Susan Grant, Director of the National Consumers League's National Fraud Information Center/Internet Fraud Watch Programs

     On behalf of the National Consumers League, the oldest nonprofit consumer organization in the United States, I am pleased to provide the Senate Permanent Committee on Investigations with information about the newest frontier of consumer fraud -- the Internet. The League has advocated for fairness in the marketplace since its founding in 1899. Some of the scams we see on the Internet, such as pyramid schemes, are as old as the League. Others are more recent, springing from advancements in technology that have created new types of products and services.

     Fraudulent promoters always seize the same opportunities as legitimate companies to use new ways to reach consumers. The challenge before Congress, law enforcement agencies, and consumer groups such as the League is to protect the public from abuse while ensuring that the Internet realizes its full potential as a means of communication and commerce.

NCL's Initiatives to Combat Internet Fraud

     To meet that challenge, in February of 1996 the League created the Internet Fraud Watch. It operates in tandem with our National Fraud Information Center, which was set up in 1992 as a toll-free hotline that consumers could call for advice about telephone solicitations and to report telemarketing fraud. Now consumers can get tips on avoiding both telemarketing or Internet scams and report those types of fraud through our web site, www.fraud.org, or by calling the hotline at 1-800-876-7060. Though the web site was launched only two years ago, we have had more than 5 million visitors to date.

     Every week, the National Fraud Information Center and Internet Fraud Watch programs receive an average of 1,500 calls and an equal number of e-mails, plus dozens of letters. Most of the consumers who contact us are seeking advice about solicitations they have received. While we do not provide the public with information about specific companies, we do help people identify the danger signs of fraud. By doing so we prevent them from becoming fraud victims.

     We also take reports from consumers about possible telemarketing or Internet fraud and relay them to a variety of federal, state and local law enforcement agencies in the United States and Canada. Our data system uploads new reports daily to an electronic database maintained by the Federal Trade Commission and the National Association of Attorneys General. In addition, the system automatically faxes consumers' reports to over 160 individual agencies according to preset criteria. In essence, we provide an early-warning system for law enforcement agencies, alerting them to scams they may wish to investigate and supplying them with information about potential witnesses.

     At the same time, we are assisting consumers who have been victimized by routing their fraud reports to the myriad and often confusing array of agencies that may be appropriate to receive them. There is no charge for the consumer or law enforcement services that we provide. These programs are sustained by the members of the National Consumers League and by charitable donations from foundations, corporations and trade associations that are concerned about the integrity and safety of the Internet.

A Snapshot of Internet Fraud

     Since no other organization, private or public, acts as a central point for collecting reports of scams in cyberspace, the National Consumers League is in a unique position to offer the Senate a snapshot of this emerging problem. No one knows the full extent of Internet fraud. Not all victims contact our Internet Fraud Watch program; some go directly to their state attorneys general or other law enforcement agencies, others to private attorneys, and many consumers probably do not report the crime at all. However, we do know that we are hearing from more people than ever before.

     E-mail inquiries have increased ten-fold since the inception of the Internet Fraud Watch program and reports of possible Internet fraud have tripled, from an average of 32 per month in 1996 to nearly 100 per month in 1997. While the 1,152 fraud reports we received last year are just the tip of the iceberg, they present a revealing picture of the types of scams that are proliferating on the Internet and how they work.

1. Web Auctions - items bid for but never delivered by the sellers, value of items inflated, shills suspected of driving up bids, prices hiked after highest bids accepted;
2. Internet Services - charges for services that were supposedly free, payment for online and Internet services that were never provided or falsely represented;
3. General Merchandise - sales of everything from T-shirts to toys, calendars to collectibles, goods never delivered or not as advertised;
4. Computer Equipment/Software - sales of computer products that were never delivered or misrepresented;
5. Pyramids/MLMs - schemes in which any profits were made from recruiting others, not from sales of goods or services to the end-users;
6. Business Opportunities/Franchises - empty promises of big profits with little or no work by investing in pre-packaged businesses or franchise operations;
7. Work-at-Home Plans - materials and equipment sold with false promise of payment for piece work preformed at home;
8. Credit Card Issuing - false promises of credit cards to people with bad credit histories on payment of up-front fees;
9. Prizes/Sweepstakes - requests for up-front fees to claim winnings that were never awarded;
10. Book Sales - genealogies, self-help improvement books, and other publications that were never delivered or misrepresented.

     Other prevalent scams reported to the Internet Fraud Watch in 1997 included bogus investments, empty travel and vacation offers, scholarship search services, loans that required advance fees and never materialized, dubious claims for health products and services, foreign lotteries, even services to supposedly help immigrants obtain green cards. The common elements of these scams are: requests for advance payment from sellers with whom the consumers are not familiar, who were usually located in another state, or even another country, and who have made exaggerated claims or false promises concerning the goods or services they offer.

     I should note that obviously there are many legitimate offers on the 'Net for goods through auctions, multilevel marketing distributorships, Internet services, and other products and services. That is precisely why it is so important to be aware of fraud and to deter it.

