Shares of CYNK Technology (CYNK) crashed another 30% last Friday, almost closing the book on one of the most spectacular pump and dumps in history. CYNK rose from $0.10 to almost $22 in just a few months, earning a $6 billion valuation despite having no revenue, no assets, and a sketchy social media business that doesn’t seem to do anything.
Shares of CYNK now trade at $0.55, but there’s definitely somebody out there who got out of the stock at $20. That person may have been the perpetrator of a “pump and dump,” a scheme intended to artificially pump the value of the stock and dump it after investors are tricked into buying up shares at high prices.
Pump and dumps have been a staple of American greed and financial deception for decades. They are also easier to execute today than ever before thanks to the power of the internet, particularly social media and other open sources of information.
What is a Pump and Dump?
A pump and dump is a scheme to artificially increase the value of the stock by misleading investors. Pump and dump schemes are typically deployed on microcap stocks, which are easily manipulated thanks to their small market caps and share price. The overall goal is to buy a stock, artificially pump the price, and dump the stock at a massive profit.
In addition to old-fashioned cold calls and snail-mailers, perpetrators of pump and dump schemes have been known to go online and take to Twitter (TWTR) , Facebook (FB) , message boards, stock forums, and email newsletters to spread word about a promising “investment opportunity” in a stock that they own. If the argument is convincing, other investors will buy the stock, which can rapidly increase the share price.
After an extended rally, the stock may become overvalued based on the company’s fundamentals. However, these fundamentals are often hard to find given that financial statements of micro-cap stocks are often difficult to obtain, so the stock can rise tremendously without any resistance from value investors.
For example, let’s say that Charlie's Chocolate Chip Cookies is a new company with a market cap of $10M, with shares trading at $0.03 per share. Pump and dump perpetrators may decide to buy $50,000 in stock on the open market or via an IPO at $0.03 per share.
After starting their position, the schemers would then take to the Internet and their phones to spread word about Charlie’s Chocolate Chip Cookies, a company they have deemed “the next Chips Ahoy.” As speculators buy up the shares, the price rises tremendously because there simply aren’t very many shares in existence. Charlie’s isn’t profitable yet and not all their financial statements are available online, so the price that new investors are willing to pay is pure speculation.
In the coming days and weeks, the "penny stock" rises to $0.075, valuing the company at $25M. Thrilled with a quick and easy 150% return and a $75,000 payday, the pump and dump schemers dump their shares. The stock comes crashing down to pre-pump levels and those foolish enough to take the bait are left with massive losses.
Are Pump and Dumps Legal?
Pump and dumps are highly illegal and can land the perpetrator behind bars or slapped with huge fines. In January, a Florida man named Jordan Levy was sentenced to nine years in prison after his company Tube Media Corp was found to have perpetrated a series of pump and dumps. According to Bloomberg, Levy distributed misleading marketing materials for the penny stocks he helped take public, dumping his shares after significant gains.
Although pump and dumps are illegal and harmful, it is often not worth the time and the money for the SEC to take legal action against pump and dumpers. Using the Charlie’s Chocolate Chip Cookies example, the SEC has much bigger fish to fry than the perpetrators of a $75,000 pump and dump scheme. Big-time insider traders, money launderers and Ponzi schemers are sure to attract more of the SEC’s time, resources, and money.
In fact, some would even argue that pump and dumps should be legal. They would probably argue that there’s a winner and a loser behind every trade, and that free speech should apply to everything – including the stock market. Perhaps they are simply “recruiting” investors and taking advantage of free speech on the web, rather than perpetrating an organized scheme.
However, in reality, pump and dump schemers are intentionally manipulating the price of a stock by misleading investors. They directly cause inefficiencies in the stock market and hinder the public’s ability to make informed decisions on small cap investments. Pump and dump schemes are one of the most significant issues plaguing the market at the moment, and they seem to be happening with greater frequency thanks to open sources of information on the Internet.