Ramp-and-Dump Schemes and Fat Tail Risks in Low Float Small-Cap IPOs

Empirical evidence of securities fraud in small cap IPOs, pig butchering, and foreign bad actors.

Recent years have seen a surge in a new type of securities fraud in small capitalization IPOs, called a “Ramp-and-Dump” scheme. A Ramp-and-Dump is a form of stock market manipulation where fraudsters use different means to “ramp” up the share price of a listed company and then induce unwary investors to purchase the shares that the fraudsters then “dump” at an artificially high price. The schemes are typically conducted using social media platforms.

Fraudsters begin orchestrating at an early stage in the IPO process by placing allocation into controlled accounts, which is financed by the funds diverted from unusually high underwriting fees or other listing expenses during the IPO process.¹

In October 2022, the Nasdaq halted IPOs of Chinese companies to investigate. It was alleged that bad actors were exploiting loopholes around liquidity standards at the exchange. The Nasdaq requires a company going public to have at least 300 unrestricted round lot shareholders, with at least half of the minimum required number of round lot holders must each hold unrestricted securities with a minimum value of $2,500.² However, these requirements have not been effective in preventing manipulation in these IPOs.

The SEHK and SFC elaborate on the scheme further, “to compensate the controlled placees for creating a “market” or to subsidize the placees to subscribe for the shares at an inflated price, part of the listing expenses may have been funneled to them in the form of rebates. We also noticed instances where the listing applicant paid out a material amount of additional “discretionary” listing expenses post-listing, without explaining the basis for doing so. In many instances, the resulting reduction to the net proceeds available to the applicant as compared to that disclosed in the prospectus was significant.”

Liquidity and Halt Risks

By allocating the IPO placing tranche to controlled accounts, the fraudsters are able to satisfy the exchange’s initial listing requirement. Since the fraudsters have effectively cornered the shares to better enable market manipulation once the shares are trading publicly, they have total control of the float. This is a dangerous situation for other market participants as they are now at the whim of the scammers.

As the fraudsters lend shares out, the short sellers get stuck with no liquidity on the other side and traders end up stepping over themselves to get out as they drive the price from one LULD band halt to the next. When the float is completely locked like this, there are on average over 15 LULD halts in a trading day. During these “Day 1” events, the average traded volume between LULD halts is only 13,535 shares with an average execution size of only 16 shares.

Insight and Characteristics for Risk Management

While there is no universal formula to predict every “windowmaker”, an analysis of past occurrences can provide crucial insights. From my study of “Day 1” events, several patterns and characteristics have been identified:

• 88% have volume of less than 100% of float before a “Day 1” event

• 77% have volume of less than 25% of float before a “Day 1” event

• 50% have less than 50% float/outstanding

• 77% have less than 30m shares of floats

I defined a “Day 1” event as the first or only day a stock moved significantly higher (>100% intraday). A stock could have multiple “Day 1” events so long as they were not part of the same larger trending move, on average they were around 4 months apart, but some observations had gaps of 11+ months, this insinuates that fraudsters maintain control of these manipulated securities or at least reuse them.

To detect small-cap stocks with high-fat tail risk, I have identified several key factors that can guide the construction of a risk-sensitive watchlist. The IPO structure serves as a significant indicator; firms raising around $25m, typically issuing 5 million shares pricing at $5.00 present substantial risk. Predominantly, these risky issuers are foreign companies from Hong Kong and China, though a few originate from the United States.

Another vital element to consider is the underwriting group or syndicate of the equity issuance. Certain broker-dealers are consistently linked to high-risk offerings. Their involvement should trigger caution and increased scrutiny from traders. Pay attention to foreign broker-dealers.

On November 17^th, 2022 the Nasdaq, FIRNA, and NYSE all put out regulatory notices regarding small capitalization IPOs. These notices provide further background and considerations for risk management strategies around small capitalization IPOs:

• Whether the underwriter is prepared to make appropriate efforts to fulfill its price stabilization obligations after the IPO has been priced

• Whether the issuer and any of the underwriters are under common ownership or otherwise affiliated with each other

• Whether the underwriter has experience successfully marketing an IPO of the proposed size and type in the United States

• Whether the proposed size of the offering and disclosed price range are appropriate in light of the potential market for the offering and the issuer’s likely public market value

• Foreign Omnibus Accounts – Omnibus accounts at U.S. broker-dealers maintained for foreign financial institutions, including foreign broker-dealers, have been observed liquidating large amounts of shares of the small-cap issuers at the peak of price spikes associated with suspected ramp-and-dump schemes. In some cases, the accounts in question did not trade the securities at all until significant price increases occurred and appeared to time their sales for when the stock price peaked.³

• Nominee Accounts — It’s possible that account holders lack awareness that their identities have been used to open the accounts.

Twitter “Girls” and Pig Butchering

Anyone on FinTwit has probably received an unsolicited message from a twitter account with a profile picture of a woman, they could be as inconspicuous as a “hey 😊” or as direct as “Hello friend. My team only focuses on U.S. stocks, free sharing of popular stocks at 9:00 every day, at least 15% weekly income in the past, no cryptocurrency, no leverage, no fees, looking forward to your contacting my whatsapp [WhatsApp Redacted]”.

This is the WhatsApp profile associated with the previous Twitter DM.

Pig butchering scams originated in China (big surprise), where they are known as Shāz Hū Pán. Pig Butchering is a type of romance scam where the scammers catfish their victims and build relationships to gain the victim’s trust and then persuade them to make investments in fictitious opportunities.

Researchers say that crime syndicates in China developed scripts and playbooks that allowed them to offload the work at scale onto inexperienced scammers or even forced laborers who are victims of human trafficking.⁴

In the Finra notice regarding the heightened threat of fraud in small cap IPOs, they specifically mention that investors in securities that are the subject of suspected ramp-and-dump schemes (including investors in the IPOs) have complained about investing in a ramp-and-dump scheme through pig butchering. “After a relationship is established, the bad actor will make a recommendation to the victim to place limit orders in certain securities at a specific time and price.”

Here’s a victim’s devastating story, worth a read: How One Man Lost $1 Million to a Crypto ‘Super Scam’ Called Pig Butchering

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Members Only: Scammer claims involvement in ILAG