Pump and Dump

Pump and dump is a type of stock scam. Under this fraud, the operators of a security artificially inflate its price. Once the price is increased, these operators offload their cheaply acquired stock to make profit. Consequent to such selling, the price generally drops down to its original level, causing potential loss to the common investor buying that stock.

Pump and dump schemes are generally employed in the case of microcap or small cap stocks. Though, in rare cases, it can also be used for dumping large cap stocks. Arguably, the most infamous example of such behavior occurred in the case of Enron.

Such scams are typically perpetrated through cold calls or cyber spamming. In earlier years, fraudsters used to make phone calls from boiler rooms in order to spread false positive news about the stocks. Nowadays, with the proliferation of internet, scammers spam online message boards and discussion boards with rumors about the stock, and may also send spam emails. Such stocks are known as Chop Stocks. Nowadays, cold calling has been almost overshadowed by internet, which offers efficient and cheap means for disseminating false information.

Pump and dump scams may be carried out in a variety of ways. Generally, the chop stock promoters spread false claims about having inside news about the stock. Such operators may also send out newsletters further asserting the claims. Such stocks are artificially propped up by bombarding positive news about them. Once such information captures the attention of unsuspecting investors, it creates artificially high demand, which further pushes the price up. The sharp price spike creates further interest in the security. Once the price reaches a certain level, the fraudsters dump their holding and cease endorsing the stock. Such sell off cause the price to decline sharply. In such cases, promoters make money at the cost of regular investors, who are left holding substantially less valuable stock.

Such scams are used in penny stocks and illiquid stocks. These stocks are generally listed on Pink Sheets or on Over the Counter Bulletin Boards. Such stocks generally do not fulfill the criterion required for listing on major exchanges such as the NASDAQ or the New York Stock Exchange. Scammers prefer such stocks as these are not covered by analysts and little information is available about such scrips. Such lack of reliable information makes it easier for fraudsters to manipulate the view point of investors. Outside of the US, fraudsters target small companies listed on OFEX or AIM. In essence, such stocks are not very well known to retail investors.

However, not all scammers pump up the prices by spreading false positive news. In some cases, completely opposite approach is applied. Such technique is called short and distort. Under this approach, operators short target stock and then proceed to spread negative rumors about the stock to beat down the price. Fraudsters use the same channels such as cold calling, email spam and bulletin board spam to tarnish the company’s reputation. Once the price is low enough, operators buy back their already sold shares.

Pump and dump techniques have changed a significantly over time. A modern take on pump and dump scams is now called hack, pump and dump. Under such schemes, fraudster buy penny stocks and the prices are driven up by using hacked security trading accounts. This scheme involved considerable computer skills to hack the trading accounts. Such large purchases drive the security price up and then operators dump their stocks to reap up the profit. Increased volume and activity also attract day traders and their activities further push the price up.

There are several instances of such frauds.  One of the most high profile security dumping scam belongs to erstwhile energy company Enron. In 2001, the company operated a massive pump and dump scheme in collusion with its top management. Enron executives spammed bulletin boards and spread false rumors about the stock. The energy company also fudged its books to announce profits to increase its stock price. Enron also made use of dubious accounting practices to hide the real numbers. Company executives used the opportunity to dump their stock holding at inflated prices. Soon, the company went bankrupt causing massive losses to the buyers of the stock. The Enron scandal is unique as usually pump and dump scams take place in case of small and micro cap stocks. Enron carried out its elaborate ruse in such a way that even prominent Wall Street analysts could not gauge the wrongdoings.

Another prominent pump and dump scam was perpetrated by a teenager called Jonathan Lebed. The scam was carried out during the dot com boom. Jonathan Lebed relied massively on the internet for executing his plans. He purchased microcap stocks and propped them up on internet boards. Lebed offloaded his holding once the stock price reached a high. He caught SEC or US Securities and Exchange Commission’s attention and the commission charged him with a civil suit. He was charged with security manipulation charges. Finally, Lebed settled the case by paying fines. However, in reality, such fines amounted to a small fraction of the gains made by him. Lebed promised to not repeat the offense of security manipulation but he neither denied nor admitted any wrongdoing.

More recently, a pump and dump scam was executed by Park Financial Group in 2002-2003, with the company being charged by the SEC in 2007. The group had pumped and dumped the stock of Spear & Jackson Inc., a company listed in Pink Sheet.

Internet spam constitutes the main channel for executing pump and dump scam. According to a survey, pump and dump spam email constitutes about 15 percent of total spam messages. The survey suggests that an average pump and dump scam can help the perpetrator make up to 6 percent return. Victims, on an average, lose 5 percent of their outlay. Scamsters mainly use penny stocks for this purpose, stocks that generally trade for less than $5 apiece. They are also not listed on major stock exchanges and are generally not very liquid.

However, this kind of spam is different from regular fee scam and lottery fraud emails. These emails do not ask the receiver to transfer any funds or to get in touch with the sender. Some of these emails contain minimal information which cannot be traced, making it is extremely difficult to track down the source of origin. Some pump and dump spam email contain only a small picture or image file of a stock icon.

Such scammers may breach the database of brokers to obtain email addresses and other information about potential victims. In 2005, several TD Ameritrade users reported receipt of such spam. At that time, it was the 3rd biggest dataloss event. Later, TD Ameritrade reported that its database containing sensitive information such as addresses, email addresses and social security numbers had been breached. The database contained information about 6.3 million clients. These clients became victim of spam pump and dump emails. This breach was brought into public eye by an article appearing in Slashdot in 2007. It was rumored that the breach occurred through one of the Ameritrade’s affiliate companies.