Remarks of Richard Walker at the National Press Club Washington, D.C., April 5, 1999 A Bull Market in Securities Fraud? Good afternoon and thank you Russell. I am honored to have been invited by the Corporate Crime Reporter to speak here today at this magnificent Washington institution where government officials regularly engage in a dialogue with the press. While I know that this audience is not comprised solely of members of the press, I'd be remiss if I didn't take this opportunity to thank those of you that are. I thank you not just for having me as your luncheon speaker but also for the work that you do in helping us leverage our resources to accomplish our primary mission -- protecting investors and safeguarding our capital markets. You have been our partners in getting our enforcement message out far and wide, where it will have the greatest chance of deterring potential wrongdoing and protecting the largest number of investors. I was asked to offer my views today_ and they are my views and not necessarily those of the Commission or its staff -- on whether we are experiencing "A Bull Market in Securities Fraud." The short answer is yes. Investors are being magnetically drawn to the markets either because they can't help but notice the Dow break new records almost daily or because they are trying to get rich quick by finding the next E-bay, Amazon, or anything "dot com." This rush of investor money hasn't escaped the notice of fraud artists, who have a knack for following the action. As Jane Bryant Quinn recently wrote: "As the stock market rises, so does the amount of fraud. If Willie Sutton were alive today, he wouldn't rob banks, he'd set up a thieving stockbrokerage house." What is more notable than the current rise in fraud itself is the medium by which much of it is taking place. As the Dow has soared over the last decade, so too has the Internet experienced explosive growth. History will no doubt record the evolution of the Internet as among the most significant developments of all time, in the same league as the invention of the printing press or the discovery of electricity. By providing cheap, quick, and easy access to vast sources of investment opportunities, the Internet has, among other things, transformed the way we invest. Unfortunately, the access it has provided to potential investors on a relatively anonymous basis has also made the Internet a favorite tool for many con artists. For example, it has helped to revolutionize the old fashioned boiler room. Who needs an army of telemarketers when you can reach millions of investors worldwide with the simple click of a mouse? A prominent state regulator has aptly noted, "Any con artist not on the Net should be sued for malpractice." Whereas policing insider trading was perhaps our greatest enforcement challenge a decade ago, policing the vast universe of the Internet is unquestionably our greatest challenge today. What makes this challenge even tougher for us is that we do not have available to us new or additional resources to do the job, although some members of Congress have expressed interest in making additional resources available. At least currently, however, policing of the Internet comes on top of all the other traditional types of frauds that have occupied our staff full time in the past. With that introduction, I'd like to share with you what we are doing at the SEC to combat Internet fraud and help maintain our markets' reputation as the fairest and most trustworthy in the world. Despite what I've said so far about the enormity of the challenge that the Internet poses for us, I believe that the future of the Internet is very bright in terms of our ability to detect, prevent, and punish fraudulent conduct. I've already seen that our efforts have made an important difference in the way that some securities activities are conducted on the Net, and I'm very excited about some of the projects we have underway currently which will be revealed in the coming weeks and months. In particular, our Chairman will be speaking here early next month, and I know he intends to fill in some of the details of how we are aggressively expanding our enforcement efforts to fight Internet fraud. But first, let me set the stage as to how we came to this historical point in time. The past decade has witnessed more explosive growth in our markets and more rapid technological change than at any other time in history. At the beginning of 1990, the Dow hovered in the 2,700 range. Just two weeks ago, it rained confetti on the floor of the New York Stock Exchange when the Dow broke the 10,000 barrier for the first time in history. Record numbers of individuals have shown their faith in our markets by putting more money in stocks and securities than ever before. We have also seen revolutionary advancements in technology during this past decade. Ten years ago, the word "Internet" was not in most people's vocabulary. Today, a reported 147 million people use the Internet worldwide with predictions that this number will increase to 700 million within five years. To put that number in perspective, one in five American households has access to the Internet. The net result, if you'll forgive the double entendre, is that not only are more people investing today than ever before, but more are doing so via