The financial fraud known as pump and dump involves artificially inflating the price of a stock or other security through promotion, in order to sell at the inflated price. This practice is illegal under securities law, yet it is particularly common. While fraudsters in the past relied on cold calls, the emergence of the Internet offered a cheaper and easier way of reaching large numbers of potential investors.

Here's how it works: A company's web site may feature a glowing press release about its financial health or some new product or innovation. Newsletters that purport to offer unbiased recommendations may suddenly tout the company as the latest "hot" stock. Messages in chat rooms and bulletin board postings -- or, more often, spam -- may urge readers to buy the stock quickly.

Unwitting investors purchase the stock in droves, creating high demand and pumping up the price. But when the persons behind the scheme sell their shares at the peak and stop promoting the stock, the price plummets, and investors lose their money.

Fraudsters frequently use this ploy with small, thinly traded companies -- known as "penny stocks," and generally traded on the over-the-counter bulletin boards, rather than on the larger exchanges like the NYSE or Nasdaq -- because it's easier to manipulate a stock when there's little or no information available about the company. [1]

One example of a highly successful pump-and-dump operator is Jonathan Lebed. Lebed was 15 years old when the SEC accused him of manipulating several securities -- he settled the charges by paying a fraction of his total gains. While Lebed has many apologists, who note that his promotional activities are similar to those used by analysts every day, they fail to take into account that he not only made false and misleading statements about companies, but purchased enough shares to temporarily move the market (creating an artificial burst of activity that provoked investor interest).[2]

In fiction

A good example of how this works can be seen in the movie Boiler Room.

Sources

Elements of this page are taken from publications of the United States Securities and Exchange Commission and are not subject to copyright.