Short and Distort scams involve short selling a stock while smearing the company with rumors to drive the stock’s price down.
Are you familiar with the classic “pump and dump” stock scheme? If so, then short and distort stock scams are the opposite. In a pump and dump scam, people usually on the inside of a company disseminate false information about the company. This information is meant to pump up the perceived value of the company and make its stock look very attractive for purchase.
Many stock scams are insider jobs
Unwitting victims start buying the stock along with the folks on the inside. When the stock makes a jump in price based on the increased purchases, the insiders sell off everything and make a tidy profit. The price falls due to the sell off and those who weren’t in the know, are left holding the bag containing lots of now worthless stock.
The pump and dump is especially effective during a bull market. When a majority of stocks are increasing in value, it’s much easier to convince investors to purchase stocks with false claims of making a quick buck or two. When the market is experiencing a down turn, as in a bear market, the opposite can happen. It’s easier to sway investors that a stock is overpriced and overvalued. Add in fears about large scale collapse as we’ve seen recently in the banking sector and it’s a perfect environment for taking advantage with a short and distort stock scam.
Definition of Short Selling or Shorting a Stock
Short selling occurs when an individual sells a financial instrument (exchange traded derivatives, OTC derivatives, other cash or securities) that they don’t actually own during the time of the sale. The seller does this with the intent of purchasing the financial instrument later at a lower price. Short sellers do this as an effort to profit from an anticipated decline in the price of the financial instrument.
The person wishing to sell short will typically borrow or rent the securities to be sold. At a point later in time, the short seller repurchases like securities for restoration back to the lender. If prices fall on the security, then the short seller makes a profit from selling the borrowed security for more than they pay for them later. If prices increase, then the opposite occurs and the short seller suffers a loss. This is a risky proposition as prices can rise and fall without bound.
How Does the Scam Work?
Shysters hoping to benefit from short selling will do so by perpetrating fear. They use online personas that imply they are with the Securities and Exchange Commission or the National Association of Securities Dealers. And use these associations to pump up their reputation for spotting worthless stocks. By cluttering message boards and forums with lots of negative messages, short seller con artists try to make it as difficult as possible to find positive information regarding a particular security. They say things like, “Get out before it all comes crashing down”. And imply they are looking out for investor’s best interests by highlighting stocks that will go to zero in price causing a complete loss for anyone holding the stock. These short and distort manipulators will do everything in their power to keep buyers away from the stock so the price will continue to decline.
The effect from all of this manipulation and distortion is that those holding the stock will sell it based on the misinformation about the company and its stock. Even if that means taking a loss by selling the stock for less than it was originally purchased for. Simultaneously, the short and distort scammers cover at the low prices and lock in their potential for profits. This can be devastating for the company and the investors who fell for these smear campaign tactics.
There are a few things you can do as an investor to protect yourself:
- Verify facts – don’t believe everything you hear or read about a security or company.
- Spend quality time on your due diligence and discuss any stock acquisitions or sales with your broker first.