the Internet. The Net has transformed our markets and brought significant benefits to investors. Investors are turning to the Net both to gather investment information and to execute their trades. The benefits to investors are mainly enhanced access to information and lower costs to execute trades. Nearly 14 percent of all trades are now conducted on-line. At the same time, however, the Internet has opened new avenues for securities fraudsters to swindle the investing public. There is indeed a bull market in Internet securities fraud taking place. The problem is of such great concern that hearings on the subject were held two weeks ago by the Senate Permanent Subcommittee on Investigations, chaired by Senator Susan Collins. I testified at that hearing on the Commission's Internet enforcement program. The Commission's program is one of humble origin. We began to surveil the Internet for fraud in 1995 at a time when our equipment and technological support barely even allowed us to obtain access to the Internet. We immediately witnessed some of the most outrageous frauds we had ever seen. One in particular stands out. Early on we received a complaint about an advertisement for the "Online Scam Guide." The guide proclaimed to have over 1,001 ways to scam people on the Internet. We put a crack team of cyber gumshoes on the matter who were able to track down the phone number of the mastermind behind the scheme. We called and were told that the perp was not home. We asked when the perp would be available, and were told that he would be available later in the afternoon -- he was not yet home from school. At 4:30 p.m., we were able to get the culprit on the phone. We read him our standard warnings including advising him of his right to counsel and other important due process considerations. He responded by bursting into tears and pleading with us: "I am only a teenager. Please don't tell my mommy." Now, from time to time we require notification of a defendant's employer of malfeasance; I don't know if we've ever required parental notification. In this case, however, the remedy proved to be very effective. The child's mother assured us that she would take care of the matter, and that we needn't worry about the offensive web site anymore. Given the successful resolution of this matter, it occurs to me that parental notification might be a powerful new remedy that Congress might consider for the new generation of cyber-scamsters. Since cracking that caper, we have brought dozens of Internet-related enforcement actions, the majority during the last year. Each case involves fraud. The substantial increase in Internet cases brought last year marks a trend we expect to continue. It's impossible to log onto the Internet and not be bombarded within minutes with any number of "get rich quick" investment opportunities. For example, how many of you have recently received an e-mail offering free stock for visiting a particular web site? Call me a cynic but in my line of business if there is one certainty it is that nothing in life comes for free. These giveaways are illegal more often than not. Why? Because, at a minimum, they are no different than an unregistered sale of securities. You can expect to hear more from us on this topic soon. Our experience patrolling the Internet leads us to conclude that the scams taking place online are the same basic scams that have long plagued our markets. They mainly break down into three categories. The first is sham offerings. Here, con artists create fancy web sites and use mass e-mails, or "spam," to pitch securities in offerings that either do not exist or are misleading. These scams are often exotic. For example, we have seen interests pitched in eel farms, coconut plantations, and, my personal favorite, projects to explore near earth asteroids. The second category of Internet fraud is market manipulation _ most often the "pump and dump" scheme. Here, fraudsters circulate widely false and misleading information to drive up a stock's price, then sell their shares at the inflated price. When the scheme is complete, the share price normally collapses. They work the other way, too _ a practice known as the "cybersmear." Often perpetrated by short sellers, this fraud is intended to driven down a stock price on the basis of false information. These scams routinely involve "microcap" stocks -- which are low-priced thinly traded securities. In conducting these scams, the Internet has served as the modern day "boiler room" replacing the traditional army of salespersons working the phones with scripts in hand. Finally, we have witnessed illegal touting. This occurs when promoters are paid to make positive statements about a company without fully disclosing that they have been paid to do so. The wealth of information available over the Internet aids investors only to the extent it is credible and reliable. If the information is simply "bought and paid for," investors have a right to know. The Commission has already made positive strides toward combating illegal touting. On October 28, 1998, we announced our first nationwide Internet fraud sweep, centering largely on illegal touting. We filed 23 enforcement actions against 44 defendants and respondents. In total, the touters received for their services almost $7 million in cash and 