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Marijuana Stocks: Here Come the Lawsuits

By Sean Williams – Dec 8, 2018 at 8:21AM

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There's a not-so-green side to pot stocks you may not be aware of.

In just a little over three weeks, the marijuana industry will wrap up its most impressive year ever.

Even without pot stocks soaring into the stratosphere, as they did in 2016 and 2017, investors have to be pretty happy. That's because Canada gave the industry long-term validation by becoming the first industrialized country in the world to legalize recreational marijuana. This potentially paves a path for other industrialized countries to follow suit, and could open the door to billions in added annual sales for the legal cannabis industry.

A person filling out lawsuit paperwork.

Image source: Getty Images.

Lawyers are licking their chops

But there are two sides to every coin, and investors have learned in recent months that the marijuana space can have a dark side, too.

The cannabis industry, like every high-growth industry before it, has all the makings of a bubble. We've witnessed similar share-price gains and volatility in the past from the likes of internet stocks, business-to-business commerce companies, genomics stocks, 3D-printing stocks, and even blockchain businesses. And what each of these bubbles had in common was the desire of opportunistic law firms to pounce on any instance where a company's management team was perceived as not having operated in the best interests of investors. In some cases, something as simple as a bad earnings report has been enough to draw a class-action lawsuit.

With marijuana stocks highly volatile and investors expecting the world from the weed industry, it was only a matter of time before pot stocks began to contend with the legal side of being publicly traded companies.

A judge's gavel next to a small pile of dried cannabis buds.

Image source: Getty Images.

Aphria becomes an all-too-easy class-action target

This past week, Ontario-based Aphria (APHA) shed 43% of its value in a span of two days after noted short-seller Gabriel Grego, the founder of Quintessential Capital Management, referred to the company as a "black hole" and implied it was worth "zero." According to Bloomberg, which broke the news, Quintessential released a damning report that suggested Aphria grossly overpaid for three Latin American and Caribbean assets purchased from SOL Global Investments, which in turn had purchased the assets for very little from three separate Canadian shell companies. The chairman of SOL Global Investments is Andy DeFrancesco, who also happens to be an Aphria advisor.

As yours truly pointed out following this report, this isn't the only time that an Aphria acquisition has been called into question. Back in March, Aphria acquired Nuuvera for 425 million Canadian dollars, which seemed like a steep price to pay for a company that didn't add any production capacity. Rather, Aphria purchased Nuuvera to gain access to its infrastructure in eight new markets. But the red flag was that CEO Vic Neufeld and other members of Aphria's management team disclosed stakes in Nuuvera just a day prior to the deal closing. Though not unheard of for the management team of one company to have a vested interest in a company being acquired, investors would like to know about it more than one day prior to the deal closing.

On Tuesday, Dec. 4, a slew of class-action lawsuits were filed against Aphria on behalf of shareholders that concerned Aphria's recent acquisitions, Quintessential's subsequent report, and the huge share-price decline. It could take a long time for Aphria to regain the trust of investors, and it'll be a costly process to do so. 

A confused young man in a suit grabbing his hair in frustration.

Image source: Getty Images.

But wait -- there's more

And Aphria certainly isn't the only pot stock to draw the ire of lawyers. Before Aphria had a bull's-eye on its back, Las Vegas, Nev.-based CV Sciences (CVSI -0.23%) was a go-to for class-action law firms.

CV Sciences has two means of generating sales. First, it produces and sells consumer products containing cannabidiol (CBD) oil. Cannabidiol is the nonpsychoactive cannabinoid best known for its perceived medical benefits. With the global CBD market expected to grow by 147% per year through 2022, it's not hard to understand why investors are a bit excited about this company.

And second, CV Sciences is attempting to create a drug that combines CBD and nicotine as a smokeless tobacco-cessation solution. This initial drug candidate is where those lawsuits have originated.

You see, back in August, noted short-seller Citron Research released a report showing that patent application requests for this CBD-nicotine combo had been rejected by the U.S. Patent and Trademark Office. Yet, per the lawsuits and Citron, this rejection was never disclosed to shareholders. 

Oddly enough, shares of CV Sciences have held up relatively well despite the allegations. In fact, shares are up more than 630% on a year-to-date basis through Dec. 4. Nevertheless, CV Sciences could be facing extensive legal fees to save face moving forward.

The reality of every fast-growing, volatile industry over the past quarter century has been the presence of class-action lawsuits, and it's unlikely that the marijuana movement will be any different.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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