Should Investors Fight The SEC?

Investors are quite familiar with the concept of "don't fight the Fed", which is an adage to beware the power of the Federal Reserve's monetary policy, but what about the SEC? Some believe that the SEC, with its seven suspensions since March in the cannabis sector, has an agenda that extends beyond its own charge. However, there is no evidence that its actions are anything but an attempt to protect investors in the microcap arena. In order to assess the current actions, it is helpful to review the history of FINRA, which is charged with investor protection, and the creation of the SEC Microcap Fraud Task Force last year.

Related: Marijuana Investors Beware: SEC Warns Traders Of Fraud In The Industry

Looking at the SEC first, it is important to note the alert it issued last week after the seventh suspension. It began this warning suggesting that "the SEC’s Office of Investor Education and Advocacy is issuing this Investor Alert to warn investors about potential risks involving investments in marijuana-related companies. The SEC has seen an increase in the number of investor complaints regarding marijuana-related investments." 

It should be clear that the SEC is focused on the entire sector and not just individual stocks in the sector, but the bulk of the warning is related to risks relevant to all microcaps. With that said, the SEC warns investors that "marijuana-related companies may be at risk of federal, and perhaps state, criminal prosecution."

Last summer, the SEC created a Task Force as part of a broader initiative:

"The Microcap Fraud Task Force will investigate fraud in the issuance, marketing, and trading of microcap securities. These abuses frequently involve serial violators and organized syndicates that employ new media, especially websites and social media, to conduct fraudulent promotional campaigns and engage in manipulative trading strategies to amass ill-gotten gains, largely at the expense of less sophisticated investors.

"The principal goal of the Task Force will be to develop and implement long-term strategies for detecting and combating fraud in the Microcap market, especially by targeting "gatekeepers," such as attorneys, auditors, broker-dealers, and transfer agents, and other significant participants, such as stock promoters and purveyors of shell companies."

In a separate press release, the co-chair of the Microcap Fraud Task Force, Elisha Frank, called out the marijuana sector as having new opportunities for fraud given recent legislative changes. The SEC's actions follow two loud warnings by FINRA, including its initial alert last August and a follow-up in January. FINRA has been alerting the public about potential scams for more than a decade, beginning with warnings about anthrax-related and other post-9/11 scams back in 2001 and most recently about Bitcoin. The types of behavior sadly don't change over time, but the topic certainly does. With respect to marijuana, FINRA's initial warning last summer took place after the market had lost over 60 percent of its value from the early 2013 peak. That second warning came after prices more than doubled to begin the year. FINRA lacks enforcement capability, but by working with the SEC, it has certainly impacted the market.

There is little doubt regarding the need for intervention by the regulators, though investors in the sector are struggling to understand why certain companies have been targeted while perhaps more obvious examples of potential fraud have thus far escaped notice. Part of the challenge is that the SEC doesn't provide any sort of update after the end of the two-week suspension. The rapid number of new companies entering the space through reverse mergers earlier this year accompanied by the seven times jump in prices most likely alarmed SEC, as five of the seven suspended stocks have been recently formed companies. Whether investors agree or disagree with the intervention of the regulators, it will serve investors well to understand the regulatory environment.