Buyer Beware: Investing In Marijuana Stocks

This industry has been called the wild west of investing, littered with overvalued companies and even scams in some cases. Despite the high risks, many investors have been considering investing in marijuana stocks.

Anytime you invest you need to know what you’re getting into and, as always, do your research. There are unique differences between investing in this budding industry and more established ones. If you’re set on investing in this space, it’s a good idea to know the warning signs of scams, differences between federal and state laws in the United States, and what’s going on with legalization in Canada. You might also be interested in learning about one area that isn’t operating in violation of federal laws.

Getting Bubbly: This video highlights some risks and considerations investors must take into account before entering this volatile and unproven market.  

Tips to Avoid Marijuana Stock Scams 

When FINRA—the organization authorized by Congress to protect America’s investors—finds it necessary to issue Investor Alerts on marijuana stock scams, alarm bells should be ringing. Still not shying away? Be sure to also check out the U.S. Securities and Exchange Commission’s Investor Alert on marijuana-related investments. 

According to the SEC, “fraudsters often exploit the latest innovation, technology, product, or growth industry—in this case, marijuana—to lure investors with the promise of high returns”. Many marijuana companies are penny stocks trading on over-the-counter, or OTC, markets. For the most part, there is limited publicly-available information on these companies and the SEC warns investors to be cautious if these red flags are present: 

• SEC trading suspensions 
• E-mail and/or fax spam recommending a stock
• Insiders own large amounts of stock 
• False and/or exaggerated press releases 

Beyond the SEC’s tips, other behaviors that investors should be cautious around include frequent name changes as well as a pattern of shifting business strategies—like when an iced tea company turns into a blockchain company, or a blockchain company turns into a cannabis company, for example. 

When the SEC charges a company with fraud. Investors in Fusion Pharm Inc. FSPM, once a hot marijuana stock, lost virtually all of their money after the Securities and Exchange Commission suspended trading in the stock and charged the company and its officers for violating registration and antifraud provisions of the federal securities laws. Chart source: thinkorswim^® by TD Ameritrade. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

Federal and State Marijuana Laws

Nine states and Washington D.C. have legalized the recreational use of marijuana, and 46 states have laws governing medicinal use. Both medical and recreational laws vary from state to state, which adds complexities that can result in companies or individuals violating state production and distribution laws. 

An even greater source of uncertainty for companies is that all these activities are illegal under federal law because marijuana is still a Schedule I substance under the Controlled Substances Act. The U.S. Drug Enforcement Administration defines Schedule I substances as “drugs with no currently accepted medical use and a high potential for abuse.” How are these companies getting away with it then?

Under the Obama administration, former Attorney General James Cole issued a memo outlining the federal government’s priorities on marijuana enforcement. It instructed Justice Department attorneys and law enforcement to “focus their enforcement resources and efforts, including prosecution, on persons or organizations whose conduct interferes with any one or more of these priorities, regardless of state law”:

• The distribution to minors
• Revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels
• The diversion of marijuana from states where it is legal under state law in some form to other states
• State-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity
• Violence and the use of firearms in the cultivation and distribution of marijuana
• Drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use
• The growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands
• Marijuana possession or use on federal property

However, the new Attorney General, Jeff Sessions, issued his own memo at the beginning of the year, which basically voids previous memos like the Cole memo. The gist of it is Attorney General Sessions said “prosecutors should follow the well-established principles that govern all federal prosecutions,” and that the existing Federal laws “reflect Congress’ s determination that marijuana is a dangerous drug and that marijuana activity is a serious crime.” 

Since that memo’s release in January, President Trump told the press he’d support a bill that would legalize marijuana. So you can see the situation is not only a little murky and confusing, it’s changing regularly.     

Legalization in Canada

Canada legalized marijuana for medical use in 2001. Medical use faced tight regulations at first, but those have loosened over time. More recently, Prime Minister Justin Trudeau followed through on his campaign promise to legalize it recreationally. The bill passed Canada’s Senate June 19 this year, and regulated sales are expected to start October 17.

Just like the use in the U.S. states where it is legalized, research the company as much as possible, using source information like 10-Ks and 10-Qs that are filed with the SEC. These source documents provide extensive information about the business and outline risks, which can help you make a more informed decision. 

Thorough research might help you avoid investing in a sham company that could result in you losing your entire investment. If you’re having doubts or can’t afford the potential risk, it might be a good idea to wait until the industry has matured.