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Money, February 2000

THE SEEDY WORLD OF ONLINE STOCK SCAMS

Stock fraud is one of the Net’s fastest-growing industries. Here’s what you need to know to protect yourself.

John Famularo was playing around on his home computer one day last July when he came across some message-board threads discussing a company called Uniprime Capital. The firm had recently made the astounding announcement that it was successfully developing a cure for AIDS. True believers were posting glowing comments on message-board sites like Raging Bull at a furious pace. Within two days, Uniprime’s over-the-counter shares had spiked from $1.50 to a midday high of just under $8. More than 5.2 million shares changed hands on the stock’s busiest day, vs. a typical daily volume of well under 100,000 shares. It was into that buying frenzy that Famularo, a 37-year-old air-traffic controller at the Dallas/Fort Worth airport, called in his market order of 1,000 shares. It was filled at $5 apiece. An active trader, Famularo says he didn’t bother to research Uniprime. He just believed no company could be allowed to lie about having a cure for AIDS if it didn’t. “I got suckered in and fell for it hook, line and sinker,” he says today. “I got into that state that it had to be real, and I couldn’t get out, so I just watched it. Then I got to that point where you feel you got suckered. Screw it! Go crawl under a rock.” Uniprime shares were recently trading at 3 cents each, making Famularo’s $5,000 investment worth $30.

Uniprime, it turns out, was no healthcare company but a Las Vegas car dealership — a fact that went unnoticed by many investors. According to fraud charges filed in related civil and criminal cases, Uniprime and Alfred Flores, a major Uniprime shareholder and president of its New Technologies and Concepts subsidiary, lied about the company in a series of false press releases in order to pump up the price of its stock. Not only was Flores not the medical researcher he claimed to be, according to court papers, but he had actually been convicted of conspiracy to commit murder and was in prison in Colorado when the research was supposedly done. In a collect call from jail, where he is being held without bail until trial, Flores told us: “I never lied to nobody, and I didn’t sell stock. I don’t even know how the market works.”

The case would be funny if it weren’t so serious — and so common. Age-old money frauds of all types are flourishing on the Internet. No longer do con men need rooms full of cold-calling brokers. Now, with just an e-mail address list and a chat-board alias or two, penny-stock promoters can spam tens of thousands (if not millions) of investors, run up a stock’s price and sell their shares to unwitting buyers — only to disappear into cyberspace. The cost to pull off such a fraud: less than one-tenth of a cent per name for the e-mail addresses; most everything else is free. “You just need one person, and they just need to have access to a computer somewhere,” says John Stark, head of the Securities and Exchange Commission’s office of Internet enforcement.

And while there’s no question that the Internet can be a powerful tool for investors, the great bull market has created a lot of gullible — or perhaps just lazy or overly optimistic — Web-enabled investors. “People don’t have a good perspective about probabilities,” says Terry Odean, a behavioral-finance professor at the University of California-Davis. “They have unrealistic expectations, and then they see these ads about truck drivers who own islands, and they think, ‘It must be my turn.’”

The combination of that mind-set and the huge numbers of people now investing online have made cyberscamming the three-card monte of the new millennium. Online and off, investors get ripped off to the tune of an estimated $10 billion a year — that’s more than $1 million an hour — according to the North American Securities Administrators Association (NASAA). While there are no good figures on cyberfrauds, let alone for how many investors have been fleeced in them, regulators and attorneys say that both numbers are on the upswing. So pervasive has the problem become that it’s drawn the attention of the Department of Justice, the Federal Trade Commission, the U.S. Attorneys’ offices, and even the FBI. Since the SEC first set up its online unit five years ago, it has brought more than 100 Internet-related lawsuits, involving tens of millions in ill-gotten gains; and a number of con men have been sent to the slammer in related criminal actions.

In spite of the cops’ best efforts, however, the complaints just keep pouring in. The SEC’s Internet complaint hotline (e-mail address: enforcement@sec.gov) gets up to 300 messages a day, a thirtyfold increase since its June 1996 founding. NASAA gets another 500 a week. The No. 1 complaint: spam e-mails touting stocks, typically little-known and illiquid ones, often with false or inflated claims. Some come from the companies themselves, others from unaffiliated spamming groups. While not all spam stock e-mail messages are frauds, it’s a rare one that turns out to be a good deal for investors. A typical spam, one of many coming to this reporter’s personal e-mail address in recent weeks, promotes a money-losing CD-ROM and website producer calls Digs Inc. with a “Strong Immediate Buy Recommendation.” It then claims that Digs’ stock (recently at $9) would hit $15 within two months. (An attorney for Digs says the company had nothing to do with the e-mail and had forwarded information about it to federal regulators.) Another recent tout came from the Stock-Tipper cybernewsletter (“Growth stocks featured daily!!”). This one promoted NELX Inc., which it claimed was negotiating to buy a private oil-and-gas company with reserves potentially worth more than $41 billion. Though NELX hadn’t turned a profit, its bulletin-board-traded shares certainly have soared this year, rising 225% to a recent 12 cents apiece. And then there’s the July 19 spam about Uniprime (forwarded later to MONEY by a large Uniprime investor) that claimed the company had found the cure for AIDS, that it was working on interviews with Time, 20/20 and 60 Minutes and that the stock — so undervalued it was “like buying Microsoft now at a nickel” — was headed for $50.

Who falls victim to these promotions? The money losers represent the broad range of American investors of all ages, locales, occupations and net worths. “It is anybody who has got Internet access and is following these message boards or is capable of receiving e-mail,” explains Cameron Funkhouser, vice president of market regulation at the National Association of Securities Dealers. “With all this information on the Internet, people are doing their own research and getting sucked into these schemes.”

Look, for example, at who fell for the Uniprime story. In addition to Famularo (the air-traffic controller), the stock’s investors included Quentin White, 33, a full-time stock trader in Denver (invested $1,375, worth around $30 now); Rob Abrams, 46, an environmental consultant near Trenton (invested $5,000, planned to sell for tax purposes before year-end); and a 43-year-old real estate developer in California, who spoke on condition of anonymity (invested a whopping $65,000 and cashed out for just over $1,000).

What is it that allows a stock like Uniprime to attract more than 13,000 posts on Raging Bull alone (55% more messages than Microsoft garnered) since the beginning of 1999? And what accounts for investors’ suspension of disbelief about a Las Vegas car dealer with a $1.50 stock discovering the cure for AIDS? Says White, the burned trader: “It’s greed, and in this situation, it was stupidity.”

It’s a laissez-faire world on the Net, with no brokers to read you suitability requirements and few of the other safeguards that might protect you offline. And though the securities cops are beefing up their enforcement efforts, the best way to avoid getting taken in a cyberscam is to protect yourself before you plunk down your hard-earned cash. Get hold of the financial documents, read them, find out about the people behind the investments, and learn more about what you’re planning to get than you would to, say, buy a car. If, despite your best efforts you do get burned, don’t be embarrassed. You’re surely not alone. Save all your documents and alert the securities cops at the SEC (www.sec.gov), the NASD (www.nasdr.com) or NASAA (www.nasaa.org). You may not get your money back, but at least you’ll clue others in to the problem. Bio photo