Back in December 2022 I covered the story of eight US based social media influencers charged with conspiracy to commit securities fraud for a social media-based “pump and dump” scheme. One of them appears to have done some rapping which is why I covered the story.
The influencers had ripped jeans, tattoos, McLaren cars, those watches that online scammers always wear and contrasting facial hair. They had a YouTube channel called “The Goblin Gang” which claimed to show you what it’s like to be a multi-millionaire day trader and a Podcast called “Pennies – Going in Raw” where I imagine they discussed DCF models and stock valuation methods (I haven’t actually listened to it – I’m not really interested in that stuff) But on all their YouTube thumbnails they had their mouths wide open – in the style of a Wall Street securities analyst or billionaire investor.
The group (all of whom had silly nick names) were accused of engaging in a wide-ranging securities fraud conspiracy in which they used their extensive social media presence to hype interest in penny stocks by posting false and misleading information in order to “pump” the prices of those securities up, while concealing their intent to later “dump” their shares by selling them at the artificially inflated prices. Between January 2020 and April 2022, the defendants are alleged to have made $114 million dollars in profit from their scheme.
Now, some of these actions might sound illegal to you, if you go to the SEC website (for example), pump and dump schemes are described as one of the most common investment frauds, and fraud is usually considered a crime. So, the case looked pretty simple to prosecute at the time as the SEC and criminal prosecutors had access to the eight defendants trading histories, their social media postings, their discord chats and their private communications. And if there is one thing you can be sure of, when people are busy committing fraud, they send lots of emails documenting their illegal activities.
Now, it might have been a struggle for the prosecutors tasked with reading their emails and social media posts, due to their terrible grammar and spelling, but, the original complaint shows that the influencers themselves felt that they were breaking the law and they frequently discussed how to conceal their illegal activities.
We have since learned that they didn’t need to make as much effort concealing their activities as a Texas court recently dismissed all charges against them, ruling that the government failed to state an offense amounting to securities fraud.
According to Matt Levine at Bloomberg – Pump and Dumps are Now Legal – and nothing is securities fraud. And while this might seem like bad news for investors, and even worse news for Gary Gensler (it’s hard to know what his job involves anymore). It is good news for me as I will be able to restructure my YouTube channel, twitter account – and most importantly my Instagram (where I have almost two thousand followers) to show people pictures of cars – and then trick them into buying penny stocks and various crypto tokens.
Cornell Law School describes the steps of a pump and dump scheme on their website – which they still haven’t updated with the news that such schemes are now totally legal. They say that a typical “pump and dump” scheme begins with stock promoters loading up the stock of a microcap company. The promoters then promote or “pump” the stock (possibly by spreading false positive news about it), and if this is successful, the promoters continue to spread good news about the stock, while “dumping” their own position. Once they have sold, they move on, the stock price falls and the people who bought the stock lose their money.
This is a decent description of how such a scheme works, but it leaves out the important first step of showing people pictures of cars on the internet (which is why an Instagram account is so valuable.) They also leave out the bit about writing a memoir while in jail, becoming a motivational speaker and eventually teaching sales training courses.
The whole – go to jail, write a memoir and become a motivational speaker bit is kinda out of date now that Pump and Dump schemes are entirely legal. A good motivational speaker needs that “Heroes Journey” where there is a call to adventure – then some sort of mentor guides you through the early challenges and later a crisis comes along which transforms you.
If a pump and dump scheme doesn’t end with prison time, you just have an influencer who keeps pumping and dumping until people slowly grow tired of them – that’s not much of a book – it won’t be made into a film, and you can’t really give motivational speeches about how people slowly got tired of you and moved on.
While this dismissal may have been bad for investors, it’s even worse for Hollywood. So, why did a District Court Judge dismiss all charges against these defendants, and should you start your own pump and dump scheme as a side gig?
So, what went wrong in this court case? Well, the defendants were accused of committing securities fraud (which is illegal under US federal law) by artificially pumping up stock prices with bullish—and false—pronouncements and claims that they were buying shares while instead selling their positions into the market at a profit while their social media followers were buying. The court’s dismissal raises legal questions about what the government now has to prove to convict a defendant for engaging in a “scheme to defraud” with “intent to defraud” under the federal fraud statutes.
