Stock Spam Is Effective at Manipulating Shares

Times may have changed, but stock scammers are still driven to make a quick buck through any illicit means necessary. Thanks to technology, all it takes today to manipulate prices is a computer and high bandwidth. By sending out loads of spam using come-ons like "ride the bull" and "fast money" to hype tiny over-the-counter stocks, scammers drive up prices and then dump their shares. Subsequent buyers are left to discover the company's prospects weren't so bright after all.

Yes, it's illegal. Yes, regulators are cracking down on the practice. In March, the Securities and Exchange Commission suspended trading for 35 companies that were the subject of spam email campaigns. The move was part of a larger effort called "Operation Spamalot," in which the SEC is targeting microcap stocks traded on the Pink Sheets.

Despite the regulatory crackdown, the bottom line is stock spam works. According to research by Rainer Böhme and Thorsten Holz in their 2006 paper, "The Effect of Stock Spam on Financial Markets," email campaigns are successful in temporarily boosting share prices and trading volumes. The day a stock spam email hit in-boxes, Böhme observed a 215% increase in trading volume. And over the first few days from when the spam is received, the stock sees a "cumulative abnormal positive return," he adds.

Stock spamming is a profitable business model. The price run-up, however, lasts for only a few days, says Böhme, an assistant professor at Technische Universität Dresden in Germany. By the fourth day after the spam was sent, the price turns negative, says Böhme, who is currently working to expand his research to include more data.

So who actually buys the stuff touted in spam? The study's authors attribute the dynamics in traded volume and prices to three groups: the spammers themselves, who trade the stock to profit from their campaigns; "naive recipients" — suckers, essentially — who believe in the faux investment advice; and "smart recipients," who try to get in on the action they know is coming from the other two groups.

"It is not irrational to buy the stock if you know the campaign is just about to start and you suspect the abnormal returns will increase in the next one or two days," says Böhme.

We asked Böhme about his findings, why spam works only up to a point and why it's not going away anytime soon.

SmartMoney.com: Your results show that stocks experience positive abnormal returns for the day of spam and two days after, then negative abnormal returns for the first, third and fourth day after the day of the spam. The movement seems a bit erratic.

Rainer Böhme: We have a bit of fluctuation. It's puzzling when you look at the daily abnormal returns. We don't put too much emphasis on those daily returns. We work with the end of the data; it's much more interesting to look at the cumulative abnormal returns. From the cumulative point of view, the returns are positive until the fourth day. They turn negative on the fourth day. So it's around plus-two percentage points on the first day (the day of the spam message), then the fourth turns negative.

SM: Are the spammers the ones who are doing the buying and selling of the stocks?

RB: Our story is that somebody wanted to dump a lot of stock of these companies and they hired someone to promote the stock, to first increase the price and increase the volume. The lower the volume, the more market impact you have [on the stock price].... We think people who want to sell these stocks ask some agent to provide the volume, and these spammers create the volume.... The person who wants to sell the stock could be a shareholder, an investor or even the spammer. We don't know; we just observe the reactions.

So if you're a shareholder in a company and you want to get rid of stock, you can't sell shares without affecting the price negatively. So you want a stable price while you disinvest. These stocks are very illiquid. There are days when the company is not traded at all.... This is one of the main motivations: People want to disinvest, they want to create volume to allow them to sell at stable or inflated prices.