Pump and Dump Examples

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How to Spot a Pump and Dump

Bernard L. Madoff’s escapade has made you suitably wary of Ponzi schemes. Now here’s another investment scam, equally venerable, that you should be sensitive to. It is called pump-and-dump. It involves the building of feverish excitement around a tiny company in such a way that insiders can unload worthless shares on suckers.

The Securities & Exchange Commission has brought a number of cases recently against what it considers pump-and-dump artists. Unfortunately, there are slim prospects of meaningful restitution for aggrieved investors. As Bernie’s victims can tell you, assuming that securities cops will nab the bad guys in a timely fashion is a ticket to the poorhouse.

The good news is that pump-and-dumps, like many frauds, throw off plenty of recognizable warning signs. The (as yet unproved) case of My Vintage Baby is a good example of what to watch out for.

In Pictures: 10 Ways To Spot A Pump-And-Dump Scam

In three civil suits dating back to 2008 and still pending, the SEC alleges sharpies using pump-and-dump tactics hosed investors in the Dallas-area maker of high-end infant clothing. In a pattern that’s classic pump-and-dump, the promoters (so it is alleged) cheaply acquired a large position in My Vintage Baby’s stock in the summer of 2007. Then they began touting the company via e-mail and Internet stock sites and trading shares among themselves. Together these activities created what looked like a buoyant market to those who didn’t look too closely.

The share price went from 40 cents to $2.88. Along the way the pumpers dumped their stock for a $9 million profit.

Today My Vintage Baby is essentially worthless: A buck buys 5,000 shares. That’s too bad for those who bought on the rise and held on. One such victim, regulatory filings say, was someone in the United Airlines pilots’ self-directed retirement plan.

The SEC says that the My Vintage Baby scam was one of several orchestrated by Ryan M. Reynolds, Jason Wynn and Carlton Fleming. For this one, the feds say, the trio had help from Robert Feeback, a Plano, Tex. financial consultant who sat on My Vintage Baby’s board, and New York lawyer Stephen A. Czarnik, who signed letters saying things were fine.

Each man is a defendant in one of the SEC cases. None has acknowledged wrongdoing; to forbes they or their lawyer either denied culpability or didn’t comment. My Vintage Baby and its boss, Jessica Wiswall, aren’t named as defendants in the SEC suits; they are aiding authorities, according to their lawyer.

Inquiring investors would have had a hard time uncovering the well-disguised role of the promoters or their backgrounds. Reynolds, for example, is a former stockbroker who’s been banned from the industry and whose name did not appear in the early public documents of My Vintage Baby. Still, there were plenty of telltale signs that a pump-and-dump might be under way. Watch for these if you ever get excited about a fast-moving stock, especially one with a low share price.

Reverse Merger. There’s nothing inherently wrong with a reverse merger, which involves a formerly private company gaining access to the stock market by allowing itself to be acquired by a firm whose shares already trade. However, this variety of reorganization happens to be a common first step in penny stock scams. It allows insiders to take a venture public without filing the usual registration statement with candid disclosures about assets, liabilities, insiders and risks.

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My Vintage Baby was private until May 2007, when the promoters arranged for it to merge into, take over and give its name to something called Comprehensive Medical Diagnostics Group. As little more than a publicly listed shell, Comprehensive Medical had shares capable of being quoted and traded, even though it had last reported financial results in 2001.

Pink Sheets. Shares of the newly public My Vintage Baby were listed in the Pink Sheets, a thinly regulated public marketplace that contains 9,300 companies with, for the most part, unimpressive balance sheets. Some of these companies are tiny but honest; some are larger but possess more hot air than assets. Most Pink Sheet outfits are too small or have too few shareholders to be required to file financial statements with the SEC, a group that includes My Vintage Baby. But SEC filings are no guarantee of anything; over the years plenty of pump-and-dumps have involved reporting companies.

Pink Sheet companies are usually marked on financial Web sites with a “PNK” or the like next to the ticker.

In Pictures: 10 Ways To Spot A Pump-And-Dump Scam

Sketchy Financials. Before it started trading publicly, My Vintage Baby filed three pages of unaudited, bare-bones financials with the Pink Sheets that contained results for 2007’s first quarter. The paucity of information was itself a red flag; the numbers were not reassuring. They showed a negative net worth and little cash. My Vintage Baby lost $173,000 on $429,000 in sales in the quarter. A potential investor should have asked why, in five weeks starting that June, the shares enjoyed a 600% run-up that endowed the firm with a $225 million market capitalization.