In his dismissal the judge writes that even accepting as true that the victims ultimately lost money on the stock market because the value of their shares went down, the Defendants did not obtain something of value from those who were deceived. The investors trading losses are one step too far removed from the defendants alleged fraudulent misrepresentation. Instead, the property right of the investors that the defendant’s conduct harmed according to the judge was their right to control their assets, or stated another way, was their right to make an informed discretionary decision.
This dismissal relies on two recent cases both interpreting the “scheme to defraud” and “intent to defraud” elements under federal fraud statutes. The securities fraud charge in this case according to the judge required, showing that the defendants intended to harm victims’ traditional property rights by causing them to buy the stock at allegedly inflated (or pumped up) prices. Because the losses to victims happened incidentally rather than as the “object of” the scheme, or because the defendants were totally indifferent to the effect of the scheme on their alleged victims it was OK. So, the trick is that as long as you don’t care about – or don’t think about the people you defraud, it’s probably legal.
This judgement should also help people accused of insider trading, which also involves stock market transactions rather than personal transactions and are similarly aimed at making money rather than depriving a specific person of property.
The judge based his dismissal on a 2023 Supreme Court decision called Ciminelli v. The United States where, a contractor bribed public officials to get a city contract and was convicted of wire fraud. The Supreme Court overturned that decision ruling that that it is not wire fraud to “to deprive a victim of ‘potentially valuable economic information’ ‘necessary to make discretionary economic decisions,” only depriving victims of money is wire fraud.
The other case the judge relied on was United States v. Greenlaw, a case on a “ponzi like” scheme where money was transferred out of one fund to pay distributions to another fund’s investors. The appellants argued that they did not intend to deprive their investors of money or property as a conviction under the fraud statutes requires. In that case the court found that the government had failed to prove that the investments in question were not worth what the investors had paid for them and that the criminal securities fraud statute requires a specific “intent to defraud” not just a “scheme to defraud.”
A northwestern Law Review analysis by Sue Guan of Santa Clara University argues that a ruling that a fraud victim must directly surrender property to a fraudster, means that any investor who buys listed securities on the basis of a fraudster’s misinformation cannot recover. She argues that this ignores longstanding tenets of economic theory and contradicts established securities law doctrine. Further, because the structural reality of today’s markets means that nearly every pump and dump scheme using social media will involve investors purchasing stock on the stock market, the ruling would effectively immunize nearly all fraud perpetrated using social media.
Professor Guan explains in her paper that two foundational concepts underpin the informational focus of US securities laws. First, corporate finance theory teaches that stock prices can be expected to be efficient and act as “information transmission mechanisms.” The more accurate stock prices are, the more efficiently stock markets can help allocate capital and productive resources across the economy. This is the argument that there is a direct link between stock prices and information about the stock.
Securities jurisprudence she explains, reflects this link between stock prices and information. A primary purpose of securities laws is to regulate information in markets. Two aspects of modern securities regulation work together to do this: the disclosure regime and prohibitions against fraud and manipulation. The disclosure regime incentivizes firms to disseminate accurate information, and the antifraud and antimanipulation prohibitions regulate and promote the accuracy of that information.
She highlights that, antifraud and antimanipulation doctrine largely focus on fraud, deceit, falsity, and artificiality and that court opinions in securities fraud and securities manipulation cases are riddled with the concern over the protection of the “integrity of market prices.”
In 1988 the Supreme Court endorsed what is known as “The fraud on The Market Theory” that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business. Misleading statements, therefore, defraud purchasers of stock even if the purchasers did not directly rely on the misstatements.
The Court recognized with this theory that requiring each individual plaintiff to prove direct reliance on a defendant’s alleged misrepresentation would create an unrealistic evidentiary burden. So, while in face-to-face transactions, the inquiry into an investor’s reliance upon information depends on how that information affected the price the investor was willing to pay. With the existence of a market, the market is interposed between seller and buyer and, ideally, transmits information to the investor in the processed form of a market price. Thus, the market is performing a substantial part of the valuation process performed by the investor in a face-to-face transaction. The market is acting as the unpaid agent of the investor, informing them that given all the information available to it, the stock is worth its market price.
