Scams in the Cannabis Industry
Cannabis!! It seems that news about Cannabis is everywhere nowadays. A recent New York Times article estimated that 44 million people in the US were using Cannabis products and that Cannabis businesses might be a great way for the general public to latch onto the exploding world of all things Cannabis. The hotshot CEO of Med Men, the largest Cannabis distributing company in the US suggested recently that “if you don’t get a piece of Cannabis, Cannabis is going to take a piece of you!” In 2017 investors poured $500 million into private Cannabis businesses. BUT, Cannabis investing including medical marijuana investments can be very risky for reasons that we will explore in this article. One of the biggest risks in Cannabis investing is a variety of different scams which you should beware of if you are considering making an investment in Cannabis industry stocks. An investment in a Cannabis business could be a part of the content of sound financial planning but it will require careful consideration of your options.
First of all, we might define what a scam is. A scam can be defined as a dishonest scheme or fraud according to Webster “a fraudulent or deceptive act.” The Business Dictionary defines a scam as “ a fraudulent scheme performed by a dishonest individual, group or company in an attempt to obtain money or something of value.” In the past scams often involved individuals claiming to be authority figures like doctors or lawyers or in the case of investments, people could claim to be investment advisors with special knowledge of the stock market. With the advent of the internet new forms of scamming appeared which could affect large numbers of people in a short period of time such as phishing, IRS misrepresentation, lottery scamming, requests for help, or claiming to have a large amount of money due to the person being scammed.
How does all of this relate to the burgeoning Cannabis Industry? Because this industry has expanded so rapidly in the past months and years, there is a general belief that there is a lot of money to be made as an investor in this industry. In fact, there are many difficulties for the proprietors of businesses in the Cannabis Industry whether growers, processors, shippers, or distributors. These difficulties include the conflicts between Federal and State laws regarding Cannabis growth, distribution, and use and importantly the competition of unlicensed marijuana businesses with legitimate ones.
Once and often still, Cannabis companies were and are looked upon as windfall tax sources for states, counties, and municipalities but these tax burdens on legitimate Cannabis businesses have resulted in increased pricing at the distribution level so that, in fact, there remains much more revenue in illegitimate Cannabis businesses than in legitimate ones. Nevertheless, there is a general perception that there are tons of money to be made in Cannabis businesses and therefore the opportunity for scams is out there. The Financial Industry Regulatory Authority (FINRA) has published an investor alert report which provides investors information about marijuana stock scams. In this article, we will help you to better recognize signs of fraud and market manipulation.
What are the 6 Biggest Cannabis Scams to be avoided?
Investing in Cannabis Penny Stocks.
Perhaps we should consider what penny stocks are before we relate them to Cannabis businesses. Penny stocks, also known as micro-cap stocks, nano-cap stocks, small-cap stocks, or OTC stocks, are common shares or securities of small public companies that initially are trading at low prices per share. It is also a term for inexpensive stocks that subsequently become highly lucrative holdings. Penny stocks typically sell below $5 a share and many sell below $1 a share and thus the designation of “penny” stocks.
Penny stocks are attractive for small investors because of their low price and the possibility of large gains when starting from such a low price but Penny Stocks are ripe for scammers. One of the main scams is the so-called “pump and dump” scam. In this scam, the price of Penny Stocks is artificially and rapidly raised by large purchases by scammers in companies, including Cannabis companies, with few assets and little revenue. When the Penny Stock prices are high the scammers sell off leaving the other investors with worthless stock. It was estimated that by 1989 Penny Stock scammers, often perpetrated by organized crime were fraudulently gaining $2 Billion a year from duped investors!!
Cannabis Penny Stocks are attractive to stock buyers not only for their low prices but also because of the general euphoria about Cannabis which says that Cannabis is booming, therefore Cannabis businesses are booming so why don’t I get on the bandwagon and go along for the ride and make a bundle of money?? The problem is that many, if not most, public traded Cannabis companies are not very sound financially and are primarily in the business of raising their stock prices rather than operating a valuable company. Some Cannabis business lawyers were asked recently if they would invest in publicly traded Cannabis companies and their responses ranged from “no way” to “are you kidding!” So, the bottom line is that trading in Cannabis Penny Stocks is risky and you may be more likely to lose than to gain.
An example of a penny stock company is the medical marijuana company called Medical Marijuana Inc. a holding company with many subsidiaries in hemp-related businesses. MMI has been around since 2008 and in 2015 its stock sold for 15 cents a share. It reached a peak of 20 cents per share but currently, the Medical Marijuana Inc. stock price is only 4 cents per share!
Reverse merger Cannabis Stocks.
