Seniors [are] particularly vulnerable to investment scams’ read one news headline. ‘We are taking further steps to find and eliminate from our system pump-and-dump scammers, those who prey on retirees’, noted Jay Clayton, the Chairman of the Securities and Exchange Commission. The perception that those who are duped into buying into such fraudulent schemes are the elderly and the most vulnerable has long been claimed in the news, movies like the Wolf of Wall Street, and even regulators. Yet, do we actually know who invests in pump-and-dump schemes? It is a critical question as designing effective investor protection requires understanding who invests and why.

In our paper, we intend to shed light on investor participation in pump-and-dump schemes. Our analysis combines a large set of frauds provided to us by the German supervisory authority, BaFin, along with trading records for over 110,000 individual investors from a major German bank. The confidential trading records not only allow us to assess the returns or losses of individual investors that participate in pump-and-dump schemes, but also contain information about the characteristics of participating investors, their trading behavior and their portfolios. Using this data, we can examine some of the common perceptions —or as we find, sometimes misperceptions— on who invests in pump-and-dump schemes.

Frequency of investment: We find that participation in pump-and-dump schemes is quite common. Nearly 6% of the investors in our sample invest in at least one pump-and-dump scheme during our sample period of 2002-2015. Moreover, in any given year, there is a 2% chance that a sample investor would take a position in at least one tout campaign. This amounts to a considerable amount of trading in such frauds: we document 6,569 individuals making over 20,000 purchases during the first 60 days of 421 pump-and-dump schemes.

Characteristics of tout investors: When compared with other equity investors that do not invest in promoted stocks, we find that tout investors tend to be older, male, less wealthy, living outside of cities, and having a higher self-assigned risk tolerance for investments. However, personal characteristics alone can only explain the propensity to become a tout investor to a limited extent. Instead, we find that tout investors can be better identified based on their portfolio composition and past trading behavior. Specifically, we find that tout investors hold substantially larger shares of risky penny stocks, lower shares of blue chip stocks, and more individual stocks overall.

Size of pump-and-dump investments and investor losses: Investments in pump-and-dumps tend to be considerable and comparable in size relative to other equity investments made by these investors. Investors put on average close to €7,000 into a tout, which is sizeable relative to their average portfolio value (11.4% of its total value). By comparison, the average investment outside pump-and-dump schemes for these investors is around €6,000. As would be expected, tout investments on average produce considerable losses with the average return to a pump-and-dump scheme being -28%. Aggregating losses across investors in our sample, we estimate that the average tout generates losses for German online investors alone that exceed one million euros. This illustrates that pump-and-dump schemes are not small financial crimes.

Repeat pump-and-dump investors: Given the significant negative returns to tout investments, it is perhaps surprising that we find a considerable number of individuals investing in more than one tout (36%). In fact, roughly 11% of the tout investors even place money in four or more touts during the sample period. These multi-tout investors perform less poorly in their initial tout investments, but they still lose on average 24% across all their touts. These investors place larger-than-average investments and have a large fraction of penny stocks in their portfolios.

The frequency with which some investors invest in touts as well as the composition of their portfolios suggests that not all tout investors are gullible or fall prey to pump-and-dump schemes. Instead, it appears that some investors seek out pump-and-dump schemes and view them as gambles or lotteries.

Types of investors in pump-and-dump schemes: To assess the characteristics of tout traders and better understand the vulnerability of retail investors to tout schemes, we group investors based on their past trading behavior in non-tout stocks. By relying on their prior non-tout trading to characterize types and their investment behavior, we can assess how the likelihood of participation differs across types of investors. We find that more than 35% of the tout investors have been day-trading in penny stocks or are frequent traders with short investment horizons. These investors appear to be willing to take substantial risks and trade aggressively also in other stocks. We find that these investor types are more likely to invest in touts, place larger bets and have relatively better returns.

Broader ramifications on portfolio and later trading behavior: Finally, we find that investors’ subsequent investment behavior is associated with prior tout performance. Specifically, investors with relatively poor returns in their past tout are less inclined to invest in another tout or may stop trading all together. Those with more positive returns invest more quickly into the next tout and stay in for a longer period (which tends to hurt performance and perhaps indicates overconfidence). Moreover, we find that, even three years after the tout, investors who lost money in a pump-and-dump campaign still make fewer equity trades than before the tout. Thus, we find some evidence that participation in a pump and-dump campaign can have a lasting effect on the behavior of some investors.

Overall, our analysis contributes to a more nuanced understanding of market manipulation and investor protection. Our findings highlight the significant heterogeneity among investors participating in deceptive market manipulation like pump-and-dump schemes. There appear to be several types of individuals, including investors who trade infrequently and perhaps are more vulnerable. But there is also a substantial fraction of investors who trade frequently and often day-trade in penny stocks. These investors are more likely to gamble with tout stocks, rather than being fooled by the schemes. Importantly, we find that demographics provide only limited insights into who participates in pump-and-dump schemes. Instead, portfolio characteristics and past trading behavior, which are probably indicative of the trading motives, play a much larger role.

In sum, the ‘Wolf of Wall Street’ still causes considerable damage to investor portfolios. But our investigation indicates that the common perceptions of who, on average, is most adversely affected may need to be reconsidered. The results also suggest that a more nuanced approach to investor protection in the microcap space might be worth considering.

Christian Leuz is the Joseph Sondheimer Professor of International Economics, Finance and Accounting at the University of Chicago's Booth School of Business.

Steffen Meyer is a Professor Leibniz Universität Hannover.

Maximilian Muhn is a PhD Candidate at Humboldt University of Berlin.

Eugene Soltes is the Jakurski Family Associate Professor of Business Administration at Harvard Business School.

Andreas Hackethal is a Professor of Finance at Goethe University in Frankfurt.