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How does a ‘pump and dump’ stock fraud scheme work?

On Behalf of | Jun 7, 2022 | Securities Fraud |

Every investor is looking for an edge. Usually, the edge they seek is legitimate. Investors are allowed to research companies using publicly available information such as annual reports, assessments by experts and other relevant information in order to develop an educated opinion about a particular stock.

That’s not all that goes into the assessment of whether to buy a certain stock, however. Investors also consider any market conditions that could affect that stock. This assessment often includes information from the media and even the gossip on social media. Is there buzz around a particular company that might drive the stock price up? What are people in the know saying?

You know you can’t use confidential insider information to trade stock, but you’re absolutely allowed to consider public information, opinions and the like.

The pump

Unfortunately, some of that buzz may be manufactured. Companies often spread the good word in order to impress investors and drive their share prices up. This can be perfectly legal – or it may be fraud if the information is false or misleading.

Companies and other actors sometimes flood the media – and social media – with rosy projections about a particular stock. They often make it sound like they are offering insider information, or the closest thing to it. They may give the impression the information is limited to a select few, or that the average investor wouldn’t understand the relevance of the information. They encourage people to feel astute.

In an artificial pump, there is almost always pressure to buy quickly in order to get the greatest benefit. This time pressure is a red flag.

The dump

What’s going on is that the party trying to pump up the share price already owns stock in the company – and they’re looking to sell. As soon as they believe the scam is played out, they will dump their shares onto the open market and make a killing.

Of course, all that stock being dumped onto the market will drive prices down. The investors who felt so astute are now stuck with the devalued stock.

Investors should ideally avoid red flags in the first place, but that isn’t always possible. If you have received false or misleading information from a particular company or other actor that led you to invest in a particular stock, you may be the victim of stock fraud.

If you can identify the party who committed the fraud, you may be able to get your money back by making a legal claim through the Financial Industry Regulatory Authority (FINRA).

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