Pump and Dump Schemes: The Trojan Horse of Investments

by | June 7, 2018 | Investment Fraud

In the realm of financial services, unknowing investors often fall victim to various securities fraud schemes, and one of the more common ones is the “pump and dump.” “Pump and dump” schemes are often associated with penny stock fraud and microcap fraud and are serious violations of the law.

The “pump and dump” is a real-life example of the saying “all that glitters is not gold.” The “pump and dump” takes place in two parts:

1. The “Pumping” Stage:

This stage is all about the hype, which is designed to create investor demand. Investment advisers and stockbrokers contact unsuspecting investors and provide them with outrageous predictions about the prospects for a stock selling at rock-bottom prices. They make false claims about exclusive insider information, promise big announcements are coming and boast about the once-in-a-lifetime buying opportunity.  The icing on the cake is that they name a number of prominent individuals who supposedly own the stock.  In reality, these companies typically are nothing more than a storefront or a post office box with no revenue, no customers, and no business prospects.

2. The “Dumping” Stage:

Lured by outsized profits, unknowing investors are convinced to invest, thinking that they are ahead of the curve. But once the fraudsters have set the hook, they then sell all their shares into the demand they have created. Following the “dump”, the price of the stock falls significantly, leaving investors holding the bag with devastating losses in their wake.

Typically, the stocks sold in a “pump and dump” scheme are penny stocks. These are stocks that sell below $5 per share and trade outside major market exchanges in what is called the “pink sheets.” Due to the lack of public information regarding the companies connected to these stocks, penny stocks are often illiquid, speculative, and volatile. As a result, penny stocks should be considered investments that come with a high risk of loss.

How to protect yourself from penny stock fraud

The reason “pump and dump” schemes are successful is because fraudsters tap into to the public’s “get rich quick” mentality. However, don’t let yourself be fooled and drawn into something that seems too good to be true. Be wary of pitches for stocks that sell for under $5 per share and those that do not trade on a major stock exchange such as the New York Stock Exchange or Nasdaq. Always familiarize yourself with the stocks that you are buying and ask lots of questions of your investment adviser. Protect your investments and don’t let yourself fall into the traps set up by manipulative fraudsters.

If you believe you have been a victim of a “pump and dump” scheme or any other form of securities fraud, please contact one of the investment fraud lawyers in the San Diego or New York offices of Sanford Heisler Sharp.