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)

Ponzi Schemes

What is a Ponzi Scheme?

Named after Charles Ponzi, a man with a remarkable criminal career in the early 20th century, the term has been used to describe pyramid arrangements whereby an enterprise makes payments to investors from the proceeds of a later investment rather than from profits of the underlying business venture, as the investors expected, and gives investors the impression that a legitimate profit-making business or investment opportunity exists, where in fact it is a mere fiction. (Source: CFTC)

Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. Ponzi thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons. Ponzi told investors that he could provide a 40% return in just 90 days compared with 5% for bank savings accounts. Ponzi was deluged with funds from investors, taking in $1 million during one three-hour period—and this was 1921! Though a few early investors were paid off to make the scheme look legitimate, an investigation found that Ponzi had only purchased about $30 worth of the international mail coupons.

Decades later, the Ponzi scheme continues to work on the "rob-Peter-to-pay-Paul" principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses. (Source: SEC)

A Ponzi scheme is a fraudulent investment operation that involves paying abnormally high returns ("profits") to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business.

A Ponzi scheme usually offers abnormally high short-term returns in order to entice new investors. The high returns that a Ponzi scheme advertises (and pays) require an ever-increasing flow of money from investors in order to keep the scheme going.

The system is doomed to collapse because there are little or no underlying earnings from the money received by the promoter. However, the scheme is often interrupted by legal authorities before it collapses, because a Ponzi scheme is suspected and/or because the promoter is selling unregistered securities. (As more and more investors become involved, the likelihood of the scheme coming to the attention of authorities will continue to increase.)

The scheme is named after Charles Ponzi, who became notorious for using the technique after emigrating from Italy to the United States in 1903. Ponzi was not the first to invent such a scheme, but his operation took in such a large amount of money that it was the first to become known throughout the United States. Today's schemes are often considerably more sophisticated than Ponzi's, although the underlying formula is quite similar and the principle behind every Ponzi scheme is to exploit lapses in judgment arising out of greed. (Source: Wikipedia)

Churning

What is churning?

Churning is excessive trading of a discretionary account by a person with control over the account for the purpose of generating commissions while disregarding the interests of the customer. (Source: CFTC)

For churning to occur, your broker must exercise control over the investment decisions in your account, either through a formal written discretionary agreement or otherwise, and must engage in excessive trading in light of the financial resources and character of the account for the purpose of generating commissions. (Source: SEC)

Churning is the practice of executing trades for an investment account by a salesman or broker in order to generate commission from the account. It is a breach of securities law in many jurisdictions, and it is generally actionable by the account holder for the return of the commissions paid.

Courts generally look at the turnover of an investment account, or the number of times the investment capital has been re-invested during a year. For example, for an actively traded mutual fund, the entire assets of the fund will be involved in buying and selling transactions once every six to twenty-four months. In churning cases, the entire assets of the investor are often traded once a month, or even more frequently. As a commission is paid on each trade, commissions can substantially destroy the value of an investment account in a very short period of time.

Critics of the practice of paying brokers commissions for managing investment accounts point to churning as one of the indicators that the brokerage system indirectly encourages such behavior by its members to the detriment of investors. Accounts invested in securities with steady returns and little price fluctuation generate no commissions, and brokers are therefore not encouraged to invest their client's money in such investments. There have been several instances of brokers rising very high in the hierarchy of their firm who have later been shown to have been generating commission income from churning or placing their client's stock into investments with an unnecessary degree of risk. (Source: Wikipedia)

Boiler Room

What is a boiler room?

An enterprise that often is operated out of inexpensive, low-rent quarters (hence the term "boiler room"), that uses high pressure sales tactics (generally over the telephone), and possibly false or misleading information to solicit generally unsophisticated investors. (Source: CFTC)

Dishonest brokers set up "boiler rooms" where a small army of high-pressure salespeople use banks of telephones to make cold calls to as many potential investors as possible. These strangers hound investors to buy "house stocks"—stocks that the firm buys or sells as a market maker or has in its inventory. In the context of the forex market, a boiler room may be an operation selling fraudulent or non-existent currency trading products. (Source: SEC)

The term boiler room typically refers to a room where telemarketers work, often selling stocks, and using unfair, dishonest sales tactics, sometimes selling fraudulent stocks. The term carries a negative connotation, and is often used to imply high-pressure sales tactics and sometimes, poor working conditions.

A boiler room usually has an undisclosed relationship with the company being promoted or undisclosed profit from the sale of the house stock they are promoting.

A boiler room promotes (via telephone calls to brokerage clients or spam email) thinly traded stocks. The boiler room usually holds a large position in the stock and plans to dump it on brokerage clients at a high price.

The boiler room usually has close ties to or the same owners of the company whose stock is being promoted.

Some traits of a boiler room include presenting only good news about the stock to be sold, and discouraging outside research by customers or brokers working there.

The term is likely to have originated from the cheap, hastily arranged office space used by such firms, often just a few desks in a the basement or utility room of an existing office building. The term is a fitting analogy due to the secretive nature of these firms, the connections with the company they are promoting and the high-pressure nature of their activities. (Source: Wikipedia)

Forex Fraud - A CFTC Consumer Advisory

Forex fraudsters typically:

• Promise profits, but they don't deliver — their customers lose money instead!
• Claim most customers make money, when in fact most lose.
• Claim to be trading customers' funds, when in fact they are stealing them.
• Give you phony success stories from made-up customers.
• Create fake account statements showing false trading profits.
• Claim that they have been in business for years, when in fact it is often only months.
• Claim to be solid and stable firms, until they disappear and leave customers' calls unanswered.

Be Alert

If you hear this....

"You can make six-figure profits within a year."

"Forex investments are very low risk."

"You can double your money."

"Mortgage your house or use your retirement funds.
My recommendations can't miss."

"You will make money whether exchange rates move up or down."

"You must invest right now or it will be too late."

....Don't Invest!

In a recent period, the CFTC filed over 80 enforcement actions in federal court against hundreds of firms, owners and employees for defrauding over 23,000 customers who lost over $300 million in these Forex schemes.

Many of these Forex fraudsters were also criminally prosecuted and are now in jail. However, the defrauded investors rarely recovered any of the funds they lost.

Consumer Advice

• No matter what you're told, Forex trading is risky.
• Don't be pressured into an immediate decision.
• Use common sense.
• Get everything in writing.
• Check with the CFTC.
• Seek advice from an accountant, lawyer or an independent 3rd party.
• Don't invest more than you can afford to lose.
• Don't mortgage your home or cash in your savings to trade Forex.

If it sounds too good to be true, it probably is!

Source:
Commodity Futures Trading Commission