Tag Archives: BCC

M&A in Cannabis: A Guide for Buyers and Sellers

By Abraham Finberg, Rachel Wright
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Mergers and acquisition activity in the cannabis space tripled from 2020 to 2021, and that pace is on track to continue in 2022. With big players entering the global cannabis market, we’re fielding more questions about mergers and acquisitions of cannabis businesses.

In this guide, we look at the evolution of the U.S. cannabis industry and some best practices and considerations for M&A deals in this environment.

The New Reality of Cannabis M&A Activity

The industry has evolved since adult use cannabis was first legalized in some U.S. states in 2012. More cannabis companies have a professional infrastructure—legal, financial and operational—with executive teams and board members ensuring the organization establishes proper governance procedures. Investors and private equity firms are showing more interest, and some cannabis companies have celebrated their first IPOs on the Canadian Securities Exchange (CSE).

At the same time, we are seeing a kind of “market grab” by multistate operators (MSOs) looking to acquire various licenses and expand their market share. MSOs tend to understand the current state of the market. For example, in California and some other states, there is a surplus of cannabis on the market for various reasons, partially due to so-called “burner distribution”—rogue distributors using licenses to buy vast amounts of legally grown cannabis at wholesale prices and selling the product on the black market, thereby undercutting retailers and other legal cannabis businesses. Another reason for the surplus is simply the entrance of many legal cultivators into the market over the past year.

Due to these trends, MSOs are interested in acquiring the outlets to be able to sell the surplus cannabis within California and other new markets.

Transferring Cannabis License Rights

One of the biggest challenges to M&A activity in the cannabis sector is the difficulty of transferring or selling a cannabis license.

Different types of cannabis licenses in California

Cannabis licenses are not expressly transferable or assignable under California law and many other states. However, the parties involved aren’t without options. For example, a business that is sold to a new owner may be able to retain its existing cannabis license while the new owner’s license application is pending, as long as at least one existing owner is staying on board. At the state license level, a change of up to 20% financial interest does not constitute a change in ownership, although the Bureau of Cannabis Control (BCC) must be notified and approve the change.

This process can take a while—often a year or more—since licensing involves overcoming hurdles at the local level as well as the state level with the BCC. It’s crucial to talk with legal counsel about the particulars of the license and location early in the process to best structure the terms of the agreement while complying with state and local requirements.

Seeking a Tax-Free Reorganization in the Cannabis Space

In many cannabis mergers and acquisitions, the goal is to accomplish a tax-free reorganization, where the parties involved acquire or dispose of the assets of a business without generating the income tax consequences that would result from a straight sale or purchase of those assets.

IRC Section 368(a) defines various types of tax-free reorganizations, including:

Stock-for-stock exchanges (IRC Section 368(a)(1)(B)

In a stock-for-stock reorganization, all of the target company’s stock is traded for a portion of the stock of the acquiring parent corporation, and target company shareholders become minority shareholders of the acquiring company.

Often, it’s tough to meet the requirements to qualify for this type of tax-free reorganization because at least 80% of the target stock must be paid for in voting stock of the acquirer.

Additionally, companies may be saddled with too much debt. If the acquirer assumes that debt, it may be classified as consideration paid to the seller and therefore disqualify the transaction as a tax-free reorganization.

In other M&A deals, the acquiring corporation may be unwilling to assume the debt of the target corporation—perhaps because showing these items on its balance sheet would impact its debt-to-equity and other financial ratios.

Stock-for-asset exchanges (IRC Section 368(a)(1)(C)

Rather than acquiring the target company’s stock, the acquirer may purchase its assets. In a stock-for assets exchange, the buyer must purchase “substantially all” of the target’s assets in exchange for voting stock of the acquiring corporation.

A stock-for-assets format offers the buyer the benefit of not having to assume the unknown or contingent liabilities of the target. However, it’s only feasible if the acquirer purchases at least 80% of the fair market value of the target’s assets AND all or virtually all of the deal consideration will be stock of the acquirer.

Tax Consequences Arising from Sale of Assets

If the sale price doesn’t consist primarily of the buyer’s stock, the transaction may be a standard asset sale. This leads to very different tax results.

If the seller is a C corporation, it will typically face double taxation—paying tax once on the sale of assets within the corporation and again when those profits are distributed to shareholders. If the target company has net operating losses (NOLs), it can use those NOLs to offset the tax hit.

