The SEC’s Renewed Focus On Internet Fraud

Between 1998 and early 2002, the SEC made it a priority to investigate and prosecute Internet fraud.  The agency established the Office of Internet Enforcement (OIE) to administer the Enforcement Division’s Internet program and review the numerous leads generated from investor tips forwarded to the SEC’s complaint center.[1] 

The SEC filed well-publicized cases against Internet promoters, including stock-picker “Tokyo Joe.”  See SEC v.Park a/k/a Tokyo Joe et al., 99 F. Supp. 2d 889 (N.D. Ill. 2000).    Other lesser-known actions were filed against pump-and-dump “spammers” such as Rodona Garst, the victim of an anonymous hacker who created a website featuring the entire contents of her computer, including highly personal photos.[2]  The agency filed four groups of actions, called “sweeps,”  against individuals and small entities that spread false information through websites, e-mail messages and postings on message boards. [3]  Richard Walker, then the Director of the Division of Enforcement, described the Internet as “a favorite tool for many con artists,” and stated that “policing the vast universe of the Internet is unquestionably our greatest challenge today.”[4]  Mr. Walker further stated that Internet scams included offerings, market manipulation, and illegal touting.[5]  The SEC’s annual reports for 2000 and 2001 touted the number of Internet cases filed by the agency during those fiscal years – 26 cases included in two “sweeps.”

Starting in 2002, the explosion of accounting scandals surrounding well known public companies, including Enron Corp., Worldcom, Inc., and Qwest Communications, replaced Internet enforcement as the SEC’s leading priority area.  The SEC’s annual reports for 2002 through 2004 failed to highlight Internet cases as a separate enforcement category.[6]  Even more strikingly, the number of Internet enforcement actions listed on the OIE website peaked at 139 in 2002, but decreased steadily in each successive year.[7]   These numbers demonstrated a dramatic shift in priorities.

However, recent public statements and enforcement actions indicate that the SEC may again be focusing on Internet fraud.  In a 2005 speech, Stephen M. Cutler, Mr. Walker’s successor,  stated that “[w]hen fraudulent issuers are weeded out of the microcap marketplace by enforcement action, not only are investors protected from unscrupulous promoters, but legitimate microcap companies reap tremendous benefits as well.”[8]   In apparent illustration of this new priority, on November 16, 2005, the SEC sued several individuals and entities in connection with a “pump and dump” scheme involving the stock of PacketPort.com, Inc., a publicly traded microcap company based in Norwalk, Connecticut.  The SEC’s litigation release stated that the company’s principals hired an “Internet-based stock newsletter” to publish false publicity and bogus recommendations.[9]  More recently, a February 10, 2006 Wall Street Journal article stated that the SEC and the FBI were investigating websites offering astronomical returns on “membership fees” to investors who agree to view their ads.  The article expressed concerns that the websites were, in effect, “Ponzi schemes under which funds from recent investors are used to pay “returns” to earlier investors.”[10]  This publicity indicates that after several years of neglect, the enforcement pendulum may be swinging back towards the Internet. 

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[1] See http://www.sec.gov/complaint.shtml

[2] See http://www.sec.gov/litigation/admin/33-8161.htm

[3]  See SEC’s Annual Report (2000) p. 5, http://www.sec.gov/pdf/annrep00/ar00full.pdf

[4]  See Remarks of Richard Walker at the National Press Club (Apr. 5, 1999), http://www.sec.gov/news/speech/speecharchive/1999/spch265.txt.

[5]  See id.

[6]  See http://www.sec.gov/about.shtml (containing links to all annual reports since 1999).

[7] http://www.sec.gov/divisions/enforce/internetenforce/litreleases.shtml

[8] Stephen M. Cutler, Remarks before the Directors’ Education Institute at Duke University: Staying the Course (March 18, 2005), available at http://www.sec.gov/news/speech/spch031805smc.htm.

[9] See SEC v. PacketPort.com, Inc., Civ. No. 3:05cv1747 (D. Conn. 2005), http://www.sec.gov/litigation/litreleases/lr19465.htm.

[10] See “FBI, SEC Probe Web Sites Offering Large Returns for Looking at Ads,” Wall Street Journal (Feb. 10, 2006).