Active Traders, Not Novices, Fall for Scams

Participants in pump-and-dump schemes tend to be middle-aged, affluent and male. They also have prior trading experience, particularly with penny stocks, and exhibit a high tolerance for risk.

Participants in pump-and-dump schemes are often not the novice investors many perceive them to be. Rather, they tend to be middle-aged, affluent and male. They also have prior trading experience, particularly with penny stocks, and exhibit a high tolerance for risk. Slightly more than a third have participated in more than one pump-and-dump scheme and actively seek out such stocks. About 6% of all investors analyzed in a random sample of a large German broker’s clients participated in at least one such scam.

A pump-and-dump scheme commonly follows a three-step process. First, a scamster builds a position in a stock. These are typically penny stocks that have prices below $5, trade over-the-counter and are generally unfamiliar to the broader investing public. Then a promotion is undertaken to create interest in the stock. Such promotions typically rely on email, but can also use phone calls, newsletters and social media. As targeted investors respond by buying shares, the fraudsters unload their shares at the elevated prices. Hence, they “pump” up the stock’s price through promotions and then “dump” the stock at the artificially inflated price.

Pump and Dump Schemes	Avg per Scheme
Number of shares	10,638
Size of investment (euros)	6,972
Average return	(28%)
Gross loss (euros)	(1,305)

The result is an average loss of 28% for a stock purchased during the pump period. In monetary terms, the average loss was €800 (about $910). On a cumulative basis, the study’s authors calculated the average aggregate losses of German investors per pump-and-dump scam “is comparable to the 90th percentile of the damages caused by prosecuted frauds in the United States ($1.75 million).”

Though pump-and-dump schemes have been around for a long time, little research has been conducted about who participates in them. For this study, the authors gathered trading and portfolio data from a large, national German bank with over half a million clients. The data not only included all trading activities, but also information about demographics. Scams were identified both by working with German securities regulators and through German websites and internet forums. The data covered the period of January 2002 through 2015.

While less traded, smaller-capitalization exchange-listed stocks can be mispriced, those that trade over-the-counter should be avoided. They have weaker reporting rules and are much more subject to manipulation.

Source: “Who Falls Prey to the Wolf of Wall Street? Investor Participation in Market Manipulation,” by Christian Leuz, Steffen Meyer, Maximilian Muhn, Eugene Soltes and Andreas Hackethal; CFS Working Paper Series, No. 609, November 2017.