Con Artists on the 'Net

     Scams can be found everywhere on the 'Net -- on flashy-looking web sites, in online classified ads, in unsolicited e-mail, in newsgroup postings and in chatrooms. For example, last year the New York Attorney General prosecuted Kevin Jay Lipsitz for consumer fraud in connection with unsolicited e-mails sent to consumers, supposedly from fellow participants in newsgroups, touting his great prices and service for magazine subscriptions.

     Those testimonials turned out to be fictitious, sent by Lipsitz himself to drum up business. Furthermore, his real customers, many of whom contacted our Internet Fraud Watch, never got the magazines they paid for.

     The Federal Trade Commission has also used information from the Internet Fraud Watch and other sources to take action against web site operators promoting pyramids and other illegal schemes. In one interesting case, the FTC halted a "Trojan horse" scam in which consumers who thought they were downloading a free program from a web site to view pictures were unwitting disconnected from their regular Internet service providers and reconnected to the Internet through a telephone number in Moldova, resulting in huge international phone bills. The perpetrators of the scheme were actually located in New York. Our Internet Fraud Watch was the first to receive reports of this scam and issue a general warning to the public.

     Another Internet case brought by the FTC concerned the Fortuna Alliance, a pyramid scheme in which consumers were promised they would net at least $5,000 per month if they paid an initial fee ranging from $250 to $1,750 to hire the company as their "personal marketing expert." Subsequent monthly fees would be deducted from the profits that would supposedly come from others joining the program. To that end, Fortuna supplied members with promotional materials to use in recruiting others. The fact that it was an unsustainable pyramid was masked by the use of a complex mathematical formula showing how profits would be distributed. However, because pyramids must rely on an infinite number of new recruits, they invariably collapse, leaving only the originators to profit and the vast majority to lose. The defendants transferred their ill-gotten gains to a bank in Antigua.

     The Internet is ideal for abuse because anyone can put up a handsome web site, as Fortuna did, making it difficult to distinguish fraudulent promoters from legitimate ones. The Internet also makes it possible to send e-mails to thousands of people at once at relatively low cost. Moreover, it is easy to post information in newsgroups or to lurk in chat rooms, offering phony stock tips or money-making opportunities. Return addresses can be masked to make them look like they are coming from one place when they are really coming from another. For instance, Kevin Lipsitz used a variety of return addresses to make it appear that his e-mails were from various individuals. Thus it is relatively easy for cyber crooks to hide their real identities and locations.

     Furthermore, geographic boundaries are meaningless in cyberspace. Crooks targeting citizens in the United States may be based in Australia, Hong Kong, Malaysia, South America, the Caribbean, Europe -- all over the globe. As you can see from our chart showing the top 20 locations of fraudulent Internet operators in 1997, countries other than the United States or Canada ranked 12th. Con artists were also lurking in Ontario (ranked 13th) and British Columbia (ranked 20th). As in telemarketing fraud, California, Florida, Texas and other sunshine states are also popular roosts for cyber crooks.

     New technology that makes it possible for legitimate vendors to offer new products and services also facilitates Internet fraud. For instance, the Moldova case illustrates how computer programs can be devised to highjack consumers' Internet service and how telephone switching and billing systems can be used for fraudulent purposes.

     Problems with web auctions also demonstrate how the ease of communicating via the Internet can be abused. These auction sites enable sellers to offer their wares at very low cost and buyers to bid for them without having to be at a physical auction location. The problem is that it is difficult for consumers to ascertain who the sellers really are, whether they actually have the items they are advertising, and whether those items are accurately described. There is no preview where potential buyers can physically examine the goods, nor can the auctioneer vouch for their authenticity. Many of the sellers appear to be private individuals, and it is possible that some are not bent on fraud but simply do not understand the need to represent the items they are selling accurately and fulfill their contractual obligations promptly. We suspect that others may be posing as private individuals when they are not, since we have seen the same sellers' names in multiple fraud reports. As the Internet opens the doors for honest individuals and small companies to participate in the new marketplace in cyberspace, it also provides ready access to those with fraudulent intent.

Internet Fraud Victims

     Victims of Internet fraud can be also be found everywhere in the United States, as well as in other countries. In our chart showing the top 20 locations of consumers who reported scams to the Internet Fraud Watch in 1997, the states with the largest populations tend to rank highest, but we also heard from numerous consumers in countries outside of the United States and Canada, ranking 8th on the list.

     In July of 1997, we made programming changes to our system to track the ages of consumers reporting fraud. Not everyone agrees to provide that information, but from those who have, we know that Internet fraud touches people of all ages. While most of the consumers who reported Internet fraud to us last year were in their thirties, forties or fifties, as the pie chart shows, we have heard from youngsters of 17 and seniors of 78.

Methods of Payment in Internet Fraud

     Consumers pay for goods and services promoted through the Internet in a variety of ways. As the graph shows, checks and money orders were the most common methods of payment, but alarmingly, cash ranks 4th. In one scam reported to the Internet Fraud Watch last year, consumers received unsolicited e-mails offering loans of $59,000 that never had to be paid back. The catch was that they had to send $20 in cash to a Las Vegas address. The solicitation specifically stated that any other form of payment would be returned to the sender. To our trained eyes, the promotion appeared to be a combination of advance-fee loan and pyramid scheme, where each person would supposedly get a loan once enough people paid their $20 into the program. Cash payments are often requested for cable television descramblers, adult videos, and other types of purchases that consumers may wish to make anonymously. Of course, cash payments also enable con artists to maintain anonymity and make it difficult to document fraud.