If the seller is an S corporation, it won’t have to pay corporate tax on the transaction at the federal level. Instead, shareholders will pay tax on the gain on their individual returns.

For the buyer, the benefit of an asset sale is that the assets acquired get a “step-up basis” to their purchase price. This is beneficial from a tax perspective, as the buyer can depreciate the assets and may be able to claim accelerated or bonus depreciation to help offset acquisition costs.

Reverse Triangular Merger

Often, in practice, we come across what is termed as a reverse triangular reorganization. In this type of merger,

  1. The acquiring company creates a subsidiary,
  2. The subsidiary merges into the target company before liquidating,
  3. The target company then becomes a subsidiary of the acquirer, and
  4. The target company’s shareholders receive cash.

Structuring the deal this way may work to overcome the hurdle of transferring the license but may not qualify as a tax-free reorganization.

Bottom Line

The circumstances and motivations for mergers and acquisitions in the cannabis industry are diverse. As a result, there is no one-size-fits-all approach to structuring the transaction. In any event, it’s crucial to start the process early and seek advice from legal counsel and tax advisors to minimize the tax burden and ensure that both parties to the transaction get the best deal possible. If you need assistance, contact your 420CPA strategic financial advisor.

The Inflated THC Crisis Plaguing California Cannabis

By Erik Paulson, Josh Swider, Zachary Eisenberg
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Fraud

The THC content you see on a label when you walk into a dispensary? There is a very good chance the number is false.

In every state with regulated cannabis, there is a requirement to label the potency of products so consumers can make informed purchasing and medicating decisions. The regulations usually state that the THC/cannabinoid content on the label must be within a particular relative percent difference of the actual tested results for the product to be salable. In California, that threshold is +/- 10%.

The problem is, with all the focus on THC percentage in flower and concentrate products, enormous pressure has been placed on cultivators and manufacturers to push their numbers up. Higher numbers = higher prices. But unfortunately, improving their growing, extraction and formulation processes only gets companies so far. So, they proceed to ‘lab shop’: giving their business to whichever lab provides them the highest potency.

There are roughly 50 Department of Cannabis Control (DCC) licensed labs in the state, and competition is fierce to maintain market share in a maturing and plateauing industry. Whereas competition used to be healthy and revolved around quality, turnaround time and customer service, now it’s essentially become a numbers game. As a result, many labs have sacrificed their scientific integrity to chase what the clients want: higher THC potency results without contaminant failures. The practice has become so prevalent that labs openly advertise their higher potency values to gain customers without fear of recourse. Here are two examples:

 

Over a year ago, a few labs fed up with what was happening got together to determine the extent of the potency inflation issue. We proactively purchased and tested over 150 randomly chosen flower samples off dispensary shelves. The results were staggering. Eighty-seven percent of the samples failed their label claims (i.e., were >10% deviant of their labeled values), with over half of the samples >20% deviant of their labeled THC values (i.e., over 2x the legal permitted variance). Additionally, our labs found multiple cases of unreported category 1 pesticides in some of the analyzed samples at multiple times the legal limit – a significant public health concern. The deceit was not limited to small cultivators trying to get by but also some of the industry’s biggest brands.

The same issues and economic conditions are in play for concentrates. Manufacturers of these products also hunt for the highest D9 THC values because wholesale prices for distillate are determined by THC content: <86% for the lowest value, 86-88%, 88-90% and >90%, with a new price point for over 94%. As a result, consumers can walk into a dispensary and find concentrates like the one shown below that report>99% total cannabinoids (>990mg/g) and contains almost 10% additional terpenes. You don’t have to be an analytical chemist to realize those numbers add up to well over 100%, which is physically impossible.

Blame

Everyone can agree that the system is broken, but who is at fault? Should the blame be placed on dispensaries, many of whom use THC % as their only purchasing or marketing metric? Or on cultivators, manufacturers and distributors, who seek the highest results possible rather than the most accurate ones? Or on the labs themselves, who are knowingly reporting inflated results?

Ultimately, the individual businesses are acting in their own self-interest, and many are participating in this practice simply to stay afloat. Dispensaries can’t reasonably be expected to know which results are inflated and which are not. Cultivators and manufacturers feel obligated to use labs that provide them with the highest results; otherwise, they’re putting themselves at a disadvantage relative to their competitors. Likewise, labs that aren’t willing to inflate their numbers have to be ready to watch customers walk out the door to maintain their principles – an existential dilemma for many.