Horn-Blowing. Immediately upon going public, My Vintage Baby became the subject of promotions via mail, e-mail and Internet sites touting it as a “strong buy” that “could make a fortune” for early investors. The company issued press release after press release announcing new deals and products.

Lots of legitimate outfits have busy p.r. departments. What should make you suspicious is self-promotion out of alignment with discernible financial results.

Dubious Connections. Many of the early press releases listed as the contact for My Vintage Baby the phone number of Cervelle Group, an “investor relations” firm now in Winter Haven, Fla. Internet research would have shown that the shares of a number of other companies promoted by Cervelle had risen and then crashed. Among them: Superior Oil & Gas and Itronics , a fertilizer firm. Cervelle, which often was paid in shares of the outfits being flogged, did not respond to requests for comment. It is not a defendant in any of the SEC’s three My Vintage Baby cases.

Trading Surge. According to the SEC, My Vintage Baby’s promoters obtained 20 million of what became 77 million shares outstanding at prices ranging from a half-cent to 7 cents and traded among themselves and associates to create the appearance of investor interest. Share volume went from zero one day to 1.5 million the next in June 2007. Did no one among the marks find that odd? As the stated price climbed, volume topped 3.5 million shares on one day five weeks later, when, the feds say, the pump really turned into the dump.

Pump and Dump

What Is Pump-and-Dump?

Pump-and-dump is a scheme that attempts to boost the price of a stock through recommendations based on false, misleading or greatly exaggerated statements. The perpetrators of this scheme already have an established position in the company’s stock and sell their positions after the hype has led to a higher share price. This practice is illegal based on securities law and can lead to heavy fines.

Pump And Dump

The Basics of Pump-and-Dump

Pump-and-dump schemes were traditionally done through cold calling. But with the advent of the internet, this illegal practice has become even more prevalent. Fraudsters post messages online enticing investors to buy a stock quickly, with claims to have inside information that a development will lead to an upswing in the share’s price. Once buyers jump in, the perpetrators sell their shares, causing the price to drop dramatically. New investors then lose their money.

These schemes usually target micro- and small-cap stocks, as they are the easiest to manipulate. Due to the small float of these types of stocks, it does not take a lot of new buyers to push a stock higher.

Pump-and-Dump 2.0

The same scheme can be perpetrated by anyone with access to an online trading account and the ability to convince other investors to buy a stock supposedly ready to take off. The schemer can get the action going by buying heavily into a stock that trades on low volume, which usually pumps up the price.

The price action induces other investors to buy heavily, pumping the share price even higher. At any point when the perpetrator feels the buying pressure is ready to fall off, he can dump his shares for a big profit.

Pump-and-Dump in Pop Culture

The pump-and-dump scheme formed the central theme of two popular movies, “Boiler Room” and “The Wolf of Wall Street” – both of which featured a warehouse full of telemarketing stockbrokers pitching penny stocks. In each case, the brokerage firm was a market maker and held a large volume of stock in companies with highly questionable prospects. The firms’ leaders incentivized their brokers with high commissions and bonuses for placing the stock in as many customer accounts as possible. In doing so, the brokers were pumping up the price through huge volume selling.

Once the selling volume reached critical mass with no more buyers, the firm dumped its shares for a huge profit. This drove the stock price down, often below the original selling price, resulting in big losses for the customers because they could not sell their shares in time.

Avoiding Pump-and-Dump Schemes

Investors should be wary about notices that a stock is about to take off – especially when they are unsolicited – no matter how tempting it may be. Consider the source and check for red flags. Many notices come from paid promotors or insiders, who should not be trusted. If an email or newsletter only talks about the hype and doesn’t mention any of the risk, it’s probably a scam. Always do your own research in a stock before making an investment.

Pump and Dump

Pump & Dump Meaning

Pump and dump is a practice of artificially inflating the market price of a stock to gain by selling it before it falls again. Pump and dump is an illegal activity as ruled by the Securities and Exchange Commission (SEC).

An investor or an investing firm engages in this activity by buying the stocks of a firm the prices of which are easy to manipulate. This is, then followed by excessive endorsing of that stock until it rises significantly. The investors then sell the stocks thus making illicit profits and the common investor lose their money.

