Modern-day investors need to be wary of various types of scams. These scams may be in the form of accounting scandals, insider trading, or other forms of fraud. One such scheme is a pump and dump scam.
Through this scam, investors of a particular stock promote the company extensively. Once hype has been created, these investors tend to sell their holdings to unsuspecting buyers, eventually leading to a sharp decline in the stock’s share price. This situation results in ordinary investors suffering from huge financial losses.
Explore the key aspects of such pump and dump scams to ensure you avoid falling prey to these schemes.
The first part of these scams is that existing investors start to spread news and rumors about upcoming announcements that could lead to a sharp increase in share prices. These future announcements are touted as game-changers that could help spark a sharp move in higher valuations.
The general motive is to create hype in the market and to increase the demand for shares. Many investors are attracted to such news and they purchase the stock in the hopes of making money. This increase in demand results in a short-term bump higher in the company’s share price.
DUMPING THE STOCK
Once the share price has risen to a certain range, the original investors then begin to dump the stock, thereby realizing immense profits. However, when the market realizes that the original investors have backed out of the company, share prices begin to fall.
The new investors who had been attracted to the share are now left exposed to heavy losses. Such a pump and dump fraud strategy can be extremely dangerous for young investors, and it can result in significant wealth erosion.
EXAMPLE OF A PUMP AND DUMP fraud
A recent example of a pump and dump scam was witnessed back in 2015. The scam was perpetrated in an American firm known as Jammin’ Java.
The CEO and a few key promoters of the firm created a complex pump and dump scheme to cheat new investors. The fraudsters executed this crime by releasing fake and inaccurate newsletters about the company.
Once these newsletters became popular online, a large number of new investors chose to purchase the shares of the firm. The fraudsters also created complex offshore entities in order to conceal and transfer funds from one place to another.
The price of the company’s stock stood at just $0.17 per share before the pump and dump scheme was executed. However, it reached an intra-day high of $6.35 per share after the hype was generated. Once the share price of the company shot up, the fraudsters chose to sell off their shares and realized significant profits.
According to estimates provided by the Securities and Exchange Commission (SEC), the total profits realized by the fraudsters were in the range of $78 million. The CEO and eight other people were charged by the SEC under a civil complaint.
It is clear that pump and dump scams can be extremely damaging for investors. These scams are executed in a complex manner so that new investors are unaware of the fact that they are being cheated.
The example discussed above also shows that the top management of firms can also be involved in these scams. Therefore, investors need to be really careful before investing in a stock that has been overhyped. Conducting thorough research is a good way to ensure that you are protected against these scams.