Daisy Chain

What Is a Daisy Chain?

Daisy chain is a term for a financial scam conducted by a group of investors in the public equities markets or in real estate. It is similar to a pump-and-dump scheme. These securities market fraudsters work together to buy a particular security and artificially increase the value of the security. They then flip their ownership of that equity to unsuspecting investors who are chasing an upward trend.

Understanding a Daisy Chain

Investors who are unsophisticated and do not look carefully at a stock are usually the victims of a daisy chain. As a stock rises due to the artificially increased volume, investors who do not do their homework are 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 operators have sold 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 a significant influence on the public markets, publicly disseminate faulty or misleading information that encourages other investors to believe the stock is a good investment. Public investors take the information presented at face value and use it in an investment decision to purchase shares of the small-cap stock. This actvity increases its trading volume and demand above normal levels and thus 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 original investors realize a profit on the sale and then subsequently stop the false marketing campaign, allowing the stock to return to normal volume and value levels.

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 a Daisy Chain

Daisy chains in securities 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 of market manipulation in the public markets. Anyone found guilty of participating in such a scheme faces heavy fines and penalties.

The SEC, the primary federal regulator for the securities industry, views all daisy chain activities as fraud under the Securities Act of 1933 and Securites Exchange Act of 1934. When it believes that such fraudulent conduct has occurred, the SEC can seek to impose regulatory penalties, including fines, restitution, and suspensions or bars, seek civil fines in court, or refer the matter to the Department of Justice for possible criminal prosecution which can result in fines and imprisonment.

In real estate, daisy chains are not illegal, but they are frowned upon by many real estate investors who decline to purchased daisy-chained properties. In addition, given the risk of being left out of the payment stream mentioned below, daisy chains in real estate may not be worth doing either.

Daisy Chain in Real Estate

In real estate, a daisy chain occurs when a wholesaler signs a contract with a seller and then assigns the contract to another wholesaler, who then does the same. A real estate wholesaler is in the business of finding under-priced real estate, obtaining a contract on it, and then finding an interested buyer (usually another wholesaler), adding an assignment or finder's fee to the price.

Each wholesaler who assigns the contract to the next wholesaler also marks up the price. The wholesaler profits when the ultimate buyer pays the sale price plus the extra fees. The seller gets its sale price while the wholesalers get the fee. The risk to the chain of wholesalers is that the ultimate buyer will buy from the first wholesaler because it offers the lowest sale price, and the deal will be consummated without informing any of the others in the chain.

Example of a Daisy Chain

In the mid-1990s, the SEC brought and settled a regulatory action against a registered representative (RR) of a registered broker/dealer (BD). The SEC alleged that for a period of about three months, the RR had generated virtually all of the retail demand for a particular stock and controlled the supply, such that demand always exceeded supply.

By doing so, the RR was able to control the artificially high price at which shares of the stock traded in the market. The RR engaged in daisy chain trading with market participants to fill retail customer orders, inducing BDs to enter arbitrary quotes, and marked the close by orchestrating end-of-day trades executed at or near the day's high price for the security.

The BD was alleged to have been involved in the fraud by encouraging its other RRs to cold call their customers to solicit purchases of the stock. The representative was barred for life from the securities industry by the National Association of Securities Dealers, Inc. (NASD, now the Financial Industry Regulatory Authority or FINRA). The BD was expelled from NASD, while the SEC fined the firm $250,000 and the RR $175,000, and ordered ordering restitution in the amount of $536,921. Several states also took regulatory action against the BD and the RR.

Take the Next Step to Invest
×
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.
Service
Name
Description