When the value of a stock skyrockets, its investors may think they’ve hit the jackpot. But if the stock in question is part of a “pump and dump” scheme, investors may, in fact, lose their shirts. Here’s how to avoid getting taken by this type of investment fraud. Beware pump and dump schemes!

A penny for your stocks

In the typical pump and dump scam, a fraud perpetrator buys shares in an inexpensive, relatively illiquid stock (often referred to as a “penny” stock) whose price will react dramatically when trading volume increases. Then the crook makes false or misleading statements to encourage people to sink their savings into the stock and drive up its price. When it hits a certain dollar amount, the fraudster sells, locking in short-term gains and causing the stock to crash. Investors are left with what often are worthless shares.

This summer, the FBI uncovered an international pump and dump scheme that netted its perpetrators $15 million in profits over a five-year period. The criminals bought millions of shares in small, thinly traded companies, then staffed call centers to hype the stocks to senior citizens. The scheme might have continued indefinitely if not for the fact that one of the crooks’ “co-conspirators” wasn’t the greedy stockbroker he claimed to be, but an undercover agent.

Hot tips, cold shoulder

As the above case suggests, investment scammers often target seniors with retirement savings to invest. Novice investors who aren’t familiar with how the stock market works are also popular marks. However, even experienced investors can get snared when offered a “hot tip.”

You can help avoid becoming a victim by following some common-sense guidelines. For example, never buy a stock based on an email or telephone solicitation, no matter how compelling the sales pitch. Simply hang up the phone or delete the message.

If you’re intrigued by the sound of an investment, do your research to determine whether the company is (1) legitimate, and (2) a good investment opportunity. Also pay attention to the stock’s trading volume. The more thinly traded a stock, the greater the potential for fraudulent manipulation.

Too good to be true

The bottom line: When an investment sounds too good to be true, it probably is. If you’d like to invest (say, for retirement or other financial goals), but don’t know how to pick stocks or build a portfolio, work with a reputable financial advisor. There are no guarantees in investing, but your advisor can help you beware of pump and dump schemes, and to invest only in securities that meet your criteria.

(This is Blog Post #627)