GameStop Anyone? Pump and dump of micro-cap securities: ASIC's view on retail investors bearing the brunt

A new ASIC report summarises pump and dump activities of micro-cap securities in 2020-21. The report assesses how pump and dump activities in the form of momentum ignition and social media campaigns led to unusual price movements. ASIC responded by actively monitoring social media accounts, working closely with ASX and other market participants to shut down suspect client accounts.

What does ‘pump and dump’ mean?

’Pump and dump’ refers to an artificially constructed trading scheme participants acquire securities in a company and organise a program that seeks to increase the share price (pump). The pump can be orchestrated in a range of ways but commonly involve making unsubstantiated recommendations, or the spreading of false news, to generate a sense of excitement and increase third-party buying activity. The shares are then sold when the price has moved higher (dump) to make a profit.

In order to implement a pump and dump schemes, participants will generally engage in a form of market misconduct, or other prohibited conduct (under Part 7.10 of the Corporations Act 2001 (Cth)). Such conduct can attract significant penalties including fines of over $1 million and up to 15 years of imprisonment or equivalent penalties under the ASIC Act.

The structures have attracted widespread media interest, particularly in the USA, with activity in relation to GameStop shares, with trades occurring on the increasingly popular Robinhood trading platform and excitement generated on threads on Reddit.

The report

ASIC analysed Australian market activity between January 2019 and July 2021 (review period) and observed a marked increase in anomalous price moves in the market, elevated interest in small and micro-cap securities and significant increases in day trading.

The report found that the unusual price moves were sometimes the result of pump and dump events in the form of ‘momentum ignition’ and organised campaigns on social media. The resulting price movements led to significant financial losses for retail investors.

ASIC has responded by working closely with third party market operators such as the Australian Securities Exchange (ASX) and market participants such as brokers to detect and disrupt pump and dump activities. ASIC has proactively monitored social media accounts and engaged with market participants to identify pump and dump activities on social media platforms.

The drivers of the pump and dump activities

COVID-19 lockdowns, low market prices and high interest in Australian equity markets sparked interest in retail investors. ASIC observed a surge in market participation by retail investors across all capitalisation segments compared to pre-pandemic levels.

ASIC observed that the pump and dump events trended upwards in 2020 but peaked in early 2021. The report identified the following two key driving factors for the unusual price movements in pump and dump activities:

1. Momentum ignition
   Momentum ignition is the practice of aggressively purchasing a particular security in a short time-frame to generate an upward price move outside the normal range of market volatility.
   
   Momentum ignition can be undertaken by a single trading account or several accounts in a coordinated attempt to move the price of the underlying security.
   
   The report identified a number of individual accounts that traded when markets were unusually volatile through online retail brokers. ASIC identified that these accounts regularly traded on the same securities at the same time. Traders would also use strategies such as one-sided layering of the orderbook and then timely removal of bids to avoid trading to move market prices. In some instances, it appeared that individual traders accounted for 30% of a targeted security’s turnover which gave a false impression of market demand.
    
2. Social media campaigns
   
   The report found that promoters of pump and dump activity used social media platforms as a tool to encourage their followers to purchase securities. Followers were encouraged to purchase low liquidity securities susceptible to market impact, and were motivated by the prospect of trading manipulated markets at a profit.
   
   Some promoters would post on social media about a target security to be traded on a particular day with a view to pushing the pre-open market demand for the target securities higher. Those promoters were found to have positioned themselves to sell the promoted securities early into the created demand, for a profit.
   
   For those day-trading accounts that participated in social media trading campaigns, it was estimated that approximately 81% lost money or broke even in those events.

Impact on retail investors

Momentum ignition, and pump and dump trading activity, was found to significantly undermine the capacity of markets to efficiently price securities. Such activity lowered the quality of investor outcomes, led to losses for retail investors of up to $6.3 million per month over the review period, and damaged confidence in segments of the market.

ASIC observed that certain investors (accounts that did not day trade) could benefit from volatility but that relative financial outcomes were sensitive to size. In particular smaller accounts appeared less able to handle price volatility and suffered greater financial harm as a result.

Key takeaways

ASIC is likely to take a more proactive approach and continue monitoring social media platforms to investigate pump and dump activities. This may result in further enforcement actions against perpetrators where there is sufficient evidence of a breach to protect the public interest.

Retail investors should remain vigilant when faced with indicators of potential pump and dump trading and immediately stop and avoid suspicious activity. Key indicators to watch out for include:

• High volume day trading in micro-cap securities in the market that result in sharp price movements;
• Traders that engage in one-sided layering of the order book and sell;
• Traders who aggressively cross the spread and ignite momentum;
• Any sudden or unusual surge in trading interest that cannot be verified by external sources;
• Excessive commentary on social media on a targeted stock; and
• Buying and selling illiquid securities between related parties.

Additionally, investors can report suspicious activity through ASIC’s regulatory portal or by email to markets@asic.gove.au.

More information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Commercial team.

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