Most people know the adage, “Buy low, sell high.” Pump and dump schemes are a form of illegal market manipulation in which fraudsters buy stocks at a low price, then do a blast of marketing to get others to buy them and thus “pump up” the stock price. Often, once the price rises as high as the fraudsters – usually company insiders – think it will go, they sell off their stocks – “dumping” them while they can get a high price. The sudden sell-off causes prices to drop. Meanwhile, the victims of the scam did not know the big sell off was about to happen, so they hold onto their stocks and are only able to sell them after the dump has lowered prices drastically. The fraudsters buy low and sell high, but their marks buy medium/high and sell low. Fraudsters profit, innocent investors lose.
Simply talking up a stock (on social media or otherwise) is not illegal, but when it is paired with fraudulent statements or omissions, particularly involving insiders, that behavior may run afoul of the law.
Pump and dump schemes are common with microcap or “penny” stocks. These are stocks in companies with a low valuation, known as a low “market cap” (for “market capitalization”) – usually below $300 million. These types of stocks are not sold on major exchanges like the New York Stock Exchange or Nasdaq, but rather over-the-counter through networks of broker dealers. Companies whose stocks are sold over-the-counter do not have to make the same public disclosures as those required to be listed on a major exchange, and there is less scrutiny by analysts, which means there is no counterweight to the false hype being offered by a fraudulent actor.
It is easiest to manipulate stocks in the smallest publicly traded companies, partly because it’s easier to affect their prices – think of the fraudster’s shares as a slosh in the bucket of a small company’s stock price vs. a drop in the ocean of a large company’s stock price. It also helps that there tends to be very little publicly available information about such small companies, making it harder for investors to learn the truth about them. When pumping up stocks, fraudsters often claim that something major is about to happen that will cause the company’s value to skyrocket. That story is easier to propagate in the absence of other information about the company. Other common sales tactics include creating a sense of time pressure, leaning on characteristics the marketer and prospective investor have in common (“affinity fraud”), and promising guaranteed returns that are too good to be true.
Like many phenomena, pump and dump schemes have gotten easier and more widespread in the age of the internet. They rely on building up hype about a stock, which used to happen via mass mailings and phone calls, but now can happen via social media and communications platforms like Telegram and Discord. The world of cryptocurrency has been a hotbed for pump and dump schemes, and the CFTC issued a Customer Advisory about crypto pump and dump fraud in March 2021. Both the SEC and CFTC have brought enforcement actions against pump and dump schemes, and whistleblowers can provide key information to bring down the perpetrators.
If you suspect an illegal pump and dump scheme, contact a lawyer well versed in financial fraud whistleblower programs, such as those run by the Securities and Exchange Commission’s and the Commodity Futures Trading Commission, who can help you file a claim.
Liz Soltan is an Attorney at Constantine Cannon