     Telephone bills, ranked 5th in methods of payment, reflect the Moldova case, in which the charges for viewing the supposedly "free" pictures were assessed as international calls on victims' phone bills.

     In cases where consumers did not provide the payment methods or where they reported attempted fraud but did not yet pay, the method of payment is listed as unknown. Relatively few people reported paying by credit card, which is ironic considering the fact that consumers have more protection in the event of fraud, deception or nondelivery under their legal dispute rights with credit card purchases than they do with other payment methods.

     For this reason, we encourage consumers to use their credit cards whenever they make significant advance payments for goods or services, regardless of the medium used to promote them. It should be noted that we do not have information about how many consumers are actually making their payments online, but judging from the fact that checks, money orders and cash payment rank so high and that credit card payments could be made either online or offline, we must conclude that most transactions are consummated by mail or telephone.

Meeting the Law Enforcement Challenges Posed by Internet Fraud

     As a global medium for communication and commerce, the Internet poses great challenges for law enforcement agencies. As has been alluded to before, it may be difficult to identify and locate the perpetrators of fraud. It may be even more difficult to prosecute them and to seize their ill-gotten gains. In cross-border cases, jurisdictional problems, such as the inability of the Federal Trade Commission to legally share information about investigations with agencies in other countries and the difficulty of obtaining search warrants, freezing assets and taking other legal actions in foreign courts are real impediments to law enforcement. Furthermore, the expense to send investigators and to transport defendants and witnesses can be prohibitive.

     These problems must be addressed if cyberspace is to be a safer place for advertising and commercial transactions. While most state and federal laws against unfair and deceptive acts and practices apply to online and Internet promotions, the Federal Trade Commission's Telemarketing Sales Rule does not.

     We believe that the Telemarketing Sales Rule should be expanded to cover promotions via the Internet and online services so that federal and state prosecutors can go into federal court to take action on interstate violations. It would also aid enforcement efforts if the enabling statute was amended so that states could sue in federal court when either the defendants or the victims are located within their jurisdictions. Currently, jurisdiction is victim-based.

     In addition, federal law should be changed to make it easier for agencies in this country to share information with those in other countries and take legal action across borders. A funding pool should also be established to help state and federal agencies bring those actions. Moreover, government support for the law enforcement services that organizations such as ours provide would also be helpful in the continued fight against Internet fraud.

Preventing Internet Fraud

     While clear legal ground rules for Internet promotions and good law enforcement mechanisms are crucial, public education must be a major component of any effort to curb Internet fraud. Consumers need to know how to check out the offers they see and the companies that make them. They need to learn how to identify the hallmarks of fraud in this new medium, how to protect their privacy, and what payment methods are safest. And in light of the fact that many private sales are occurring through auction sites, online classified ads, newsgroups and chat rooms and that private sales are not usually covered by the same consumer protection laws and remedies that apply to sales by businesses, consumers must be educated about the ramifications of different types of transactions.

     Businesses and individuals that use the 'Net to promote their goods or services must also be educated about their basic responsibilities. The National Consumers League has taken a lead role in educating the public about Internet fraud. One way we are doing this is by using the very same medium -- the Internet. Last September, we announced that we had remodeled our National Fraud Information Center web site. Among the improvements is a new Internet Fraud Watch section, which consumers can access directly at www.fraud.org/ifw.htm to find a wealth of free information on safe cybershopping and how to avoid fraud. The web site also has articles about enforcement actions and links to government agencies, the Better Business Bureau's BBBOnLine program, and other resources.

     The National Consumers League also works with the private sector in coalitions such as the Online Public Education Network, Project OPEN. In partnership with the Interactive Services Association and major Internet and online service providers, we have produced materials for consumers on subjects such as privacy in cyberspace and unsolicited e-mails. By encouraging consumers to guard their privacy on the Internet and helping them sort out legitimate e-mail messages from fraudulent ones, we can reduce the potential for their becoming victims of scams in cyberspace.

     Government must be a major partner in this effort as well, by helping to fund educational programs and lending other types of support. The contributions that we have received to help sustain the League's Internet Fraud Watch program from Bell Atlantic, Direct Selling Association, MasterCard International, MCI and NationsBank do not cover the costs of the law enforcement services or public education we provide.

     Copies of charts and graphs illustrating the 1997 Internet Fraud Watch statistics are appended to our written testimony. We applaud the Senate Permanent Subcommittee on Investigations for focusing attention on the emerging problem of Internet fraud and look forward to working with Congress and others concerned with making cyberspace a safer place for communication and commerce.

Respectfully submitted by:
Susan Grant, Vice President for Public Policy
Director, National Fraud Information Center/Internet Fraud Watch Programs
National Consumers League
1701 K Street NW, Suite 1200
Washington, DC 20006
202) 835-3323