Who Really Gets Duped by Stock Pump and Dump Scams?

Stock Pump and Dump scams currently account for about 20% of the spam email that we see in the MX Logic Threat Center. Most of it is image based (spam that consists mostly of a single image as the advertisement instead of plain text or using HTML tricks to piece text together).

How does a "pump and dump" scam work?

Typically, a stock is chosen (in many cases an over the counter stock) which is trading for only a few pennies. This way the scammer can purchase many shares of the targetted stock with only a small investment. These stocks typically also trade in low volumes such that easy manipulation of the stock price is possible.

This is where the scam begins.

Once the scammer has purchased some of the target company's stock, they can slowly manipulate the price based on the amount that they purchase. They then send out blast spam emails claiming the stock is "ready to explode" or "will gain 400% over the next two weeks" in an effort to lure potential victims. This is the "pump" and this cycle may repeat several times until the scammer is satisfied with their return at which point they "dump" their holdings and the stock price plummets leaving his victims holding the bag. On average the pump and dump scammer makes about 5.75% per scam and the victims lose about 5.5%.

There are several other scenarios to the pump and dump scam, but this is the most common and easiest to explain.

The other innocent victim aside from the people who thought they were going to make a great deal on this stock tip they got is the company who was targetted. In many cases the company has no idea that they were targetted for a pump and dump scam and also in some cases the stock price after the scam ends up lower than it was before the scam.

So, what is being done about this? The SEC is in the process of examining brokerage firms to ensure that they have adequate technology and staff training to prevent fraud, but in many cases by the time the fraud is detected it is too late. Fraud cost brokerage firm E*Trade approximately $18M in the third quarter of 2006 alone!

Obviously, there is still a lot more to be done. Few lawsuits have actually been filed to date. This is largely because scammers have gotten so good at staying hidden that it is difficult to track them down. Although some have been prosecuted, it is still barely making a dent in the overall fraud economy.

The key takeaway from all of this is to never take investment advice from anonymous or unsolicited email. Do your own research and ignore the noise of "Get Rich Quick" schemes. As the addage goes, "If it sounds too good to be true, it probably is."