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Simple English definitions for legal terms
Investor Protection Guide: Micro-cap Stock Fraud ("Pump and Dump")
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A quick definition of Investor Protection Guide: Micro-cap Stock Fraud ("Pump and Dump"):
"Pump and Dump" is a type of stock fraud where people lie about a company to make its stock price go up. They then sell their own stock to make money, leaving other people who bought the stock with nothing. This happens a lot with small companies that don't have a lot of money or information available to the public. The people who do this often use the internet to trick people into buying the stock. Investors should be careful and do their own research before buying any stock. If something sounds too good to be true, it probably is. If you think someone is trying to trick you, you can report it to the Securities and Exchange Commission (SEC)."
A more thorough explanation:
Definition: "Pump and Dump" is a type of stock fraud where people use false or misleading information to increase stock prices and then sell the stocks to the public. This type of fraud is common with microcap stocks, which are stocks of small companies with limited assets. Microcap stocks are easy to manipulate because they lack reliable public information and have a limited history. They often trade on over-the-counter (OTC) markets, which have lax financial standards and lack transparency in trading.
Example: A group of stock promoters buy a large amount of stock in a microcap company. They then spread false information about the company, such as claiming that the company has received FDA approval for a new drug. They send unsolicited emails and post messages on bulletin boards and chat rooms to promote the stock. People start buying the stock, and the price goes up. The promoters continue to promote the stock while selling their own shares, causing the price to eventually fall. The people who bought the stock lose their money.
Explanation: The example illustrates how "pump and dump" works. The promoters use false information to create demand for the stock, causing the price to go up. They then sell their own shares, causing the price to eventually fall. The people who bought the stock based on false information lose their money.
Warning Signs: Investors should watch for the following warning signs of “pump and dump”:
- Promotion of a microcap company as the next hot stock
- "Inside" information about a company provided through unsolicited means
- A surge in trading of a microcap company without material public news
- Huge return predictions such as “10k could return 25k in 30 days”
- Promotion of stocks on the OTC markets
Advice: Investors should be cautious when taking advice from people they do not know. If an investment opportunity sounds too good to be true, it probably is. Investors should perform due diligence before purchasing any stock by conducting their own research or consulting their investment advisors. Suspicious fraud activities may be reported to the SEC.
Sources:
Investor Protection Guide: Investment Seminars ("Free Lunch") | Investor Protection Guide: Misleading Senior Designations