Aug. 20, 2013 at 2:43 PM ET
Investors in marijuana-related stocks may see their profits go up in smoke, U.S. regulators said on Tuesday.
The Financial Industry Regulatory Authority, Wall Street's industry-funded watchdog, warned that scammers have been targeting investors attempting to tap into the growing U.S. marijuana industry.
Nearly 20 states permit the use of marijuana for medical purposes, and voters in Washington and Colorado recently made recreational use legal as well.
FINRA said red flags for investors range from the classic "pump and dump" - in which con artists boost the price of thinly traded stocks by misleading investors about a company's potential, then sell their shares at a peak - to executives with criminal records.
The chief executive of one company that says it is in the medical marijuana business spent nine years in prison for operating one of the largest drug smuggling operations in U.S. history, while the former head of another marijuana-related company was recently indicted for his role in a mortgage-based Ponzi scheme, the watchdog said. FINRA did not name the companies or the individual.
The majority of marijuana-related companies are so-called penny stocks that trade on the over-the counter-markets, which do not have the liquidity and reporting requirements of major exchanges such as the New York Stock Exchange and Nasdaq .
Marijuana remains illegal under federal law, severely limiting the avenues for legitimate investments. But private equity firms, whose investors tend to be institutions or affluent individuals, have been buying medical marijuana companies in anticipation of federal law eventually changing.
Seattle-based Privateer Holdings is thought to be the first firm to openly invest in the medical marijuana industry. It has raised a reported $7 million from investors.
Major tobacco companies have not announced any plans to sell marijuana in states where it is legal.
Copyright 2013 Thomson Reuters.