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The Risk of Cannabis Investing

SEC Continues Crackdown on Weed Companies

By
Tuesday, May 20th, 2014

Dozens of marijuana companies from plant cultivators to pot vendors to equipment suppliers have jumped headlong into the “weed rush” since the state of Colorado legalized marijuana for recreational use at the start of 2014.marijuana joint smoke face

The Securities and Exchange Commission – which oversees the financial reporting of publicly traded companies – treats licensed marijuana-industry companies like any other qualified business, granting them full access to public markets and investments.

But while companies in this new industry are eager to make the most of their newfound freedoms, they must learn to play by the rules. When they don’t, the SEC is right on top of them, trowel in hand, eager in its own right to weed out the unscrupulous.

“The Securities and Exchange Commission announced the temporary suspension… of trading in the securities of FusionPharm, Inc. (“FusionPharm”) of Denver, Colorado, at 9:30 a.m. EDT on May 16, 2014, and terminating at 11:59 p.m. EDT on May 30, 2014,” outlined SEC Release No. 72177 last week.

It turns out the cannabis cultivation equipment manufacturer and distributor was not being completely truthful in its financial reports:

“The Commission temporarily suspended trading in the securities of FusionPharm due to a lack of current and accurate information… concerning, among other things: (1) the company’s assets; (2) the company’s revenues; (3) the company’s financial statements; (4) the company’s business transactions; and (5) the company’s current financial condition.”

Yet FusionPharm is not the only marijuana company to be adversely sanctioned for inaccurate reporting. Since March of this year, the SEC has suspended the trading of five marijuana industry companies for the same reasons noted above plus two more: “illegal activity including unlawful sales of securities and market manipulation”.

What is going on in the marijuana industry? Is there any safe way to get in on the ground floor of this potentially multi-billion-dollar industry?

Seeding Seedy Seedlings

What’s going on in the marijuana industry is the classic but deadly “pump and dump” routine, where companies will talk up the value of their stocks, sell high, talk down their stocks, buy back low, and cycle through again.

In the “pump” phase, the company issues one or more very positive press releases, announcing favorable news, such as the winning of a new contract to supply a large amount of product, a new partnership or merger, or the development of a new process or technology that promises to greatly increase the company’s revenues and profitability.

As the stock rallies on the news, company insiders promptly sell their shares at the higher price, “dumping” stock onto unsuspecting investors who firmly believe the company’s false releases.

A few weeks later, the company issues one or more negative press releases cancelling the good news of the previous release, often citing external factors beyond the company’s control so as not to be found negligent in any way. As the stock corrects back down, the insiders buy back their shares - but at a much lower price and in greater quantity – setting themselves up for another round of profit taking as they ride the Ferris wheel around once again.

How can we know if a company is disseminating inaccurate and fraudulent information? Unfortunately, we can’t always be certain, since companies often receive legitimate good news that lift their stock value as they should.

Still, there are some patterns common to most pump-and-dump scams, and the SEC has issued warnings of what to look for, including:

• the company has been suspended by the SEC for issuing misleading reports in the past,

• there has recently been an e-mail / fax spamming campaign recommending the stock as a great buying opportunity,

• an abnormally large number of shares are owned by company insiders (executives and/or owners),

• the company has issued exceptionally positive press releases that sound very enticing,

• the company is very small, usually a micro cap (market cap below $250 million) or nano cap (below $50 million),

• shares are generally under $1, and the stock trades on the OTC (over-the-counter) market in very thin volume.
The scam works best on penny stocks, since even a small move can multiply a stock’s gains two, five, even ten times over, with thin trading volume accelerating the move.

While the OTC market is a legitimate trading forum where well-run companies trade without any problems, it nonetheless attracts pump-and-dump scams as it exacts far fewer listing prerequisites than the more highly regulated stock exchanges.

As a consequence of these looser listing requirements, “information about microcap companies can be extremely difficult to find, making it less likely that quoted prices in the market reflect full and complete information about the company,” the SEC warns.

The Financial Industry Regulatory Authority (FINRA) has been much more blunt in its warnings against marijuana stocks:

“The con artists behind marijuana stock scams may try to entice investors with optimistic and potentially false and misleading information that in turn creates unwarranted demand for shares of small, thinly traded companies that often have little or no history of financial success.”

And what of those five marijuana businesses suspended by the SEC this year? The above listed fraud-checklist fits all five companies like the fingers of a glove.

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If the Glove Fits - Avoid

Though there likely are many marijuana companies investors should stay away from in these early months of the industry, these five in particular pulsate with bright red danger beacons: FusionPharm (OTC: FSPM), Cannabusiness Group (OTC: CBGI), GrowLife (OTC: PHOT), Advanced Cannabis Solutions (OTC: CANN) and Petrotech Oil & Gas (OTC: PTOG).

The first thing we spot immediately is that all trade on the OTC; no surprise there.

Not surprising either is that three of the five are penny stocks – PHOT at 8 cents, CBGI at under 5 cents, and PTOG at 0.6 of a cent. Meanwhile, FSPM was last at $2.89 before the suspension, while CANN is the only high flier at $15.00 per share.

Nor is it surprising that all five stocks enjoyed tremendous spikes on the release of fantastic news, only to fall right back down again within weeks, as noted in the graph below.

OTC cannabis marijuana pot stocks

Source: BigCharts.com

• PTOG’s spike, not noticeable by comparison to the others, ran 700% from 1 penny to 7 cents within three weeks.

• PHOT rose 1,183% in four months when it surged from 6 cents to 77 cents.

• FSPM spiked 2,300% in two months as it shot from 40 cents to $9.20.

• CANN climbed 3,150% in two months when it ballooned from $2 to $65.

• And CBGI screeched 9,600% in four weeks when it catapulted from half a penny to 48 cents.

Still not surprising is how in every case the stock fell just as rapidly as it rose. What happened to the good news that propelled the stocks higher a few weeks before? Something unforeseen always comes up.

Perhaps the only surprising thing about these stocks is that PTOG is a petroleum and gas company. Yet one of its subsidiaries is the marijuana vendor, Legalizepot.us. As an example of what a fraudulent upbeat press releases sounds like, here’s a snippet from PTOG’s March 13th announcement:

“Legalizepot.us and LP.US Inc… have signed a letter of intent with a large Real Estate group in Seattle, Washington, this week to close on a joint venture to open a series of state of the art ‘green friendly’ cannabis retail outlets in the downtown Seattle area.”

A “large real estate group”; notice the vagueness? And what’s with that “state of the art” description? What could possibly be so state-of-the-art about a marijuana shop?

And of course, there’s the ever convenient “letter of intent”, which can be written on an ordinary paper napkin in a coffee shop, and can be just as conveniently reneged upon when it’s time to deflate the stock price back down.

Greener Pastures Than Hemp

With tens of thousands of solid companies, mutual funds and ETFs to choose from, investors have no defendable reason to plant their money in the seedy underworld of seedling companies of the still immature marijuana industry.

Without a doubt, the industry will flourish as more and more states follow Colorado’s lead in legalizing pot for recreational use in the coming years. But until the rampant fraud is weeded out of the field, investors will find greener pastures on which to graze elsewhere.

Joseph Cafariello


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