Pump and dump refer to a type of securities fraud or scheme that tries to inflate prices of stock through misleading, false, or greatly exaggerated statements. Those involved in this scheme do this so that they can be able to sell their cheap stock at a higher price. Once they are through with selling and making profits, the price of the same stock suddenly drops, and investors lose their money. As per the securities law, this practice is illegal and can lead to a hefty fine.
A Little More on What is Pump-and-Dump
The pump and dump scheme existed in the form of what we call cold calling. However, with the advancement of technology, this illegal activity has spread widely. They use the internet to post messages online that entice investors into buying stock quickly.
So, investors buy shares in large numbers because they rely on the inside false information that there is likely to be an upward price movement. Once the buyers come in to buy, the scheme masters sell their shares, causing the price to go down drastically. The new investors lose their money in the process.
Such security fraud usually targets micro and small-cap stock because perpetrators find them easy to manipulate. Since the float of these types of stocks is small, it does not require many new buyers for the stock to go higher.
In addition, there is usually a lack of information to the public creating another favorable environment for fraudsters. The reason is that potential investors usually lack adequate resources to check a company’s information. So, getting trapped in this scheme becomes easy.
Also, microcap stocks are highly liquid securities and trade at a very low volume. So, even relatively small transactions are capable of significantly inflating the security’s price.
Pump and Dump Schemes
Classic Pump and Dump Schemes
This scheme may involve any type of information manipulation regarding a firm as well as its stock. It may also include pitching of stock through fake news releases, telephone, and distribution of some kind of inside information that is likely to boost the price of the stock.
Broiler room refers to a small brokerage firm that hires several brokers who use dishonest sales strategies to sell questionable stocks to investors. These brokers work hard to sell as many stocks as they can, and by doing so, they boost the price of these stocks. Once the prices of the stock shoots up, the company sells its shares of the stock at a profit.
Wrong Number Scheme
This is a method that is a new pump and dump fraudulent practice. Some individuals may receive voicemails from unknown people with hot investing offers to a friend. These are fraudulent people to believe that the voicemail was left on their phones by accident. However, their main intention of doing so is to attract the attention of prospective investors to purchase a particular stock and then boost the stock’s demand.