In the world of investment schemes, “pump-and-dump” scams have been a mainstay for centuries.

Nowadays, these scams are often tied to microcap stocks and penny stocks as part of a plot to convince individuals they can earn big returns in a short amount of time.

What Is a Pump-and-Dump Scheme?

Here’s how the scam typically plays out:

Pump — Fraudsters aggressively promote a thinly traded, low-priced stock (often microcap stocks) to hype up its prospects. These smaller stocks may trade over-the-counter (OTC), since OTC stocks aren’t required to meet the listing standards imposed by exchanges. Misleading information about the company and its growth potential may be spread through a variety of sources, including social media, websites, investment newsletters, online ads, email, internet chat rooms, direct mail, newspapers, magazines, and radio.

Dump — Once enough misinformed investors have bought in, artificially driving up the stock price, the scammers sell (or dump) their own holdings at the inflated price. When the fraudsters dump their shares and stop the hype, the stock price usually falls and investors lose their money.

Why Microcap Stocks Are Fertile Ground for Scammers

Microcap stocks — generally defined as companies with a market capitalization under $300 million — are especially vulnerable to these scams. They are thinly traded, so a relatively small volume of buying can spike the share price. And because there is little analysis or financial reporting on these companies, it’s much easier to invent stories on their growth potential.

Real-World Examples

FINRA’s Investor Education arm has documented cases in which so-called “boiler rooms” (groups of pushy telemarketers) would cold-call retirees or new investors and pitch these microcap stocks as “the next big thing.”

In other cases, social media influencers or online promoters have been secretly paid to recommend these stocks in chat rooms or Twitter threads, without disclosing their compensation.

Once the price spikes and the fraudsters sell, the stock inevitably crashes.

Red Flags

Based on guidance from FINRA and the North American Securities Administrators Association (NASAA), warning signs of pump-and-dump scams include the following:

• Claims of “guaranteed” or “can’t-miss” returns
• Hype around a thinly traded stock with no revenue or earnings
• Pressure to “get in now before you miss out”
• Unregistered promoters or anonymous online recommendations
• Lack of independent, verifiable financial information

Protecting Yourself From Pump-and-Dump Scams

• Do your research. If you can’t verify claims through independent sources, be suspicious.
• Use FINRA’s BrokerCheck. Before acting on advice, confirm that the person selling you an investment is a properly licensed broker or investment adviser.
• Ask hard questions. If a pitch seems too good to be true, challenge it; legitimate professionals will welcome your questions.
• Stay diversified. If you put your entire portfolio into a single risky microcap stock, you are playing with fire.
• Ignore the hype. Social media has made pump-and-dump scams faster and more viral than ever. If you see a sudden flood of excitement around an obscure stock, tread carefully.
• Watch for extremely volatile stock prices. Volatility can stem from sudden interest in a normally illiquid stock. You may have stumbled upon a pump-and-dump in progress. Use FINRA’s Market Data tool to examine price and volume trends, and to research the company’s financial health.

Fraudsters will never stop trying to separate investors from their money. Stay vigilant and keep asking questions.

If you suspect a scam – or have become a victim – contact the Nebraska Department of Banking and Finance at (402) 471-2171 or file an online complaint.