Pump-And-Dump Scam - Meaning, Mode, Method and Example
Meaning, Example, Process, Communication Channel, How to identify & Bottomline
In the last few months, you must have read media reports about how some operators rigged share prices of companies like Salasar Techno, Tayo Rolls, etc. The objective of these operators was to buy shares of these companies at low prices, spread fake positive news about the company to increase their share price artificially, and then dump the shares for a profit. In the process, gullible investors lost their hard-earned money in these stocks. This is how a typical pump-and-dump stock scam works.
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What Is The Pump And Dump Scam?
A pump-and-dump is a manipulative scheme with two parts. The pump part involves artificially inflating the stock price through false and misleading recommendations. The dump part involves selling or dumping the shares at an inflated price. Let’s understand with an example.
Example Of Pump And Dump Scam
Say, an operator holds 50,000 shares in a company at Rs 10 per share. He decides to run a pump-and-dump scheme.
Step 1: He will start spreading fake news about the company. For example, he will say that the company will get a USD 100 million contract next week or that an industry leader will acquire it. All this news may not be true. But his idea is to hype the interest in the stock. As the word spreads, more people will start buying the company shares. Slowly, the share price will go up by 20, 30, 50, or even 100% in a short period.
Step 2: When the stock price has risen considerably, say, to Rs 22, he will offload the shares at the inflated price. He will make a substantial profit in the process.
Holding 50,000 shares at Rs 10 - Rs 5 lakh
Sold 50,000 shares at Rs 22 - Rs 11 lakh
Profit from pump and dump scam - Rs 6 lakh
The practice of pumping and dumping shares is illegal. But, due to people’s greed to make quick money, such schemes continue to flourish. A select few make money at the expense of the ignorant majority. It’s typically done using penny stocks, which have low trade volumes.
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Why Do Operators Target Small Companies For Pump-And-Dump Schemes?
Operators target small and micro-cap stocks. That is because it’s a lot easier to manipulate these companies for the following reasons:
Their trading volumes are low
There is limited corporate information available to the public
Typically few research analysts would be tracking such companies or publishing elaborate reports
Once operators select the stock, they start sending out recommendations, positive news, and other communications to jack up the price. Let’s understand how it is done.
Communication Channels Used For Pump And Dump Schemes
Fraudsters traditionally conducted pump-and-dump schemes through cold calling. If you have seen the movie “The Wolf of Wall Street” and those infamous pink sheets, you know what we are talking about.
A primitive but effective technique involves a fraudster accidentally leaving a message on the victim’s answering machine. The message says that some stock will double over a few weeks. We all know there is nothing accidental about the message. But, since the victim has no idea about the trap, they will buy the stock assuming that lady luck has finally shined on them. Unfortunately, they will realize that they are victims of a scam and will lose their invested amounts.
Over time, call centers and boiler room operations have given way to more technology-oriented communication modes. These days, scammers do the following:
Send millions of emails and SMSes
Conduct webinars and have dedicated YouTube channels
Make the most of social media by using Twitter, WhatsApp, Telegram, and newsletters
Let’s look at the case of Salasar Techno Engineering Limited and how operators manipulated its share price.
Salasar Techno Scrip: How Operators Used It For Pump And Dump Scam
Recently, newspapers carried reports about how the prices of Salasar Techno Engineering Limited shares were rigged. It is a construction and engineering company with a high promoter holding. It is a micro-cap company with a market capitalization of Rs. 700 crores. The company has a proper operating business. And there was no reason to suspect anything hanky-panky going on with the company.
But, on 7th and 8th March, suddenly many Twitter handles started talking about some really good things about this company. Some handles said it will benefit from 5G services that will be rolled out soon. Some said it’s good for investment on technical parameters. And some predicted it will be the best stock for 2022.
The sudden and unexpected flare-up in interest raised red flags. One or more digital marketing companies had reached out to these Twitter influencers and paid them money to promote the Salasar Techno stock.
They reached out to Mr. Shravan Venkataraman (@theBuoyantMan) also for a promotional tweet. The digital marketing agency asked Mr. Shravan to tweet good things about Salasar Techno and predict that the share price would cross Rs. 500 by the end of this year. They also asked him to give his best quote for posting the promotional tweet. But he denied it. And on 7th March 2022, he posted a tweet about this to caution Salasar Techno retail shareholders.
