Pump and Dump

jt marlin

Stratton Oakmont

Pump and dump is a form of microcap stock fraud that involves artificially inflating the price of an owned stock through false and misleading positive statements, in order to sell the cheaply purchased stock at a higher price. Once the operators of the scheme ‘dump’ sell their overvalued shares, the price falls and investors lose their money. Stocks that are the subject of pump and dump schemes are sometimes called ‘chop stocks.’

While fraudsters in the past relied on cold calls made from ‘boiler rooms’ (outbound call centers selling questionable investments), the Internet now offers a cheaper and easier way of reaching large numbers of potential investors. Often the stock promoter will claim to have ‘inside’ information about impending news. They may also post messages in chat rooms or stock message boards urging readers to buy the stock quickly. Fraudsters frequently use this ploy with small, thinly traded companies—known as ‘penny stocks’ because it is easier to manipulate a stock when there is little or no independent information available about the company.

During the dot-com era, when stock-market fever was at its height and many people spent significant amounts of time on stock Internet message boards, a 15-year-old named Jonathan Lebed showed how easy it was to use the Internet to run a successful pump and dump. Lebed bought penny stocks and then promoted them on message boards, pointing at the price increase. When other investors bought the stock, Lebed sold his for a profit, leaving the other investors holding the bag. He came to the attention of the SEC, which filed a civil suit against him alleging security manipulation. Lebed settled the charges by paying a fraction of his total gains. He neither admitted nor denied wrongdoing, but promised not to manipulate securities in the future.

A variant of the pump and dump scam, the ‘short and distort’ works in the opposite manner. Instead of first buying the stock, and then artificially raising its price before selling, the scammer first short-sells the stock, and then artificially lowers the price, using the same techniques as the pump and dump but using criticism or negative predictions. The scammer then covers his short position when he buys back the stock at a lower price.

As late as April 2001, before the company’s collapse, Enron executives participated in an elaborate scheme of pump and dump, in addition to other illegal practices that fooled even the most experienced analysts on Wall Street. Studies of the anonymous messages posted on the Yahoo board dedicated to Enron revealed messages indicating that the company was basically a house of cards, and that investors should bail out while the stock was still good. After Enron falsely reported profits which inflated the stock price, they covered the real numbers by using questionable accounting practices. Two dozen Enron executives sold overvalued stock for more than a billion dollars before the company went bankrupt.

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