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Enforcement News: Twitter and The Pump and Dump Scheme

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  • Posted on: Oct 27 2021

By: Jeffrey M. Haber

People use social media, and the Internet in general, for all sorts of reasons. Investors are no different. Investors use social media to research stocks, look up information on a broker-dealer (see Broker Check [here]) or investment adviser (see Investment Adviser Public Disclosure [here]), find guidance on investing strategies, receive up-to-date news, and discuss the markets with others.

While social media offers investors valuable information when making investment decisions, it also presents opportunities for fraudsters. Through social media, wrongdoers can spread materially false or misleading information about a company and its stock to large numbers of people with minimum effort and at a relatively low cost. They can also hide their true identities by acting anonymously or even impersonating credible sources of market information.

One way a wrongdoer can abuse social media is by spreading materially false and misleading information about a company to affect the price of its stock. Often, a fraudster will perpetuate rumors about a company and its stock on social media, as well as on online bulletin boards and in Internet chat rooms, to manipulate the price of the company’s stock. 

The Securities and Exchange Commission’s (“SEC”) Office of Investor Education and Advocacy has warned investors (here) about the use social media to perpetrate stock frauds. One type of stock fraud that is well suited for social media is the “pump-and-dump” scheme.1 In a “pump-and-dump” scheme, promoters “pump” up the stock price by spreading positive rumors that cause a buying frenzy and then quickly “dump” their own shares before the hype ends. After the promoters profit from their sales, the stock price drops and the remaining investors lose money. In other instances, fraudsters start negative rumors urging investors to sell their shares so that the stock price plummets, and the fraudsters take advantage of buying shares at the artificially low price.

In SEC v. Craig (here), the SEC accused an individual of manipulating the share prices of two publicly traded companies by tweeting false and misleading information. The defendant allegedly tweeted rumors that federal law enforcement was investigating a technology company for fraud, and that a biopharmaceutical company had tainted drug trial results and a federal government agency seized its papers. The SEC alleged that these deceptive tweets were made from Twitter accounts mimicking established securities research firms. The tweets allegedly caused investors to lose more than $1.5 million.

Fraudsters also use social media for “scalping”, another form of stock fraud. Scalping is a scheme in which the fraudster (a) acquires shares of a stock; (b) recommends that others purchase the stock without disclosing his/her intention to sell; and (c) subsequently sells the stock for his/her own benefit.2

In SEC v. McKeown and Ryan (here), the SEC obtained judgments (here) against a Canadian couple who used their website (PennyStockChaser), Facebook, and Twitter to pump up the stock of microcap companies, and then profited by selling shares of those companies. In this scalping scheme , the couple allegedly received millions of shares of these companies as compensation and sold the shares around the time that their website predicted the stock price would massively increase. The SEC alleged that the couple did not fully disclose the compensation they received for touting the stocks. The court ordered the couple and their companies to pay more than $3.7 million in disgorgement for profits gained as a result of the alleged conduct and ordered the couple to pay $300,000 in civil penalties.

Recently, the SEC brought an emergency action, and obtained an injunction and asset freeze, against Steven M. Gallagher for allegedly committing securities fraud through a long running scalping scheme using Twitter. The announcement of the SEC enforcement action can be found here

SEC v. Gallagher

According to the SEC, since at least 2019, through October 13, 2021, defendant used his Twitter account to promote and encourage the purchase of dozens of microcap stocks, while simultaneously selling his own shares and not disclosing that fact to his followers.

Defendant is an active day trader in over-the-counter securities. He created the Twitter account using the alias “Alex DeLarge,” a character from the novel A Clockwork Orange and the Stanley Kubrick film of the same name. As of October 19, 2021, defendant’s Twitter account had over 70,000 followers.

Defendant allegedly disseminated false and/or misleading information about the promoted issuers, or falsely stated that he was not selling the stock that he was concurrently recommending that his Twitter followers and other Twitter viewers buy. The SEC said that, for at least two issuers, defendant engaged in multiple instances of manipulative trading by placing multiple buy orders at the end of the trading day to raise the stocks’ price (“marking the close”) to mislead the public about the trajectory of the stocks’ price. “Marking the close” is the term used to describe the practice of buying or selling stocks near the close of trading to affect the closing price.

The SEC said that defendant engaged in scalping in connection with the stock of at least 60 issuers and generated at least $3.39 million in profits from his fraudulent and manipulative scheme. 

According to the SEC, defendant had been repeatedly warned by his brokerage firm (“Broker A”) that he appeared to be engaged in manipulative trading in violation of securities laws and regulations. Notwithstanding, defendant continued to engage in manipulative trading and scalping, said the SEC. 

On September 9, 2021, Broker A informed Gallagher that it was closing his trading account effective October 9, 2021, and that it would immediately prevent him from making new stock purchases, restrict his account to just liquidating transactions, and not allow him to open a new account in the future. The SEC alleged that this action did not deter defendant.

According to the SEC, defendant continued to engage in scalping through sales of stock he already held in his Broker A account. In addition, on the day that Broker A told defendant it was shutting down his account, defendant opened a trading account at Broker B, indicating that he intended to use the account for “active/day trading.” As of October 14, 2021, the account had approximately 40 penny stocks in it, with a market value of approximately $1 million, said the SEC. Defendant allegedly continued to engage in scalping stocks in that account as recently as October 13, 2021.

“The complaint alleges that Gallagher used his followers for his own financial gain, tweeting out false advice to pump up the price of stocks he owned, so he could sell for a profit,” said Richard Best, Director of the SEC’s New York Regional Office. “This case is a reminder that investors should be wary of taking financial advice from unverified sources on Twitter and other social media platforms.”

The SEC’s complaint, filed in the U.S. District Court for the Southern District of New York (Case no. 21-cv-8739), charges defendant with violating the antifraud provisions of the federal securities laws. The complaint seeks, among other relief, a permanent injunction, disgorgement, prejudgment interest, civil penalties, and the asset freeze granted by the court.

The U.S. Department of Justice also said in a related charge that defendant had been arrested for additional violations, including wire fraud and market manipulation, related to the same scalping and pump-and-dump scheme. The charge also specified that defendant earned over $1 million in profit. 

Commenting of the charges, U.S. Attorney Damian Williams said: “As alleged, Steven Gallagher brought old-school boiler room tactics to the Twitter age, and operated a social media pump-and-dump scam that defrauded ordinary investors, all so that he could make over $1 million in profits.” 

Williams went on to emphasize the vigilance of the SEC and DOJ in stopping the use of social media to perpetrate a fraud on investors: “Today’s arrest of Gallagher demonstrates that this Office and our law enforcement partners will be vigilant as securities fraud schemes move onto Twitter and other forms of social media.”

Acting HSI Special Agent-in-Charge Ricky J. Patel said: “Turning lies into cash, Gallagher allegedly engaged in a pump & dump scheme, where he and his followers manipulated the price of penny stocks and guaranteed profits for themselves. Pump and dump stock schemes cause mistrust in the market and have real victims who often invest large sums of money, only to have their hopes shattered by a fraudster’s greed.  Like so many Hollywood movies which have portrayed stock frauds, Gallagher met the same fate as those storylines, he was arrested and will now face justice.” 

Agent Patel echoed William’s focus on fighting stock fraud through social media: “Working with our partners at the USAO-SDNY and the SEC, identifying and disrupting illegal financial schemes like this one is a top priority for HSI.”

A copy of the DOJ’s announcement of the charges can be found here.


Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.

Footnotes

  1. This Blog examined pump-and-dump schemes here, here and here.
  2. This Blog previously examined an enforcement action involving scalping here.
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