Pump and Dump Schemes

What are pump and dump schemes?

"Pump and dump" schemes, also known as "hype and dump manipulation," involve the touting of a company's stock (typically microcap companies) through false and misleading statements to the marketplace. After pumping the stock, fraudsters make huge profits by selling their cheap stock into the market.

Pump and dump schemes often occur on the Internet where it is common to see messages posted that urge readers to buy a stock quickly or to sell before the price goes down, or a telemarketer will call using the same sort of pitch. Often the promoters will claim to have "inside" information about an impending development or to use an "infallible" combination of economic and stock market data to pick stocks. In reality, they may be company insiders or paid promoters who stand to gain by selling their shares after the stock price is "pumped" up by the buying frenzy they create. Once these fraudsters "dump" their shares and stop hyping the stock, the price typically falls, and investors lose their money. (Source: SEC)

"Pump and dump" (also known as "Stock Dump" and "Hype and Dump Manipulation") is a term used to describe a form of financial fraud that typically involves artificially inflating the price of a stock or other security through untrue or exaggerated promotion (creating artificial demand), in order to sell stock, previously purchased cheaply, at the inflated price. When the promotion stops or flaws in the promotion are exposed, the artificial demand is removed, causing a collapse in the price of the investment, leaving many investors out of pocket.

In many countries it is illegal, yet it is particularly common. While fraudsters in the past relied on cold calls, the emergence of the Internet offered a cheaper and easier way of reaching large numbers of potential investors. The fraud is in many cases conducted by people who are not involved in a company that is targeted, but despite this the process can do great harm to the reputation of the companies involved.

Pump and dump stock schemes are now a common part of email spam, accounting for about 15% of spam e-mail messages. A survey of 75,000 unsolicited emails sent between January 2004 and July 2005 concluded that spammers could make a return of 4.9%-6% by using this method, while recipients who act on the spam message typically lose 5.25% (and sometimes up to 8%) of their investment within two days – not including the costs of trading shares. A study by Böhme and Holz ("The Effect of Stock Spam on Financial Markets", 2006) shows a similar effect. Stocks targeted by this spam are typically "penny stocks", selling for less than $1 per share, not traded on organized exchanges, have small capitalization, are thinly traded, and are difficult or impossible to sell short. Consequentially, stock spam messages are universally positive. Spammers are likely acquire stock the day before sending the message (as suggested by increased market volatility, and the generally negative average returns of targeted stocks), and sell the day the message is sent.

An important structural difference between pump and dump spam and other forms of spam (such as advance fee fraud emails and lottery scam messages) is that pump and dump spam can be sent with complete anonymity. Nearly all other forms of spam require the recipient (the target) to contact the spammer in some way, either to collect supposed "winnings," to transfer money from supposed bank accounts, or to purchase commercial products. Pump and dump spam, by contrast, is pure advertising, and there is no need for the target to be able to contact the spammer. This makes tracking the source of pump and dump spam especially difficult. It has also given rise to examples of what might be called "minimalist" spam, consisting of nothing more than a small untraceable image file containing a picture of a stock symbol. (Source: Wikipedia)