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By Maryann Haggerty
Washington Post Staff Writer
Sunday, August 23, 1998; Page H5

If you have an e-mail address, you've probably seen the stock spam, nestled among porn promotions and chain letters: unsolicited electronic hypes of the hottest pharmaceutical stocks, the next America Online, the next Microsoft or any number of other tiny companies that promoters say are poised to fly.

To the consumer, they may be just an annoyance. But to regulators charged with overseeing the stock market, those ubiquitous come-ons, coupled with polished Web pages and breathless chat group messages, are the new tools the bad guys are using to separate unwary investors from their cash.

"These are the same people who have been doing boiler-room scams for years," said Cameron Funkhouser, director of market regulation at the National Association of Securities Dealers, which oversees brokers. "All you have to do is blast out the e-mail and you've got the ball rolling."

"It doesn't take a lot of money to make nothing look like something on the Web," said Nancy Smith, director of the Office of Investor Education and Assistance at the Securities and Exchange Commission, which oversees public companies and markets. "They can make something that's a total fraud look legitimate."

The SEC and NASD both have cyber-fraud investigation operations that actively search the Internet for signs of wrongdoing, as well as following up investor complaints. Although neither regulatory group will comment on current investigations, a number of cases already have been prosecuted.

One of the highest-profile cases involved Systems of Excellence Inc., a now-defunct McLean videoconferencing company known by its stock symbol, SEXI. Executives and stockbrokers who worked for the company pleaded guilty this year and last to a stock manipulation scheme that depended heavily on glowing Internet promotion.

Regulators say the Internet is particularly well suited for a classic scheme known as a "pump-and-dump." In such operations, insiders who control large chunks of stock in a small company talk up the firm's prospects. Individual investors, lured by quick returns on a low-priced issue, start buying. When the promoters have sold their stock and taken their profits, the price collapses because there is little or no real underlying business.

In the old-fashioned boiler-room world, these schemes relied on stockbrokers telephoning potential victims with their hard sells. Now with the Internet, investors are lured in with stock spam, or they come across discussions in news groups and chat rooms. The message is hammered in by the company's home page and by endorsements from Internet newsletters that sometimes accept payment from companies in return for good stock write-ups.

The chat groups can be particularly alluring, said Funkhouser. "There are scamsters out there who are paying people to just have conversations all day long on stocks they're touting." Because the shills can send messages under an unlimited number of screen names, it may appear that 50 or 100 people are joining a discussion, when there are really only one or two.

The growth of electronic trading through discount brokerages can make it tougher to stamp out these schemes, said Stephen Luparello, vice president of market regulation at NASD. In a traditional pump-and-dump operation, he said, NASD would notice increased market activity in a small stock clustered among a handful of marketmakers – the brokers selling the target stock. Now, he said, because Internet-focused investors handle their own trades via computerized accounts, the trading is spread out.

It's the nature of stock-scam enforcement that regulators usually don't shut down a shaky operation until after victims have lost money. Regulators say investors need to protect themselves.

"The most important piece of advice is to do your homework and get the facts on any investment you learn about on the Web," said Smith. That includes checking with state regulators to see whether an investment is registered, obtaining – and actually reading – a prospectus and checking out a broker's disciplinary record. The good news: You can do most of that homework through the Internet.