This is another installment of the Scam Watch. This time, let’s have a look at one particular scam related to stocks. It’s called the Pump-and-Dump Scheme.
What’s a Pump-and-Dump scheme you ask?
Basically, what happens is that the organiser of a pump-and-dump scheme buys a large parcel of shares in a company or companies, then promote the company/companies to the public, claiming to have an insider information, stating that the share price will increase substantially soon. The public believes him/her and purchase the shares. The effect of higher demand will result into the share price being pushed higher. Then the organiser dumps his shares at an inflated price, making a substantial profit. The public then got stuck with the shares as the price declines well below the purchase price.
These scams can happen to either penny stocks (stocks of low price and easily manipulated by huge orders) or non-penny stocks but usually, penny stocks are the usual weapons of choice.
There are a number of ways how these scammers “promote” the company/companies such as through cold-calling, e-mail spam, and etc.
Let me explain about the pump-and-dump scheme by way of an example:
Assume Mr. A has a brokerage firm. His firm bought a substantial amount of shares in a small-cap company at let’s say 10 cents. He then starts to call his clients and “promote” the company, saying things like, this is the next big thing, they’re about to release a price-sensitive news, and bla bla bla. His clients got sucked in, and start buying shares of the company. The price increases to 20 cents. Satisfied with a 100% profit, Mr. A’s firm starts dumping the shares. Usually, when a big sell order is being executed (i.e. more sellers than buyers), the market forces the price down, sometimes substantially. It doesn’t matter to his firm because he is already out of the market. All he cares about is that he has made a huge profit. Who cares about his clients.
One well-known figure who used to execute the pump-and-dump schemes is Jordan Belfort. He used his brokerage firm, Stratton Oakmont for that purpose. He did make a huge fortune but of course, the authorities caught up to him and he was sent to prison for 4 years.
I myself have received quite a number of spam e-mails telling me to buy some stocks because they’re the next “big thing”. I usually click the “Delete” button.
All in all, be careful with all the scams out there. Don’t let greed of making a quick buck be the catalyst of your investment journey’s destruction.
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