Pump and Dump
A manipulative scheme inflating stock prices, then sell quickly for profit.
Pump and dump (P&D) are among the oldest types of fraud involving price manipulation in securities. This fraudulent practice entails spreading misleading and false information about the security, which inflates the security price (pump).
After the price hits the target price of the fraudsters, they proceed to sell the securities at an inflated price, making a profit (dump) and causing the price to crash in the market.
Almost all the major financial markets in the world have laws against P&D fraud, and all the regulatory bodies try to ensure there is no price manipulation in the market.
Examples of some regulatory bodies of major financial markets are:
- USA
- Securities and Exchange Commission (SEC)
- Commodity Futures Trading Commission (CFTC)
- Financial Industry Regulatory Authority (FINRA)
- Japan
- Financial Services Agency (FSA)
- Tokyo Stock Exchange (TSE)
- UK
- Financial Conduct Authority (FCA)
- Prudential Regulation Authority (PRA)
- India
- Securities and Exchange Board of India (SEBI)
- Reserve Bank of India (RBI)
- Pump and dump is the illegal price manipulation of stocks or other tradable securities.
- Fraud has certain characteristics.
- It happens mostly in penny stocks or stocks whose prices can be manipulated easily and are thinly traded.
- They market false information about stocks and the potential for returns.
- They use different methods to boost the price of a stock and create a positive cycle for investors.
- They then sell or dump all their holdings at a high price, making a profit.
- This also stops the positive cycle as the price starts to crash, and a negative cycle starts, and investors who bought at a high price now have to sell at a loss.
- Individuals or companies can orchestrate pump-and-dump schemes.
- Before investing in any securities, it is crucial to exercise caution and undertake necessary precautions.
- If you suspect being defrauded, it is advisable to file a complaint with the relevant regulatory authorities.
How does the fraud work?
A group of individuals selects a stock that is trading at a low price and can be bought in bulk. Then they start buying the stock, which increases the stock price. They use this rise in price as a marketing tool for the stock and give false and misleading information to general investors.
Based on this false information, a new wave of investors starts to buy the stocks, which increases the price, and looking at the uptrend, more unsuspecting investors jump in to not miss an opportunity (pump).
This cycle continues until a target price is hit, at which point the group behind the fraud sells all their stakes at artificially elevated prices. (Dump)
When stocks are sold in the open market, their prices fall. This creates a negative cycle in the market and ultimately results in the stock price crashing.
This price crash happens because the stock price is based on false information and misleading advice, and investors fear missing out on an up-trending stock.
As there was no foundation for the valuation of the stock, the moment a bulk sale happens and the price falls a bit. A negative cycle is created as the investors start to think the uptrend is over and pull the money out.
In this fraud, all the investors who bought the stock at a low price before the pump and then sold or dumped all their stakes at an elevated price made the most money.
Pump and Dump is a fraudulent activity in which the price of a publicly traded security is manipulated by misleading information and manipulating investors to buy the security at a high price from them.
Pump and Dump in The Past
One of the biggest and most well-known examples of a pump and dump in the early 1990s was that of Stratton Oakmont, a penny stock broker. Stratton Oakmont was co-founded by Jordan Belford in 1989 with Danny Porush and Brian Blake. The firm dealt with penny stocks and used cold calling for their pump-and-dump fraud.
Belford and his team took advantage of the underregulated market for penny stocks. They bought the penny stock at a low price in large quantities and sold it to uninformed investors by misleading them about its growth potential.
Leveraging their status as brokers, they cold-called potential investors and sold these stocks at inflated prices, misrepresenting the financials and future prospects of the associated companies. This exemplified a classic case of pump-and-dump fraud.
Belford and Stratton Oakmont were charged by the SEC and FINRA for their fraudulent activity. They pleaded guilty and acknowledged running a scam for seven years, during which they manipulated the stock of at least 34 companies.
They later cooperated with prosecutors in investigating other brokerages in exchange for reduced prison time.
The story of Jordan Belford and Stratton Oakmont gained significant attention. It was later adapted into a movie titled “The Wolf of Wall Street,” based on the memoir written by Belford himself.
Penny stocks were stocks of a small company that traded below a dollar per share, but later the SEC revised the definition to below $5 per share.
Pump and Dump in The Online Age
In the 2000s, with the dot-com boom, pump-and-dump frauds found their new mode of promotion and communication with unsuspecting investors through online messaging boards and social media websites.
The Internet made it so that anyone could pump and dump by himself. It became easy to share information with a large group of people while remaining anonymous or by impersonating someone with a following.
