How To: Avoid A Penny Stock Pump and Dump

Securities fraud comes in many forms, but surely the most common scheme is the good old pump and dump. These scams have become quite complex in the modern Internet age but lucky for us they’re still fairly easy to spot.

As the name implies a pump & dump involves buying up a stock, artificially inflating the price, and then selling at the higher price for a tidy profit. As the price plummets unwitting investors are left holding the bag. Ouch.

I always find it amazing how common P&D scams still are and the gaul of the modern day stock tout. The SEC and government bodies definitely have their work cut out for them uncovering penny stock fraud, as it is pretty much rampant these days. Some clever investors are known to profit from pump and dumps by discovering them early and shorting them.

Most P&D schemes occur on penny stock markets like the OTC Bulletin Board, or Pinksheets. The main criteria and other red flags for these operations are:

• They are inexpensive (penny or sub-penny stocks)
• They are thinly traded (low volume)
• They are sold on markets with poor oversight or reporting requirements
• A recent name change or reverse merger is often involved
• Sketchy share transfers between directors and/or offshore investment entities
• Popular sectors for P&Ds include: mining, health, tech startups, and anything you might see on an infomercial.

Here’s a chart for one of the most successful pump and dumps of 2011 for JAMN or Jammin Java Corp. (Jammin Java), formerly Marley Coffee Inc.

This scheme was accomplished via insiders and involved a series of blog posts, videos, and newsletters under names like hackthestockmarket.com (website down) and others. Ads were bought on Yahoo Finance and other websites to spread the message, another red flag.

The JAMN P&D was complex but mostly done in plain sight. A lot can be gleaned from how it was pulled off, so for more details see here, here, and here.

So a typical pump and dump is almost always done in conjunction with a marketing blitz across one or several penny stock websites, stock newsletters, message boards, or even a postal campaign. You will also often (but not always) see a disclaimer in small type at the bottom of these releases disclosing payments to the marketer and other details (see right for the JAMN disclaimer). These are different from paid press releases with forward looking statements released by the company and are usually written by paid analysts and bloggers, or delivered in email newsletters. So the disclaimers disclosing payments alone are a serious red flag for you to not invest in these companies.

A pump & dump scam can be very convincing for new and old investors so be sure to keep your eyes peeled for the tell-tale signs. For more examples check out this Forbes article from 2010, or more recently the Rudy case filed by the SEC.