Types of Pump and Dump Methods

  1. Traditional Scheme: This is a fraud scheme being followed since ages where the stocks are pitched through advertising, telephone calls, press releases, etc. in order to spread the misinformation. In such a scheme, the fraudsters pitch the stock by emphasizing that they have inside information of the subject stock.
  2. Wrong Number Scheme – Interestingly, this scheme is followed to trap a customer by telling him that he is not the target customer. Usually, on a telephone call, a fraudster spits out lucrative information about a stock to a customer and pretends to have made a wrong call instead. This generally leaves the customer baffled and somewhat lured for the stock.

Noticeably, these practices have been a subject of cinema in a few instances. ‘The Wolf of Wall Street’ and ‘Boiler Room’ are two such movies where strong references to this scheme can be found. In the latter, dishonest firms practiced selling penny stocks to customers by cold calling.

In this figure, it is evident that the stock price is being pumped to $15 from a modest $5. As soon as illicit profits are made, stocks are dumped back thus causing a decline and sometimes even below the pre-pump level.

Examples of How Pump and Dump Work?

Below are the examples of a pump and dump scheme.

Pump and Dump Example #1

A former CEO of Jammin’ Java, a US company, was charged by the SEC for involvement in pump and dump practice where he had illicitly earned over US$ 75 million of profits. The CEO, then, engaged in fraudulent stock offerings and promotional campaigns in order to get a hike in the stock price. He not only ran a fraud campaign but also misused his previous position. SEC noticed that the management of Jammin’ Java realized the deceit when it observed a fall in stock prices a few days later. By this time the dumping of the already inflated stocks had taken place and huge profits were made.

Such frauds come up with different schemes every time. The one mentioned in the example above came through a ‘reverse merger’ scheme. However, the underlying principle is the same every time – inflate stock prices fraudulently to gain profits.

Remarkable is the fact that such practices also aim at manipulating stock prices by taking the volume advantage. The investing party, through a reverse merger scheme, bought about 45 million shares of Jammin’ Java company before promoting it falsely.

Pump and Dump Example #2

Another significant instance of a pump and dump scheme happened way back in the early 2000s. In the dot com era, internet services for message boards were being used extensively. In one such case, Jonathan Lebed bought penny stocks and took help of online message boards to promote these stocks. Lebed did this till the point the stock inflated so much so that he could make huge profits. Lebed made profits only to cheat the other investors. When SEC took notice of these activities, it charged Lebed of manipulating securities.

Such cases helped SEC strengthen regulations related to investing and securities while also making general investors beware of such activities.

Points to Note

  • Pump and dump stocks is an illegal activity and the consequences of such practices can be very ghastly.
  • The party or parties practicing such schemes might pocket profits for shorter periods of time.
  • No sooner than stock price turbulence comes in the notice of the concerned management, the scam alert is issued, and recovery processes are begun.

How to avoid being a victim?

Securities and Exchange Commission has issued certain tips for a general investor to practice caution while dealing with investing and trading securities:

  • Investors should carry out their own analyses during the process of investing. They can also hire/take help of a financial planner, institutions, etc.
  • Fake calls regarding investments can be identified by their sheer emphasis on big returns and zero or fewer risk offerings.
  • Investors should always consider tracing the source from where the “hot tips” are offered. More often than not it leads to getting closer to authentic information.
  • Most of these practices target small or mid-sized company stocks. Another target is the stocks trading in over-the-counter markets. This presents to investors a greater risk of being cheated; however, thorough research can mitigate the probability of risk.
  • Always read and/or back up any investment decision by official reports issued by companies. The SEC filings like the 10K and the 10Q are common sources of getting the authentic information.

Conclusion

Pump and dump schemes can always be found in the markets in some ways or the other. In the past, it used to take the form of cold calling; in the era of technology, these schemes are based on emails, internet fake news, etc. Fraudsters will more likely target penny stocks and plot schemes in the OTC markets because they are less regulated. Such scams are very prevalent and can amount to over 15% of all the email advertisement on stocks.

Pump and dump sometimes become difficult to trace in comparison to other fraud schemes where there is a fraudster-victim contact in some form or the other. With regard to regulations, US regulators, including SEC, have tightened laws governing trade activities for penny stocks. However, it remains vital to good investing practices that an informed decision is made by conducting thorough analyses on the stock in consideration.

This has been a guide to what is a pump & dump stocks and its meaning. Here we discuss how these types of pump and dump scheme work along with examples and explanations. You can learn more from the following articles –

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