Fundamentals of Pump-and-Dump
The standard pump-and-dump scheme may be the most well-known form of market manipulation; slightly less prominent is its opposite, the “poop and scoop” or “trash and cash.” Pushed into the modern psyche by movies like “The Wolf of Wall Street” and further popularized by its prevalence in crypto markets, today’s pump-and-dump scheme has now been turbocharged by social media’s predominance in contemporary life. In this analysis, we’ll walk through the modern pump-and-dump scheme, how social media has transformed it, and the even more significant changes coming around the corner.
The fundamentals of a pump-and-dump scheme involve a person or group with an existing position in an asset inflating the price through methods such as intensive promotion, misleading statements, and aggressive trading. Once the price is inflated, they sell (dump) their position for a profit. Over time, we’ve seen improvements in the pump and dump phases. In the dump phase, for example, manipulators use techniques to take profits in separate but economically related instruments to obfuscate their involvement. However, it is in the pump phase that we have seen the most development.
Historically, the pump phase has been performed through techniques like the boiler room. Not just limited to pump-and-dump schemes, a boiler room is a call center where salespeople call large lists of individuals and use high-pressure techniques to sell or promote certain stocks. At the same time, the manipulator may be aggressively buying themselves to push up the asset’s price. A recent case involving a call center based in Medellin, Colombia, shows the basic scheme is alive and effective; however, by leveraging social media and new technology, manipulators are no longer constrained by staffing.
Social Media’s Impact
The impact of social media on the financial landscape has been substantial, and that impact has not been limited to only retail actors. The Hong Kong Securities and Futures Commission (SFC) reported that in 2021, 49% of stock investors obtained information on stock investments through social media. Approximately 20% of their open investigations in 2020 were pump-and-dump social media scams. A 2022 Australian Securities and Investments Commission (ASIC) report found that 38% of investors took their primary source of investing information from social media platforms such as YouTube, Facebook, Reddit, and TikTok. Interestingly, YouTube was the most popular of the platforms. The United Kingdom’s Financial Conduct Authority (FCA) found that in 2022, 18% of investors used social media in their investment research. However, that skews to 51% for the 25-34 age group.
We have also seen phenomena such as the meme stock, best exemplified through the GameStop surge in 2021, demonstrate the incredible market-moving forces that social media can generate. This phenomenon is not unique to the United States; for example, Windeln.de, a German diaper company, experienced wild social media-fueled price swings due to information shared across the Reddit network. Concurrent with meme stocks, we have also witnessed the rise of the “finfluencer,” a person who uses social media to provide information and advice on various financial topics and can ultimately influence financial decision-making. A study published by the Dutch Authority for the Financial Markets (AFM) summarizes the risks and conflicts of interest that finfluencers represent, including recommending risky products and providing investment advice without proper licensure. These factors have created a breeding ground for new social media schemes.
Sadhna Stock Manipulation Case
India’s Securities and Exchange Board (SEBI) investigation revealed a case that mixed all these ingredients. It is important to note that the investigation is ongoing, and this information is taken from SEBI’s interim orders. Sadhna, a media company based in New Delhi, experienced a sudden rise in its share price in 2022. SEBI alleges that a group of individuals, which will be referred to as “promoters,” and which included people in senior management roles, existing ownership stakes in the company, and those with direct relationships such as family members, executed a significant portion of the trade volume from April to July 2022, a period where the stock saw a significant price increase. The promoters also traded among themselves, creating the impression of a price increase and healthy overall activity in a very illiquid stock historically. On top of this, one of the promoters in this preparatory phase was a dealer at a registered stockbroker. So far, this is a standard start to a pump-and-dump scheme.
Then, in late July 2022, a YouTube finfluencer put out a series of videos aggressively promoting the stock with what are now known to be false and misleading statements. The videos stated that the company would be acquired, and they were about to sign a big contract with an American corporation. Through some digital sleuthing, SEBI found that the finfluencer paid Google AdSense half a million USD in 2022 to promote their YouTube channels, of which US$78,000 was paid when the videos were coming out. This helped boost their following, and the five videos promoting the stock got over 30 million views -- far more people than a boiler room would ever be able to reach.
At the same time, the finfluencer was promoting the stock they were selling, and during that period, the promoters also heavily sold down their existing positions. Overall, the influx of new investors didn’t heavily push up the price but instead brought in volume, allowing the promoters to exit. The alleged profits from the scheme were estimated to be US$5 million, almost all of which went to the promoters and their network rather than to the finfluencer. Interestingly, SEBI noted that many of the same individuals were involved in a similar case involving Sharpline Broadcast, demonstrating that these types of schemes can be rewrapped and repeated.
