Legal Definitions - Investor Protection Guide: Micro-cap Stock Fraud ("Pump and Dump")

A "Pump and Dump" scheme is a type of financial fraud where individuals or groups manipulate the price of a stock, typically a small, lesser-known company, by spreading false or misleading information. The goal is to artificially inflate the stock's price (the "pump") and then sell their own shares at a profit (the "dump") before the price inevitably collapses, leaving other investors with significant losses.

These schemes often target micro-cap stocks, which are shares of very small companies with low market capitalization and limited assets. These stocks are particularly vulnerable because they often lack reliable public information, have a short operational history, and may trade on less regulated markets, making them easier to manipulate.

The process usually involves fraudsters first acquiring a substantial amount of shares in a micro-cap company. They then launch an aggressive promotional campaign, often using unsolicited emails, social media posts, online forums, or fake news articles, to spread exaggerated or entirely fabricated claims about the company's prospects. These claims might include breakthroughs in technology, lucrative new contracts, or imminent regulatory approvals. As unsuspecting investors buy into the hype, the stock price rises. Once the price reaches an artificially high level, the fraudsters "dump" their shares, selling them off quickly. This sudden selling causes the stock price to plummet, and the investors who bought into the inflated stock are left with shares that are now worth very little.

Examples of "Pump and Dump" Schemes:

• Fictional AI Breakthrough:

  Imagine a group of fraudsters secretly buys a large block of shares in a tiny, obscure tech company called "Quantum Leap Innovations." They then launch an aggressive online campaign, posting on investment forums, sending out mass emails, and even creating fake news articles claiming that Quantum Leap has developed a revolutionary artificial intelligence algorithm capable of predicting stock market movements with 99% accuracy. They highlight fabricated testimonials from "early investors" who supposedly made fortunes. As retail investors, excited by the prospect of guaranteed returns, rush to buy Quantum Leap stock, its price skyrockets from pennies to several dollars per share. Once the price is sufficiently inflated, the fraudsters quietly sell all their shares, making millions. Within days, the stock price crashes back down as the hype dissipates and the claims are revealed to be baseless, leaving the late-buying investors with worthless stock.

  How it illustrates the term: The fraudsters "pumped" the stock by spreading false information about a revolutionary AI algorithm to create artificial demand and drive up the price. They then "dumped" their shares, selling them at the inflated price, before the market realized the deception, causing the stock to collapse and harming other investors.

• Exaggerated Natural Resource Discovery:

  Consider a scenario where promoters acquire significant shares in a struggling mining company, "Gold Rush Explorers," which owns a few undeveloped land parcels. They then disseminate a series of highly sensationalized press releases and social media posts, claiming that geological surveys have confirmed the discovery of an enormous, previously unknown deposit of rare earth minerals on Gold Rush Explorers' land. They project that this discovery will make the company a global leader in critical mineral supply. This news, amplified by online influencers paid by the fraudsters, generates immense excitement among investors, causing the stock price to surge dramatically. As the stock reaches its peak, the promoters systematically sell off their holdings, securing substantial profits. Shortly after, independent geological reports emerge, debunking the claims and revealing the mineral deposits to be insignificant, leading to a rapid and devastating drop in Gold Rush Explorers' stock price.

  How it illustrates the term: The "pump" involved creating a false narrative about a massive rare earth mineral discovery to entice investors and inflate the stock price. The "dump" occurred when the promoters sold their shares at this artificially high price, profiting while leaving other investors to suffer losses when the truth about the exaggerated discovery came to light.