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Banking Fraud and Scams Grow as Cannabis Business Industry Grows

banking fraud scams in cannabis marijuana business industry

Fraud and scam artists have been and will always be present in any industry or business community (with Enron and Bernie Madoff only being two of the most recent such examples), and the cannabis industry has already seen a few such characters in its short (legal) history, with more certainly to follow.

This post will focus on fraud as it applies to investors in the cannabis industry, we’ll tackle fraud with regard to the actual product in a future post.

Introduction

Until the SAFE Banking Act is passed, the most obvious source of fraud in the cash-based cannabis world involves the greenbacks for which the green crop is grown, old fashioned cash. With financial institutions still hesitant to bank the cannabis business, the basic crime of skimming off the top (e.g. sale entries either not recorded or recorded in reduced amounts and the excess cash pocketed) or simple larceny by employees can deflate the cash proceeds of a cannabis business.

But as the industry matures (Investors poured $10 billion into the medical and retail cannabis industry in 2018 and New Frontier Daily estimates the North American cannabis market will generate more than $16 Billion of investment by the end of 2019) the opportunity for fraud beyond simple theft only grows. For now, cannabis businesses will have to combat the issues presented by transactions in a primarily cash-only business by having tight internal controls, implementing a cash count several times a day (and surprise cash count on top of that) requiring consistent journal entries and mandatory vacation periods for accounting personnel.

Investor Alert

On the investment side, the SEC has issued an “Investor Alert: Marijuana Investments and Fraud” where it warned investors interested in the cannabis industry about the risks of investment fraud and market manipulation. These warnings seem relatively basic to experienced investors (beware of unlicensed sellers, promises of guaranteed returns, unsolicited offers (often by email or text), stock suspension notices, claims that appear to be “too good to be true,” and company name changes), but it appears that the SEC is simply recognizing that with every new trend that comes along (for recent vintage think the dot-com boom and bitcoin craze) the general public needs to be reminded of safe investing guidelines. Going a step further than that, TD Ameritrade has advised investors to avoid investing in the cannabis industry altogether, as overall excitement in the industry, when added to an unclear regulatory future, can equal an extremely volatile and high-risk scenario for investors, with potential stock “pump and dump” scams always lurking in the corners.

Notwithstanding the involvement of experienced operators and savvy investors, however, fraud will still rear its ugly head.

For Example

One recent example of fraud specific to the cannabis industry is the requirement for approvals to sell or dispense the product. The Cannacea case in Oregon is noteworthy in this regard. Tisha Siler, the owner of Cannacea (a dispensary in Oregon, no longer open for reasons that follow) hired Green Rush Consulting, a reputable cannabis consulting company based in Oakland to assist in marketing her business to potential investors. Siler then proceeded to create a fraudulent letter purportedly issued by the Oregon Health Authority Medical Marijuana Dispensary Program (“MMDP”) granting approval for Cannacea to open six new dispensary locations. She provided the letter to Green Rush Consulting, and in reliance on that letter, three investors gave Cannacea $75,000 each to finance the new dispensary locations. When MMDP caught wind of the fraudulent letter and confronted Siler, she claimed Green Rush Consulting prepared the letter, thus dragging that company’s name through the mud.

As an investor, one red flag in the Cannacea case falls under the “too good to be true” category, when the fake letter included an unusual “personal invitation” to open up to six additional cannabis dispensaries, and went on to state that Cannacea was pre-approved for the process and was guaranteed to “sail smoothly through the application process.” In this heavily regulated industry, no company sails smoothly in any part of the process. The letter was also found to be printed on fake letterhead and contained a forged signature of a regulator that did not work in the MMDP, but those tells are too difficult for even a savvy investor to pick up. As a business, conducting old fashioned background checks, interviews, criminal searches, online searches and obtaining references remain essential when entering into any business relationship, but the bottom line is the adage “good people can do bad things, and bad people can do worse things” remains as true as ever.

In the court case that filed, Green Rush Consulting was found to have been duped just like the Cannacea investors (they were able to prove through forensic computer analysis that the fake letter was indeed sent by Siler) and Siler herself was found liable for state securities fraud, included creating fraudulent documents, making untrue statements of fact, and selling securities without a license. Cannacea and Siler were ordered by the Oregon Department of Consumer and Business Services to cease and desist all operations associated with the dispensary, they have been permanently banned from conducting business in Oregon and were fined $40,000.

Conclusion

Even investors in a seemingly safe cannabis company like CannTrust Holdings, a high flying Canadian based company that is listed on the New York Stock Exchange (NYSE: CTST), can feel the burn when management breaks bad, violates the law, and has its cultivation and sales license suspended. In this case, CannTrust was found to have violated regulations imposed by Health Canada law by growing cannabis illegally in five unlicensed rooms. The deception was such that fake walls were actually installed in an attempt to fool Health Canada. Adding insult to injury, it was later uncovered that the now-former CEO Peter Aceto was aware of the wrongdoing and turned a blind eye, ultimately leading to his firing. For investors, the burn came in the form of a sinking stock price: shares of CannTrust have plunged 73.8% this year.

It is important for investors interested in the cannabis space to treat the industry as they would an investment in any other start-up industry, and to exercise the basic due diligence mentioned above, and to dig deeper: actually read the proposed subscription agreement, request financial statements to verify current funding and liabilities, learn about the people responsible for management of the company and research the source of the product and whether the appropriate licenses have been obtained. To borrow yet another old axiom, an ounce of prevention is worth a pound of cure.

If you have any questions about this post or any other matters related to financing cannabis real estate, please contact me at wbrewer@norris-law.com.