Pump and Dump Schemes

Definition

Pump and dump schemes are a type of securities fraud where individuals or groups artificially inflate the price of a stock through misleading or false statements, and then sell off their shares at the inflated price, leaving other investors with worthless stock. This manipulation takes advantage of investors who are unaware of the scheme.

5 Must Know Facts For Your Next Test

1. Pump and dump schemes often target thinly traded or low-volume stocks, making it easier to artificially inflate the price.
2. The perpetrators of these schemes may use social media, email, or other platforms to spread false or misleading information about the company's prospects, products, or financial performance.
3. Once the stock price has been inflated, the perpetrators quickly sell their shares, causing the price to plummet and leaving other investors with significant losses.
4. Pump and dump schemes are illegal in the United States and can result in civil and criminal penalties, including fines and imprisonment.
5. The Securities and Exchange Commission (SEC) and other regulatory agencies actively monitor the markets for signs of pump and dump schemes and take enforcement action against those involved.

Review Questions

• Explain how a pump and dump scheme works and the key steps involved.
  • In a pump and dump scheme, perpetrators first acquire a large position in a thinly traded or low-volume stock. They then use various means, such as social media or email, to spread false or misleading information about the company in order to artificially inflate the stock price. Once the price has been pumped up, the perpetrators quickly sell their shares, causing the price to plummet and leaving other investors with significant losses. This manipulation takes advantage of unsuspecting investors who are unaware of the deception.
• Describe the role of the Securities and Exchange Commission (SEC) in monitoring and enforcing against pump and dump schemes.
  • The SEC is responsible for regulating the securities markets and protecting investors from fraudulent activities. In the context of pump and dump schemes, the SEC closely monitors the markets for signs of manipulation and takes enforcement action against those involved. This includes investigating suspicious trading activity, identifying the perpetrators, and imposing civil and criminal penalties, such as fines and imprisonment. The SEC's efforts are crucial in deterring and punishing these types of securities fraud, which can have significant consequences for investors.
• Analyze the impact of pump and dump schemes on the broader financial system and investor confidence.
  • Pump and dump schemes undermine the integrity and fairness of the financial markets, eroding investor confidence and trust. When investors suffer significant losses due to these manipulative practices, it can lead to a decline in overall market participation and a reluctance to invest, which can have far-reaching consequences for the broader economy. Additionally, the prevalence of pump and dump schemes can contribute to a perception of the markets as being rigged or unfair, making it more difficult for legitimate companies to raise capital and for investors to make informed decisions. Addressing and preventing these schemes is crucial for maintaining the stability and credibility of the financial system.

Related terms

Securities Fraud: The act of deceiving investors or manipulating financial markets for personal gain, often through the use of false or misleading information.

Stock Manipulation: The practice of artificially inflating or deflating the price of a stock through deceptive or fraudulent means, with the intent to profit from the price movement.

Insider Trading: The use of material, non-public information to trade securities or tip others, giving an unfair advantage over other investors.