How Penny Stock Pump and Dump Schemes Work

Let me start off by saying that not all pump and dumps are intentional. Sometimes these are legit companies with a real business and somethings goes wrong. That’s just part of life, businesses do fail. Pump and dump schemes apply to all stocks not just penny stocks.

Please take a few minutes to learn about the reality of the penny stock market. The following text was written in 1938 and it details the execution of pump & dumps in the early 1900’s but the practices still apply today.

“It was easy, nonetheless, to start a corporation with little cash in hand, and many oilmen did so. Unless the promoter had legal training or could prevail upon a lawyer to accept stock in lieu of fees, he had to pay for legal help in arranging incorporation, but that normally did not cost much. Next he had to pay a filing fee, $105 in Texas. To grant a charter some states required the projected corporation to have assets or money in the bank to a certain value; in Texas that amount was $5,000. The promoter who was not overly scrupulous, however, could meet this requirement by inflating the value of whatever he had: wildcat leases, played-out wells, junk equipment — anything, in short, that might by some stretch of imagination qualify as an asset. Most promoters met minimum asset requirements with little difficulty. They routinely capitalized corporations for hundreds of thousands of dollars on the basis of assets that were largely imaginary. Indeed, the founders of the Pennsylvania Rock Oil Company, whose promotion led to the Titusville discovery of 1859, did so. Thus it was possible to set up an oil corporation on very slim funds, and the precedent for it was a venerable one.

With his corporation chartered, the promoter could turn to the mechanics of launching his venture. He had to decide on what basis he would sell shares. He might sell “treasury stock,” a straightforward sale of equity in the company in which the money paid in by an investor went directly to the corporate treasury.  But if he had other objectives, like evading state blue sky laws — statutes aimed at barring sales of securities by companies whose assets amounted to no more than “so many feet of blue sky” — or providing himself with a good part of whatever cash came in from stock sales without openly stealing company funds, he might at the beginning have the company turn a large block of its own stock over to him. This maneuver permitted him to sell the “personal” stock that he awarded himself and to keep the proceeds. It also enabled him to evade blue sky regulation in most states.

Once he decided how much stock his company would sell and on what terms, the promoter looked up a printer who could turn out stock certificates. Printers like Chester Bunker, who were experienced at oil field issues, went beyond the standard visual props like screaming eagles and stars surrounded by beams of light to include supposed oil field scenes on stock certificates. Those who bought shares from a number of companies might have concluded that from Pennsylvania to California, one oil field looked much like another. Most certificates showed gushers going over derrick tops, but the settings varied a bit: gushers in valleys, gushers near hills, gushers near tank farms, gushers near factories. The same scenes showed up on certificate after certificate, and regardless of the company’s location, most scenes looked remarkably like rural Pennsylvania. One scene that was a favorite showed a gushing well directly behind a building resembling a boardinghouse that fronted on a lake or river; another frequently used view featured derricks and a long line of tank cars. Presumably such visions enhanced the investor’s disposition to think of the quick riches that would follow the purchase of a pretty piece of paper.

Certificates in hand, the promoter faced the task of converting them into cash, and that required locating likely investors. This process was often surprisingly expense. Beginning with the cheapest tactic, promoters often made their initial approaches to the public through advertisements in newspapers. Most daily newspapers printed ads for patent medicines and business promotions, and they seldom showed concern for the truth of their advertising. A few well-placed ads might reach tens of thousands of prospects at low unit costs, but ad campaigns were rarely adequate marketing devices; buyers rarely parted with more than a few dollars in response to paid advertisements, and responses tended to start quickly and halt abruptly. Long-term and large-scale security sales required other approaches.

Some promoters succeeded in locating investors by getting the investors to contact them, either to receive some variety of giveaway or to subscribe to a newsletter or tip sheet. In 1922, for example, Fort Worth promoter R.H. Manning offered a free oil lease to the first twenty people sending him names and addresses of ten friends; those who tried for the first giveaway had to send in $1 “to help pay for making your assignment and attorney’s opinion.” The tip sheet was a very useful device for a promoter because its subscribers were obviously interested in oil investments. Purporting to be an unbiased source of industry information, the tip sheet or “tipster sheet” puffed what the promoter and his friends had to sell while raking rival offerings over the coals. Frederick A. Cook, Hog Creek Carruth, and Chester Bunker were among the many Fort Worth promoters to publish tip sheets. Bunker’s Western World, for example, pushed oil ventures of Bunker and his associates as well as mining stocks; this puffery mingled with Bunker’s own diatribes against conservative bankers, blue sky laws, and the Better Business Bureau, as well as advertisements for oil investments and sexual vigor pills. Bunker thus peddled a wide range if items to the credulous.

