Pump and Dump Stock Schemes
Pump and dump schemes are a form of investment and securities fraud. The scheme involves providing false or misleading information about a company or investment opportunity in an attempt to generate increased trading allowing the fraudsters to sell their stock at inflated prices. Individuals who invest in pump and dump penny stocks often suffer significant financial loss.
The scheme involves touting a company frequently promoting a new product or innovation of the company. For example, a company’s website may contain a press release that describes the company’s financial health or an innovative product. Newsletters that claim to be unbiased will discuss how the company’s stock is “hot” and a great opportunity for investment. Additionally, individuals behind these schemes may provide messages in chat rooms and bulletin boards encouraging investment immediately. In many cases FINRA brokerage firms or stockbrokers agree to promote the company to investors.
If the scheme is successful, investors will begin buying the stock, driving demand up, which increases (“pumps”) the price. Once the price has been increased sufficiently, the fraudulent individuals behind the scheme sell their shares and discontinue promotion of the company or stock. The sale of their shares causes the price of the stock to fall and investors to suffer losses.
Frequently, pump and dump schemes are used with small companies with stock that is not heavily traded because it is easier to manipulate the stock price. Frequently, there is also little public information about the company available.
Pump and Dump Red Flags
There are numerous ways in which investors can identify potential pump and dump schemes or other penny stock frauds. After hearing about an opportunity, investigation into the source of the information should be conducted. Individuals who are touting the stock may be paid by insiders of the company or paid promoters who stand to benefit if increased trading in the stock occurs. If recommended by a stockbroker, ask whether he is receiving any additional compensation for recommending the stock.
Many smaller companies that do not have their stock traded frequently cannot meet the listing requirements of larger markets or exchanges, like NASDAQ or the New York Stock Exchange. Instead, they are traded in the over-the-counter (OTC) market, which can be riskier and more susceptible to manipulation. As a result, opportunities to invest in stock traded in the OTC market should be viewed with more caution.
The Securities Exchange Commission (SEC) EDGAR database can be utilized to determine if the investment is registered. Additionally, checking with the state securities regulator is also important because smaller companies may not be required to register their securities offerings with the SEC.
Finally, it is a red flag if the brokerage firm or stockbroker touting the stock is using high-pressure tactics. An example of these tactics include warning the investor that he or she will miss out if an investment is not made immediately. The individual discussing the opportunity should always allow the investor to consider the investment opportunity.
Pump and dump schemes are just one of the many types of securities frauds. If you believe that you have fallen victim to a fraudulent scheme, contact an experienced securities law attorney today. At the Silver Law Group, we provide representation for investors in arbitration, state, and federal court.
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