FINRA Updates Warning: Marijuana Stock Scams
Update: In early January 2014, new laws regarding the legalization of marijuana for medical and recreational purposes went into effect in a number of states. At the same time, media coverage of the issue increased, as did investor interest in shares of marijuana-related companies. In some cases, volumes for the stock of otherwise thinly traded, marijuana-related companies increased dramatically—and prices became quite volatile.
We are reissuing this alert to warn investors not only about the potential for fraud in this arena, but also to reiterate the risks of investing in thinly traded companies about which little is known. Regardless of industry sector, any so-called "hot" stock can burn your portfolio. Rather than getting swept away, take time before you invest to learn more about the company, its products or services and the people running it. And be sure you carefully assess the company’s prospects for success.
With medical marijuana legal in almost 20 states, and recreational use of the drug recently legalized in two states, the cannabis business has been getting a lot of attention—including the attention of scammers. FINRA is issuing this alert to warn investors about potential scams associated with marijuana-related stocks.
Spotting a Potential Scam
Like many investment scams, pitches to invest in potentially fraudulent marijuana-related companies may arrive in a variety of ways—faxes, email or text message invitations to webinars, infomercials, tweets or blog posts. Regardless of how you first hear about them, the offers almost always contain hallmarks of "pump and dump" ploys. 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). 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).
One company, for example, promoted its move into the medical cannabis space by issuing more than 30 press releases during the first half of 2013. These releases publicized rosy financial prospects and the growth potential of the medical marijuana market. The company was also touted on the Internet through the use of sponsored links, investment profiles and spam email, including one promotional piece claiming the stock "could double its price SOON" and another asserting the stock was "poised to light up the charts!" Yet the company's balance sheet showed only losses, and the company stated elsewhere that it was only beginning to formulate a business plan.
Smart Tips
To avoid potential marijuana-related stock scams:
Ask: "Why me?" Why would a total stranger tell you about a really great investment opportunity? The answer is there likely is no true opportunity. In many scams, those who promote the stock are corporate insiders, paid promoters or substantial shareholders who profit handsomely if the company's stock price goes up.
Consider the source. It's easy for companies or their promoters to make exaggerated claims about lucrative contracts, the company's revenue, profits or future stock price. Be skeptical about companies that issue a barrage of press releases and promotions in a short period of time. The objective may be to pump up the stock price. Likewise, be wary of information that only focuses on a stock's upside with no mention of risk.
Do your research. Search the names of key corporate officials and major stakeholders, as well as the company itself. Proceed with caution if you turn up recent indictments or convictions, investigative articles, corporate name changes or any other information that raises red flags. For example, the CEO of one thinly traded, yet heavily touted, company that purports to be in the medical marijuana business spent nine years in prison for operating one of the largest drug smuggling operations in U.S. history. The former CEO of a similar company was recently indicted for his role in a multi-million dollar mortgage-based Ponzi scheme. Check the Federal Bureau of Prisons Inmate Locator to determine if a solicitation is coming from someone who has served time in a federal prison. Many states also have similar prisoner locator systems.
Know where the stock trades. Most unsolicited spam recommendations involve stocks that do not trade on The NASDAQ Stock Market (NASDAQ OMX), the New York Stock Exchange (NYSE Euronext) or other registered national securities exchanges. Instead, these stocks may be quoted on an over-the-counter (OTC) quotation platform like the FINRA-operated Over-the-Counter Bulletin Board (OTCBB) and the platform operated by OTC Markets Group, Inc.
Generally, there are no minimum quantitative standards that a company must meet to have its securities quoted in the OTC market.
Many of the securities quoted in the OTC market don't have a liquid market. They're infrequently traded and can move up or down in price substantially from one trade to the next. This may make it difficult to sell your security at a later date.
Read a company's SEC filings, if available. Most public companies file reports with the Securities and Exchange Commission (SEC). Check the SEC's EDGAR database to find out whether the company files with the SEC. Read the reports and verify any information you have heard about the company.
Remember that just because a company has registered its securities or has filed reports with the SEC does not mean it will be a good investment—or the right fit for you. Also, be aware that not all financial information filed with the SEC, or published elsewhere, is independently audited. Unaudited financials are just that—not reviewed by an independent third party.
Be wary of frequent changes to a company's name or business focus. Name changes and the potential for manipulation often go hand in hand. One low-priced stock now claiming to be in the medical marijuana business has had four name changes in the past 10 years. Another company switched from the coffee business to focus "on the rapidly emerging medical marijuana industries." Name changes can turn up in company press releases, internet searches and, if the company files periodic reports, in the SEC's EDGAR database.
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