October 30, 1998

The Cop Is on the Beat
The SEC Busts Online Stock Promoters

On Wednesday, October 28, the U.S. Securities and Exchange Commission announced that it charged 44 individuals and companies in five cities with committing fraud over the Internet by masquerading as independent securities analysts when they were really being paid to promote the penny stocks they were writing about in spammails and newsletters, on message boards, and on Web sites.

It's not illegal to get paid to promote stocks, even penny stocks. The problem was that these people and companies were publishing newsletters and bulletins telling their readers how great certain penny stocks were, while allegedly "neglecting" to mention that they were being paid, sometimes even in stock, to promote the companies. When their promotion caused the stock prices to spike up, the promoters would sometimes sell their shares before the stocks came down.

According to the SEC, one company, Stockstowatch, touted the stocks of at least five microcaps in emails and on its website between last October and July. The price and/or volume of nearly all of the stocks sharply increased following their buy recommendations, and the company and its president reaped more than $1 million after they sold shares. Another Internet newsletter, The Future Superstock, allegedly hyped about 25 microcap stocks without adequately disclosing that it received more than $1.6 million in cash and stock as compensation from the companies. The newsletter also is said to have lied about its success in previous stock picks.

Another promoter is accused of moving his penny touts from ads in legitimate newspaper to the "Investors Edge" website he created this year, without disclosing that the penny companies had paid for his touts. While the promoter and one of his companies were recommending that investors buy a company's stock, they were scalping the shares they had received from the company, profiting by more than $64,000. The SEC also charged the defendants with making up false newspaper ads.

That sleazy promoters are out there is no surprise. Hypesters and touts have been around forever, and cold calls from them were probably the second or third phone calls made after Alexander Graham Bell's "Watson, come here! I need you." The Internet gives these people the opportunity to reach more people, quicker and cheaper than ever before. The SEC's actions demonstrate two things, though. First, cyberspace is dangerous for hypesters, because they leave footprints. Unlike a conversation at a cocktail party or a cold-call, the record of Internet hyping remains. Second, the police officers are on the beat. Investors can take some comfort and fraudsters must beware.

Finally, there are two things to remember. First, there are people out there who want to separate Fools from their money. If you do your own homework, make your own decisions, and don't buy a stock just because you read or heard a tip about it (even in the Fool), you will greatly reduce the chance that you'll be swindled. Second, because they are lightly traded, poorly covered, and often easily subject to manipulation, an investor should think twice -- at least -- before investing in microcap companies.

The SEC has posted suggestions for avoiding Internet fraud at http://www.sec.gov/consumer/cyberfr.htm.