SEC seeks securities fraud Internet sniffer

The Securities and Exchange Commission plans to develop a network application to scour public areas of the Internet to search for messages, unusual traffic patterns and other clues that may lead to the arrest of criminals engaged in online securities fraud.

The SEC this month announced it would solicit proposals from vendors who could develop a system capable of scanning the Internet to gather data from the World Wide Web, Internet listservs and newsgroups. "Now more and more [securities fraud] cases are touching on the Internet," said John Reed Stark, chief of the SEC's Office of Internet Enforcement.

The SEC each year brings charges in about 500 cases of securities fraud ranging from simple fraud to complicated schemes involving many people and corporations. Since 1995, charges have been brought in about 100 cases involving securities law violations via the Internet, Stark said.

Con artists are increasingly turning to the Internet to reach more people faster. According to the National Association of Securities Dealers, which sets professional standards for the financial services industry, about 75 percent of securities fraud now involves some type of communication via the Internet.

The scams—such as the sale of bogus stocks or touting stocks to drive up prices—are not new. "These are the same types of fraud that have been occurring for years and years," said Cameron Funkhouser, vice president of market regulation for the NASD. But the medium—the Internet—has changed.

Even though it is vast and has introduced new problems, the Web can ease the job of ferreting out fraud. That is because the Internet provides a distinct, searchable and, in some cases, traceable source of evidence in securities fraud cases, Stark said. In comparison, keeping track of stock schemes promoted via print ads, seminars and brochures can be difficult.

Automating the search process should make investigators' jobs easier. "I think the main thing is what we're really trying to do is look ahead," Stark said. He declined to specify what a new SEC system is looking for, nor did he provide a time line for putting the system in place.

The NASD uses an automated system called NetWatch to monitor aberrations in the traffic of Internet messages on securities (see "Watchdog on the Web," below).

Jon Wall, a senior technology specialist with Microsoft Federal, said that developing such a system for the SEC might involve tracking messages written in languages other than English and examining not just a Web site but the links included on that Web site. Wall said the developer of such a system should consider keeping a detailed history of messages and changes to Web sites to make the job easier for prosecuting attorneys.

The securities fraud scanner also could test constitutional protections. Ethan Preston, a law clerk at the Electronic Privacy Information Center, said the system could have a chilling effect on legitimate discussion of stocks online. People expect some anonymity when they post information on the Internet. "You don't have to worry because usually people aren't going to try and find out who you are," he said. But Jim Dempsey, senior staff counsel for the Center for Democracy and Technology, said privacy concerns may not hamper the SEC plan. "So long as they are scanning public areas—Web sites and bulletin boards and newsgroups—there is no legal impediment to what they are doing," he said. "People need to be aware that the Web is a public space: You can speak globally, but you can be searched globally too."

Moreover, SEC officials seem to be well aware of the fact that the Internet enables them to conduct searches for evidence like they never could before. "We're doing it really because we can," Stark said.

***Watchdog on the WebThe Securities and Exchange Commission's strategy could be modeled after a similar, smaller-scale project employed by a securities watchdog organization.

The National Association of Securities Dealers' NetWatch monitors publicly accessible Internet messages involving Nasdaq and over-the-counter stocks. The SEC's job is bigger, encompassing enforcement of a broad range of securities laws in the United States.

The NASD's NetWatch works by scanning a selected group of public sites on the Internet and recording levels of traffic flow for messages on stocks. When NASD officials notice an aberration in the trading price or volume of a company's stock, they can check NetWatch to see if an increase of message traffic on that particular stock may have preceded the aberration. Such an increase can indicate that someone may have tried to manipulate a stock price by disseminating false information about the company.

An NASD official would not provide examples of cases in which NetWatch has proved useful, but he said the NASD regularly passes on tips to the SEC when NetWatch and other automated tools the NASD uses reveal "red flags."