What is a pump-and-dump scheme?
Fake news is a constant hazard in today’s fast-paced digital landscape. The stock market isn’t immune. Take pump-and-dump schemes as an example.
Pump-and-dump schemes are a type of securities fraud where fraudsters artificially boost the price of an asset (the “pump”) by spreading false information about its potential, then sell the shares they own at the newly inflated price (the “dump”).
But pump-and-dump schemes weren’t born with the dawn of social media and online trading. They’re a basic type of investment fraud, one that was common from the 1970s-1990s with penny stocks and “boiler rooms.” Working from cramped offices, salespeople would cold-call investors and use phony claims to push them to buy penny stocks. (If you’re picturing The Wolf of Wall Street — that’s exactly it.)
Fast-forward to today, and pump-and-dump schemes have evolved with the times. Instead of cold calls, fraudsters now use social media, online forums, and chat groups to stir up hype around everything from traditional stocks to meme stocks to crypto tokens. Same kind of scheme, but on a bigger, faster-moving scale.
How do pump-and-dump schemes work
First, there’s the “pump” phase:
The organizer(s) will pick an asset to pump up. It could be a little-known stock that doesn’t see much trading activity, or something more obscure, like a penny stock or new crypto coin.
Usually working in a coordinated group, they start spreading misleading or widely exaggerated claims about the asset (e.g., “I have intel from a trusted source that a major tech company is about to acquire this startup. The time to get in is now!”).
To build hype, they spread those claims through social media, online forums, and other means. They buy up large quantities of the asset themselves to create the illusion of demand.
That buzz draws in ordinary, unsuspecting investors, who rush to get in while they think the getting’s good. That rush drives the price of the asset up.
Once the price is artificially high, the “dump” phase of the scheme begins:
The organizers sell their holdings at a much higher price than what they bought it for, realizing significant — but fraudulent — gains.
The price of the asset collapses after the sell-off frenzy, and ordinary investors are left with significant losses.
Signs of a pump-and-dump scheme
It can be easy to fall for a pump-and-dump scheme if you don’t know the warning signs. Here are the red flags to watch for:
Social media investment tips. Whether sent to you or if it comes across a feed — investment tips sent via social media, text, or email that urge you to buy a hot stock or token deserve your skepticism. If they come with pressure to act fast, or if you see the same tips in different places, you can assume it’s a scam. Be wary of tips that may seem genuine in spite of these red flags: “expert investors” will often give you real assets to invest in to gain your trust, and then add their pump-and-dump stock.
Limited company information. If the business behind the asset lacks a track record, reliable financial information, or is otherwise hard to dig up legitimate information on, you should be wary.
Lofty claims. Big tech companies almost never acquire startups for billions of dollars, and two-week-old cryptocurrencies don’t typically become a global payment standard. If a claim seems too wild to be true, it probably is.
Promises of guaranteed returns. If someone says returns are guaranteed and the investment is fail-safe, run. No genuine investment can guarantee profits (in Canada it’s actually illegal).
Unusual trading spikes or price hikes. When you notice an unfamiliar or lesser-known asset is suddenly gaining in price or trading volume, look for trusted sources of news or real market fundamentals that can explain why.
Protecting yourself from a pump-and-dump scheme
Knowing the warning signs is the first step in steering clear of pump-and-dump schemes. Here’s what else you can do to protect yourself:
Be skeptical. A healthy dose of skepticism is a must for any savvy investor. No legitimate financial advisor will contact you through social media. Remember that real investments always come with risk (nothing is a guaranteed payday) and take the time to analyze any recommendation you might receive.
Do your research before investing. Look into the company. Dig into its leadership, performance record, financials, and reputation.
Cross-check information. Verify any urgent “buy this, now” recommendations by checking multiple sources. Trusted financial news, regulatory filings, and expert investors can help confirm or deny the hype you’re hearing. To verify whether someone is a legitimate financial advisor, you can use the Canadian Securities Administrators’ National Registration Search to check whether they’re registered to do business in their province or territory. Scammers will often pretend to be legitimate advisors on social media. You can also look them up in the CIRO (Canadian Investment Regulatory Organization) directory and AdvisorReport. While there are some exceptions to who must be registered and regulated with these organizations, it’s a strong red flag if you can’t find them when searching.
Report suspicious activity. Help protect other investors. If all signs point to a pump-and-dump, report the fraud to your local police department.
In summary
While the promise of insider info and quick gains can be tempting, recognizing red flags and verifying information are key to avoiding pump-and-dump schemes. Staying cautious is always a good thing when it comes to investing; it’ll help you avoid being left with losses when hype fades.
