Insider Explainers: What’s the ‘pump and dump’ trading scheme shown in DiCaprio’s ‘The Wolf of Wall Street’?

Leonardo DiCaprio's portrayal of the flamboyant Jordan Belfort in "The Wolf of Wall Street" was a study in hedonism, complete with hard-partying brokers on yachts and mountains of cash. And all that loot comes from a not just outrageously unethical, but also illegal scheme that traders sometimes fall prey to: it’s the infamous “pump-and-dump”.

When aspiring, starry-eyed traders begin to engage with the wild world of the stock market, some beasts that they will want to avoid at all costs are bears, sharks and wolves. While a bear’s downwards-swinging attack is more straightforward, the latter two tend to entice and deceive. Today, we’re going to be looking at a wolfish investor’s common method of scamming traders using Belfort's Stratton Oakmont firm as a cautionary tale.

What’s pumping?

Just as portrayed by DiCaprio in the movie, Jordan Belfort was a charismatic Wall Street stockbroker who set his sights on cheap, unknown stocks called penny stocks because they’re easier to manipulate. Once he had bought said stocks, he and his cronies unleashed relentless hype to increase the value of the said stock, often involving misleading, positive statements to inflate a stock's price.

Social media wasn't a thing in Belfort's day, but the tactics he used were similar. Faxes and carefully crafted press releases are blasted out, singing the praises of these dubious companies. The movie also showed a "boiler room" of brokers, who unleash a barrage of phone calls, painting these penny stocks with a brush of pure gold, guaranteeing returns.

At its peak, Belfort’s firm Stratton Oakmont is said to have employed roughly 1,000 stockbrokers to oversee investments of more than $1 billion.

To this day, it’s common for investors to act on a “hot tip” about a stock that's about to explode from a "trusted source". The goal is to create a feeding frenzy, a wave of investor excitement that would inflate the stock prices to unprecedented highs. Consequently, the trader falls for it, seeing dollar signs before his eyes and buys a ton of shares and holds on to them anticipating a huge profit.

But before the innocent retail traders realise, it’s too late!

Here comes the dumping

Fuelled by this fabricated frenzy, as unsuspecting retail and even some large-scale investors pile in, the stock price shoots up like a rocket. Once the price reaches a sweet spot, the schemers who already own a significant chunk of the stock, simply dip — kinda like DiCaprio's alleged habit of dumping his girlfriends as they turn 25.

As Belfort and his crew dump their share, cashing in on the artificially inflated price, the stock price also plummets because it had no real substance to begin with. Investors who bought in at the inflated price are left holding the bag of worthless shares in a company that likely never had much potential to begin with.

Fortunately, Belfort did get caught. He pleaded guilty to fraud for the pump-and-dump schemes — something that may have cost his investors as much as $200 million! He was sentenced to four years in prison in 1999, but ultimately only served 22 months. As for his victims, they got nothing.

It is an ongoing issue

Now, you might be thinking that this ploy seems entirely too transparent and just because people fell for it nearly two decades ago doesn’t mean they still would. However, IIFL Securities’ former associate recently came under the scanner by Indian regulators for alleged market manipulation — no prices for guessing — using the pump and dump scheme.

Sanjiv Bhasin, known for his frequent appearances on business channels, is believed to have been advising a private company to buy specific stocks, then using his TV appearances to hype them up. This would have driven up the stock price, allowing the private company to sell their shares at a profit before the price inevitably dropped.

India's Securities and Exchange Board of India (Sebi) is reportedly examining digital evidence to support these claims. IIFL Securities has distanced itself from the investigation, clarifying that Bhasin was a short-term consultant whose contract expired early due to health reasons. The company also emphasized that Bhasin was never on their board of directors. While the investigation unfolds, it appears investors are taking a wait-and-see approach, with IIFL's stock price showing little fluctuation.

But a mellowed down version of the pump-and-dump scheme plays out in the day-to-day trading far more often than we realise. Though not strictly illegal, many early-stage investors, promotors, and founders have been accused of pumping up the valuation of their companies and start-ups using media appearances, influences, and even misleading financial statements before going public. Such practices result in retail investors subscribing to shares at a much higher price compared to what the company earns or returns to its investors in the long-run, particularly during bull markets like the one we are in right now.

Moral of the story? You can never be too wary of a wolf in a well-meaning advisor’s or influencer’s clothing.