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Stock Tip Scams: Pump and Dump

By: Chris Nickson - Updated: 7 Nov 2012 | comments*Discuss
 
Pump And Dump Answerphone Scam Fax Scam

You can make a lot of money on the stock market. But you can also lose a lot. It's a field that demands a lot of knowledge to play well and one that leaves itself open to unscrupulous wheeling and dealing. The Internet age has seen a number of stock tip scams, one of the biggest an update on an old favourite - pump and dump. The scam was at the heart of the movie Boiler Room and featured in episodes of The Sopranos. Pump and dump spam e-mails are increasing at the staggering rate of ten per cent each month. It's a crime that's continuing to grow rapidly.

How They Work

Pump and dump is a classic stock tip fraud. A company's web site suddenly begins talking about its glowing financial health, or it might be offering a new product or improvement to an existing product. Supposedly unbiased newsletters start praising the company's stock as hot. That might also be echoed on bulletin boards and in chat rooms.

Almost invariably, the people behind the fraud will choose a small company that hasn't been traded much. The reason for that is that there will be little information on the company, sometimes even none, making customers buy on faith rather than history. These small companies tend to be not very liquid, so the share price will increase sharply with trading volume.

As the stock is hyped, customers begin buying the shares, pumping up the price. When it's high enough, those behind the scam sell their shares, stop praising it, and the price plummets. Honest people who've invested their money are left with worthless stock.

A common variation used in the U.S. is a fake "wrong number" answerphone message or fax touting the stock, making the recipient feel they have an inside tip.

How To Make Sure You're Not A Victim

The simplest way is not to become involved. Delete the e-mail without even reading it. However, if you wish to investigate further, take these steps:
  • Before you invest any money in any stock, do your homework. The best stance is to be sceptical and assume that any hot tip is a scam until proved otherwise. The people promoting the stock probably either work for the company or are being well paid for their work.
  • A company can claim its stock is traded, and it's obviously true for them to be legally selling shares. But where exactly are these shares being traded? Is it on the Stock Exchange or the New York Stock Exchange? The chances are that it's not, as requirements for those are very stringent. Instead it's probably what's called an OTC, or over the counter, stock. That means they're traded via a dealer network rather than an exchange. Historically, those are much riskier and more open to stock manipulation.
  • Never believe a claim unless you can verify it independently. Any company can make a claim. Before you part with your money, make sure it's true.
  • Do your research. Before you buy and stock, inspect the company's current financial statements and their prospectus. If they're not willing to make those available, don't do business with them.
  • Beware of high-pressure sales tactics. The stock may be a once in a lifetime opportunity, but don't allow yourself to be bullied into buying it.

What To Do If You're Scammed

Inform the police. That's your first step, getting a crime reference number. After that, get in touch with the Financial Services Authority (FSA). They, too, can investigate the scam. They also have enforcement powers that can hopefully help bring the perpetrators to justice.

These days the slam is very slick, making it much harder to catch the criminals. That makes the chances of recovering your money and prosecuting the guilty more difficult.

Please, always remember that if it seems too good to be true, then it probably is.

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