A $114 Million Scam
There have been similar cases in the United States, the most notable being a US$114 million plot involving eight men charged with committing securities fraud through a social-media-based pump-and-dump scheme. The men sold themselves as stock-picking gurus and publicized their lavish lifestyles on social media. It is not often that one sees a U.S. Securities and Exchange Commission (SEC) litigation filing including pictures of Lamborghinis and Ferraris and the phrase “treat yo self.” Through platforms such as Twitter and Discord, as well as podcasts, the fraudsters encouraged their followers to buy stocks in which they had already acquired large positions. They would tweet messages such as, “I don’t dump on anyone ... I have diamond hands,” while dumping their existing positions into the demand their promotions generated. Since many of the group’s internal Discord chats were unknowingly recorded, the case gives a rare insight into the mind of a pump-and-dump stock manipulator. The degree of disdain they had for their victims, along with the self-awareness that what they were doing was illegal and they would very likely get caught, was shocking.
While this particular case occurred in the U.S., the issue is clearly one regulators globally contend with; the European Securities and Markets Authority (ESMA) earlier this month issued a warning for people posting investment recommendations on social media to raise awareness around established Market Abuse Regulation (MAR) requirements including a reminder to users that even if non-technical language is being used – it may still be considered an investment recommendation.
The Dump Phase
The two cases mentioned give a peek into the innovation we are seeing during the pump phase of the scheme. However, some schemes focus more on the dump phase. For example, in 2023, the FBI and FINRA warned of the “pig-butchering” scam. You may have received one of these scam messages yourself, which appears as if it was sent to the wrong number. Contacting many people, seemingly at random, scammers use messaging or dating apps to attempt to build rapport with their victims over extended periods. In its pump-and-dump form, the scammer herds their victims into the dump phase, advising them to purchase certain illiquid stocks or crypto assets in which the scammer has an existing position. In a similar contrivance, in 2023, SEBI shut down a bulk SMS pump-and-dump scheme scam in which the manipulator sent out bulk SMS messages promoting five stocks they had pre-positioned.
An Ever-Evolving Scheme
As technology continues to evolve, so will the pump-and-dump scheme. In the same vein as earlier innovations, new advancements in artificial intelligence could reduce the cost and expand the audience. For example, generative artificial intelligence-powered chatbots could automate pig-butchering scams, while deep-fakes make it easier for unskilled individuals to spread false information. Demography will also play a role; the U.K. FCA report identified that 16% of 55-64-year-olds used social media for investment advice, and that figure shoots to 69% for 18-24-year-olds. As a new generation ages into investing, their habits will mold future schemes. What is certain is that the well-worn pump-and-dump scheme will continue to alter and mutate in the coming years.
Regulatory Updates
19 February: Mantengu Mining warned the public of a potential seven-month downward manipulation of its share prices, which the company believes is a deliberate effort to devalue it and hamper its growth plans. The company has reported this issue to the Jamaica Stock Exchange (JSE) and the Financial Sector Conduct Authority (FSCA) for further investigation.
15 February: The Canadian Securities Administrators (CSA) published their 2023 Annual Report on Capital Markets, highlighting key trends and vulnerabilities in Canadian capital markets. Some risks identified include systemic risk in OTC markets, volatility of crypto assets, the transition to CORRA, and the credit quality of Canadian non-financial corporate bonds.
15 February: The U.K. Government sent letters to a set of regulators, including the U.K. Financial Services Authority (FSA), to update their strategic approach to AI, with the intention of increasing the transparency around how they are implementing the AI Regulation White Paper proposals. The Government asked the regulators to publish an update by 30 April 2024, outlining their strategic approach to AI and the steps they are taking in line with the expectations in the White Paper.
14 February: The South Korean Financial Intelligence Unit (FIU) found instances of potentially illegal activities linked to digital assets rose by 48.8% from the previous year, attributed to the FIU’s active engagement with local cryptocurrency service providers. The FIU is developing a system to suspend suspicious virtual asset transactions and plans to strengthen cooperation with financial institutions and law enforcement. Further information available in Korean only.
13 February: Lyft’s stock experienced a surge and subsequent reversal after a typo in its fourth-quarter earnings report caused an overestimation of its gross margin expansion. The correction led to a gain of around 18% from the day’s close, with Lyft reporting a 17% year-over-year increase in gross bookings and a net loss of $340.3 million for the full year 2023.
8 February: The Federal Court of Appeals for the D.C. Circuit heard arguments that could affect the self-regulatory organization (SRO) model for U.S. securities exchanges. Alpin Securities, which faces expulsion for violating certain rules of the Financial Industry Regulatory Authority (FINRA), states that the regulatory body acts as a governmental entity and violates constitutional provisions that are applicable to it when it takes on an enforcement role.
