The Six Top Marijuana Scams to Avoid
As cannabis business attorneys, we tend to see and hear more than our share of kooky and downright bad business pitches. Bad business ideas are one thing, but total scams and ripoffs are another. Unfortunately, like any new and high growth industry with complicated and constantly changing rules and regulations, the marijuana industry is chalk full of scammers and ripoff artists.
The following six marijuana scams are the ones we are seeing most often of late. Your job is to make sure you don’t get taken in by any of the following:
1. Marijuana penny stocks. We’ve blogged about these time and time again. Stay away from most marijuana penny stocks. As both we and the SEC keep pointing out, many (but not all) publicly traded cannabis companies are vehicles for investor fraud. As we have written before:
It almost seems that publicly traded stock companies are more focused on selling their stocks than on competing in the market. The herd mentality of investors seems to encourage this. Here’s how that basic logic works: Marijuana is booming. Therefore, marijuana businesses must be booming. In turn, all marijuana businesses must be booming. Therefore, I need to invest in a marijuana business. The only way I can easily invest in a marijuana business is to buy the stock in a publicly traded marijuana business. And so the stocks just keep booming.
All of which leads to pump and dump scams where “the group behind the scam increases the demand and trading volume in the stock and this new inflow of investors leads to a sharp rise in its price. Once the price rise has formulated, the group will sell its position to make a large short-term gain.” Pump and dump scams with publicly traded marijuana companies are still quite popular, so be careful out there.
2. Reverse merger marijuana stocks. Just like penny stock fraud, reverse merger stock fraud is nothing new. In the typical reverse merger transaction, a privately operating company seeks to acquire controlling shares in an already publicly traded company with the goal of acquiring the public company’s listing. Reverse mergers a relatively fast, cheap and easy way for a private company to “go public” without having to go through all of the SEC reporting, disclosure, and registration requirements required by a standard initial public offering. In the reverse merger scam, the underlying publicly traded company is usually just a shell company with little or no assets or positive business history. Because the underlying publicly traded shell has no assets, no real management base, and oftentimes no business at all, the whole point of these scams is to acquire investors and raise capital based on pumped-up stock statistics, prices, and claims before everything eventually goes bust. These scams tend to involve the same subset of marginal accounting and law firms that assist by securing IRS and SEC reporting delays. Like anything else, if you’re looking at acquiring stock in a reverse merger company, do your due diligence and know the red flags.
3. Marijuana franchises. Most marijuana franchise “offers” are just plain garbage because they fail to account for all of the reporting, registration, and disclosure requirements required by federal and state franchise laws and regulations. Franchising is governed by FTC and various state agency rules. Because of the state and federal law conflict with cannabis, franchising a cannabis business is a very risky proposition and we are finding that most cannabis “franchisors” are not providing their potential “franchisees” with nearly enough risk disclosures.
4. Some marijuana trademark licensing structures. Far too many marijuana companies offer trademark and intellectual property licensing agreements to cannabis cultivators, manufacturers, and retailers as a way to spread their brand (as opposed to their products) over state lines. Though definitely a viable legal and business approach, many of the licensing agreements in these deals are being drafted by lawyers who know nothing about the cannabis industry or about intellectual property and IP licensing laws. This leads to licensing contracts rife with errors and omissions and that in the end either fail to transfer any protectable IP assets or even lead to their forfeiture. We have also seen licensing agreements drafted so poorly as to accidentally trigger franchising requirements. For more on what to look for to avoid a really bad IP licensing deal, check out Cannabis IP Licensing: It’s Complicated.
5. Marijuana “crowdfunding.” In May of this year, the SEC released new crowdfunding rules designed to let the small fry swim with the sharks. As of May 16, 2016, companies can solicit $2,000 from anyone (and more in many cases) in exchange for an equity stake in their business. Companies can raise up to $1 million annually through these offerings, which fall under Title III of the 2012 JOBS Act. As we have written before, the SEC does not care whether your business is a pot business, so long as you follow its offerings rules. Though the SEC’s rules for crowdfunding advertising are incredibly strict, we are already getting wind of crowdfunding cannabis companies seeking to skirt these new rules to the detriment of investors.
6. State-illegal marijuana companies. Not all marijuana companies are lawful under state or local marijuana laws, even in cannabis-legal states. In fact, we often see blatantly illegal cannabis companies not only out there operating, but seeking investors and raising funds. Many states outlaw marijuana delivery services, online sales and distributor companies, marijuana telemedicine, marijuana bars and/or vape lounges (see Oregon and Washington), and marijuana events where cannabis is provided by the venue. Make sure you know what’s lawful under state and local law before putting your hard-earned funds or time into a company that’s only going to get shut down or be prosecuted shortly thereafter.