Don’t Believe the Hype: Detecting “Pump and Dump” schemes

August 2007

IN THIS ISSUE

— Not so Idle Chatter: Pump and Dump and “Cyber Smears”
— The Truth Squad: How to Identify Scammers and Fight Back
— In the next issue

GREETINGS!

Welcome to the August edition of our newsletter. In this issue, we’ll examine the threat posed by market manipulators who employ various tools to inflate or drive down the price of common stock issuances by spreading misleading statements about the stock. This is commonly known as a “pump and dump” scam.

Your clients are likely heavily invested in several types of financial vehicles, some of which may be vulnerable to the feeding frenzy mentality that can grip the stock market. We’ll show you some examples of how “pump and dump” is done, and suggest ways to detect who is behind the schemes.

NOT SO IDLE CHATTER: PUMP AND DUMP AND “CYBER SMEARS”

In many ways, Jonathan Lebed seemed like an ordinary teenager of the 1990s. Yet when he would return home from school starting in 1999, according to the U.S. Securities and Exchange Commission, the fifteen year old Lebed engaged in one of the most prolific “pump and dump” schemes in history, essentially becoming the Doogie Howser of stock price manipulation.

Lebed would purchase “large blocks of thinly traded microcap stocks and, within hours of making such purchases, sent numerous false and/or misleading messages . . . over the Internet touting the stocks he had just purchased,” according to the S.E.C. Although his ultra-positive messages about the stocks were “generally devoid of substantive content,” speculative traders who trawl message boards looking for “the next big thing” would buy into the hype, ultimately netting Lebed more than $275,000 in gains on his investment.

THE TRUTH SQUAD: HOW TO IDENTIFY SCAMMERS AND FIGHT BACK

The anonymity of the Internet can make identifying the perpetrators of “pump and dump” and its negative sister, “cyber smearing,” (where message posters say negative things about a stock to drive its price down) very hard to detect. This is further complicated by the emerging network of spam “botnets”, computer programs designed to proliferate electronic mail messages promoting supposedly hot stocks to millions of users under false or hijacked electronic mail addresses.

As most of these schemes and perpetrated via the Internet, you can use Internet tools to start to track down the culprit. There are several good tools to find out what someone with a particular alias, say “flashystox1”, has been saying online, and he may even give away clues to his identity. Google’s blog search tool searches millions of web logs and message boards to find information. If our fictional culprit is posting to areas monitored by the search tool, it will generate results.

The next step would be to look for accidentally placed identifiers: did the culprit end a post with their real first name or full name, if only once or twice? Also, you can look at the post’s header information carefully to determine the Internet Protocol or “IP” address from where it originated, which can be done by using search tools like ARIN’s whois lookup. Thus, with a little luck and some forensic work, the anonymous message poster and their general location can be revealed.
IN THE NEXT ISSUE

In the next issue, we’ll discuss the still controversial Sarbanes-Oxley Act passed in 2002, including its effects and costs.