Context:
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.
Relevance:
GS III: Indian Economy
About Pump and Dump Scheme:
- Manipulative Market Activity:
- A pump and dump scheme involves artificially inflating a stock’s price using false or misleading information to sell it at the inflated price, leaving investors with significant losses.
- Prevalence:
- This scheme is especially common in the micro-cap and small-cap sectors, where companies often have limited public information and lower trading volumes.
How Pump and Dump Schemes Work:
- Stock Acquisition:
- Initially, a large quantity of stock in a small or thinly traded company is acquired. These are often referred to as ‘penny stocks’ due to their low prices and susceptibility to manipulation from low trading volumes.
- Aggressive Promotion:
- The stock is then aggressively promoted to generate excitement and attract investors. This can include mass emails, newsletters with exaggerated claims, and misleading social media posts to create buzz and interest in the stock.
- Increasing Demand:
- As the promotion gains traction, more investors buy the stock, driving up its price due to increased demand. Sometimes, fraudsters engage in coordinated buying to further boost the price. This phase often sees rapid and significant price increases, giving the illusion of a high-potential investment.
- Sell-Off:
- Once the stock price is sufficiently inflated, the sell-off begins. The selling pressure causes the stock price to crash, often leaving unsuspecting investors with significant losses as the stock returns to its actual value or even lower.
Impact:
- Investor Losses:
- Those who bought into the hype and purchased the stock at inflated prices usually face substantial losses when the stock price collapses.
- Market Confidence:
- Such schemes undermine confidence in the financial markets, making legitimate investors wary of potential fraud.
*Under the SEBI guidelines, pump and dump schemes are entirely prohibited.
-Source: Business Standards