Some reports suggest that the digital marketing agency was offering Rs. 25,000-30,000 for this sponsored tweet. Who appointed the digital marketing company to promote the Salasar Techno share price is not clear. However, the pump-up trick worked. And the Salasar Techno share price went up 10% over two trading sessions.
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What Is SEBI Doing To Address The Pump And Dump Scams?
The capital market regulator SEBI’s (Securities and Exchange Board of India) primary objective is to prevent market manipulation. SEBI uses a three-pronged approach to handle the pump-and-dump menace.
1. Surveillance
SEBI is keeping a close watch on the financial results of companies. It has a separate vigilance cell called the corporate Finance Investigation Department. SEBI has also invested in a Data Warehousing and Business Intelligence System, which uses pattern recognition algorithms to identify violations, including pump-and-dump schemes.
2. Prevention
As part of the prevention strategy, SEBI has actively intervened in ways that we never thought possible. For instance, scammers widely use SMS. That is because SMS is one of the easiest and most commonly used mediums for transmitting stock tips. SEBI asked the Telecom Regulatory Authority of India (TRAI) to create special software to stop this nuisance. The software can identify specific keywords that pump and dump operators use and block those messages.
3. Education
SEBI has a no-nonsense approach toward the pump-and-dump scams. A recent example of this is when it asked Patanjali management to publish advertisements in national newspapers, discrediting an SMS floating around during the Ruchi Soya Follow-On Public Offer (FPO).
The SMS aimed to excite the retail investors to subscribe to the Ruchi Soya (FPO) by emphasizing the potential 30% discount on the issue price compared to the market price. Apart from newspaper advertisements, SEBI also mandated Patanjali to offer investors a window to cancel their FPO bids. It was the first time SEBI took this step.
How To Identify Pump And Dump Schemes?
You can follow the 4-step procedure to identify pump and dump schemes.
Step 1: Be Highly Suspicious Of Unsolicited Investment Offers
Today’s investment pitches are just a comment, tweet, email, or WhatsApp message away. More often than not, the source of the message is unclear. Hence as a rule, always ignore all such messages. The word “all” has been used quite deliberately here. Because, even if the source is known to you, they might be just reacting to a promotional message they received like what we saw with Salasar Techno.
Step 2: Look Out For Obvious Red Flags
Some of the red flags include:
Promises of very high investment returns
Cases where pressure is being exerted as a limited opportunity
Any claims being made that the recommendation is based on insider or confidential information
Step 3: Look Out For Promotional Stuff
Many content creators on YouTube, Twitter, Instagram, etc., have some influence over their viewers and followers. When these content creators talk about or promote a particular stock or cryptocurrency, as an investor, it is in your interest that you pay special attention to the disclosures.
There are three kinds of disclosures made in these content materials:
No Disclosure: There is no disclosure which is something that you should be highly suspicious of and should not pay any heed to the creator’s content.
Vague Disclosure: In this case, the content creator doesn’t specify if anyone has paid them or not for this piece of content.
Buried Disclosures: These are buried in hard-to-read prints. It would be mentioned that they may receive compensation from companies that they have written about.
Every company has these terms, conditions, and asterisks. Since your money is on the line, you must approach every piece of advice on these content platforms with extra care and caution.
Step 4: Conduct Your Research And Due Diligence Before Investing
You should conduct your research and due diligence before investing as an investor. If you are too busy or don’t have the research skills, you can invest through a mutual fund or an intelligent investing service like ET Money Genius.
There have been many instances where average investors have used below-average skills to invest in instruments that come with above-average risk.
For example, Tayo Rolls, a Tata Steel subsidiary, is in the business of manufacturing ingots, forged rolls, and pig iron. In the last year, this company’s share price has gone up from Rs 40 to Rs 124, a 200% growth. But what might come as a shock is that Tayo Rolls has not posted any revenue for the last four years.
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Bottomline
There ain’t no such thing as a free lunch. This popular adage communicates the idea that it is impossible to get something for nothing. If you remember this as an investor, you can easily avoid pump and dump or any such manipulative schemes.