Crimes And Misdeminors

By Daniel Kadlec

They used to just look like kids, these rogue traders, boiler-room con artists and Internet scamsters possessing just enough knowledge about the stock market to fleece anyone who would listen. Now they really are kids.

At 27, Nick Leeson brought down Barings bank with $1.4 billion in fraudulent trades. At 25, Gary Hoke faked a Bloomberg news report linked to a Yahoo bulletin board in a stock scam that cost investors $93,000. At 24, Rafael Shaoulian littered financial bulletin boards with unfounded hype that enabled him to sell a stock and pocket $173,000. At 23, Mark Jakob drove down the stock of Emulex with a phony Internet report. He bought with a vengeance after the decline and made $241,000 when the hoax was discovered and the stock rebounded.

Now comes Jonathan Lebed, 15, a New Jersey neophyte retracting the definition of "kid" from anyone merely young to certifiable school-age dependent. Lebed lives at home. He watches World Wrestling Federation matches. He roots for the Mets. He doesn't drive, at least not a car. But he has been in the fast lane of Wall Street swindlers for the past year, driving stocks with bogus chat-room hype that enabled him to capture $272,826 in illegal profits. Lebed settled his case with regulators last Wednesday, agreeing to disgorge the profits, plus $12,174 in interest, without admitting to any wrongdoing.

Lebed is the first minor the SEC has ever charged with securities fraud, and you may well ask, Isn't it one thing for a set of twentysomethings at work or in college to master the ole pump and dump, Net style, but quite another for a bona fide minor to get it down pat? Do we have a serious problem here?

Yes. A few of them. For starters, his antics have made Lebed something of a hero in his hometown of Cedar Grove. "I'm proud of my son," quickly proclaimed his father Gregory Lebed, a railroad worker for Amtrak who drove up to his house last week in a forest-green Mercedes suv. Proud? Support you can understand. But mass fraud seems a strange accomplishment to crow about.

"He's like a celebrity," says Anthony Callie, a friend and classmate. "I'm sure he's got a lot of new friends." Another classmate, Nicole Basalyga, chimes in, "He outsmarted the government and made a lot of money. That's pretty cool."

Well, not really, Nicole. The government nabbed him. He had to give some of the money back, and he may still face criminal charges. That's pretty uncool. The folks at home, though, aren't thinking about any of that. This is a gilded new age in which everyone has the right to get rich, regardless of the means. Historians document periods of prosperity such as the current one. These periods almost always lead to a high incidence of scamming as the get-rich-quick mindset spreads.

Today, amid an unprecedented bull market broadly enjoyed at the dawn of the Internet, the stock market is the tool of choice--and breaking the rules becomes increasingly acceptable as the players get younger. Call it extreme capitalism. If you win, you're envied as a genius.

Another problem is the settlement. Hours after it was announced, Lebed's attorney, Kevin Marino, reportedly let the world know the disgorgement would be less than what Lebed had made. "I think it's a great idea for everyone to abide by the law," says Marino. As for regulations governing the Internet, "there's still a huge gray area out there. I believe the information industry has surpassed the regulations." To get the deal, the SEC focused on just 11 of 27 trades it had investigated. The SEC could demand restitution only from the trades covered in the settlement. Did Lebed scam the SEC too?

Finally, and this is the big stuff, Internet stock fraud is a growth crime. The seeming anonymity of Web postings and chat sessions has emboldened scamsters and driven down the cost of running a first-rate swindle. No longer do con artists need elaborate "boiler rooms" filled with phone banks and fast-talking stock jocks. "Historically, perpetrators had to be more sophisticated," says John Reed Stark, chief of SEC's Office of Internet Enforcement. "There were a lot more complexities to the schemes. With these manipulations, all you need is a computer and a modem to spread false information."

That's how Lebed did it. He would buy large blocks of thinly traded stocks on the NASDAQ or the over-the-counter bulletin board, moving the price up 20% or more. After the market closed and the next morning dawned, he would flood cyberspace with as many as 600 messages under different names touting the stock as one about to "take off" or, in the case of Man Sang Holdings, "the most undervalued stock in history."

In the Man Sang case, he twice manipulated the price--once buying it at less than $2 and selling near $4, and next buying at less than $3 and selling at more than $5. Gullible chat audiences piled in, pushed up the price and then were left with big losses as the stock inevitably tanked. So cocksure of his schemes was Lebed that in some cases he entered automatic sell orders, to be triggered when the stock rose to a specific price, and then skipped off to school knowing he'd make thousands of dollars before recess. Because he is a minor, he traded through two custodial accounts in his father's name.

There's absolutely nothing new about Lebed's con. What makes it noteworthy is his age, plus the epidemic that has developed of this kind of fraud. The SEC gets 300 e-mails a day complaining about rip-offs. A quarter of its enforcement staff is dedicated to cyberspace, surfing the Net for hard sells and unrealistic investment promises.

