A decision released by the U.S. First Circuit Court of Appeals on Sept. 13 allows the Securities and Exchange Commission to proceed with its fraud action against SG Limited, operators of the Stock Generation Web site.
According to the SEC, the virtual stock site, which is licensed and operating in Dominica, violates federal security laws by offering investments in virtual companies and not paying investors profits as guaranteed by the operators.
Additionally, the Stock Generation site, www.stockgeneration.com, has been shut down and about $6.5 million in the company's assets have been frozen until the SEC's legal action against the company concludes.
The court's decision didn't sit well with SG officials. "We're very disappointed at the court's decision," SG attorney Daniel Small told the Associated Press. "The court of appeals has given the SEC the green light for a fishing expedition."
Stock Generation is a "virtual stock market" where players buy and sell shares in fictitious companies, and can win or lose money depending upon whether their share increase or decrease in value. Instead of the stock values being controlled by a computer, however, the operators of the SG site reportedly changed prices at their own discretion.
The SEC originally filed suit against the company on June 9, 2000 in the U.S. District Court for the District of Massachusetts, alleging that SG Limited was operating a massive online pyramid scheme. The SEC also alleged that investors in at least one part of the SG virtual stock market--those purchasing shares in a "privileged company" with a guaranteed return of 10 percent each month--never received a return on their investment or even a refund of their original investment money.
Thursday's court decision overturns a lower court ruling that had dismissed the SEC's action against the company. U.S. District Court Judge Joseph Tauro determined in January that the SEC had overreached its authority since Stock Generation did not actually buy, sell or trade real stock shares.
SEC District Administrator Juan Marcel Marcelino expressed satisfaction with last week's reversal, telling the Associated Press that the appeals court's decision "confirmed our position that this was (promoted as) investments."
The appeals court was blunt in its assessment of what the Stock Generation site was doing. In its decision the court stated, "We will not paint the lily. We conclude, without serious question, that the arrangement described in the SEC's complaint fairly can be characterized as either a Ponzi or pyramid scheme, and that it provides the requisite profit-and-risk sharing to support a finding of horizontal commonality. Taking as true the SEC's allegation that SG's ability to fulfill its pecuniary guarantees was fully predicated upon the net inflow of new money, the fortunes of the participants were inextricably intertwined. As long as the privileged company continued to receive net capital infusions, existing shareholders could dip into the well of funds to draw out their profits or collect their commissions. But all of them shared the risk that new participants would not emerge, cash flow would dry up, and the underlying pool would empty."
The court also agreed with the SEC that language on the Stock Generation Web site explaining how to play actually created a type of investment contract.
The SEC received complaints about Stock Generation from residents in 27 states.
Click here to view the decision handed down by the U.S. Court of Appeals
for the First Circuit in Securities and Exchange Commission v. SG Ltd. et al.