Pump and dump scheme: What is it, how it works and how is it monitored

Arshad Warsi made a profit of Rs 29.43 lakh and his wife Maria Goretti of Rs 37.56 lakh using a YouTube-run pump and dump operation last year

On Thursday, the Securities and Exchange Board of India (Sebi) imposed a penalty on Bollywood actor Arshad Warsi, his wife Maria Goretti and 29 others for their YouTube-run pump and dump operation. Reports have suggested that Warsi made a profit of Rs 29.43 lakh and his wife Rs 37.56 lakh between April 27 and September 30 last year using this operation.

What is a pump-and-dump scheme?

Pump and dump is a manipulative scheme in which a person tries to increase the price of a share using fake information. The claims are false, misleading, exaggerated, and spread to make personal gains. This is often done by a person who has monetary influence over many people.

How is the scheme used?

There is a three-step process in the pump-and-dump scheme. First, a person buys a significant holding in any stock.

Next, he makes exaggerated claims about the company, encouraging people to "pump" their money into it and buy more.

Lastly, as the stock price goes up, he "dumps" it and pockets the gains. However, as the significant stock volume is dumped, its price falls, and other investors lose money.

How are fake claims made?

In the age of the internet, the propagation of fake information generally occurs via social media platforms or emails. Unsuspecting small investors are also lured into investing in small and mid-cap stocks using banners and social media messages.

In this case, the fake information was being spread using YouTube videos on two channels--The Advisor and Moneywise.

Under Sebi guidelines, someone who spreads this information is called MMD or a misleading message disseminator.

How does Sebi identify pump-and-dump scams?

Sebi uses its Data Warehousing and Business Intelligence Systems to identify such scams. It provides "pattern recognition algorithms" to monitor trading. It then throws up data on who might be violating securities laws.

Sebi then looks into the stock and seeks clarifications from the company. If it receives an unsatisfactory response, the regulatory body cracks down on the MMD.