Corporations facing federal securities suits can sometimes avoid liability by claiming that their forward-looking statements were so vague or indefinite that they could not have affected the company’s stock price and are therefore not material. Such statements are not actionable because courts consider them “puffing,” famously described by Judge Learned Hand nearly 100 years ago as “talk which no sensible man takes seriously.” Though we cannot know today what Judge Hand would think of the civil complaint recently filed by the SEC against several marijuana-company stock promoters, it’s safe to say that this isn’t the kind of ‘puffing’ he had in mind.
The defendants in the SEC civil action are all stock promoters, most of whom operate websites where they promote stocks, including microcap or so-called “penny” stocks. The SEC alleges that the defendants promoted shares in microcap companies related to the marijuana industry. For example, one of the companies, Hemp Inc., claims to be involved with medical marijuana. According to the SEC, three of the defendants bought and sold more than 40 million shares in Hemp Inc. in order to give the appearance that there was an active market in the company’s stock. In reality, the transactions allegedly consisted of wash trades and matched orders. A wash trade occurs when a security is traded between accounts, but with no actual change in beneficial ownership, while a matched order entails coordinating buy and sell orders to create the appearance of trading activity. As the defendants were allegedly generating trading activity, they were also allegedly promoting the stock on the Internet, touting “a REAL Possible Gain of OVER 2900%” in Hemp Inc. stock. Wow, that is high.
In the civil complaint, the SEC charged the defendants with fraud under Section 17(a)(1) and (3) of the Securities Act of 1933 and Sections 9(a)(1) and 10(b) of the Securities Exchange Act of 1934. The SEC is also seeking disgorgement of some $2.5 million in profits from the scheme—not the kind of hit normally associated with this industry. In addition, three of the defendants have been charged criminally by federal prosecutors.
The SEC has issued fraud alerts concerning trading in microcap stocks, including those related to marijuana—it’s certainly a growth industry. With the sale, possession, and use of the drug now legal in Washington and Colorado, and with financial institutions continuing to grapple with how to bank an otherwise illicit market, this will surely not be the last time that the marijuana industry gets rolled up in federal securities laws.