|Law Enforcement Actions
The FTC has authority to combat fraudulent practices by bringing civil lawsuits in federal district courts. These cases involve alleged violations of Section 5 of the FTC Act, which prohibits unfair or deceptive acts or practices. Since 1994, the FTC has brought 26 law enforcement actions challenging fraud and deception on the Internet. Most of these cases challenged deceptive claims that the FTC would pursue in any medium. To date, only one FTC enforcement has involved the deceptive use of technology itself, but it is only a matter of time before technology-based fraud becomes more prevalent.
The Hijack: A New Type of Fraud
FTC v. Audiotex Connection, Inc. introduced the Commission to a form of fraud unique to the Internet. Consumers who visited the site, www.sexygirls.com, were prompted to download a purported "viewer program" to see computer images for free. Once downloaded, the consumer's computer was "hijacked" as the "viewer" program turned off the consumer's modem speakers, disconnected the computer from the local Internet access provider, dialed an international telephone number, and reconnected the computer to a remote foreign site. The international call cost more than $2 a minute, and charges accrued until the consumer turned off the computer. Consumers were charged for calls made to Moldova, even though the calls went only as far as Canada. In some cases, the charges to consumers ran into thousands of dollars.
The FTC confronted a dual challenge: mastering the technology and finding the perpetrators in cyberspace. With help from both the private sector (AT&T) and government (Secret Service), staff learned the intricacies of the viewer software, how to use the Internet to find the scammers and their assets, and how to find aggrieved consumers.
The Commission filed its complaint in February 1997, and stopped the operation one month after receiving notice of the scam. The victims, over 38,000 consumers, are expected to share $2.74 million in redress from the Audiotex case--100 percent compensation for their injury.
The Hype: Traditional Fraud and Deception on the Internet
Among the driving forces in the recent bull market are technology stocks in general and Internet-related stocks in particular. Officials of the Securities and Exchange Commission (SEC) and the North American Securities Administrators Association, Inc. (NASAA) have identified the Internet as a major breeding ground for "pump and dump" stock manipulations, penny stock frauds, and other securities schemes.(6) Meanwhile, unregistered investments have mushroomed on the Internet. It was no surprise, then, to find fraud operators who were trumpeting the riches to be reaped through online businesses.
In Project Field of Schemes, federal and state law enforcement officials targeted novel investment frauds. The Internet played a prominent role in the sweep. For example, the FTC's case against Intellicom Services, Inc. involved 12 corporate defendants and 10 individual defendants who promised enormous profits from Internet access businesses and Internet shopping malls. The FTC alleged that telemarketers sold over $30 million in bogus high-tech investments. In an offering they called Home Net, the defendants offered interests in a partnership to develop a "virtual shopping mall" where consumers supposedly could view products and buy them from their home computers. Predicting a track record like that of QVC and the Home Shopping Network, the defendants claimed that the shopping mall was under construction, that they were locating merchants, and that Home Net would feature live actors as hosts. They promised investors returns of up to 600 percent the first year.
Meanwhile, other Intellicom defendants peddled an "Enternet" investment in Internet Service Provider (ISP) businesses which provide subscribers access to the Internet. Comparing their venture to Netscape and Earthlink, two well-known national services that enable subscribers to access the Internet, the defendants allegedly claimed investors would earn as much as a 207 percent return in the first two years. Like the Home Net promoters, the Enternet group maintained a web site with hyperlinks to other sites proclaiming that the ventures were "under construction."
In both instances, the FTC alleged that the "constructed" site and the profits were nonexistent. According to the FTC complaint filed in July 1997, the defendants skimmed the proceeds, making it impossible for these ventures to succeed. The FTC, together with the California Department of Corporations, filed suit against these operations, obtaining asset freezes and preliminary relief. The SEC also filed suit against some of the defendants, and the FBI served search warrants as part of the investigations.
Other Internet-related scams involve web sites that are luring consumers off-line--into fraudulent telemarketing pitches. Another Field of Schemes target, Dayton Films, involved the promoters of a movie production offering who posted a web site with a 32-page financial prospectus and a toll-free telephone number. Telemarketers allegedly told consumers who called that the film's director had won an award from the prestigious Cannes Film Festival and had averaged a 500 percent profit in his last 10 films--claims the FTC says are false. Rosario Filosi, one of the defendants, has agreed to a permanent injunction, including a provision which bans him from telemarketing activities.
Another Field of Schemes case, Coastal Gaming, involved telemarketers for a casino ship venture who posted a web site inviting Florida tourists to visit their ship, The Dixie Duck. The FTC alleged that investors were told that they could expect a return of 100 to 300 percent on their investment from Coastal Gaming's operation of this cruise ship. In fact, in its few weeks of operation, the ship lost money virtually every time it sailed. Earlier in the offering, Coastal Gaming telemarketers allegedly claimed the company had purchased a luxury gambling cruise ship called The Midnight Gambler. They also represented that Gloria Estefan, Dan Marino and the Hilton Corporation had entered into agreements with Coastal Gaming to promote the good will and name of The Midnight Gambler. The FTC alleges that Coastal Gaming never purchased the luxury gambling cruise ship called The Midnight Gambler and had no contracts with celebrities.
