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Top 5 warning signs for cannabis investors

Carl Rowley David Kaufman September 11, 2018

The U.S. Securities and Exchange Commission has issued an alert to retail investors in the cannabis industry following a number of recent enforcement actions. The common thread in these cases is the defendants sought to capitalize on media coverage relating to state-law legalization of cannabis by allegedly defrauding investors.

These cases are an important reminder to cannabis businesses that they are vulnerable to enforcement actions by federal agencies based upon conduct that is neither permitted by nor in compliance with state cannabis laws. For investors, they underscore the importance of due diligence in evaluating investment opportunities in the cannabis industry.

Here are some of the enforcement actions instituted by the SEC between March 2016 and September 5, 2018:

  • In the most recent case, the SEC charged a Texas-based investment fund with defrauding investors with misleading marketing materials and promises of up to a 24 percent annual return on their investments. The complaint alleges that the firm’s founder spent the investors’ money on luxury items and payments to earlier investors to prolong the purported scheme. Following service of the complaint, the founder agreed to an officer-and-director bar and permanent injunction.

  • A similar complaint was filed against another company in May 2018 alleging that the firm made misleading claims about its business operations and a purported celebrity license agreement that never materialized.

  • In a March 2017 complaint, the agency alleged that a Florida-based consulting firm falsely announced in a press release that a Colorado medical and recreational cannabis license had been issued to a newly-founded cannabis business.

  • The same month, a California-based company was accused of misleading investors into believing that the company was a leader in the cannabis industry when, according to the SEC, it was just “round-tripping” money from illegal stock sales to boost revenue.

  • A year earlier, in March 2016, the SEC charged two penny stock issuers and their principals with fraud for issuing false and misleading press releases about its alleged involvement in the cannabis industry. The complaint alleged that the company falsely represented that it had successful cannabis-related partnerships and operations, and that it was earning revenue from its purported business.

These and other recent SEC complaints typically seek disgorgement and payment of fines, injunctive relief barring the alleged offenders from serving as officers or directors of public companies, and other penalties.

The defendants in these cases were not protected from these enforcement actions by the Rohrabacher-Blumenauer Amendment for a number of reasons, including that the alleged wrongful conduct (securities or investment fraud) is not permitted by and is not in compliance with state cannabis laws.

Potential cannabis investors should be on alert for these warning signs:

  1. The seller or promoter is unlicensed or unregistered. The seller’s status can be determined by using the search tool on Investor.gov.

  2. The seller or promoter promises a high rate of return, especially if coupled with claims of low risk; or the company’s press releases contain hyperbole, or implausible or exaggerated claims.

  3. The seller or promoter reaches out to you with unsolicited offers.

  4. Trading of the company’s stock has been suspended.

  5. The company has abruptly changed its name, industry, or business plan, particularly if these have occurred multiple times.

The SEC warns that any company with operations relating to the cannabis industry may be criminally prosecuted for violations of federal law, and that prosecution may affect the value of any investment in any such company.

Thompson Coburn LLP is a full-service provider of legal services to the cannabis industry. Our Securities and Investment Litigation team routinely defends companies in investigations and enforcement proceedings brought by regulatory agencies, including the SEC and State Securities Commissions. We also provides advice to potential investors to minimize the risk of falling victim to fraudulent investment schemes. Our Cannabis team includes first-chair trial lawyers with decades of experience in litigating and trying civil cases of all types through verdict.

David Kaufman is a member of Thompson Coburn’s Securities and Investment Litigation group. Carl Rowley chairs the firm’s Mass Tort Practice and is a member of its Cannabis Practice.

Thompson Coburn advises clients on state laws governing the business of cannabis to facilitate compliance with those state laws. Federal laws concerning cannabis currently conflict with state laws in states that have legalized cannabis or possession of cannabis. Although federal enforcement policy may at times defer to these states’ laws and not enforce conflicting federal laws, interested businesses and individuals should be aware that compliance with state law in no way assures compliance with federal law, and there is a risk that conflicting federal laws may be enforced in the future. In addition to this Cannabis-specific note, readers should review Thompson Coburn’s Conditions of Use / Disclaimers page containing other important information.