Case Study : Internet Fraud

May 2002

Eunsoo Ha

Financial Supervisory Service

The views expressed in this paper are the views of the authors and do not necessarily reflect the views or policies of the Asian Development Bank (ADB), or its Board of Directors or the governments they represent. ADB makes no representation concerning and does not guarantee the source, originality, accuracy, completeness or reliability of any statement, information, data, finding, interpretation, advice, opinion, or view presented.

Overview

Cyber Development in KoreaNumber of Internet UsersTrend of Internet Stock TradingDetails of Internet Traders“Internet Cafes”

Case StudyCase 1Case 2Case 3

Conclusion

Cyber Development in Korea

Number of Internet Users

-

5,000

10,000

15,000

20,000

25,000 (unit : 1,000)

Users 138 366 731 1,634 3,103 10,860 19,040 24,380

1994 1995 1996 1997 1998 1999 2000 2001

Trend of Internet Stock Trading

0%

20%

40%

60%

80%

100%

1998 1999 2000 2001

YearInternet Off-line

Details of Internet Traders

KSE(March, 2002)

Individual73%

Institution27%

KOSDAQ(March, 2002)

Individual92%

Institution8%

“Internet Cafes”Places for computer games, chatting and stock trading on the InternetHigh-speed internet network equipped with the latest computersNumber of “Internet Cafes” : 21,500 (as of Feb. 2002)

Case StudyCase 1 : Company A

Key Point Committed fraud over the internet by making material misrepresentation about the company’s financial information

OverviewSmall, liquor producing company (founded in April, 2000)Registered with the FSS (June 15, 2000)Advertised Public offering on the Internet (900 million won, approximately 700,000 USD)Misrepresented material financial information about the companyOnly two individual investors subscribed (3 million Won, approximately 2000 USD)

Contents of Misrepresentation

1.6 billion won (approx. 1.2 million USD)

9.7 billion won(approx. 7 million USD)

Actual

015 billion won

(approx. 11.5 million USD)Internet

Advertised

Debts of the CompanyValue of Facilities

- These facts were verified through the FSS investigation.

ResultsReported to the prosecutor

SEA (Securities Exchange Act) prohibits individuals or institutions to profit by falsely leading investors with incomplete or inaccurate material facts.

Case 2 : Company BKey point

During the state of bankruptcy, the company subscribed from the investors via the Internet

OverviewA small company which manufactures and sells communication equipment (founded in March, 1997)Paid-in capital : 200 million won (approx. 150,000 USD)Went bankrupt (on June 26, 2000)Public offering (990 million won, approx. 750,000 USD) on the Internet (on June 19th – 29th, 2000)38 investors offered (32 million won, approx. 20,000 USD)The CEO withdrew the money through PC banking and disappeared.

Content of Misrepresentation

Hadn’t told the investors that the company is going through bankruptcy during the public offering period

ResultsReported to the prosecutor

- 62 million wonActual

62 million won (approx. 45,000 USD)Internet Advertised

EBIT(Earnings Before Interest and Taxes)

Lessons from the Two CasesThe two companies took advantage of loopholes in the public offering rules

An issuer is not required to file a registration statement with the FSS, unless the offering value exceeds 1 billion won (changed to 2 billion won – approx. 1.5 million USD, in Sep. 2001)* As of Sep. 2000, although the value of public offering is

under the 1 billion won threshold, the “small public offering disclosure documents” must be filed.

Company A : 900 million wonCompany B : 990 million won

Some small sized companies take advantage of waiver of the registration statement.Needs careful monitoring.

Case 3Key Point

Price manipulation by Internet tradingOverview

When : Jan. 2001Where : KSE (Korea Stock Exchange)Who : Mr. KimWhat : Stock price manipulationHow :

Using the InternetChose preferred stocks with a small number of outstanding shares due to their easiness to manipulate price

Why : To profit

Mr. Kim

(The leader of the club)

Recommend stock investment via E-mail Legendary Fortunes

(Stock Investment Club)

Contents of RecommendationOpen stock investment account

Suggested delegation of the account management to Mr. Kim

Guaranteed the principal

Told the club members that the earnings will be divided according to the contributed capital

Mr. Kim

Securities Companies

Office Home

Club Members(10 people,25 accounts)

Internet ChattingCorrespond, Order

(www.humanbelt.com)

4 Internet lines 1 Internet line

HTS

Deposit or Withdraw Money

Transaction Order

Price Manipulation ProcessMr. Kim’s Tactics

1. Chose preferred stocks with small number of outstanding shares

The details of the selected company for price manipulation;• Total outstanding shares : 661,514• Total market price : 344 million won (approx. 250,000

USD)2. Bought stock with his own account first3. Bought stock with his members’ accounts4. After the share price went up5. Sold stock his own account first6. Sold stock his members’ account7. Divided the earnings

Transaction Details

279,250102,180No. of Shares

279,250 (42.2%)102,180 (15.4%)No. of SharesJan. 26-30, 2001

Jan. 3- 8, 2001Mr. Kim

Jan. 30-31, 2001

Jan. 8-26, 2001Members

TimeSell

TimeBuy

Accounts

Change of Price

0

500

1000

1500

2000

01/12

/00

08/12

/00

15/12

/00

22/12

/00

29/12

/00

05/01

/01

12/01

/01

19/01

/01

26/01

/01

02/02

/01

09/02

/01

16/02

/01

23/02

/01

Date

Price

Trans act i on Vol ume Trend

050,000

100,000150,000200,000250,000300,000350,000

01/12

/0008

/12/00

15/12

/0022

/12/00

29/12

/0005

/01/01

12/01

/0119

/01/01

26/01

/0102

/02/01

09/02

/0116

/02/01

23/02

/01

Date

Vol

ume

Price and Volume Correlation

01,0002,0003,0004,0005,000

01/12

/0008

/12/00

15/12

/0022

/12/00

29/12

/0005

/01/01

12/01

/0119

/01/01

26/01

/0102

/02/01

09/02

/0116

/02/01

23/02

/01

Date

Pric

e an

d (V

olum

e/10

0)

PriceVolume

Earning Distribution

20.8%57,745276,951Total

6.2%10,713-14.1%-24,476172,662Members

45.1%-35,19078.8%82,221104,289Mr. Kim

The Last Rate of Return

Earning Distribution

Rate of ReturnEarningsInvested

MoneyAccount Owner

Unit : 1,000 Won

ResultsMr. Kim attempted 7 other cases with the same tactics until November 2001 and earned approximately 5.9 billion won (approx. 4.5 million USD)Mr. Kim’s members didn’t realize that Mr. Kim had deceived them when he divide the earningsThe FSS reported Mr. Kim’s case to the prosecutor

Conclusion

With the advancement of communication channels, Internet Frauds have begun to prevail in securities marketsThe need for special team(s) to deal with Internet Fraud more effectively has risen.International Cooperation is urgently needed

MOU

Investor Education