The initial identification of potential investors was so vital a part of any promotion that it produced a business of its own, developing and selling “sucker lists,” compilations of names, addresses, personal information, and investment history of people who might buy shares. Promoters with experience developed their own files of such individuals, and for a price they would sell them to newcomers. Depending on the extent and quality of a list, its price ran from several hundred dollars to several thousand; one Ne York brokerage firm was said to have paid $100,000 for a high quality list of 65,000 – 70,000 names. These lists were sometimes traded, sometimes pirated from clerical workers, and on occasion stolen. Those who lacked the money to buy them were not above rifling trash baskets for envelopes after company offices were closed. A successful prospect list was, in effect, a proven directory of the approachable, if not of the gullible, and it could save a promoter much time, effort, and expense.

Failing a good sucker list the promoter had to hunt for his own investors, a time-consuming task. Hungry promoters scanned newspapers for names of contributors to charity drives and for people who were written up in society columns. The obituary pages yielded names of widows and potential heirs. Better yet, newspapers in the twenties often published lists of local people who paid income tax and what they paid. In September 1925 the New York Times, for eample, published such a list for New York City and New York State; it took up eight pages and included mailing addresses. As useful as this list was, however, a promoter did not know which of those people in the paper were good prospects; he could spend a great deal of money on wages, printing, and postage to find out.

Using tip sheets and buying sucker lists took money. So did the professional production of advertising literature, another service experienced promoters commonly used. The most important people in this phase of a promotion were the copywriters, called “pens” by their employers. The promoters of the teens and twenties were willing to pay high salaries for the services of such men as John H. Cain, Walter Keeshan, and the genius of bunkum, Seymour Cox. A good pen could develop a letter or brochure that captured the potential investors’ attention and aroused their greed, and that was what the promoter needed.

Once he developed his literature, the promoter sent out plenty of it. A name on a sucker list was worth much more than a single contact, and after several letters some promoters tried telegrams and phone calls. S. Shallcross, for example, besieged the potential investors in his 500 Percent Syndicate with ten letters and three telegrams within three weeks. There were obvious limits to this approach, for it seldom extracted more than $200 from the individual investor, but it paved the way for further exploitation in the form of visits from salesmen. Because that kind of contact could milk far larger sums from the gullible, the pen’s work of preparing the ground for others was of great importance. Promoters in large cities, however, favored using the telephone to contact investors; wild promises of instant riches thus left no evidence in print.

When sales failed to take off after cultivation of investors, many promoters resorted to dubious and even dishonest practices. The most common one was the early “dividend,” a small payment made shortly after a promotion was launched. The promoter hoped the dividend would encourage shareholders to purchase more shares and to tell their friends what a wonderful stock they had found, thus encouraging additional individuals to invest. Unfortunately, this strategy raised two difficulties. The promoter commonly had no earnings frm which to pay dividends, so he made payments Ponzi-style from proceeds of share sales. That led to the second difficulty: paying dividends from money not earned was illegal and often brought federal authorities to investigate the promotion.

Most new promoters progressed to form their own sales organizations after advertisements and mail contacts failed to raise sufficient capital. In-house marketing usually involved the recruitment of salesmen, a difficult process as the directors of Lubbock-Bridgeport and Big Diamond oil companies learned. Usually this approach was not much more successful than newspaper advertisements, and it took much more skill. For that reason many promoters chose to sell stock through intermediaries, brokers and salesmen. Brokerage houses could be the creation of promoters themselves; Frederick A. Cook, S.E.J. Cox, and Paul Vitek were among the many who used their own brokerage operations to rake off commissions for themselves from the sale of shares in the ventures they promoted. But there were many other professional brokerage operations like that of Leslie Vincent Company in Chicago, which specialized in selling shares of dubious value. Leslie Vincent’s managers, E.V. O’Dowd and Walter Marks, employed a corps of experienced salesmen who traveled through the country; using many an alias, these men were adept at being hard to find when law enforcement authorities took too close an interest in their activities. The salesmen were masters of high-pressure sales techniques and, promising quick returns of hundreds of percent, they wrung thousands of dollars from those they visited. The promoter who retained Leslie Vincent could be sure his shares would sell, but he had to pay the brokers and their employees hefty commissions of three-eighths or more of the revenue from stock sales, and that did not reckon in small amounts of stock to which the salesmen occasionally helped themselves. A promoter short of cash might well be reluctant to hire such expensive professional help.

Easy Money: Oil Promoters And Investors In The Jazz Age, pages 54-58.
Novel by Roger M. Olien, 1938

Easy Money 
by Roger M. Olien is very a insightful novel that’s about as good as it gets when it comes to learning about the reality of today’s penny stock market.

I highly recommend this novel to anyone who wants to learn more about the intricacies of stock promotion and pump & dump operations.

Add a Comment

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Read previous post:
How Are Stock Prices Determined?

What Does the Share Price of a Stock Tell us? The price action of a stock is simply caused by supply and...