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Mod (Andy) note: "Blast from the past - Best of Eddie" - This one is originally from September 2010 . If there's an old post from Eddie you'd like to see up again shoot me a message.

I'm changing things up a little today. I was going to make today's post about net-net deals, but I've decided to take tomorrow's post about predatory trading techniques and break it into two posts. Today's post is about the Pump and Dump - predatory trading to the long side. Tomorrow's post will be about the Short and Distort - predatory trading to the short side. Just so you don't feel cheated, I'll break a net-net deal down into a couple sentences, and if you want me to expand I can do so in the comments.

A net-net deal happened when a C-level exec at a public company (usually the CEO) decided the company was going under and wanted to sell off his shares without anyone knowing. Through an intermediary (usually a promoter of some kind) brokers would be paid cash under the table (hence, net-net) for each share of the stock they sold to their customers which in turn enabled the errant CEO to unload the same number of his shares. Payments were always in cash, always in a brown paper bag, and always delivered in a nudie bar (don't ask me why; but I've never heard of a net-net deal being handled in any other way. Seriously.)


THE MECHANICS OF THE PUMP AND DUMP

The pump and dump is probably the most basic scam running continuously in the markets. It is as old as the stock market itself, and has evolved a great deal over time. Its elegance is in its simplicity.

Paulie the Promoter receives shares in WXYZ on the cheap. There are many ways this can happen, and they're not important at the moment. What is important is that the Paulie has WXYZ stock at some level below the current market value.

For whatever reason, WXYZ is more or less a piece of shit stock. Either the company is struggling, or is completely unknown and therefore has no market for its stock, or has been a fraud since day one and just did a reverse merger into a shell company to get their stock trading publicly. It doesn't matter. The important thing is that the stock is going nowhere fast.

Now, Paulie has all these shares but he knows that if he sells them, the market for the stock will collapse and he'll get nothing for them. This makes Paulie sad. But then he has a great idea! What if I tell people that the company just found the cure for cancer, he says to himself. People will start buying the stock, the price will go up, and then I can sell all my shares for even more money! This makes Paulie happy.

So Paulie puts out a bunch of bogus news and rumor, hypes the stock to kingdom come, and when the buying comes in and runs the stock up (the Pump) Paulie unloads his shares and tanks the stock (the Dump). It's no more complicated than that.

While the scam itself doesn't change, its execution varies based on the strata of the perpetrator. Some pump and dumpers are merely lowlifes who think they can get liquid if they cast a wide enough net. I call these guys the bottom feeders. There is another strata of pump and dumpers, though, that are extremely sophisticated, and manage to pull off their scam without even breaking any laws. I call these guys the Professionals, and you'll see why in a minute.


THE BOTTOM FEEDERS

Who among us hasn't received a SPAM email touting some Bulletin Board piece of shit that is supposed to move mountains in the next couple days? This never ceases to amaze me. I just feel that if someone is intelligent enough to use email that there's no way they'd be dumb enough to fall for that. But I have to be wrong. Because if people weren't falling for it, the spammers would quit doing it.

This particular method of pumping a stock has no finesse. It's an ugly shotgun approach to finding buyers, and isn't the least bit scientific. Even when successful, the promoters are forced to guess where the buying will come from and how much they'll be able to unload without crushing the bid. Most of the spam comes from servers in Eastern Europe.

This method originated with the message boards, primarily the Yahoo! message boards. Yahoo! was one of the first providers to offer a message board for every stock, where buyers and sellers could meet to discuss the stock in question. These boards were usually a great resource, because disgruntled employees would often get on the boards and air a company's dirty laundry.

The boards soon became a haven for pump and dumpers, though. The boards offered a captive audience, all interested in making money. The technology was still new enough for people to give the information the benefit of the doubt (if it's on the Internet, it must be true...) and the pump and dumpers were able to clean up.

These days, I don't know how successful the spam method is. It must work on some level because, again, they'd quit doing it if it didn't. But I don't think I know anyone dumb enough to be taken in. At least I hope I don't.


THE PROFESSIONALS

About ten years ago, I got a call from an old buddy of mine from back in the day. He told me I needed to check out this outfit downtown (red flag #1 - when an old buddy of mine from back then refers to a firm as an "outfit", I move my wallet to my front pocket). He said they were run by an old J.W. Gant guy (red flag #2), that they were nationwide, and that they were looking for a guy like me to do some training for them. When I balked, he told me they weren't doing anything illegal, that they were just an investment relations firm who needed some help getting banks to initiate coverage on their portfolio stocks.

I had to admit I was intrigued, so I told him to set up a meeting. I also have to admit that I was not prepared for a pump and dump operation with this level of sophistication. They proudly displayed the company name on the side of the building, and had been there for a few years. Most pump and dumpers fight to maintain the lowest possible profile and change addresses every couple of months.

Their office was beautiful. Everyone looked professional, the place was well-appointed, and there was a real-time digital stock crawl (still something of a novelty at the time) mounted to the wall in what I would call the bullpen. The secretary was attractive and demure, nothing like the ex-strippers we always hired when I was trading commodities.

I met with the guy in charge and liked him instantly. I found out this was just a satellite office, and that their headquarters were in D.C. He explained to me that companies came to them for public relations purposes. The companies wanted exposure and coverage by the investment banks, but often couldn't afford a big time PR firm. He explained that his firm offered the companies the exposure they were looking for in exchange for treasury stock instead of cash.

When I pointed out that it was illegal for unlicensed reps to be selling stock to the public, he looked shocked. "We never speak to any individual investors for that very reason. The only people we talk to about our portfolio companies are investment professionals like stockbrokers and research guys. That's where we were hoping you could help out. Some of our guys don't speak the language of investment bankers, and we were hoping you could do a little training for us."