Operation Mousetrap was a law enforcement sweep that attacked misrepresentations by invention promotion firms. The FTC filed suit against Davison & Associates, alleging that the company claimed to prepare objective and expert analyses of patentability and marketability of consumers' invention ideas and claimed to have an extensive database of corporations with whom they regularly negotiate licensing agreements. Davison & Associates operated a web site allegedly representing that inventions could be marketed profitably if the inventors would contract with a particular invention promotion firm; however, consumers were never able to recover their investment through Davison & Associates' services.
In summary, the Internet is teeming with pitches to make easy money as legions of "traditional" fraudsters search for new targets. Indeed, the Internet is a "target-rich" environment. While the fastest-talking telemarketer may be hard-pressed to make more than 150 calls a day, a scammer can e-mail thousands of individuals in less than an hour. Consumers are likely to be inundated with e-mail solicitations in the future, and should view unsolicited commercial e-mail with the same healthy skepticism they would use to evaluate any other sales solicitation.
Like multi-level marketing programs, pyramid schemes provide financial incentives to recruit new distributors. Pyramids compensate distributors almost exclusively for recruiting other distributors; product marketing activities are merely incidental. Pyramid schemes, unlike multi-level marketing plans, are generally prohibited because it is a mathematical certainty that the pyramids will collapse when no new distributors can be recruited. When the plan collapses, most people--except perhaps those at the very top of the pyramid--lose their money. Unfortunately, the Internet offers a fast lane for pyramid builders by facilitating large-scale recruitment in little or no time.
As part of the Field of Schemes Sweep, the FTC brought two cases involving alleged pyramid schemes. In FTC v. Rocky Mountain International Silver and Gold, Inc. (RMI), the FTC alleged that a pyramid scheme masqueraded as a multi-level marketing operation selling silver and gold coins. Although RMI initially advertised the scheme by direct mail, it abandoned this method in favor of the Internet by the time the FTC filed suit. Promising that "silver is your golden opportunity," the Internet advertisement hyperlinked customers to RMI's web site, which featured brochures, applications, and participation agreements for recruiting new members. The FTC obtained a preliminary injunction and asset freeze against RMI.
In FTC v. JewelWay International, Inc. (JewelWay), the FTC alleged that the defendants ran a pyramid scheme via an Internet home page and group presentations. The FTC charged JewelWay and six individual defendants with making deceptive earnings claims. The claims induced an estimated 150,000 consumers to invest an average of $1,000 each in an allegedly illegal multi-level marketing plan. The defendants offered consumers the chance to earn up to $2,250 a week--plus bonuses--by participating in a multi-level marketing plan to sell fine jewelry. Consumers who joined the plan were told to recruit two new representatives each. Last June, the FTC alleged that the company paid commissions based on the recruiting of new participants, not the retail sale of products. As a result, the FTC said, the defendants were running an illegal pyramid scheme, not a bona fide multi-level marketing plan. Last November, the FTC settled charges against JewelWay and its corporate officers in an agreement requiring a $5 million redress payment for distribution to injured consumers.
FTC v. Nia Cano, et al., filed in October 1997, showcased a new combination--an alleged pyramid that used "spam," or unsolicited e-mail advertising, to recruit distributors. Nia Cano allegedly promised consumers huge profits for selling memberships in an organization that issued credit cards with a credit limit of $5,000. Actually, the cards were debit cards, which provide for payment for purchases by immediate withdrawals of funds held in bank accounts. Consumers never received the credit cards. Distributors were assured that they would earn $18,000 a month for signing up new recruits. Some distributors then recruited down the line with unsolicited e-mail containing allegedly deceptive claims. Interestingly, this case resulted from staff review of unsolicited commercial e-mail and news group messages. Last October, the FTC obtained an injunction, an asset freeze, and a court-appointed receiver over the business. An estimated $2 million has been frozen in this case.
Health and diets are popular subjects on the Internet. Much of the content is simply a free exchange of information, opinion, and conjecture unrelated to the commercial promotion of particular health products or services. The Internet also hosts thousands of commercial health promotions--not all of them legitimate.
In SlimAmerica, a defendant with a history of using traditional media to scam consumers is charged with using the Internet to make allegedly deceptive claims for a diet product called "Super-Formula." The defendant claimed that the product would "blast" 49 pounds off in 29 days, "obliterate" five inches from waistlines, and "zap" three inches from thighs. Consumers spent $9.5 million purchasing the diet product before the FTC intervened. The FTC filed suit in federal district court in Florida last January, obtaining an asset freeze over $1.4 million, as well as other preliminary relief. A trial was held in December 1997, and post-trial pleadings are pending.