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Computerized Investing > July 19, 2014

Social Media and “Pump and Dump” in the 21st Century

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by Wayne A. Thorp, CFA

While it is hard to argue with how much technology has made investing easier, there are always two sides to every coin. The same technology that allows us to access a wealth of research and to speed up the analysis and tracking process also gives would-be fraudsters a platform to fleece naive investors.

Decades ago, these operations took the form of the “boiler room”—phone banks with high-pressure salespeople working off of “sucker lists” touting thinly traded micro-cap stocks and the promises of fast and easy gains.

As technology has progressed, so too have the platforms and tactics used by stock manipulators. During the dot-com boom, online stock bulletin boards, such as SiliconInvestor.com and Yahoo! Finance Message, were fertile ground for “pump-and-dump” (P&D) schemes. P&D is a form of stock fraud whereby the price of a stock is inflated through false or misleading statements (the pump). The party doing the hyping purchases the stock cheaply and then turn around and sell, or dump, their shares at a higher price. As the operators exit the stock with large gains, unwitting investors are left holding the bag and little else.

During the late 1990s, one of the most famous pump-and-dumpers was Tokyo Joe, aka TokyoMex, aka Paku Matsudai, born Yun Soo Oh Park (I’ll use Park here). This former burrito salesman made millions charging investors for access to his stock trades, which on paper appeared to be extremely prescient. The problem was that he was, in some cases, being paid to promote certain stocks. Then, on at least 10 occasions, Park recommended stocks he had already bought without disclosing his ownership positions.

In a civil complaint filed by the SEC, he was also accused of culling his winning trades after the fact and posting them on his website as a fraudulent inducement to would-be subscribers.

It is important to realize that stock hucksters come in all shapes and sizes, as well as ages. Someone else who gained notoriety during the dot-com era was 15-year-old Jonathan Lebed. He bought penny stocks and then promoted them on Internet message boards, touting their performance. As others bought the stock, driving it still higher, Lebed would sell.

Sadly, neither Lebed nor Park saw the inside of a jail cell. Both paid restitution that amounted to only a fraction of their ill-gotten gains and neither one admitted or denied wrongdoing. While Park has seemingly faded from the investment landscape, Lebed operates a stock trading website today specializing in, what else, penny stocks.

Fast forward 15 years or so, and stock manipulation has adapted to the latest technological trend: social media. Back in mid-June, Seeking Alpha contributor Weighing Machine referenced CYNK Technologies (CYNK), a company that is “a development-stage company focused on social media.” At the time, per the company’s financial filings, CYNK had one employee, no revenues, accumulated losses of $1.5 million and assets of $39. Yes, $39, and, no, we did not leave off any zeroes. Weighing Machine also pointed out that CYNK had yet to create a social network and did not have a website. And, for good measure, the company was incorporated in Nevada but relocated its business to Belize City, Belize.

When Weighing Machine first highlighted CYNK on June 18, it had closed the previous day at $2.25, up 3,650% from its close on June 16. According to Yahoo! Finance, 367,400 shares of CYNK were traded on June 17, after having any no trading activity at all for 198 of its previous 222 trading days. Weighing Machine also offered a list of tweets from several penny stock promoters, all of whom appeared to be the same operator since the tweets were exactly the same.

I first heard about CYNK Technology via my Facebook news feed on July 10, when Mashable reported that the company’s market cap had soared as high as $6 billion. Between the close on June 17 and the close on July 10, CYNK shares had rocketed an additional 518% in a mere 16 trading days (an increase of more than nearly 36,500% from a low of $0.06 on June 16 to an intraday of $21.95 on July 10). I shared the article with my Facebook friends, commenting that it was “nice to see that ‘pump and dump’ has evolved.”

As it appears now, that was the last hurrah for CYNK. The next morning, I was greeted with the news that trading in CYNK Technology was halted by the SEC “because of concerns regarding the accuracy and adequacy of information in the marketplace and potentially manipulative transactions in CYNK’s common stock.” An accompanying order said trading was suspended until July 24. I think it is safe to assume the stock will drop once it starts trading again.

While it certainly appears that CYNK’s meteoric price rise was due to manipulation, this may not be a simple pump-and-dump scheme. Another seeking Alpha contributor, Paulo Santos, outlined how this apparent scheme works:

  • Insiders controlling 100% of the stock of trade between themselves, pushing the valuation to an unsustainable level to attract short sellers;
  • At which point, the insiders release some shares for selling short;
  • Short sellers jump at the opportunity, given the unsustainable valuation;
  • The insiders once again shut down the availability of stock to sell short and once again drive the stock price up; and
  • Short sellers are then caught in a short squeeze and are forced to close out the insiders at a gain or hold a position that is increasingly turning against their favor.

But Santos also pointed out that insiders control the shares being lent and sold short as well as the pricing short sellers need to pay just to keep their positions open. This so-called “short rebate” for CYNK shares, according to Santos, jumped from 16.82% on July 1 to 120% on July 10, meaning the short positions have to pay a fee at an annualized rate of 120%. But, compounding the problem, Santos stated that the 120% fee applies to the current stock quote, which means paying 1,200% on the short seller’s cost basis. So the schemers benefit from short sellers closing them out by buying shares and driving the share price higher, or they receive exorbitant fees to allow short sellers to hold their short positions.

Schemes such as this prey on two human failings: gullibility and greed. Before you invest in a micro-cap stock with dreams of earning returns of several thousand percent, understand that such a proposition is probably too good to be true because it actually is.

Ratio Analysis Spreadsheet

This month, CI intern Jackie McClellan has put together a useful ratio analysis spreadsheet to help you analyze individual companies. The real beauty of the spreadsheet, however, it that it requires almost no manual entry of data, nor does it rely on data you must pay for. Jackie outlines a straightforward copy-paste method for importing free Morningstar data into the spreadsheet. From there, you can analyze time series data for a variety of financial ratios to help gauge the financial strength of a company.

52-Week Low Formula

Last month we presented Luke Wiley’s 52-Week Low Formula. This contrarian stock selection strategy looks for financially strong companies that the market has turned its back on, driving the stock price near its 52-week low. In that article we used Portfolio123’s online stock screener to recreate Wiley’s approach as best we could. The “problem” with the screen, however, is that several factors are qualitative in nature, which forced us to try and use proxies for such things as “durable competitive advantage.”

For this month’s issue, I had intended to replicate the screen using AAII’s Stock Investor Pro fundamental stock screening and research database program. Part of the idea was to develop better proxies for the qualitative elements of Wiley’s screen. As I was starting my research for this article, Luke Wiley was kind enough to reach out to me with a treasure trove of data that, I believe, will allow me to better quantify the qualitative aspects of the 52-Week Low Formula.

So if this month’s newsletter seems a little light on content, it is because I wanted to take an extra month or two in order to present you with a more useful screen. My hope is to have this ready no later than mid-October. So be on the lookout!


Discussion

Lance Morikawa from NC posted 5 months ago:

Moral to the story do not buy penny stocks or anything too good to be true.


Steven Helton from IN posted 5 months ago:

The part about the shorts getting burned also is interesting. You always think it's just the small longs that are losing money. Thanks for the article. Twitter is the new Yahoo message board.


Dave from CA posted 4 months ago:

Whoa! This explains why & how you can get burned even betting with gravity! Cause you know these penny stocks are pumped & they have to fall!

But it is so difficult borrowing shares to short. Even if you are able to get short, you get forced out. Huh. Good to know, this story shines a light in a dark area.


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