on Yahoo! Finance.
But the best protection for any investor is his or her own common sense. “When it comes to protecting people from their own foolishness,” says Saul Cohen, a New York City securities attorney, “there aren’t enough regulators in the world for that.”
Staff writer David Futrelle also writes a weekly column for our MONEY.COM website.
E-mail him at email@example.com.
ONLINE BROKERS MAY RECOMMEND STOCKS THE WAY AMAZON TOUTS BOOKS: LIKE CISCO? THEN YOU’LL LOVE LUCENT!
1 MINUTE INTERVIEW
Guest scholar at the Brookings Institution and author of The Bankers: The Next Generation
► In The Bankers, Mayer describes how innovations such as the credit card and the brokerage cash-management account have eroded large banks’ dominance of America’s finances. We asked Mayer how banks are dealing with a more momentous innovation: the Internet.
How are banks faring?
Not very well. Banks have abdicated e-commerce to the credit-card companies. Banks are closely tied to the Federal Reserve and are controlled by regulations that don’t affect other entities. When you buy on the Web using a Visa card, you don’t get a paper confirmation. If banks tried to compete with this system, it’s not clear that the Fed wouldn’t force them to set up a paper trail. The notion that a digital trail is as good as a paper trail is not really accepted at the Fed.
Could the banks be doing anything about that?
The credit card is the infrastructure of the e-commerce system because, over the dead bodies of the banks. Congress legislated a $50 maximum loss if something happened to your credit card. So people feel very safe using credit cards. Banks, however, have resisted having limits put on debit-card losses, so people don’t feel as safe using debit cards. Somebody at the banks has to make a guarantee. has to say, “This is a safe system, and we put our money behind it.” but nobody has said that yet.
Which banks are making the best online efforts?
Bank One is in the lead, but — how shall I say this? — Bank One has often understood what the technology should do, without, in fact, being able to do it. The banks aren’t doing terribly well with all of this. The e-brokers, meanwhile, have been carving out niches. They’re much faster on their feet. If I had to put my money on this, I would say that Internet guys will develop banks before banks will develop competent Internet activity.
A new edition was released in 1998.
Why hasn’t retail online banking taken off yet?
There’s the whole issue of electronic bill presentment. The Internet payment systems that the banks have just aren’t very well developed yet. People expect a payment system to work like a watch, and the banks haven’t really crossed every T. Until a year or so ago banks were doing bill paying on proprietary networks, not on the Internet, and switching has proved more difficult than they thought.
» Before eBay halted the auction, bids on 500 pounds of marijuana hit $10 million—20 times street value.