Pump and Dump Schemes Explained.

Pump-and-dump stock schemes are far from new. For decades, fraudsters have used these scams to fleece would-be investors. While advancements in technology have impacted the schemes and how they operate, the basic framework and goal behind them have not changed.

Most pump-and-dump schemes have three main elements: the setup (when they choose their target stock), the pump (when they attempt to raise the target stock’s price), and the dump (when they rapidly sell the stock to maximize their profits).

Targeted Microcap Stocks

Generally speaking, scammers have historically targeted microcap stocks that trade over the counter (OTC) and provide limited public information. Recently, however, scammers have expanded their target selection and have also been going for stocks with low prices trading on national exchanges.

Before they do the pumping, the scammers discretely try to snap up as much of the company’s public float as they can. (The public float is the number of shares that are available for trading by average investors. These shares can come from both public and private stock offerings.) This way, they have a substantial stake in the company, which makes it easier for them to artificially inflate its price.

Pump-and-dump schemes like these are also sometimes called ramp-and-dump schemes.

Drive up the Price of a Stock

In the “pump” stage, the scammers work to drive up the price by promoting the stock online, on social media and through emails. They can drum up interest by making claims about “good news” the company is going to release soon or even pointing to the company’s earlier announcements regarding popular trends.

The way scammers target potential marks has changed somewhat too. In the past, this was largely done through word of mouth or cold calling. However, more and more, scammers are using text messages and encrypted messaging apps. For example, their ads on social media for an investment club may serve as a gateway to discussions via encrypted group chats about stocks they are trying to pump.

This way, they can drive up the price quickly - and by a lot. The higher the price rises, the more profit the fraudsters make. As the price goes up, the hype surrounding it can also attract more and more investors to keep driving up the price, and some may want to invest only because the price is rising.

In the “dump” stage, the fraudsters sell their shares as the price of the stock increases. The selling - and subsequent crash - can happen within seconds. Anyone still holding shares when this happens will have a tough time getting out of their positions without taking a huge loss.

After the crash, the victims of these scams are sometimes contacted again. This time it’s to try to get them to engage in a recovery scam, which offers to recover their losses - for a fee.

Why do people get taken in by these scams? Fear of missing out (FOMO) is a powerful motivator for many. It’s why the pitches often have an added element of urgency. You have to invest now, or you will miss your opportunity.

Steps You Can Take to Protect Yourself

It’s not always easy to know if the interest in a stock is a scam or if it’s just genuine excitement. There are, however, steps you can take to protect yourself.

Don’t accept stock tips from a stranger who “accidentally” contacts you and then tries to get you to invest in a sure thing. In fact, it’s better if you don’t engage with the stranger at all. If you do, scammers will often pretend to be someone or something you’re familiar with, like a firm or person you know. So, check them out with FINRA BrokerCheck. Contact the number listed in BrokerCheck or a number on the firm’s website to verify the legitimacy of the individual or firm. Don’t use the phone number that is provided to you.

If you are considering investing, take the time to do your own research. Don’t rush. In some cases, fake investment clubs will start off by promoting well-known investments and then move on to those that are obscure, trading at a low price. This can be a way to create small initial wins and get people to trust the scheme. You should also be wary if you are told that you can borrow money to invest - a home equity line of credit, for example.

Keep an eye out for dramatic price swings in a stock. If a normally illiquid stock suddenly generates a lot of interest, it could be a sign that a stock is being pumped. Scammers will focus on the short-term gains a stock can generate, but you can see price and volume trends over months and even years with FINRA’s Market Data and Investments Explorer.

Do not give out personal or account information. The more information you share, the more opportunities scammers have to take advantage. One common scam tactic is to ask you to send a screenshot that proves you have made a trade. This should be a signal that you need to walk away.

If you think you were the target of - or victim of - a scam, you can submit a regulatory tip to FINRA, report it to local law enforcement and for cyber scams, to the FBI’s Internet Crime Complaint Center.