2 million shares of cheap insider stock and options of potentially unlimited value. The reaction to the sweep has been overwhelmingly positive. Investor sensitivity to on-line fraud has been heightened. We received a record number of visits by investors to our web site on the day the sweep was announced. Our on-line complaint center, which normally receives 120 messages a day, received seven times that amount in the days following the sweep. We currently receive between 200 and 300 complaints, on average, every day. In addition, the sweep produced lively discussions in chat rooms and other discussion forums and, most significantly, helped to bring about substantial improvements in the types of disclosures that accompany touts. We are not foolish enough, however, to think that our enforcement work is done. In February 1999, we brought a follow-up sweep and announced four more actions against 13 defendants and respondents for committing fraud over the Internet. And we will continue to bring actions against touts who either fail to disclose that they are being paid or whose disclosure is incomplete or inadequate. The impact of Internet fraud has been brought to the fore recently by the Senate Permanent Subcommittee on Investigations, chaired by Senator Collins. The Subcommittee has been active in looking at a variety of fraudulent practices that harm consumers and investors. Most recently, the Subcommittee held hearings on Internet fraud on March 21 and 22. A central issue of the hearings was whether regulators, including the SEC, have enough resources to police the Internet. The resource issue is one of great concern and has not been lost on Capitol Hill or the press. Just last week, Mike Schroeder of the Wall Street Journal addressed the issue in article headlined, "Growth in Internet Securities Fraud Will be Difficult to Combat." The same day, the Los Angeles Times had a story titled, "Rise in Net fraud could overtax SEC." While it is true that our resources are strained by the growth of Internet fraud, it would be a mistake to underestimate our commitment to attacking fraud on the Net. I can assure you that the reports of our demise are greatly exaggerated. We can and we will spare no effort to fight fraud in this new medium. As many of you know, in July 1998, we formed an Office of Internet Enforcement in recognition of the need for more coordinated and focused efforts in this area. The Office is currently comprised of staff who are Internet experts. They coordinate our enforcement initiatives which are handled by our entire enforcement staff of 850. The Office also provides the staff with training and technical guidance, and helps direct special projects such as our touting sweep. Finally, the Office manages our online Enforcement Complaint Center and also oversees our "Cyberforce." The Cyberforce is a group of 135 staff members who spend time each week surfing the Net in search of securities fraud. You can expect that the Office of Internet Enforcement and the Cyberforce will grow rapidly. Their activities, with the muscle of the entire Division of Enforcement behind them, should make believers out of those who think that the task of adequately policing the Internet is doomed to failure. We are not naive enough, however, to believe that even with increased resources we can regularly surveil every nook and cranny of the Internet. More is needed to win the war. To this end, we have supplemented our efforts to fight Internet fraud and microcap fraud with aggressive investor education efforts as well as a number of regulatory measures. Effective investor education is the best line of defense against fraud. Our Office of Investor Education and Assistance has done an excellent job of preparing and distributing a host of educational materials for investors. In addition, our Chairman, Arthur Levitt, has held 28 town meetings across the country where he has met with investors and helped them to understand and identify the warning signs of Internet and microcap fraud. On the regulatory front, in February of this year, the Commission engaged in a number of rulemakings designed to make it more difficult to engage in microcap fraud by tightening up the rules relating to the sale of unregistered securities. Microcap fraud and the Internet have proved to be a combustible mix with the Internet acting as a dangerous accelerating agent. In addition to the progress we have made on the enforcement, investor education, and regulatory fronts, we have made important progress in other areas as well, notwithstanding inherent limitations on our authority. As you know, the Commission has only civil jurisdiction. We cannot put people in jail. It has been my experience, however, that there is a certain breed of bottom feeders who are simply not deterred by the prospect of civil injunctions or even stiff monetary penalties. For this group of fraud artists, civil sanctions are simply a cost of doing business. There is no other option to achieving deterrence for them than the threat of a life behind bars making license plates. We have worked very closely with criminal prosecutors to make criminal prosecution a real threat, and our efforts are paying substantial dividends in the microcap area. During the last year, Chairman Levitt and I have met with a number of criminal