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The Securities Exchange Board of India’s (Sebi) on June 1 slapped a fine of Rs 7.75 crore on 11 individuals for allegedly operating a ‘pump and dump’ scheme in the scrip of Svarnim Trade Udyog.
The pump and dump scheme was operated through recommendations shared through Telegram channels, resulting in public shareholders purchasing the stock at an inflated price.
In November 2022, the market regulator indicated that it was framing rules to govern the growing base of financial influencers on social media, to strengthen the regulatory regime on tips by unregistered persons.
So what is the ‘pump and dump’ scheme and why should investors be aware of it?
In the stock market, while many participate with the aim of long-term investment or legitimate trading, some exploit the market. One such stock manipulation activity is known as a ‘pump and dump’ scheme. This practice is illegal and can have severe consequences for investors and the integrity of the market.
What is a pump and dump scheme?
In the stock market, a pump and dump scheme is a type of manipulation activity that involves artificially inflating the price of a stock through false and misleading information, only to sell the stock at the inflated price and leave investors with significant losses. This manipulative tactic is particularly prevalent in the micro-cap and small-cap sectors, where companies often have limited public information and trading volumes are lower.
How does pump and dump work?
This process involves several steps:
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First, a significant amount of stock in a relatively small or thinly traded company is acquired. These stocks are often referred to as ‘penny stocks’ because they trade at low prices and are more susceptible to price manipulation due to low trading volumes.
Then the stock is aggressively promoted to create a buzz and attract investors. This promotion can take various forms, including sending out mass emails or newsletters with exaggerated claims about the company’s prospects, as well as misleading social media posts. Promoters aim to create buzz and drive interest in the stock.
As the promotion gains traction, more investors buy into the stock, driving up its price due to increased demand. Sometimes, fraudsters may also engage in coordinated buying to further boost the price. During this phase, the stock often experiences rapid and significant price increases, creating the illusion of a hot, high-potential investment.
Once the stock price has been pumped up sufficiently, the sell-off begins at the inflated prices. This selling pressure causes the stock price to plummet, often leaving unsuspecting investors with significant losses as the stock returns to its actual value or even lower.
Impact on investors and the market
Those who bought into the hype and purchased the stock at inflated prices typically face substantial losses when the stock price crashes. These schemes undermine confidence in the financial markets, making legitimate investors wary of potential fraud.
Participants in pump and dump manipulation can face severe legal penalties, including fines, disgorgement of profits, and imprisonment.
Regulations around pump and dump
Under the Securities and Exchange Board of India’s (Sebi) guidelines, pump and dump schemes are completely banned.
On March 2 ordered cracking down on a YouTube-run share pump-and-dump operation is a precursor to the regulations on financial influencers (finfluencer) that the watchdog is in the process of framing.
The steady rise of influencers in India doling out financial and investment advice, without being qualified to do so, has been detrimental at times, especially in the case of recent start-up listings. And with the proliferation of social media channels on platforms like Telegram and Instagram etc, the task for the regulators is cut out.
Recently, the markets regulator also took action against popular Bollywood actor Arshad Warsi and his wife categorising them as volume creators. They bought and sold shares, contributing to a rise in trading volumes and interest in the scrip. Their method involved buying thinly-traded stocks and then publishing videos on the platform disseminating false information.
How can investors protect themselves?
Experts suggest that investors must exercise caution with unsolicited investment offers from unknown sources, as these are often indicative of a pump and dump scheme. Investors must do their research before investing in the stock market. Blindly following celebrities and promoters can lead to significant financial losses.
Investors should be cautious of investments that promise unusually high returns or those that are promoted through unsolicited means.
They also suggest that regulators need to stay ahead of scammers by using social media surveillance mechanisms to protect the hard-earned money of the public.
