Chris Collins (D) New York.
Chris Collins was arrested last week for passing along insider information related to stock he and his family owned. The information he passed along was that a clinical trial of the drug the company produced had failed and the stock was going to plummet. Collins was warning his family to sell quickly before the information became public.
One of the reporters who broke the story said that this was a classic “pump and dump scheme.” Most of the coverage, however, has centered around the “dump” part of the scene, that is, the getting rid of the stock before the price tanked.
According to Investopedia, a “Pump and Dump” scheme is a “scheme that attempts to boost the price of a stock through recommendations based on false, misleading or really exaggerated statements. The perpetrators of this scheme, who already have an established position in the company’s stock, sell their positions after the hype has led to a higher share price. This practice is illegal based on securities law and can lead to heavy fines.”
Pump and Dump schemes usually involve what are called “micro’ and small-cap stocks, since they are the easy to manipulate. It only requires a few buyers to push a stock higher.
According to Invesopedia: “Through huge volume selling, they pump up the price of the stock. Once the selling volume reaches critical mass with no more buyers, the firm dumps its shares for a huge profit. This drives the stock price down, often below the original selling price, resulting in huge losses for the customers because they can not sell their shares in time.
This can be done by anybody who has access to an online trading account and “the ability to convince other investors to buy a stock that is supposedly ready to take off.” The schemer buys heavily into a stock that trades on low volume which pumps up the price.
The stock is usually promoted as a “hot tip” or “the next big thing” with details of an upcoming news announcement that will “send the stock through the roof”. The details of each individual pump and dump scam tend to be different but the scheme always boils down to a basic principal: shifting supply and demand. Pump and dump scams tend to only work on small and micro-cap stocks that are traded over the counter. These companies tend to be highly liquid and can have sharp price movements when volume increases. The group behind the scam increases the demand and trading volume in the stock and this new inflow of investors leads to a sharp rise in its price. Once the price rise has formulated, the group will sell their position to make a large short-term gain.
(Two movies use the pump and dump schemes as a central theme: The wolf of Wall Street and Boiler room.)