Courts recognize that investors who trade in public markets rely on the integrity of that price, and “because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations may be presumed for purposes of law.
The Supreme Court recognized with the “Fraud on The Market Theory” how modern markets work where participants are buying and selling anonymously through market makers, brokers, exchanges ETF’s and investment funds, rarely transacting directly with each other. In such a market you can’t have a requirement that an investor is only able to make a claim if they bought securities directly from a fraudster, because that’s not how modern securities markets work. Because stock prices transmit information, reliance on the integrity of market prices is enough. A fraudster only needs to disseminate a lie or misinformation that is material - to break the law.
To somewhat misquote Matt Levine, if a direct connection between a fraudster and victim was legally required, with the way modern markets work, you would never be able to conclusively prove that the victim traded with the fraudster.
Dr Guan points out in her paper that no such “direct sale” requirement exists in the legal doctrine, nor is any such requirement supported by economic theory.
In the Finfluencer case, the judge’s opinion states that “while the Court acknowledges that defendants allegedly intended to “maximize their own trading profits through their tweets and posts,” it finds that it is the “other half of the equation—harming a victim’s traditional property right—that is lacking” as the only thing the investors were deprived of was of accurate information necessary to make discretionary economic decisions.
I contacted Professor Guan for advice on best practices when running a pump and dump scheme or any other sort of securities fraud. Normally I would worry about putting my plans in writing or discussing them openly here on YouTube – but In this new world where pump and dump schemes are totally legal as long as you don’t think about the victims, I figured it should be fine, and if the SEC wanted to press charges, the courts would likely be impressed by my advance written statement that I’m indifferent to the effect of my schemes on any future potential victims.
Professor Guan seemed unwilling to provide any help in committing financial crimes, I probably need to talk to a “Criminal Attorney” like Saul Goodman.
She did tell me that while the Texas ruling dismissed the indictment against the social media influencers, it appears that the government will appeal the dismissal to the Fifth Circuit (and in fact they filed a notice of appeal in April).
She says that with respect to the overall rule of law, this is a federal district court decision and as such, it basically has no binding legal effect on other courts. She says that If the Fifth Circuit were to affirm the dismissal, that would bind future federal district courts within the Fifth Circuit.
She went on to say that the judgment strikes her as being an outlier. The district court seems to have cast the allegations as falling under a "right to control" theory, a theory that the Supreme Court largely rejected in 2023 in Ciminelli v. The United States. Essentially, the district court said that the indictment alleged a scheme to defraud investors of information rather than money or property. In Ciminelli, the Supreme Court basically rejected the "right to control" theory, ruling that depriving someone of "potentially valuable economic information necessary to make discretionary economic decisions” is not protected by the wire fraud statute, because that kind of information is not a "traditional property interest" like money or property.
In her opinion, in doing so, the district court ignored both the economic reality of the stock market as well as the practical reality of a pump and dump scheme - where the point is certainly to obtain money. Thus, she says that she would be surprised if other courts accepted this theory or this reframing of securities pump and dump schemes.
According to a law dot com article by Elisha Kobre a Dallas based lawyer, an appeal would almost certainly center on the fraudulent inducement theory of fraud that Ciminelli and Greenlaw managed to sidestep. In an appeal from a motion to dismiss, the original indictment’s factual allegations have to be deemed true— meaning that this alternative theory of fraud will be squarely presented and very likely decided, providing clarity to this important issue.
That probably means that I should hold off for a bit to launch my crypto coin, or discord chat where I give “not financial advice.” [clip] For now, I’ll just post pictures of cars on Instagram, as the steps are – post photos of cars, accumulate penny stocks, pump the penny stocks and then dump.
I’ll check with Professor Guan if she thinks I should do one of those influencer coin scams instead – I’ll let you know what she says, as reading through the original case against “The Goblin Gang” they seemed to spend a lot of time discussing how they should cover their tracks, and finesse their pump and dump scheme, an influencer crypto rug pull seems so much easier – you just publicly rip people off – avoid caring about them – to keep it legal – openly admit that you did it, spend the money on an iced out watch and move on.
Thanks once again for tuning in to this week’s podcast – which is entirely funded by listeners like you on Patreon. Talk to you again next week, bye.