prosecutors to urge them to bring more securities cases. And we are committed to supporting their efforts oftentimes detailing our own staff to U.S. Attorneys' Offices to assist with the cases. I am pleased to report that the level of interest in criminal prosecutions is on the rise. In the last several years, we've seen criminal prosecutions of some of the most notorious broker-dealers and their principals -- firms such as A.R. Baron and Sterling Foster and individuals such as Randy Pace of Rooney Pace fame and Jordan Belfort and Daniel Porush of Stratton Oakmont. And in one of the most dramatic law enforcement efforts, the New York Attorney General made a number of arrests at the firm of Monroe Parker. I can assure you that the prospect of being led off the premises in handcuffs will do more to deter a 21 year old kid from committing fraud than anything we at the SEC can do. Just as increased criminal prosecution has helped to make real inroads in the microcap arena, criminal prosecution of persons committing fraud on the Internet should likewise help us deliver a strong message to would be fraudsters. For example, the Santa Cruz District Attorney's Office recently prosecuted an individual who had raised a relatively modest amount of money over the Internet _ $190,000 -- through the fraudulent sale of securities. The defendant in that matter stole the money he raised and used it to buy numerous items, including stereo equipment and groceries. He was successfully prosecuted and received a whopping 10 year jail term in a state penitentiary. In addition to stepped up civil and criminal prosecution, there is also a possibility that help may be on the way from Congress. Following the Senate hearings on Internet fraud two weeks ago, Senator Collins announced her intention to sponsor legislation that would provide the SEC with enhanced remedies that would make it easier for us to bring cases and bar people from the securities industry. In particular, Senator Collins announced two proposals that we think could greatly aid our battle against Internet and microcap fraud. The first would allow the SEC to bar broker-dealers who have violated the law not just from the brokerage industry, but from promoting microcap stocks as well. Under current law, if we bar a broker from the industry, even for fraud, he or she remains free to come back as a so-called "promoter" over whom we have no direct regulatory jurisdiction. This creates a path for corrupt brokers to continue to deceive investors. And even a quick tour of the web makes clear that there is no shortage of gurus, touters, and promoters claiming with certainty to have found the "next Microsoft." Senator Collins also proposed to allow the Commission to bring follow-up administrative proceedings based on actions by state securities regulators. State regulators have been quite active in cracking down on both microcap and Internet fraud. For example, last June, California issued nine actions against Internet investment opportunities, including a floating condominium and a time machine. I applaud the efforts taken by our state partners. Their remedies, however, apply generally to activities solely within their borders. Senator Collins' proposal would allow us to give their orders nation-wide effect. We've faced and surmounted many challenges by ingenious fraudsters over the years. I'd like to conclude my remarks by noting what may be a parallel between the challenge posed by wide-spread insider trading in the 1980s and that of containing Internet fraud in the 1990s. In 1981, Fortune magazine ran a story titled, "The Unwinnable War on Insider Trading." People had little faith that the Commission could adequately stamp out this rampant market taint. Twenty years later, I can say we have made remarkable strides toward proving that headline false. Does insider trading still occur? Of course it does, and it will continue to occur as long as human frailty continues to exist. But we've unquestionably changed behavior in this area. With limited exceptions, no longer do we see insider trading in large magnitude by investment bankers and other Wall Street professionals, though we still bring cases against such persons. Former SEC Chairman Richard Breeden knew that the only way to quash insider trading was by meting out stiff penalties. You may recall his famous quote that people who engage in insider trading should be "left naked, homeless, and without wheels." Those caught perpetrating frauds on the Internet should similarly expect us to have little tolerance. Internet fraud artists will be left naked, homeless, and without modem. In the insider trading arena, we've clearly demonstrated that the cops are on the beat and that we have the ability and the wherewithal to find and prosecute those who profit from the misuse of inside information. Our commitment to effectively policing the Internet is no less strong. Over the years, our enforcement program has demonstrated remarkable resilience in adapting to changes in the markets. As we approach the new millennium, I am confident that we will continue to provide strong and effective measures to combat fraud in the age of the Internet. And I am also confident that you, the press, will continue to help us leverage our resources as we engage in this endeavor. Thank you.