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Fighting Internet "Cyber Investment Fraud"

Since 1994, California has been working with the other states through the North American Securities Administrators Association (NASAA) to alert the public to the risks of investing through the Internet or investing in Internet products or services. In conjunction with NASAA Investor Education Week, the Department of Corporations introduced a new page on its Website devoted to the effort to combat investment fraud on the Internet.

California was one of the first states in the nation to recognize the threat to investors from unscrupulous dealers intent on defrauding consumers. Below, please find frequently asked questions regarding investment fraud on the Internet:

  1. What violations of state securities laws is the Department of Corporations seeing on the Internet?
    • Offer and sale of unqualified securities
    • Unlicensed broker-dealer and investment adviser activity
    • Fraudulent offers and sales of securities
    • Market manipulation
    • Insider trading
  2. Why is the Internet attractive to con artists as a marketing tool?
    • It is a global borderless trading environment
    • It offers instant access to 300 million people
    • Con artists can be anonymous through the use of fictitious names, multiple aliases, remailers, coffeeshops and libraries with Internet access
    • State and local governments have limited resources and defined jurisdictional boundaries, while con artists can operate from anywhere with the most modern technologies.
  3. What kinds of offerings involve the Internet?
    • Use of the Internet to market illegal and fraudulent offerings of investment products
    • Use of Internet products or services as the subject of the investment
    • The millions of websites on the Internet are essentially passive and not likely to generate much interest unless aggressively marketed through newsgroups, chat rooms, bulletin boards and spamming.
  4. What is the Department of Corporations doing about it?
    • Investigates referrals from Department of Corporations counsel, other states, the Department of Corporations Investor Complaint Desk, and outside sources such as the North American Securities Administrators Association (NASAA) Internet Neighborhood Watch Program. NASAA has an e-mail address for investors to report suspected Internet fraud. It is cyberfraud@nasaa.org.
    • Scans investment related websites such as Silicon Investor (www.techstocks.com).
    • Scans investment related Usenet Newsgroups.
    • Utilizes undercover off-Department of Corporations-network high speed computers and undercover identity to shop apparently illegal offerings and solicit offerings of investment products. The use of certain search criteria make it more likely that the Department of Corporations will receive targeted spam and solicitations by offerors of investment products.
    • Uses search engine technologies to identify offerings containing certain key words that are indicative of possible fraud.
    • Prioritizes cases based on location of the subjects or victims in California, the targeting of California citizens in the offering or the priority of the subject of the offering.
    • Refers cases to other states or the Securities and Exchange Commission (SEC) or Federal Trade Commission (FTC) if the focus of the offering affects their jurisdictional interest more than that of California.
    • Refers cases involving apparent violations of California law for assignment to staff to take enforcement action to stop the violations of the law.
    • All staff will utilize the Internet as an investigative tool in all open cases.
  5. What next?
    • The demographics of Internet users will change as more people gain access to the Internet via their television sets and cable hookups. These new users will be less sophisticated and more vulnerable to fraudulent schemes.
    • The Department of Corporations will continue to emphasize bringing enforcement actions on a range of violations, public education and outreach, and cooperation among regulators and law enforcement in order to meet the challenges of the Internet.
    • The Department of Corporations is seeking to develop a web-based complaint form and web-based questionnaires to obtain complaints directly from members of the public and will input them directly into a database to be used for targeting, prioritizing and trending.
    • Internet commerce will be the cutting edge issue for regulators and law enforcement in the next decade. It creates many new and unique problems of jurisdiction, evidence gathering, and the ability to bring enforcement actions that are effective and meaningful. To be effective will require focus and discipline and a clear understanding of who the department is trying to protect and from what. The Department of Corporations believes that it has the tools and the skills in place to play a leading role in dealing with both legal and illegal investment activities on the Internet.
  6. What about on-line trading in securities? Are there any risks?

    There is nothing inherently wrong with on-line trading in securities, but there are some things to be aware of. If the on-line trading account is with a full service broker, it is merely an alternative form of trade placement and execution, but it is dependent on technologies that are changing and growing rapidly and that are not foolproof. Customers can reduce the risk of delayed execution or execution at a price higher or lower than the price they were expecting by using limit orders. On-line accounts with discount brokers are less expensive but the customer does without the research, due diligence, recommendations, support services and fiduciary relationship of an account with a full service broker. On-line investors should find out about back-up systems available such as telephone access and local branch offices and should keep records of orders and confirmations in case there is any dispute about the orders placed on-line.

  7. Is day trading advisable?

    Day trading is a strategy of trading securities multiple times during the course of the day and is extremely risky for both the unsophisticated and the sophisticated investor. In order to be profitable, the trades have to beat the "house" in terms of commissions, spreads, capital gains taxes and other costs. Many day trading firms offer systems based on market trends and numerical formulas that are unrelated to the fundamentals of valuing securities, and those systems are no more reliable than systems for gambling in Las Vegas. Regulators have brought actions against a number of day trading firms for unlicensed investment adviser activity, unlicensed broker-dealer activity, and fraud. Any guarantees of success in day trading systems are a red flag that the company is probably engaged in illegal activity.