8 February: The South Korean Financial Services Commission (FSC) announced the enforcement of the Act on the Protection of Virtual Asset Users from July 19, 2024, a law aimed at protecting virtual asset users and maintaining market order. The act largely covers asset protection for virtual asset users, the prohibition of unfair trading activities in the virtual asset market, and the supervisory and sanctioning authority over Virtual Asset Service Providers (VASPs) and related market activities.
8 February: The FCA published an update on its progress in tackling financial crime, which identifies four areas of focus for the coming year: data and technology, collaboration, consumer awareness, and metrics.
7 February: The Commodity Futures Trading Commission’s (CFTC) Office of Customer Education and Outreach (OCEO) issued a customer advisory warning of a scam where fraudsters use dating/messaging apps and social media to offer fraudulent investment advice or ask for financial support. The advisory highlights several warning signs of such scams, which often involve criminals promoting cryptocurrency investments, and suggests steps users can take to protect themselves.
6 February: The European Securities and Markets Authority (ESMA) published a warning to raise awareness of requirements established by the Market Abuse Regulation (MAR), which apply when posting investment recommendations on social media. They are also warning about the risks of market manipulation in such publications.
31 January: The FCA observed potential instances of ‘flying and printing,’ activities that create a false impression of a financial instrument’s liquidity and/or price across several markets, including fixed income, commodities, and currencies. To mitigate the risks and potential harms caused by these activities, firms are advised to enhance compliance, training, surveillance procedures and disciplinary processes, as well as ensure adherence to relevant legislation.
30 January: The World Federation of Exchanges (WFE) announced its priorities for 2024, including the following: fostering better corporate governance in the entire financial ecosystem, the CCP’s reassurance promise, how market infrastructure can lead on ESG issues such as standardization, harmonization and reporting frameworks, WFE education, and new technologies, including the evolution of crypto market design.
23 January: The Hong Kong Monetary Authority (HKMA) issued a public consultation to gather feedback on its proposal to allow Authorized Institutions (AIs) to share customer account information to prevent and detect financial crime. This proposal addresses the increasing global financial crime, especially digital fraud, which threatens public confidence in digital financial services. The HKMA seeks views on legislative amendments to provide legal protection to AIs and safeguards for data privacy and customer confidentiality, aligning with similar developments in other international financial centers.
Enforcement Actions & Fines
The Financial Industry Regulatory Authority (FINRA) fined Morgan Stanley Smith Barney LLC $1.6 million for the firm’s repeated failures to timely close out failed inter-dealer municipal securities transactions and to take prompt steps to obtain physical possession or control of municipal security positions that are short more than 30 calendar days and related supervisory failures. This is the first disciplinary action in which FINRA has charged a firm with violating the close-out requirements of Municipal Securities Rulemaking Board (MSRB) Rule G-12(h) and related supervisory failures.
The FINRA fined Goldman Sachs over $500k for neglecting to include certain securities in nine surveillance reports from February 2009 to April 2023, which were designed to detect potential manipulative trading. This omission resulted in the failure to identify approximately 5,000 alerts for potentially manipulative trading activity.
The Eastern Magistrates’ Court approved an application by the Department of Justice to transfer the first-ever ramp-and-dump case brought by the Securities and Futures Commission (SFC) to the District Court. The two defendants were charged in August 2023 with the offense of conspiracy to employ a scheme with intent to defraud or deceive transactions involving securities.
In a trial at Southwark Crown Court brought by the FCA, a former Goldman Sachs analyst was found guilty of six offenses of insider dealing and three offenses of fraud. The former analyst came into possession of inside information related to potential mergers and acquisitions that his employer was advising on.
The French Energy Regulatory Commission’s (CRE) Dispute Settlement and Sanctions Committee (CoRDiS) fined Engie EUR 500,000. Engie breached the REMIT Regulation by carrying out trading operations based on inside information multiple times and failing to publicly disclose inside information related to the unavailability of their electricity generation facilities.
The FCA, in collaboration with the National Crime Agency (NCA), conducted an operation to arrest three London-based individuals on suspicion of insider dealing, conspiracy to insider deal, and money laundering linked to organized crime. Several digital devices were seized in searches conducted by investigators. All three individuals were interviewed, and a fourth suspect remains under investigation.
The Securities and Exchange Commission (SEC) charged TradeStation Crypto, Inc. for failing to register a crypto lending product that allowed U.S. investors to deposit or purchase crypto assets in exchange for interest payments. TradeStation has agreed to pay a $1.5 million penalty to settle the charges and has announced its intention to terminate all crypto-related products and services in the U.S. market on February 22, 2024.
The SEBI imposed a fine of Rs 7.41 crore on five guest experts from the Zee Business news channel and 10 other entities for misleading investors. The scheme involved the experts sharing information among each other and profit makers, then “misleading” investors to “take positions in securities” and letting others “make profit.”
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