The good news is that this stuff is easy to track down. The SEC has cracked 180 Net-fraud cases in the past five years, most of them in the past two. The charges against Lebed coincided with a nationwide fraud sweep involving 15 cases and 33 defendants. Some 70 micro-cap stocks--low volume and thinly traded--worth $1.7 billion were involved, and the total illegal profits came to $10 million. The SEC likes to bundle its cases for maximum effect. This was its fourth such sweep since the Net became a popular stomping ground for stock fraud a few years ago.

Conventional fraud investigations usually take six months to a year. But Internet fraud often wraps up in less than a week. The electronic trail is that clear--far easier to trace than the paper trail of the old economy. Last year Silicon Investor, based in Seattle and owned by Go2net, reprimanded Lebed for "violating the terms of his membership" (which can mean anything from spamming to being abusive to going "off topic" on message boards). The last time he posted a message to the site was July 17, 1999. He then apparently gave up and moved to the less regulated environment of Yahoo. What may have helped the SEC is that Silicon Investor has archived all 15 million of the messages placed on its 20,000 message boards since inception. A trail was easy to generate.

"You've got great evidence, and it's easy to find people," says the SEC's Stark. "Internet con artists may try to hide behind multiple screen aliases, but most computers leave their own electronic footprints that are relatively easy for experts to track."

For the con to work, it must be done out in the open where investors will see it and throw money at it. "You want people to find you," Stark says. "You want them to read your information." That's what makes the stock go up, but it also makes you easier to find. Lebed may have got away with his schemes for a year, but others have been identified within days. In the Emulex case in August, Jakob was targeted within hours of his phony press release. Hoke, an employee at PairGain Technologies, was nabbed just a week after his bogus release declared that PairGain was about to be bought out.

One of the amazing aspects of Lebed's story, or that of any Net fraudster, is that people act on the hype they see online. Large banks like Chase Manhattan pay millions of dollars a year in premiums to insure against a rogue trader like Leeson. Your best protection against a rogue Internet hypster is just not to listen. Most pump-and-dump schemes involve micro-cap stocks. That's your first tip-off. Often they hype them as likely to double or better in weeks. If you have questions, the SEC has a brochure, "Pump&Dump.con," with tips for avoiding scams. It's available at www.sec.gov

The rash of Net fraud cases has done little to deter online investors from their passion, nor should it if they stick to investing in what they know. "Sure, there's a lot of garbage out there," says Bob Smith, a Houston oil executive. He upgraded his computer five years ago specifically to dump his broker and trade online. He checks the financial Web postings and tunes in to chat sessions on the market. But he also does his own research and notes that the hype-and-con element of Wall Street isn't just online. "Highly paid analysts hype Internet stocks with outrageous price targets, then drop their estimates," he says. "I am sure they get their firms out of a position before they drop the bomb on the rest of the investing public."

Jordan Feiger, a Chicago businessman, is another who hasn't been turned off by the scams. "When you go into a chat room, it's like picking up a copy of the Star," he says, referring to the gossipy supermarket tabloid. "Some of the stories might be true and valid, but they certainly should not be your main source of information."

By all accounts, Lebed is intelligent and likable, considered a tad geeky because of the black leather briefcase he totes to school. "He's not very active in school and stuff," notes Kristel Rice, a senior at Cedar Grove High School, where Lebed is a junior. While students knew of his interest in stock trading, he kept to himself, asking only a few to join him. "He kept quiet about it," says classmate Tom McCarthy. "He kept it personal."

Before he discovered the dark side of Net investing, he seemed on a fast track for a dream career on Wall Street. With help from his father, he began investing at the age of 12 and a year later formed an alliance, dubbed the Triple Threat, with two friends. As a team, they placed fourth among 3,500 in a national investment derby sponsored by CNBC and MCI. Lebed and his pals rolled out of bed regularly at 5 a.m. to troll for stocks on the Internet and TV.

He has railed at town-council meetings about laying high-speed cable for better Net access. He and a friend, Jared Glugeth, started a Web-based business called Promotion Solutions www.eprolutions.com) which purports to help clients advertise their websites, and PRHost.com a web-hosting service. They're a pair of go-getters. Glugeth had the foresight to use Lebed's media moment last week to hype their Web business. "I'm not here to talk about Jonathan," Glugeth told a swarm of reporters outside Lebed's house. "I'm here to talk about our company."

The press, though, wasn't biting. Soon the media wave will wash over, and Lebed and his friend will be left in anonymity again. Let's hope they have learned something.

--Reported by Edward Barnes, William Dowell, Kate Kelly and Elaine Rivera/New York and Chris Taylor/San Francisco, with other bureaus

With reporting by Edward Barnes, William Dowell, Kate Kelly and Elaine Rivera/New York and Chris Taylor/San Francisco, with other bureaus