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The financial fraud known as pump and dump (aka "Stock 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 what will soon become the peak) and stop promoting the stock, the price plummets, and other 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 New York Stock Exchange or NASDAQ -- because it's easier to manipulate a stock when there's little or no information available about the company. The same principle applies to the London Stock Exchange, where target companies are typically small companies quoted on AIM or OFEX.

During the dot-com era, when stock market fever was at its height and many people spent significant amounts of time on stock bulletin boards, 15-year-old Jonathan Lebed showed how easy it was to use the Internet to run a successful pump-and-dump. Lebed bought penny stocks and then promoted them on message boards, pointing at the price increase. When other investors bought the stock, Lebed sold his for a profit, leaving the other investors holding the bag. He came to the attention of the U.S. Securities and Exchange Commission (SEC), which filed a civil suit against him alleging security manipulation. As is commonly the case in SEC actions, Lebed settled the charges by paying a fraction of his total gains. He neither admitted nor denied wrongdoing, but promised not to manipulate securities in the future.

Reaction to the incident was mixed. Some defended Lebed as not having done anything wrong; some criticized the SEC for going after a small-time incident when there were bigger ones ongoing; some were appalled that he was allowed to keep most of his ill-gotten gains; some claimed he was just a symptom of a corrupt system (pointing out his activities' similarity to the activities of stock analysts at investment banking firms). It was clear, though, that Lebed had both made false and misleading statements about companies, and purchased enough shares to temporarily move the market (creating an artificial burst of activity that provoked investor interest). This combination is apparently unforgivable.

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 SEC and are not subject to copyright.

• Financial regulation
• Fraud