Pump and Dump: What Is It?
A pump-and-dump scheme is a deceptive scheme that aims to raise the price of a stock or investment by making false recommendations. These recommendations are founded on statements that are untrue, deceptive, or excessively inflated. In a pump-and-dump plan, the culprits already hold a position in the company’s stock, and they will sell it once the hype has driven up the share price.
According to securities law, this activity is prohibited and can result in large fines. The industry has seen a rise in pump-and-dump scams as a result of cryptocurrencies’ rising popularity.
- Pump-and-dump is an illegal scheme to boost a stock’s or security’s price based on false, misleading, or greatly exaggerated statements.
- Pump-and-dump schemes usually target micro- and small-cap stocks.
- People found guilty of running pump-and-dump schemes are subject to heavy fines.
- Pump-and-dump schemes are increasingly found in the cryptocurrency industry.
Cold calling was commonly used in pump-and-dump tactics. The majority of this activity has moved online since the invention of the Internet; con artists can now send out hundreds of thousands of emails to unwitting recipients or post remarks online, enticing investors to acquire a stock rapidly.
These messages generally assert to have inside knowledge of a forthcoming event that will cause a sharp increase in the share price. The perpetrators of the pump-and-dump scam sell their shares once purchasers jump in and the stock has dramatically increased. In these situations, the volume of sales of these shares is frequently sizable, leading to a sharp decline in the stock price. In the end, a lot of investors suffer significant losses.
On over-the-counter platforms, which are less regulated than traditional exchanges, pump-and-dump schemes typically target micro- and small-cap stocks. Because they are simpler to control, micro-cap stocks — and occasionally small-cap stocks — are preferred for this kind of abusive behaviour.
The float of micro-cap companies is often minimal, and there is little business information available. As a result, a stock might go much higher with a small number of new buyers.
Anyone with access to an internet trading account and the skills to persuade other investors to buy a stock that is apparently “ready to go off” can pull off the same scam. The schemer can start the action by investing a lot of money in a stock that has limited volume of trading, which often drives up the price.
Other investors are prompted to buy substantially by the price movement, driving the share price even higher. Any time the perpetrator senses that the buying pressure is about to ease, they can sell their shares for a significant profit.
Boiler Room and The Wolf of Wall Street both had the pump-and-dump scheme as their main topic. In both of these movies, telemarketing stockbrokers were seen pitching penny stocks out of a warehouse. In each instance, the brokerage firm served as a market maker and controlled a sizable amount of shares in businesses with dubious futures. High commissions and bonuses offered by the firms’ owners rewarded their brokers for putting the stock in as many customer accounts as they could. By selling in such large quantities, the brokers were driving up the price.
The company sold off its shares for a sizable profit after the selling volume hit a critical mass and there were no longer any purchasers. Due to their inability to sell their shares in time, this caused the stock price to drop, frequently below the original selling price, causing the customers to suffer significant losses.
To help people avoid falling prey to a pump-and-dump operation, the Securities and Exchange Commission (SEC) has provided some advice. Here are some things to remember:
If you get unsolicited communication about an “investment opportunity,” proceed with extreme caution. Such questionable investment pitches may contact you by email, a comment or post on your social media page, a direct message, a call, or voicemail on your cellphone, thanks to the abundance of virtual communication channels. Avoid responding to such letters because doing so could lead to huge losses rather than the enormous rewards that the con artists have promised.
Is the allegedly profitable investment too good to be true? Does it make big “guaranteed” returns promises? Do you feel under pressure to purchase immediately before the stock soars? Investors should be wary of stock touts and dishonest marketers who frequently employ these techniques.
Investment fraud is the term for fraud that targets those who belong to particular groups, such as certain religious or ethnic communities, the elderly, or certain professional groups. You might be convinced of the trustworthiness of an investment pitch by a member of a group you are a part of, but the person might have been unknowingly duped into thinking the investment is legitimate (when in reality, it is just a scam).
Perform your own study and due diligence before investing your hard-earned money. Online, you can easily find a variety of information about reputable businesses, including their financial records, management team, and commercial prospects. The absence of such data might frequently be a warning sign in and of itself.
The latest location for pump-and-dump operations is the market for cryptocurrencies. Due to the enormous gains made by Bitcoin and Ethereum, cryptocurrencies of all kinds are generating a ton of attention. Unfortunately, due to the absence of regulation in the cryptocurrency market, its opaqueness, and technological complexity, cryptocurrencies are particularly well-suited for pump-and-dump operations. The incidence of pump-and-dump strategies in the cryptocurrency market was investigated in a 2018 study. Over the course of just six months of observation on two group-messaging platforms used by bitcoin speculators, researchers discovered more than 3,400 such schemes.
The U.S. Commodity Futures Trading Commission (CFTC) warned customers in March 2021 to steer clear of pump-and-dump scams that can take place in cryptocurrencies that are either newly released or thinly traded. The CFTC also introduced a program that would allow anyone who reported a pump-and-dump scheme to get a financial incentive of between 10% and 30% if their information led to an initial enforcement action that resulted in fines of at least $1 million.