What is a reverse merger? In a typical reverse merger, also known as a reverse takeover, a privately operating company seeks to acquire controlling shares in an already publicly-traded company with the goal of acquiring the public company’s listing on a stock exchange. In this way, the private company now has a listing on a stock exchange without going through the requirements of the Securities and Exchange Commission (SEC) for reporting and disclosure which would be required if that private company wanted to make an initial public offering of its stock. A reverse merger is a fast, legal, and relatively inexpensive way of getting its stock for sale on a stock exchange but the goal, as with Penny Stocks, is often to induce stock buyers to invest in that company when in fact there is no real “company” at all in the form of a management base, company assets and oftentimes no business at all. The whole point of these scams is to acquire investors and raise capital based on pumped-up stock statistics, prices, and claims before everything eventually goes bust with the scammers pocketing the money paid for the shares and the investors holding the empty bag of worthless stock! Consequently, if you are looking to invest in stock in a Cannabis business, do your due diligence and beware of reverse merger companies.
Cannabis business franchises.
You are probably familiar with companies that offer franchises but what exactly is a franchise? According to the Business Dictionary, a Franchise is an arrangement whereby one party grants another party the right to use its trademark or trade-name as well as certain business systems or processes. The franchisee usually pays a one-time franchise fee plus a percentage of sales revenue and in exchange gains immediate name recognition, known products, standard building arrangements, and business practices. Franchising is regulated by the Federal Trade Commission (FTC) as well as by various state and federal laws and this is where Cannabis business franchising runs into trouble. The conflicts between federal and state laws that regulate marijuana businesses make franchising a dangerous gamble. Even for legitimate business franchising, the various state and federal laws for reporting, registration, and disclosure are complex requirements to meet. It appears that most Cannabis business-related franchisers do not provide sufficient benefit to the franchisee to make it possible for Cannabis franchisees to prosper.
Cannabis trademark licensing agreements.
Many Cannabis businesses offer trademark licensing agreements to Cannabis growers, manufacturers, and retailers in an effort to expand their brand recognition often across state lines. Cannabis businesses may offer to license various intellectual property (IP) to others in an effort to consolidate their brand name as prominent in the Cannabis business field. Given the extensive experience in the Cannabis business prior to legalization, it may be difficult or impossible to determine what entity actually owns certain IP and therefore is legally able to license it.
Crowdfunding is strictly regulated by the Securities and Exchange Commission (SEC) which in May 2016 changed the rules to allow anyone with a minimum of $2000 to invest in and obtain an equity share in a company without buying stock on a stock exchange. Previously, the SEC policy required an annual income of $200,000 or net worth of at least $1 million to make a direct investment in a company via crowdfunding but with the new rules, small-time investors can now participate in and take the risks associated with crowdfunding. The SEC also regulates advertising for crowdfunding by companies seeking to attract individuals to invest directly in their companies but a recent article suggests that anyone who is considering investing in a Cannabis business via crowdfunding should be aware of possible deceptive advertising and perform their own due diligence before making that kind of investment.
Illegal Cannabis Companies.
Currently, at least 33 states allow medical marijuana use, and 11 also allow recreational use but even in those states where marijuana use is legal, some county or municipal governments do not allow Cannabis companies to operate. Furthermore, certain types of Cannabis businesses such as Cannabis delivery services, online sales, and distribution companies, telemedicine companies related to Cannabis, and marijuana bars or vape lounges may be illegal. When considering an investment in a Cannabis Company be sure that you investigate whether the company adheres to the laws within whatever jurisdiction it operates before you invest your hard-earned money.
On the other hand, there is a potential for real profits in the Cannabis Industry. For example, Canopy Growth, a Canadian Cannabis company, shares could be purchased for $1.76 Canadian dollars in May of 2016 but are now trading at $24.89 Canadian dollars an almost 1400% gain!
And those who have bet against Cannabis stocks using the mechanism called “short selling” have lost millions. During August of 2018, for instance, short-sellers of Cannabis stocks lost $626 million!
So the bottom line is this: there are great opportunities for investment in Cannabis businesses but there are also substantial risks unless you are a wise investor and are able to evaluate any Cannabis company investment option carefully before parting with your hard-earned cash! And just because a big-time name like former Speaker of the House John Boehner’s name is attached to something called the “American Marijuana Summit” doesn’t mean that is a good source of information for you as a potential Cannabis investor. Perhaps a better place to start is on the website of the US Securities and Exchange Commission which recently provided an “Investor alert: marijuana investments and fraud.” Many investors rely on investment advisors or brokers for advice about what investments to purchase but a recent article advises you to be careful when taking investment brokers advice because they may not have good information about the rapidly changing business of Cannabis and they may have ulterior motives like guiding you to stocks that their company specializes in. And there are many online sites with advice on how to begin investing in Cannabis stocks but as a recent Wall Street Journal article indicates, not all investment options or advice are alike.