Not even one year in, the legal cannabis industry in Canada has endured supply issues, compliance issues — and now the first allegations of fraud are being brought to light in the nascent sector. The Ontario Securities Commission (OSC) has accused three former executives at an upstart cannabis firm of defrauding its investors.

The financial regulator claims Canada Cannabis Corp. (CCC) raised about $3.2 million and US$8.8 million from roughly 125 investors — about half in Ontario — between 2014 and 2016.

The statement of allegations was brought forth last Friday against CCC and Benjamin Ward, Silvio Serrano and Peter Strang, who “misused” the investor’s funds and “syphoned off more than $3 million from CCC by making a loan to a company owned by Serrano.”

By the fall of 2016, Ward, Strang and Serrano had resigned from CCC, leaving behind a company “depleted of all investor funds without ever having engaged in the cultivation or distribution of cannabis.”

None of the allegations against all parties involved have been proven, and a hearing on the matter is scheduled for Sept. 30.

Office of the Secretary: Notice of Hearing and Statement of Allegations re: Canada Cannabis Corporation, Canadian Cannabis Corporation, Benjamin Ward, Silvio Serrano, And Peter Strang, File No. 2019-34 >> https://t.co/1hQHGezEkw pic.twitter.com/QtRMHKckfQ

— OSC News (@OSC_News) September 13, 2019

How the OSC alleges the fraud occurred

Ward was CCC’s chief executive and a director, while Strang and Serrano were vice-presidents, all three were either directors or de facto directors of the firm, according to the OSC.

Serrano owned a lighting firm called Growlite, which the OSC claims was used to syphon the $3 million by making a loan to the company without informing the investors.

In the eight-page statement of allegations, the OSC alleges the men reached a “handshake” agreement” and “devised a scheme” to use $1 million of the investor funds to acquire a 45 per cent stake in Growlite, without divulging details of the conflict of interest to investors, nor hiring a valuator. In addition, another $3 million was used for a loan to the lighting firm.

The regulator claims, in total $2.7 million and US$224,000 was funneled from Growlite to Serrano, Strang, their families and the companies they owned between February 2014 and August 2016.

The OSC said no interest payments were ever made after the loan agreement was signed March 31, 2014, and there was “no attempt to recover the loan.” The loan ended up being written off in April 2016.

Eyeopener for cannabis investors

In its statement, the OSC pointed out:

“Investors … believe that they can earn a quick and profitable return from their investment in this industry. These investments, however, can be highly speculative, and the cost of an investment in a cannabis company may be based on the expectation of its future success rather than its current performance.”

The regulator’s warning is a sobering reality not just for investors of Canada Cannabis but for any investor looking to profit off the sector.

The ongoing regulatory scandal plaguing CannTrust Holdings (TSX:TRST) would be a prime example. The company, and its investors are now at the mercy of Health Canada after the discovery of its numerous compliance breaches.

Cannabis companies try to lure investment based on future success, but it comes down to investors to do their own due diligence while determining if a company is a sound investment.

Ultimately, investors should be aware of the extreme risks of investing in a firm that isn’t generating money, especially when it doesn’t even have operations or licensing in place.