Pump-and-dump schemes are manipulative tactics designed to artificially inflate the price of a stock or security through false recommendations. These misleading endorsements are crafted to trick investors, resulting in significant financial gains for the scammers and often substantial losses for the deceived investors. These fraudulent actions exist in both traditional stock markets and the burgeoning cryptocurrency industry, posing risk for naive stakeholders.
Key Takeaways
- Pump-and-dump schemes are unethical and illegal attempts to boost a stock or security’s price based on deceptive statements.
- Micro- and small-cap stocks are typical targets due to their lower regulation and ease of manipulation.
- Severe legal penalties can be imposed on those found guilty of participating in pump-and-dump schemes.
- The rise of cryptocurrencies has seen a notable increase in pump-and-dump tactics within the sector.
The Basics of Pump-and-Dump
Initially executed through cold calls, the internet has evolved to become a primary avenue for pump-and-dump schemes. Perpetrators now easily distribute thousands of enticing emails or online posts urging potential investors to act swiftly on a stock poised for a monumental price increase. Once the price surges due to heightened investor interest and volume, scammers liquidate their stocks at premium rates, leading to a drastic price fall and consequent losses for the unsuspecting buyers.
These schemes target micro- and small-cap stocks found in over-the-counter exchanges. Due to their small volume and limited public information, it’s simpler for the fraudsters to manipulate the market, pushing up prices with relatively minor administrative changes or purchase activity.
Pump-and-Dump 2.0
With the anonymity afforded by the internet, modern pump-and-dump schemes can be conducted by virtually anyone with an online trading account. The perpetrator starts by making substantial purchases on low-volume stocks, causing the price to rise. Encouraged by the seemingly robust price action, other investors also begin to buy, further inflating the stock’s value. The initial scammer then sells off their shares for significant profit, causing a sharp price drop and heavy losses for the latecomers.
Pump-and-Dump in Pop Culture
Pump-and-dump schemes have been entertainingly depicted in hit movies like “Boiler Room” and “The Wolf of Wall Street”. Both films showcase telemarketing stockbrokers aggressively promoting penny stocks, backed by unscrupulous brokerage firms holding large volumes of these stocks. Encouraged by lucrative commissions, brokers heightened their trading volumes, artificially inflating stock prices. Once purchase interest waned, the firms would sell off their large holding shares, plummeting the stock prices and leaving investors at a loss.
Avoiding Pump-and-Dump Schemes
The US Securities and Exchange Commission (SEC) provides recommendations to help investors avoid falling victim to these fraudulent schemes:
Be Extremely Wary of Unsolicited Investment Offers
Exercise extreme caution with any unexpected investment proposals, regardless of how they reach you—via email, social media posts, direct messages, or phone calls. Such unsolicited communications are often red flags representing potential scam efforts.
Look Out for Obvious Red Flags
Be skeptical of investments that sound too good to be true—promises of guaranteed returns or urgent buying pressure are common red flags indicating deceitful practices.
Be Aware of Affinity Fraud
Investment pitches targeting specific groups, like religious or ethnic communities, may create a false sense of trust. However, even well-meaning members pitching these schemes might be mistaken about their legitimacy.
Conduct Thorough Research and Due Diligence
Before making any investment, conduct exhaustive research thoroughly examining company backgrounds, prospects, and financial health. Lack of available information can often signal fraudulent activity.
Pump-and-Dump 3.0 in Cryptocurrencies
Pump-and-dump schemes are now infiltrating the cryptocurrency markets. With heightened interest in digital currencies like Bitcoin and Ethereum, and considering the market’s less regulated nature, these digital assets become prime targets for such deceitful tactics. Studies have shown thousands of pump-and-dump occurrences in cryptocurrency platforms over short periods. Therefore, both regulatory bodies and investors must remain alert to such scams.
In response, bodies like the U.S. Commodity Futures Trading Commission (CFTC) have advised caution, encouraging whistleblower participation, and providing monetary rewards for uncovering fraudulent pump-and-dump activities that lead to substantial sanctions.
Related Terms: Securities fraud, Insider trading, Market manipulation, Cryptocurrency, Affinity fraud.
References
- SSRN. “An Examination of the Cryptocurrency Pump and Dump Ecosystem”, Download PDF, Page 26.
- Investor.gov. “Investor Alert—Don’t Trade on Pump-And-Dump Stock Emails”.
- Investor.gov. “Updated Investor Alert: Social Media and Investing - Avoiding Fraud”.
- SSRN. “Cryptocurrency Pump-and-Dump Schemes”, Download PDF, Page 12.
- Commodity Futures Trading Commission. “Customer Advisory: Beware Virtual Currency Pump-and-Dump Schemes”.
