A pump and dump fraud scheme is a type of microcap stock fraud in which an entity purchases an inexpensive stock and deceptively promotes the company in order to inflate its value. Once enough investors have purchased the stock and “pumped” up the value of the company, the fraudsters will quickly dump shares to earn a significant profit for themselves. This causes the price of the stock to plummet, leaving investors with huge losses. In fact, according to the North American Securities Administrators Association, these schemes cost investors billions of dollars each year.
Pump and dump schemes qualify as a type of microcap stock fraud because these schemes involve companies that are worth less than $250 million. Many times, microcap stocks are considered penny stocks, meaning that they are worth less than one dollar per share. Because these stocks are so inexpensive, schemers can afford to purchase a high volume and earn a large profit without risking a great deal of money.
How Perpetrators Lure Their Victims
In order to pull off a pump and dump scheme, fraudsters must trick investors into purchasing a specific stock in order to drive up the price. They do this by reaching out to consumers and falsely promoting the company. Fraudsters often claim to have inside knowledge of important company happenings, like revolutionary new products or secret company mergers, and urge consumers to invest while stock values are still low. Often, so-called insider information is shared through social media, counterfeit company press releases and commonly through large e-mail campaigns. Some stock promoters also employ telemarketers who cold-call possible investors and attempt to lure them in with promises of large profits.
To further confuse investors, fraudulent stock promoters typically choose thinly-traded stocks offered by small companies. This is because it is easy to alter the price of these stocks and often difficult to find a lot of information about the company, making it possible for schemers to tell investors whatever they wish. Instead of promoting stocks traded over large markets, like the New York Stock Exchange (NYSE), fraudsters target stocks that are available over-the-counter, like those traded through dealer networks like the Pink Sheets or the OTC Bulletin Board. These stocks usually do not meet the requirements necessary to be traded on larger stock exchanges. Some deceptive stock promoters will even use stocks connected to companies who are dormant or are no longer in business.
The Prevalence of Pump and Dump Schemes
According to a study performed by the Social Science Research Network from 2004 to 2005, 15 percent of the spam e-mail delivered to consumers was connected to a pump and dump scam. The study showed that stock promoters who targeted their victims through spam e-mail campaigns made an average return of 4.19 percent. Innocent investors, however, lost an average of 5.5 percent of their initial investment within two days. This research not only uncovers the frequency of the issue, but it also proves how fast these schemes unravel to the detriment of the average investor.