Attention investors: If you’re thinking about pumping money into cannabis stocks, be very, very careful.
That’s the advice a self-regulatory agency for brokerage firms and exchange markets issued this week. In an alert to investors, the Financial Industry Regulatory Authority (or Finra) said that con artists are increasingly setting their sights on the medical marijuana industry by creating and promoting “potentially fraudulent” companies offering products tied to cannabis and hemp.
The warning highlights the difficulties cannabis investors face at this stage of the industry’s development. Many publicly traded marijuana companies have little in the way of tangible products and revenues, and even some of the few high-profile MMJ firms that offer stock have struggled with credibility and transparency issues.
Aside from trying to determine which stocks will provide a good return, investors often struggle to figure out if a company and its products are actually legit. Spotting the reputable players is not as black and white as it is in other industries.
Additionally, all of the public companies that focus on the cannabis market are “penny” stocks that trade on the over-the-counter market rather than the bigger exchanges such as the Nasdaq, meaning they aren’t subject to many financial reporting requirements. That lack of transparency makes it harder to get a handle on their financial health.
When it comes to MMJ stock scams, Finra said the most common method of luring investors is through “pump and dump” schemes, in which scammers hype a questionable company via press releases, online investing message boards, emails, texts and other methods, artificially inflating the firm’s shares.
“Specifically, fraudsters lure investors with aggressive, optimistic—and potentially false and misleading—statements or information designed to create unwarranted demand for shares of a small, thinly traded company with little or no history of financial success (the pump),” Finra said in its alert. “Once share prices and volumes reach a peak, the cons behind the scam sell off their shares at a profit, leaving investors with worthless stock (the dump).”
Finra cites several examples, though it declined to provide specific company names. In one case, it says a company that moved into the medical marijuana industry issued 30 press releases in the first half of 2013 about its “rosy” prospects and the potential of the MMJ market. Despite a promotional piece saying the stock could double, “the company’s balance sheet showed only losses, and the company stated elsewhere that it was only beginning to formulate a business plan,” Finra said.
Many thinly traded companies in other industries are indeed attempting to move into the medical marijuana sector, offering everything from hemp protein powders to cannabis-based treatments for pets. Some of these may very well be legit, but others raise red flags.
Finra said investors should be wary of companies that frequently change their name as well as those tied to unsolicited emails and messages pumping their stock. It advises investors to do their homework by researching the company’s executives and major stakeholders, knowing which exchange the stock trades on, scanning financial reports and checking the background of the broker/investment adviser who is recommending the stock.
Additionally, Finra said to be cautious when investing in companies that abruptly move from another industry into the medical cannabis sector as well as those run by executives who have been indicted or convicted of various crimes. It points to one company (likely Hemp Inc.) run by an executive who was sent to prison for nearly a decade for “operating one of the biggest drug smuggling operations in US history.”
Still, investors shouldn’t rely on any one of these factors to make their decision. Many successful, reputable executives and entrepreneurs in the cannabis space, for instance, ran afoul of the law for being involved in marijuana at one time or another in the past. The expertise they developed back then could make them qualified professionals today. So it’s important to put everything in context and then make an educated decision.