Investing In Marijuana Stocks? Don't Let Your Money Go Up In Smoke

I don’t think I’ve ever written an article that had so many opportunities for pun placement, but I held back because risky investments are no laughing matter (as a huge fan of puns, I couldn’t resist some of the temptation). This industry has been called the wild west of investing, littered with overvalued companies and scams. Despite the high risks, many investors are wondering if they should be 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.

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? Well, 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

Fusion Pharm, a marijuana stock, price decline after the company had been charged with fraud.

FIGURE 1: WHEN THE SEC CHARGES A COMPANY WITH FRAUD. Investors in Fusion Pharm (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.  Data source: Standard & Poor’s. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

Federal and State Marijuana Laws

Eight states and Washington D.C. have legalized the recreational use of marijuana, and 44 states have laws governing medicinal use. 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, 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”. You read that right, the Cole memo leaves the door open for federal enforcement, but these are the specific priorities the memo said the federal government should focus on preventing:

• 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

Legalization in Canada

Canada legalized marijuana for medical use in 1999. Medical use faced tight regulations at first, but those have loosened over time. Now Prime Minister Justin Trudeau is following through on one of his campaign promises. He recently introduced legislation to legalize recreational marijuana use and, if all goes according to plan, the Canadian government hopes to allow legal sales by the middle of next year.

Canada’s proposed law requires purchasers to be at least 18 years old and limits the amount you can have to 30 grams, which is close to the recreational use amounts allowed in Colorado and California. The Canadian government will license and supervise commercial growers, similar to the current regulations they have in place for the cultivation of medical marijuana. The proposed law would eliminate certain legal risks for Canadian companies that American companies are still exposed to.

Investing in Medical Marijuana Stocks

There are pharmaceutical companies developing cannabis-based treatments for a variety of uses. Several have developed marijuana-based treatments that have been approved by the Food and Drug Administration (FDA), and others are in the process. These companies operate legally under federal and state laws, with stocks listed on major exchanges with strict reporting requirements.

At the end of the day, only you can decide what to invest in. If you’re considering investing in marijuana stocks, do your homework and research the company as much as possible. 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, it might be a good idea to wait until the industry has matured.