By Taylor Bandy
Historically, pump-and-dump schemes occurred when brokerage firms holding a large volume of stocks in a company would incentivize brokers to cold-call customers and pitch penny stocks in the company. The large number of stock sales would greatly increase the share price, then the brokerage firm would dump the stock. As a result, the firm would profit while the investors were left with low priced stock they could not sell.
Unfortunately, the Internet has allowed these scams to expand in scope and occur at a faster pace. Last week the Securities and Exchange Commission (SEC) issued a press release charging ten individuals, including Phillip Frost, a University of Miami Trustee, and ten entities for unlawfully generating $27 million from pump-and-dump schemes. The SEC alleges the individuals purchased large portions of small companies’ microcap stock. Then, they spread false or misleading information while participating in manipulative trading to pump up the share price before dumping the stock.
Now, pump-and-dump schemes are spreading to cryptocurrency markets. These scams are growing in popularity as a result of groups where anonymous members pay from $50 to $250 a month for access to chat room groups. The group monitor decides the date, time, exchange, and coin to be purchased. The coin will be pumped up and sold minutes later. Even the participants of the pump can fall victim to the scam if they do not sell their tokens quickly before the token price plummets. The SEC and the Commodity Futures Trading Commission (CFTC) have issued warnings, even though they do not regulate cryptocurrencies. The SEC warns crypto investors to not purchase tokens or coins based on sudden price increases or information gained from social media.
The Financial Industry Regulatory Authority (FINRA) has issued tips for investors on how to avoid falling victims to pump-and-dump scams:
- Examine the source of your information. Investors should be wary of press releases, newsletters, blogs, and spam emails, as they could contain false information. Use caution if these materials mention the benefits but not the risks of the investment.
- Research the company and its officers. Exercise caution if there are indictments, convictions, or previous charges filed by the SEC against any officials.
- Determine if it involves a reverse merger. The SEC has warned many of these companies fail.
- Learn where the stock trades. The majority of these schemes occur with penny or microcap stocks that are not traded on the NASDAQ or New York Stock Exchange. Instead, they are listed on an over-the-counter quotation platform.
- Check the SEC’s EDGAR database to determine if the company files with the SEC. If so, compare the report information with the company’s newsletter, blog posts, and website to ensure the information is accurate.
As the debate over whether the SEC can regulate cryptocurrencies continues, the increase in pump-and-dump scams in crytpocurrencies markets may spur regulatory enforcement. Until then, investors should exercise caution when purchasing penny stocks, microcap stocks, or cryptocurrencies, as these risky investments are subject to pump-and-dump schemes.