Matt Levine, 01 July 2021
Here’s a thing you can do. You start a company and sell some stock to the public. You say “we are a good company and we plan to do good things, give us money to do them.” You sell, say, 10% of the company to the public at a low price. You keep the other 90% for yourself, as the founder of the company. Then you start putting out press releases saying “we did a bunch of good things!” These press releases are not true. Also you buy a bit of the publicly traded stock for yourself, to create volume and move the price up. Investors read the press releases and see the buying activity, and they think the stock is good. So they buy it. The stock — the 10% that is publicly traded — goes up. The price is now high. Then what you do is, you sell your stock — the 90% that you kept — at the new high price. Then you close up the company and move on to your next scam.
This is a thing that people very much do. It is generally called a “pump and dump.” There are some obstacles to doing it. A lot of them are legal and regulatory restrictions. Generally you can’t start a company and sell stock to the public without registering it with the Securities and Exchange Commission, hiring an auditor, etc. Also if you keep 90% of the stock for yourself, you can’t sell that stock without a prospectus, which means disclosing that you (the founder) are selling. Also it is securities fraud to put out press releases full of lies. Also it is market manipulation to buy stock for the purpose of pushing up the price and creating misleading volume. People very much do pump and dumps, but they also very much get in trouble for them. (Sometimes.)
But there is another limitation on pump and dumps, which is that the market for these companies is usually pretty small. When you decide to dump — to sell your stock — who will buy it? In the first instance the answer is “market makers,” generally high-frequency electronic trading firms that stand ready to buy or sell stock on the exchange. But they will generally not provide all that much liquidity in some weird small company, and they will move their prices quickly in the face of sustained selling. The only way to really get out is to have fundamental buyers: The people you pumped the stock to need to keep buying even as you are selling. You need to deceive people not just on the way up — the pump — but also on the way down — the dump. The dump takes time, and during that time you need buyers so you can sell your stock.