How to Identify Pump and Dump Schemes
Pump and dump schemes can be one of the most traumatic experiences for investors. Thinking they’ve got their hands on the deal of the century, most endure a harrowing experience seeing their investment rapidly sink into worthlessness.
Schemes of this nature are unfortunately all too common, and very costly. For instance, the SEC recently announced fraud charges against this coffee company. It was involved in a pump and dump scam that is estimated to have cost investors up to $78 million.
The terrible thing about schemes such as these is that they result in damaging loss to victims. Most lose money they have worked hard for in these schemes and for an unfortunate few, it results in loss of their life savings.
At Weltz Law, we believe no person should have to suffer the damaging loss that pump and dump schemes often bring. If you have lost your investment in a pump and dump scheme, contact us immediately to get an assessment of your options. While it is notoriously difficult to recover one’s losses in scams such as these, it may be possible to recoup your loss.
Understanding Pump and Dump Schemes
Pump and dump schemes are scams that leverage on investor interest in seemingly well-performing securities. The scams generally involve two stages, the pump and the dump. Together, they operate to falsely inflate the price of stocks, get investors to buy and then offload their holdings before the value crashes.
The pump part of the scheme begins with spreading false information about low-priced stocks held by them. Ordinarily, these stocks won’t be traded on established exchanges like the New York Stock Exchange. The schemes tend to only work on small to micro-cap stocks that are often traded over the counter (OTC). The company stocks also tend to be very illiquid and prone to sharp price movements.
The fraudsters start their scam by spreading overly positive news about the stock, usually in conjunction with an insider at the company. They do this through a combination of methods include messages on online platforms and even emails. One scam involved the use of voicemail messages sent to victims’ phones, faking as a “wrong number”.
Along with all this positive news, they will purchase the securities en masse. This increases demand and trading volume in the stock, leading to a sharp rise in its price. This in turn creates further demand until the price of the stock is driven to its peak.
Then comes the dump part of the scheme. While the stock is right at its peak, the fraudsters will offload their significant holdings onto the unsuspecting market. Their initially worthless shares will now be worth multiple times its initial value.
Of course, soon enough, the hype around the securities will turn out to be just that and investors will start to sell. Just as rapidly as it rose, the value of the shares will crash almost overnight and investors will lose massively.
Tips to Avoid Pump and Dump Schemes
The best way to deal with pump and dump schemes is to avoid them totally. This can be a bit difficult though because they are not always easy to identify. Regardless, if you pay close attention to the circumstances, you should be able to spot a few suspicious points. These tips can help:
- Pay attention to the source: You should be very suspicious when someone gives you tips about “hot” stock over social media. Be wary about emails that constantly invite you to invest in “fast-selling” stocks that don’t seem to have any bad in them. These usually come from paid promoters or insiders at the company. This means the message may look genuine, but that’s exactly how it’s meant to look. Check to see if the communications provide an objective assessment of the stock. If no mention of risk is made, it is likely to be a scam.
- Investigate the shares: Don’t take the communications at face value. Find out more about the stocks that you are being invited to invest in. You can do a Google check on the owners or the company for instance. You’ll be surprised what you’d turn up. See if the company is registered in the US. Many pump and dump scams originate through reverse mergers that allow private companies located outside the US access US markets.
- Check for where the stock trades: As mentioned above, stocks used in pump and dump schemes are rarely traded on major exchanges. Instead, they are usually thinly traded, small cap stock that tend to be traded on OTC platforms.
- Ask for and read a prospectus: If what you see tends to be convincing, ask for the company’s investment prospectus before you make any decision. You can check to see if the information on the prospectus tallies with what is on the company’s SEC filings.
- Rapid rise is usually an indicator: If you have been able to find out information about the company and the stock, you should also check its history. If the stock has experienced long periods of slow trading and suddenly sees rising volumes of trade, you should be wary. That may be indicative of an attempt to artificially inflate the stock’s price.
Even with these tips, it’s not unlikely that many can still fall victim to these schemes. If you are in this position, is there any recourse for you? What can you do to recover compensation, and from whom?
Who can You Hold Responsible?
Fraudsters that set up pump and dump schemes usually take steps to cover their tracks and spirit away their ill-gotten wealth. This generally makes it difficult to find the responsible parties and hold them to account.
Notwithstanding this, there are still situations where you may have recourse for compensation. For instance, the company whose stocks were used in the pump and dump may be implicated in the scam. It may be possible to take action against the company for compensation.
Even if the company is now in trouble due to its worthless stocks, it may be possible to petition the court for a winding-up. This basically means that the court may order the company to close business and its assets will be sold to offset claims like yours.
The process can however be complicated. It is usually best, in these sorts of situations, to get in touch with a lawyer immediately. They can quickly get to work analyzing the facts of your case and possibly work to track down the fraudsters before they disappear.