Marijuana stock scams: Don't let your money go up in smoke

September 11, 2013: 4:44 PM ET
marijuana stock scams
Federal regulators are warning consumers to be on guard against potential marijuana-related stock scams.
NEW YORK (CNNMoney)

You've probably seen one in your inbox or Facebook newsfeed: an email or posting advertising the next hot investment, with share prices that are sure to skyrocket soon!

With medical marijuana now legal in almost 20 states, shares of companies selling anything related to the drug are being touted as the latest "hot stocks." While such offers may sound tempting, federal regulators are warning they could actually be "pump and dump" stock scams.

Spam emails related to such schemes, marijuana-related or otherwise, have spiked in the past year, the Financial Industry Regulatory Authority said recently.

"Spam email is the bait used to lure people into making bad investment decisions," Cameron Funkhouser, executive vice president of the Financial Industry Regulatory Authority's Office of Fraud Detection and Market Intelligence, said in a statement. "No one should ever make an investment based on the advice of an unsolicited email."

The schemes often work like this: Fraudsters, often paid promoters or company insiders, use emails and posts on social media and message boards to drum up interest in thinly-traded stocks with overly optimistic and, in some cases, false information.

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The buying frenzy that ensues artificially pushes the low share price upwards ("the pump"). The scammers then sell off shares at a profit and flee, at which point the share price plummets, leaving investors with stock that is basically worthless ("the dump").

"These companies often don't have a lot of outstanding shares," said Gerri Walsh, senior vice president for investor education at FINRA. "Prices get driven up so quickly, but can crash again so quickly."

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One marijuana-related company, for example, was touted on the Internet through sponsored links and spam email, including a promo that claimed the stock "could double its price SOON." If an investor did some more digging, though, they would learn the company's balance sheet contained only losses, and it was only beginning to create a business plan, according to a FINRA release.

No enforcement actions have been filed related to a specific marijuana-related company or stock, Walsh said. The Securities and Exchange Commission, meanwhile, could not confirm whether there were any investigations taking place.

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"The scams use emotion to get people out of the logical part of their brain," Walsh said. "We want people to step back and take a breather so they are investing based on logic, not emotion."

In order to avoid getting caught in a scheme, make sure to do your research before you invest any of your hard-earned cash, she said. Here are some other tips to consider before investing in the "next big thing."

  • Consider the source. Tread carefully with companies that issue a flood of press releases or other promotions in a short time period.
  • Find out where the stock trades. Most unsolicited investment advice involves stocks that trade on over-the-counter platforms, as opposed to national securities exchanges, like NASDAQ or the New York Stock Exchange.
  • Do your research. If a company's stock is traded publicly, then information on the company should be available publicly. Read through the company's filings with the Securities and Exchange Commission. Search the names of key corporate officials, as well as the company itself, and proceed with caution if you find recent criminal indictments, convictions, civil suits or investigations, as well as securities or trading violations.
  • Look up the person selling the stock or investment. Legitimate investment salespeople must be properly licensed and work for firms registered with FINRA, the SEC or a state securities regulator. To check a broker or investment adviser's background, use FINRA's BrokerCheck site.

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