Pump and dump schemes are a type of securities fraud that involve artificially increasing the price of a stock with false or misleading statements, in order to later sell at a higher price. Once the seller dumps his stock, this causes the price to fall drastically, leaving the new investors with a loss. The scam is most commonly associated with penny stocks and has more recently become popular with cryptocurrencies.
Penny stocks are targeted for pump and dumps by fraudsters as they are easier to manipulate because of their low float, meaning it doesn’t take a lot of buyers to increase the price. The scheme starts with someone accumulating a large position in a company and then finding an effective medium to advertise the stock to potential buyers. The stock is hyped as “the next big thing” with details of an upcoming announcement that will cause the shares in “soar in price”.
Example of a Pump and Dump – Jammin Java
In 2o11, former CEO of Jammin Java, Shane Whittle organized a $78 million international pump and dump scheme of a coffee company originally founded by Bob Marley’s son. In April 2011, the companies stock price traded at $0.50 per share, by the middle of May the stock price reached $5.17 before collapsing. By the end of 2011 the price fell bellow $0.30 and nearly ten years later the company now trades for $0.00020 per share!
In the 1990’s cold calling, message boards and email was the best way to promote investment opportunities. Two movies that do an excellent job at depicting how cold calling works is the Wolf of Street and Boiler Room.
Boiler rooms were outbound call centers full of sketchy salespeople pitching stocks to strangers. Typically a salesperson made over a 200+ calls per day looking for suckers to buy. 90% of people hung up while the remaining 10% would give someone 30 seconds of their time to hear their pitch. Boiler room operations slowly died out as the SEC clamped down and their practices became more widely known.
During the late 90’s/early 2000’s, message boards was a great place to promote stocks. 15 year old Jonathan Lebed was the first minor to get prosecuted by the SEC for stock manipulation through the help of internet forums. In high-school at the time, young Lebed published false information about stocks he owned on Yahoo message boards through dozens of fake profiles he created. He aggressively recommend companies as strong buys, everyone who took his advice and bought pushed the stocks higher. Lebed would later dump his shares for massive profits, sending the shares crashing back to reality. In the space of six months, he earned $800,000 and was later ordered to pay back $285,000 of his illicit gains, leaving the youngster with half a million dollars.
The rise of the internet in the 2000’s took stock manipulation to new heights. Stock promoters setup professional websites to build up massive email lists to promote their latest “free stock picks”. Awesome Penny Stocks at the one time was the biggest penny stock promotional companies in the game. Over a span of five years they promoted 38 stocks that cost investors tens of millions in losses. The person allegedly behind the website was a Canadian man John Babikian. Nicknamed the Montreal Playboy, he acquired a $100 million fortune from his promotional activities. He fled Canada in 2012 to avoid tax evasion charges and his whereabouts are still unknown.
Penny stocks are risky to buy if you’re an inexperienced trader. Never buy a stock based on a “hot tip” from a stranger on the internet. Always do your research and form your own opinions, 5 minutes of research is enough time to discover if a penny stock is a legit company. Remember if it sounds too good to be true, it probably is.