Pot stocks: Don’t do drug scams

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The medical marijuana business may very well be big business at some point. And hey, maybe recreational, too; who knows? For now, basically all of the public cannabis companies trade in the over-the-counter market, which makes them penny stocks.

The over-the-counter, or OTC, market  is notoriously volatile and less regulated than exchanges such as the Nasdaq or the New York Stock Exchange. The relative lack of regulation makes penny stocks the province of very, very small companies or scam artists, as well as foreign companies that don’t want or can’t afford the regulatory hurdles of listing on an exchange.

At the end of August, the Financial Industry Regulatory Authority, more commonly known as FINRA, issued a warning about investment scams in marijuana stocks. Here’s what it had to say.

Regardless of how you first hear about them, the offers almost always contain hallmarks of “pump and dump” ploys. Specifically, fraudsters lure investors with aggressive, optimistic — and potentially false and misleading — statements or information designed to create unwarranted demand for shares of a small, thinly traded company with little or no history of financial success (the pump). Once share prices and volumes reach a peak, the cons behind the scam sell off their shares at a profit, leaving investors with worthless stock (the dump).

Medical marijuana is legal in nearly half of all states, and recreational use was approved by voters in Colorado and Washington. People are thinking, “Maybe this is the next big thing” — and scam artists know it.

“That is the message of FINRA: Be careful. There are people out there that are focused on marijuana stocks because they are hot,” says Alan Brochstein, CFA, a securities analyst and founder of the website 420Investor.com.

“Unfortunately, there are unscrupulous people out there, and they jump on certain topics when they’re timely and try to separate people from their wallets,” he says.

To avoid investment scams in general, shun unsolicited pitches for investments, and do plenty of homework.

But I do want to invest in cannabis

So the question is, can regular small investors confidently invest in cannabis companies? Not just yet — unless you want to gamble on penny stocks.

“I’m not pointing anyone toward it, but I’ve been following this market for seven months. It’s a huge thing economically. They call it ‘the green rush.’ It’s going to create jobs and tax revenue, taking money from the illegal dealers and putting it into legitimate taxpayer hands,” Brochstein says.

“Unfortunately, there is only one company that is not OTC. All (the others) are OTC, where the regulations are a lot less,” he says. “Several are SEC filers, but that is not fail-safe protection.”

The fact is that the penny stocks or OTC stocks are a lot riskier — even those companies on the up and up.

The non-OTC medical marijuana company trades on the Nasdaq and is called GW Pharmaceuticals. It’s based in the United Kingdom.

What do you think? Is this an area you have your eye on?

Follow me on Twitter: @SheynaSteiner.

Senior investing reporter Sheyna Steiner is a co-author of “Future Millionaires’ Guidebook,” an e-book written by Bankrate editors and reporters. It’s available at all the major e-book retailers.