The Internet has revolutionised the way that pump-and-dump scams are distributed. But the end result is the same - the fraudster wins and you lose your money.
I regularly receive emails that go something like this:
"XYZ company is trading at less than 10 cents! Our 5-day target is 75 cents, and we rate this a strong buy. This stock will explode on Monday! Now you know what to do."
In my case, I know exactly what to do -- sigh despondently, then shove the email where it belongs -- in the "deleted items folder". Unfortunately not everyone does that. According to Prof Laura Frieder of Purdue University and Prof Jonathan Zittrain from OxfordUniversity some people do respond to these 'pump and dump' scams and buy the shares mentioned.
In reality, pump and dump has been around for ages. In ye olden days, fraudsters would rely on cold calling to tout dodgy shares, and this was primarily done through boiler rooms. But the Internet has revolutionised the way that scammers operate. In fact, the Internet has made it much cheaper for fraudsters to reach large numbers of potential investors quickly.
According to the academics, approximately 730 million spam emails are sent every week, of which one in seven specifically tout shares. That means around 15 million share-related spam emails are hitting our mailboxes every day! Thing is, it doesn't take too many people to respond to a pump and dump scam to allow fraudsters profit from their illegal activities.
Significantly, the shares that are being touted are generally 'penny shares'. What this means is the shares are comparatively illiquid and thinly traded. So, small changes in demand can have a disproportionate effect on the price. And this is precisely what unsuspecting investors do when they buy shares in the companies. They are unwittingly forcing up the share price allowing fraudsters to sell their shares at what will soon be the peak.
Frieder and Zittrain also discovered that if spammers bought shares the day before starting an email campaign and then sold them the day after then they could make a return of around 5%. In fact they estimated that particularly effective spammers could improve their return to roughly 6%. But on the other side of the equation, recipients who responded to the scam could lose up to 8% of their investment, and that doesn't include trading costs.
So what can we do to avoid it?
As it stands, the practice of pump and dump is illegal, but putting a stop to it is nigh on impossible. Consequently, investors should always consider the reliability of a source before buying shares. Try also to verify any claims that are made especially if the promoter is making grandiose declarations about new product developments and lucrative contracts. Finally, always treat unsolicited emails with scepticism. After all, if something looks too good to be true, then it probably is!
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