Taking Stock Scams Off-Line

By Adam Zagorin/Washington

Tell your idiot subscribers about how great the stock is, and, like sheep, they will run out and buy it," riffed the message. "Dump the shares you bought...[on] all of these suckers...watch the stock steadily tank...and laugh all the way to the bank."

It sounds like dialogue from Boiler Room, the new film featuring Ben Affleck as a Gen X stock-scam artist. But according to the feds, the scene is a real-life drama that threatens the 10 million investors expected to have online brokerage accounts by year's end and the millions more who use the Web to make investing decisions.

The author of this particular script is Douglas Colt, a third-year law student at prestigious Georgetown University in Washington. With his mother Joanne, who is a city-council member in Colorado Springs, and three law-school buddies, he scored profits of more than $345,000 in an online scam made public last week. "The migration of fraud from boiler rooms to the Internet is the most important new trend to hit U.S. markets in years," warns Richard H. Walker, top cop at the Securities and Exchange Commission.

Liar, beware. In announcing a settlement with the Georgetown crew--who neither admitted nor denied the allegations and promised not to violate securities law in the future--the SEC was showcasing a stepped-up effort to crack down on rampant Internet stock swindlers. With the Net now America's stock-tip central, boiler rooms have become inefficient relics.

Today one preferred technique of hype artists is ticker spamming. A number of legitimate services like Business Wire and the PR Newswire accept press releases for a fee and channel them onto the Net, automatically sorting them onto stock bulletin boards. This gives spammers a chance to float releases, which just might mention well-known companies in the text alongside the dogs they're hyping. "You go on Yahoo, [ask for] a news story on Microsoft, and you could end up with some manufactured handout touting shares that have no prospects whatsoever," warns Kevin Lichtman, creator of the Stock Detective, a website devoted to ferreting out scams.

The rising tide of disinformation has prompted furious investors to send the SEC up to 300 e-mails every day complaining of one scam or another. That's why the agency has bulked up its CyberForce to 250 investigators, who prowl tip sites, chat rooms and other back roads on the Web. Another crew of 50 electronically monitors Internet fraud on the tech-heavy NASDAQ as well as other over-the-counter markets.

The Georgetown caper underscores how investors can be duped by outright amateurs. Ringleader Colt, 24, attracted 9,000 subscribers to a website he called Fast-Trades.com according to court papers. He used the site to issue stock picks, eventually singling out four penny stocks in which he and his friends had bought up thousands of shares at rock-bottom prices.

Using Web aliases, Colt and friends allegedly hyped these stocks with hundreds of misleading messages planted in Yahoo chat rooms and other popular cybervenues like Raging Bull. As unwitting investors loaded up on the "recommended" shares, some, such as American Education Corp., rose as much as 700%. By the time reality set in and the price crashed, Colt & Co. had already sold out, leaving thousands in the lurch. Investigators say this classic "pump and dump" could have netted millions. But Big Brother was watching.

The feds found scholars of this approach on the West Coast too. A pair of California pharmacy students and a friend, two of whom face a criminal trial next month, allegedly logged on to computer terminals at UCLA's biomedical library and planted more than 500 messages on a variety of hot websites to pump up the stock of NEI Webworld Inc., a bankrupt commercial-printing firm in Dallas.

Before doing so, the feds say, they bought 97% of the company's available stock for between 5[cents] and 17[cents] a share. The students then allegedly launched a final message-board barrage over one weekend last December, falsely reporting that NEI would soon be bought out at a much higher price. On the following Monday, the stock opened above $8 and climbed to a high of $15.50. The trio quickly sold out for a combined profit of more than $363,000. NEI tanked when investors realized that no takeover was in the offing.

Then there's the case of a well-known stock tipster who calls himself "Tokyo Joe" and uses his investment website to post colorful snapshots of himself. The sec says the New York-based entrepreneur, a Korean whose real name is Yun Soo Oh Park, charged members of his investment club up to $200 a month and then pushed them to buy stocks he was simultaneously selling from his own account. Beyond this practice, known as "scalping," the agency also claims Tokyo Joe lied about his trading record and touted companies without disclosing that he had received shares from the owners as payment for his promotion.

Tokyo Joe is still in business and plans to vigorously contest the civil fraud charges against him. The California students also protest their innocence. Some experts in securities law point out that Internet stock-fraud cases are such a new and rapidly evolving area of jurisprudence that it is too soon to tell how judges will treat the SEC's recent wave of them. "Messages on stock bulletin boards are nothing more than graffiti," argues Mark Werksman, a lawyer for one of the California defendants. "Posting them is an exercise in free speech that imposes no clear legal obligation."

There are plenty of day traders who couldn't care less whether bulletin-board messages are true or not. They buy or sell a stock simply because it's moving in a given direction. As long as the information moves the market, they may be willing to act on it. "Traders today are willingly complicit in the dissemination of false information," says John Coffee, an expert on Internet securities fraud at Columbia University Law School. "That's why they often flock to [the] chat rooms with the worst information, so they can find material that will destabilize the market one minute before they profitably pull out the next."

As for Colt, his mother and fellow law students, their travails with the SEC have already cost them hundreds of thousands of dollars in legal fees, depleting their savings, which is why the agency waived further penalty. At Georgetown law there are plans for workshops starting next month on "the ethical responsibilities of lawyers" in a high-tech environment, including trading securities on the Internet. The school has not yet decided whether enrollment will be mandatory.