What Is a Daisy Chain?
Daisy chain is a term used to describe a group of unscrupulous investors who, when practicing a kind of fictitious trading or wash selling, artificially inflate the price of a security they own so it can be sold at a profit. Small-cap stocks with low liquidity are highly susceptible to daisy chains because price manipulation is typically harder for stocks with high trading volumes.
Daisy Chain Explained
Daisy chain is a financial scam conducted by a group of investors in the public equities market. These investors team up to increase the value of an equity security, and then flip their ownership of that equity to unsuspecting investors who are chasing an upward trend.
Investors who do not look carefully at a stock are usually the prey of a daisy chain. As a stock rises due to increased volume, investors who do not do their homework may be attracted to the stock because they want to participate in the rising price. These investors are typically caught owning a stock that continues to depreciate long after the daisy chain sells out their positions for a profit. In fact, sometimes these unsuspecting investors increase their positions as the stock prices fall, thinking they are buying a dip, only to find the stock will never again reach its unnatural peak.
How a Daisy Chain Scam Works
A group of investors teams up to create a daisy chain by purchasing long positions in a low-priced and thinly traded small-cap stock. The group of investors, who normally have significant influence on the public markets, publicly disseminate faulty information that leads other investors to believe the stock is a good investment. Investors take the information presented and use it in an investment decision to purchase shares of the small-cap stock. This increases its trading volume and demand above normal levels and increases its price.
The group of investors associated with the daisy chain then waits until the small-cap stock reaches peak levels and sells its long position. The investors realize a profit on the sale and then subsequently stop the false marketing campaign so the stock returns to normal levels of volume and value.
For example, Broker I will buy a stock at $50 and sell it for $60 to Broker II, who is also part of the daisy chain. The second broker then sells the stock for $70 to another broker who’s in the chain. Broker I will then buy the stock back at the end of the day for $60. Someone who isn’t part of the chain will see that the stock sold for $60 during the day, and, thinking it’s a good investment because of the $10 price increase, will jump in to purchase the stock.
Punishments for Conducting a Daisy Chain
Daisy chains have become more prevalent in recent years due to the rise of marketing on the internet. The Securities and Exchange Commission (SEC) is therefore tasked with the increased enforcement of punishment for any daisy chains. All daisy chain scams are considered an illegal practice in the public markets, and anyone found guilty of participation can face heavy fines and penalties.