Multiple accounts created by a single individual can act as a group of individuals talking about a certain stock, giving the impression that there is a legitimate interest in the stock. Moreover, all of this can be executed for very little cost.
One famous case of this was that of Jonathan Lebed. At 15 years old, he used the internet in his favor. He used to buy cheap penny stocks and use online public messaging boards to hype the stock and start a trend to pump the price.
Later, as the price rose, he would start selling all his shares at a higher price. Finally, the SEC filed a civil suit against Lebed, alleging security manipulation. He and his family settled with the SEC and paid a fine of USD 285,000 without admitting or declining the allegations.
The case of Jonathan Lebed exemplifies how the internet facilitated pump-and-dump fraud in the online age, allowing individuals to manipulate stock prices through online platforms and exploit unsuspecting investors.
Can a company pump and dump its stock?
While pump and dump frauds are typically associated with external individuals or groups manipulating stock prices, there have been cases where companies themselves have engaged in similar practices.
Enron was one of the largest accounting and securities scams and company bankruptcies in US history at the time. They were manipulating their books of accounts to give false and misleading information to their shareholders and general investors.
Despite knowing that the company was not doing well financially, the higher management pushed the narrative that the company was healthy and had a great opportunity for growth. All the while selling their shares in the market.
Although Enron's actions deviate from the traditional pump-and-dump scheme, they encompass key elements of fraud: dissemination of false information, making exaggerated promises about the company's future, and selling shares while encouraging others to invest.
The only difference was that it was the company itself that did the price manipulation. When they could no longer inflate their earnings, they declared bankruptcy in 2001. The SEC later investigated the firm for price manipulation, insider trading, and false financial reporting.
The difference between pump-and-dump fraud and insider trading is that insider trading is based on non-public information, whereas pump and dump might involve trading based on insider information but mostly actively spreading misleading data to raise the stock price.
Pump and Dump in Crypto
With the popularity of cryptocurrency growing, we see an uptick in pump-and-dump frauds and other similar price manipulation techniques used in the regular financial market.
The lack of comprehensive regulation surrounding cryptocurrencies and digital assets, including non-fungible tokens (NFTs), has created an environment where bad actors can execute these frauds on a large scale with minimal regulatory scrutiny.
In the realm of crypto, pump-and-dump schemes heavily rely on social media platforms and paid promotions to market their products. In addition, they take advantage of the general lack of knowledge about cryptocurrencies to manipulate investors.
Furthermore, they leverage the soaring valuations of Bitcoin and other projects to generate hype and attract interest.
They use fear of missing out, or FOMO, on uninformed investors by showing record-breaking gains, which in most cases were achieved artificially.
While some big names like FTX and Bitconnect have faced charges by regulators, most individuals who engage in these frauds face no regulatory investigation. This is because, at large, there are no similar laws and protections for crypto as there are for traditional securities.
How to avoid pump and dump
The SEC has some general advice for investors on how to avoid "pump and dump." To avoid falling victim to the schemes, it's important to follow these guidelines:
1. Be cautious of unsolicited investment opportunities.
If you get a call or email from an unknown source advising you on any type of investment, be cautious and identify the source's legitimacy before investing any amount.
Sometimes the advice can come from your close friends or someone you know. Messages and emails can be compromised, so look for any irregularities in your conversation.
2. Research the investment
Before investing your money in any securities, try to self-research the investment, its history, and any news regarding it.
Even if a registered broker recommends an investment, you should never invest blindly, regardless of who is giving the advice. Always try to do some level of due diligence before investing.
Check the regulator's website for a list of band brokers and firms not allowed to sell or advise on investments or securities. For example, you can get a list from FINRA of the individuals who are banned from any association with any of its members.
3. Beware of hype and pressure.
Any investment done based on hype or FOMO is a bad investment. If someone is using pressure-selling tactics, immediately stop the conversation and do your research.
An investment that is sold as the next big thing or a thing that will change everything is most probably a scam, so try to avoid the hype.
4. Be cautious of online forums and social media.
Avoid taking any advice from any type of online forum or social media influencer. Most of the time, the investment promoted on social media is paid advertising and may not contain information about all the associated risks.
5. Report suspicious activity
Try to report any suspicious investment pitch you come across, and if you are a victim of any pump and dump or any type of securities fraud, report it to the relevant regulatory body.
By following these guidelines and staying vigilant, you can reduce the risk of falling prey to pump-and-dump schemes and make more informed investment decisions.
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