Obligatory pun aside, this post deals with a serious issue for many retail investors-scam artists who use hot news items to cheat you out of your money. On August 20, 2013, the Financial Industry Regulatory Authority (FINRA) published an Investor Alert warning of potential scams involving marijuana-related stocks. In today’s economic environment, and particularly after so many Americans saw their retirement savings evaporate in 2008, an investment tip promising big returns in a hot new business can be very tempting.
Dubious stock tips are nothing new, of course, and this new batch is born of the media buzz surrounding the current trend toward the legalization of marijuana in the United States. During last year’s general elections, voters in Colorado and Washington passed ballot initiatives to legalize the recreational use of marijuana in those two states. In addition, medical marijuana use is now legal in 20 states. According to a recent Gallup poll, a record 58% of Americans now support legalizing marijuana.
While most news coverage focuses on the social and political aspects of this trend, the economic dimension has also received some attention. Despite its continued illegality under federal and most states’ law, widely-reported estimates place annual U.S. marijuana production at $40 billion per year. If true, this would place marijuana behind only corn ($63.3 billion in 2012) and even with soybeans ($40.2 billion) among the top cash crops in the U.S.
Moral objections aside, who wouldn’t want to get in on the ground floor of a newly-legitimized $40 billion per year industry? Doesn’t this mean that legitimate businesses can now tap into a lucrative market that was previously open only to criminals and drug cartels? Won’t legalization cause this business to expand dramatically? And how can the retail investor get in on the action?
According to a few companies’ press releases, sponsored internet links, and spam emails, the answers to those questions are, “Nobody,” “Yes!” “Absolutely!” and “Buy our stock!!” As FINRA reports in its Investor Alert, one company “promoted its move into the medical cannabis space by issuing more than 30 press releases during the first half of 2013.” The releases “publicized rosy financial prospects and the growth potential of the medical marijuana market,” and sponsored links claimed the company’s stock “could double its price SOON” and was “poised to light up the charts!”
As with any stock, however, the wise investor does his homework before he buys. This is particularly the case when a company’s stock is sold “over-the-counter” (“OTC”), meaning it isn’t traded on an exchange like NYSE or NASDAQ. While there are many great opportunities in OTC stocks, there are great risks as well because many such stocks are not subject to the same reporting requirements as exchange-traded stocks. In addition, because OTC stocks tend to trade at a much lower volume and have a much lower capitalization (“market cap”) than most exchange-traded stocks, they can be particularly vulnerable to price manipulation schemes.
Let us do a little homework on the subject. First, as with so many other statistics, “widely-reported” is not the same thing as “accurate” when it comes to the claim that marijuana is a $40 billion per year cash crop. The popular figures showing marijuana as one of top U.S. cash crops come from a 2006 study by a pro-cannabis activist. As pointed out in a more recent RAND corporation paper, this figure has no factual basis, but rather is based on a purely hypothetical number from an internal DEA memo. The truth is that marijuana production is still a black market activity that cannot be reliably measured.
Second, the cultivation, sale, possession, and use of marijuana is still a crime under federal law, and that law applies in all fifty states. In the 2005 case Gonzales v. Raich, the U.S. Supreme Court upheld Congress’s power to criminalize even purely intrastate commerce in marijuana, and there is no indication that there is any appetite in Congress to repeal federal drug laws any time soon. This means that even if a marijuana-producing business is located in Colorado or Washington, federal authorities may still shut it down, seize its assets, and arrest its owners and employees. This would, of course, present quite a risk to investors.
Finally, to look directly at the company itself, FINRA reports that its balance sheet “showed only losses” and that “the company stated elsewhere that it was only beginning to formulate a business plan. Despite the promises made in the company’s press releases, a prudent investor would be wise to look elsewhere under the circumstances.
When presented with an investment opportunity that looks too good to be true, do your homework, ask questions, and use common sense before you buy. As the saying goes, “tips are for waiters,” and free investment advice from a stranger is probably worth what you paid for it. Often, these tips come from “pump and dump” scammers who buy worthless stock, “pump” up the stock’s value by convincing strangers to buy through spam, internet posts, or through old-fashioned phone calls (known as the “boiler room”), and then “dump” the stock for a quick profit by selling it at the artificially inflated price.
While you can never completely avoid risk while investing, you can minimize the risk of being scammed with caution, preparation, and a healthy amount of skepticism. However, we all make mistakes with our money, and sometimes others unscrupulously take advantage of those mistakes. While it is best to avoid being scammed in the first place, both state and federal law provide remedies to investors who have been taken advantage of through fraudulent or other illegal practices.