Pump and Dump Scheme in the Stock Market

10.06.2024

Pump and Dump Scheme in the Stock Market

Why in the news?                        

The Securities Exchange Board of India’s (SEBI) recently slapped a fine of Rs 7.75 crore on 11 individuals for allegedly operating a ‘pump and dump’ scheme.

About 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.
• It 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:

○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 of the Pump and Dump Scheme:

• 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.
• Under the SEBI guidelines, pump and dump schemes are completely banned.

                                                       Source: Business Standard

Ques :- With reference to Pump and Dump Scheme in Stock Market, consider the following statements:

1. It involves artificially inflating the price of a stock through misleading information, only to sell the stock at the inflated price.

2. It is particularly prevalent in large-cap stocks.

3. Under the SEBI guidelines, pump and dump schemes are completely banned in India.

How many of the statements given above are correct?

A. Only one

B. Only two

C.All three

D. None

Answer B