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Marijuana And The Sec: Alleged False Statements Result In Enforcement Action

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  • Posted on: May 28 2018

In the United States, support for legalizing marijuana has been growing. Thirty states and the District of Columbia have enacted legislation that legalize marijuana in some form. Eight states and the District of Columbia allow recreational use of marijuana. According to a 2017 Gallup Poll, 64% of Americans support legalizing marijuana for recreational use.

With marijuana becoming more accepted, the cannabis industry has grown. Many of the companies fueling this growth are publicly traded and listed on the MJIC Marijuana Index (here) – the Index includes 17 companies, including four that are based in Canada but operate in the United States.

As public companies, these entities are required to disclose material information about their business and operations. Legitimate companies do so when newsworthy information, both good and bad, necessitates such dissemination. Companies issuing multiple press releases during a compressed period of time, e.g., daily or weekly, that only speak glowingly of the entity may be disseminating false information to shareholders and potential investors.

Against this background, this Blog will examine the latest SEC enforcement actions against a penny stock cannabis company and its chief executive officer (“CEO”), among others.  The first action involves Bud Genius Inc. (“Bud Genius”), a medical marijuana firm run by Aaron “Angel” Stanz (“Stanz”), that issued false financial statements and claimed to have a licensing agreement with comedian Tommy Chong of Cheech and Chong fame. SEC v. Bud Genius, Inc., Civil Action No. 18-cv-01005 (S.D. Cal. Filed May 21, 2018). (A copy of the complaint can be found here.)

In the complaint, the SEC alleged that Bud Genius, a Wyoming corporation previously known as Rightsmile, Inc., and Stanz, the company’s sole director and CEO, issued false and misleading press releases about a purported licensing agreement with comedian Tommy Chong. In one press release, Stanz allegedly described Chong as a “partner,” and in a subsequent blog post, he described the purported licensing agreement with Chong as a “crowning achievement.” The agreement never materialized, and the defendants allegedly knew at the time that, in light of Bud Genius’s weak financial position, it was extremely unlikely that an agreement would ever be reached. The SEC charged that the defendants’ false and misleading claims about the agreement were picked up by multiple media outlets. The defendants also are alleged to have published fraudulent financial statements and to have facilitated an unregistered offering of Bud Genius securities.

The unregistered offering is the subject of a second action filed by the SEC in the Northern District of Iowa against Taylor Moffitt, Carlos Febles, and U.S. CoProducts LLC. SEC v. Moffitt, Civil Action No. 18-cv-03034 (N.D. Iowa Filed May 22, 2018) (A copy of the complaint can be found here.) The SEC alleged that the defendants acquired, offered, and sold billions of shares of unregistered Bud Genius stock for a total profit of more than $540,000, approximately $140,000 of which was paid to Bud Genius and Stanz.

Regarding the company’s financial condition, the SEC alleged that between 2012 and 2014, Bud Genius issued materially false and misleading financial reports to the investing public. In 2012, 2013, and the first three quarters of 2014, for example, the defendants allegedly inflated the company’s “total revenue” by adding revenue generated by the company and that of a charter jet business owned by Stanz. In 2012, and the third quarter of 2014, the defendants allegedly inflated the company’s “intangible assets” related to software developed overseas. Under GAAP, while some initial and preliminary development costs are expensed, costs incurred to develop website and computer software during the application development stage are capitalized using their historical (i.e., actual) cost. In the case of Bud Genius, the software development work was primarily performed by foreign subcontractors at a significant lower cost than if the work was performed in the U.S. The SEC claimed that Stanz knowingly assigned an inflated and unjustifiable value to the intangible assets by estimating what the cost would have been to perform the development work in the U.S., even though the actual cost was much less. Although the company’s accountant advised that the valuation violated GAAP, “Stanz insisted on going forward with the inflated valuation.” Finally, for 2013 through 2014, Bud Genius and Stanz allegedly reported loan payments owed to Bud Genius by a company owned by consultant Taylor Moffitt as “accounts receivable”. By mischaracterizing the loan as an “account receivable,” the SEC claimed that Bud Genius and Stanz created the false and misleading impression that the company was generating, or had previously generated, more business and operating revenue than was actually the case.

Without admitting or denying the SEC’s allegations, Stanz agreed to a judgment enjoining him from violating Sections 5(a), 5(c), 17(a)(1) and 17(a)(3) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, imposing five-year officer-director and penny stock bars, and ordering disgorgement and prejudgment interest of $158,829. Without admitting or denying the SEC’s allegations, Bud Genius agreed to a judgment enjoining it from violating Sections 5(a), 5(c), 17(a)(1) and 17(a)(3) of the Securities Act, and Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. The settlements are subject to court approval.

Without admitting or denying the SEC’s allegations, Moffitt, Febles, and U.S. CoProducts agreed to a judgment enjoining them from violating Sections 5(a) and 5(c) of the Securities Act and all three will be jointly and severally liable for $435,595 in disgorgement and prejudgment interest. In addition, Moffitt and Febles agreed to penny stock bars of three years and one year respectively, and to pay civil penalties of $35,000 and $20,000, respectively. These settlements also are subject to court approval.

A copy of the SEC press release announcing the two enforcement actions can be found here.

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