I knew it had to be a scam, but I hadn't figured it out yet. I agreed to talk to the guys before I did any formal training so I could get an idea where they needed the most help. After talking to the worker bees, I figured the whole deal out and I have to tell you, I was impressed.

These guys truly weren't doing anything illegal (totally unethical, of course, but not illegal), and they really didn't have any interaction with the public. They were pitching stocks to stockbrokers.


THE EASIEST SALE IS A SALESMAN

Here's how the operation worked. They'd get hired by a portfolio company to generate interest in the stock and raise the stock price (the Pump). For this service they were paid in stock. The outfit's employees (investment relations professionals, haha) would call investment professionals like stockbrokers and traders and convince them to sell the stock to their customers. Rather than calling individual investors, they'd just get a broker all hyped up about a stock and then let him do the heavy lifting.

Wait, it gets better.

They told the brokers they worked with that they didn't make a commission (they were just providing information, after all) but that they needed to report any purchases to the portfolio company through their firm's headquarters. So the brokers (ostensibly, these guys' clients) would call these guys whenever they bought some of the stock and report the Time and Sales to them. The reps would then fill out a sheet reporting the time of the trade, the number of shares purchased and the purchase price, and the name of the firm their "client" worked for. They would then get paid 7-12% of the value of the trade, depending on the stock.

Think about it for a minute. Not only is it easier and more efficient to get one guy hyped up about a stock and then turn him loose on his own clients, these guys never broke any laws. They never spoke to the public. As the brokers would drive the price of the stock higher, the firm would sell into them (the Dump).

Another departure from the typical pump and dump was the perceived quality of the stocks they had on offer. Most pump and dump outfits try to run up bullshit penny stocks listed on the Bulletin Board or Pink Sheets. Not these guys. One of the deals they were working was a software company on the NASDAQ that they managed to run up from $9 a share to $16 bucks a share before it collapsed (and I do mean collapsed - the company eventually went under and the stock was worth two cents until another sham company did a reverse merger into their shell and now trades around $4). Another was a NASDAQ NMS stock they ran up to $12 a share before a truly legendary amount of accounting fraud drove the company to zero and the founders to prison.

I'll be honest with you. It's hard for me to be sympathetic to an investment professional who gets taken in on a scam like this. Those guys really should know better. Yes, the public is unsophisticated and should be protected from scams like this. But seriously, if a broker or ER guy can't smell a rat, they're in the wrong line of work.

I apologize for the length of these posts, guys. Hopefully they've been entertaining and maybe you've learned something about the darker side of the Street. I promise I'll get back to my usual dick and fart jokes next week. In the meantime, if you have any questions, hit me with them.

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Comments (19)

  • Buster McGillicudy's picture

    Great post. When I saw this title I thought it was going to be a life lesson about unsavory women.

  • TheKing's picture

    Don't apologize,these posts are awesome.

    Who wants to start a pump-and-dump email chain with me?

  • lucasblane's picture

    Keep it up Edmundo! These are great and enlightening.

  • Cmoss's picture

    penny stock prophet --

    shit gets ridiculous in the microcap world

  • accountingbyday's picture

    I get an email from the same place about once a quarter. It always says that they have "initiated coverage" and something big is coming for XYZ OTC company. Then, a few days later I get an email with big news about XYZ. Obviously, I have never traded on this, but I'm always curious. No doubt this is shady as hell, but these stocks always seem to go up during the week of the emails and announcements.

    I never follow up to see what happens after a week or so (I'm sure the stock drops), but I'm curious to back test how much I would've made if I just held these stocks for 3 days upon the receipt of the initial email.

    I can't imagine who would buy based on these spam emails, but it sure appears as though someone is.

  • In reply to Edmundo Braverman
    Buster McGillicudy's picture

    Edmundo Braverman:
    MikeMoney:
    When I saw this title I thought it was going to be a life lesson about unsavory women.

    Is there another kind?

    Haha, touche. I guess when you find the savory one you hang up the cleats and put away the bow and arrow from the hunt.

    Edmundo, I take it you are a Saints fan. Did you check out the new pregame ritual?

  • In reply to accountingbyday
    Cmoss's picture

    accountingbyday:
    I get an email from the same place about once a quarter. It always says that they have "initiated coverage" and something big is coming for XYZ OTC company. Then, a few days later I get an email with big news about XYZ. Obviously, I have never traded on this, but I'm always curious. No doubt this is shady as hell, but these stocks always seem to go up during the week of the emails and announcements.

    I never follow up to see what happens after a week or so (I'm sure the stock drops), but I'm curious to back test how much I would've made if I just held these stocks for 3 days upon the receipt of the initial email.

    I can't imagine who would buy based on these spam emails, but it sure appears as though someone is.

    BUY BUY BUY!

  • blastoise's picture
  • Jorgé's picture

    Another great post Edmundo, keep it up.

    People like Coldplay and voted for the Nazis, you can't trust people Jeremy

  • happypantsmcgee's picture

    If I had asked people what they wanted, they would have said faster horses - Henry Ford

  • TaTa's picture

    "This makes Paulie sad" EPIC!!

  • realjackryan's picture

    I've always wondered, In a grey/otc market (where most of these penny stock.micro caps are) the firms are not obligated to provide the price of the stock with the same rules as the major exchanges are required... So are these pump and dump penny stock pushers just making up the graphs they are showing? Who is listing the prices. many of them seem to follow very basic sine wave function, some of which i have graphed, but never been dumb or ballsy enough to trade on.

  • Scott Irish's picture

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  • sofib09's picture