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Why marijuana investments may go up in smoke

Wednesday, 23 Oct 2013 | 6:00 AM ET
Warning signs of pot stock scams
Wednesday, 23 Oct 2013 | 12:00 AM ET
Marijuana stocks sound like they may be the next big thing as some states move to legalize the drug, but Herb Weisbaum says you need to watch for signs you're getting scammed.

It's not exactly corn or wheat, but marijuana is now a cash crop that generates a staggering amount of money in the U.S. each year—$40 billion and growing, by one estimate.

The federal government still classifies cannabis as an illegal drug, but medical marijuana use is now permitted in about 20 states and the District of Columbia. Recreational use is legal in Washington and Colorado.

Brent Lewin | Bloomberg | Getty Images

A Gallup poll released on Tuesday, shows that for the first time a clear majority of Americans (58 percent) say the drug should be legalized.

Investors are watching this momentum. Some of them believe legal pot sales will be the next big thing and hope to strike it rich by getting in on the ground floor.

This "green rush" mentality is custom-made for scammers.

"Anytime something has cachet and people are paying attention to it, there's the chance that people with evil intent will take advantage of that," said Bill Beatty, director of the securities division in the Washington State Department of Financial Institutions.

(Read more: 'Pot mom' admits running a weed warehouse)

The Financial Industry Regulatory Authority (Finra), an independent, not-for-profit organization authorized by Congress to protect American investors, warns people about marijuana stock scams disguised as money-making opportunities, and it recently issued a Marijuana Stock Scams alert.

Money will be made, money will be lost

"There will be significant financial returns for people who are smart," said Brendan Kennedy, CEO of Privateer Holdings, a 3-year-old Seattle company that intends to be big in the legal marijuana industry. It has already raised more than $5 million from investors.

"They see the opportunity," he said. "They see the inevitability. They see the Berlin Wall of cannabis prohibition being toppled."

It's not like investors have to hope some technology is going to be invented, Kennedy said. People are already using cannabis. He estimates the industry at $40 billion, with the potential to grow.

You can already buy medical marijuana stocks through the over-the-counter (OTC) market. Companies include Medical Marijuana, Cannabis Science, GreenGro Technologies, Growlife, Hemp and Medbox.

(Read more: US busts 'Dread Pirate' on cyberdrug Silk Road)

Some of these OTC stocks, which are often a penny a share, are infrequently traded and can move up and down in price substantially from one trade to the next. Finra points out that there are generally no minimum standards a company must meet to have its securities quoted in the OTC market and that many of these stocks are not liquid, meaning they're difficult to resell.

"Many investors have made a quick buck betting on legalization via marijuana stocks over the past year," said Alyssa Oursler, assistant editor at InvestorPlace.com, in a recent report. "Still others, though, have watched their investment fall flat following a big-time February spike."

Fraud alert: The scams are coming

Like many other scams, pitches for bogus marijuana investment opportunities will be made in a variety of ways, Finra said. These include email, tweets, blog posts, faxes, webinars, infomercials and invitations to attend a presentation in your area.

"People get burned when they act solely on some stock tip they hear about from a source they don't know," said Finra President Gerri Walsh. "Such wide solicitations, where a large number of people are being invited to get in on the ground floor, that's the hallmark of a scam."

Her advice: Stop and ask yourself, "Why me?" Why is a total stranger telling you about this really great investment opportunity?

"Con artists sometimes use false and misleading information to create unwarranted demand for shares of small, thinly traded companies that often have little or no history of financial success," Finra warns.

Once the stock rises, those behind these "pump-and-dump" schemes sell off their shares, and those who bought later in the game are left with worthless shares.

(Read more: Obamacare is coming, and so are the con artists)

One company highlighted in Finra's Marijuana Stock Scams alert issued more than 30 press releases during the first half of this year. It also used sponsored links and spam email to promote its entry into the medical marijuana business. The company said its stock was "poised to light up the chart!" and that it "could double its price SOON."

Finra found that the company had just started to formulate a business plan and had nothing but losses on its balance sheet.

"Beware of any sort of guaranteed yield or return on investment, because no one knows how successful these companies are going to be. And beware of anyone who promises there's no risk," said Colorado Securities Commissioner Fred Joseph.

The bottom line

Be cautious. Don't be rushed or high-pressured into something, and don't get greedy. Investigate before you invest. Check with your state's regulatory agencies, and make sure the promoter is licensed in your state using Finra's BrokerCheck. You can check on the investment using the SEC's EDGAR database.

Remember, any investment in the marijuana business, no matter how legitimate, is risky because cannabis is still viewed as illegal by the federal government, which could decide to shut down a company at any time.

—By CNBC contributor Herb Weisbaum. Follow him on Facebook and Twitter @TheConsumerman or visit The ConsumerMan website.

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