The primary reason why potency inflation has become so prevalent is that there have been no negative repercussions for those that are cheating.  

The axiom is true – don’t hate the player, hate the game. Unlike most businesses, testing labs operating with integrity want meaningful regulations and oversight to assure a level playing field. Without them, the economics force a race to the bottom where labs either have to inflate more and more or go out of business. Since 2016, the DCC (formerly BCC) has taken zero meaningful actions to discourage or crackdown on potency inflation— not a single recall of an inflated product or license suspension of an inflating lab— so predictably, the problem has gotten progressively worse over time.

So, to answer the question above – who is at fault for our broken system? The answer is simple: the DCC.

Inaction

In the Fall of 2021, we began engaging with the DCC to address the industry’s potency inflation concerns. The DCC requested we provide them with direct evidence of our accusations, so we collected and shared the flower data mentioned above. The Department tested the same batches off the shelf and confirmed our results. Somehow not a single recall was issued – even for the batches containing category 1 pesticides.

We pushed for more accountability, and DCC Director Nicole Elliott assured us steps were being taken: “The Department is in the process of establishing a number of mechanisms to strengthen compliance with and accountability around the testing methods required of labs and will be sharing more about that in the near future.”

Instead, we got a standardized cannabinoid potency method (mandated by SB 544) that all labs will be required to use. On the surface, a standardized methodology sounds like a good thing to level the playing field by forcing suspect labs into accepting generally accepted best practices. In reality, however, most labs already use the same basic methodology for flower and concentrate cannabinoid profiling and inflate their results using a variety of other mechanisms: selective sampling, using advantageous reference materials, manipulating data, etc. Furthermore, the method mandated is outdated and will flatly not work for various complex matrices such as gummies, topicals, beverages, fruit chews and more. If adopted without changes, it would be a disaster for manufacturers of these products and the labs that test them. Nevertheless, the press release issued by the DCC reads as though they’ve earned a pat on the back and delivered the silver bullet to the potency inflation issue.

Here are a few more meaningful actions the DCC could take that would help combat potency inflation:

  • Perform routine surveillance sampling and testing of products off of store shelves either at the DCC’s internal lab or by leveraging DCC licensed private labs.
  • Recall products found to be guilty of extreme levels of potency inflation.
  • Conduct in-person, unannounced audits of all labs, perhaps focusing on those reporting statistically higher THC results.
  • Conduct routine round-robin studies where every lab tests the same sample and outliers are identified.
  • Shutdown labs that are unable or unwilling to remediate their potency inflation issues.

For some less disciplinary suggestions:

  • Remove incentives for potency inflation, like putting a tax on THC percentage
  • Set up routine training sessions for labs to address areas of concern and improve communication with the DCC

Fight

Someone might retort – who cares if the number is slightly higher than it should be? No one will notice a little less THC in their product. A few counterpoints:

  1. Consumers are being lied to and paying more for less THC.
  2. Medical cannabis users depend on specific dosages for intended therapeutic effects.
  3. Ethical people who put their entire lives into cultivating quality cannabis, manufacturing quality products and accurately testing cannot compete with those willing to cheat. If things get worse, only the unethical actors will be left.
  4. Labs that inflate potency are more likely to ignore the presence of contaminants, like the category 1 pesticides we found in our surveillance testing.
  5. This single compound, delta-9 THC, is the entire reason why this industry is so highly regulated. If we are not measuring it accurately, why regulate it at all?

We will continue to fight for a future where quality and ethics in the cannabis industry are rewarded rather than penalized. And consumers can have confidence in the quality and safety of the products they purchase. Our labs are willing to generate additional surveillance data, provide further suggestions for improvement in regulations/enforcement, and bring further attention to this problem. But there is a limit to what we can do. In the end, the health and future of our industry are entirely in the hands of the DCC. We hope you will join us in calling on them to enact meaningful and necessary changes that address this problem.

Lab Shopping: Highlighting the Need for Checks and Balances in Cannabis

By Josh Swider
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Cannabis, we have a problem. Legalizing adult use cannabis in California caused the demand for high-potency cannabis to increase dramatically over the last several years. Today, many dispensary buyers enforce THC minimums for the products that they sell. If smokeable flower products don’t have COAs proving the THC levels are above 20% or more, there is a good chance many dispensaries won’t carry them on their shelves. Unfortunately, these kinds of demands only put undue pressure on the industry and mislead the consumer.

Lab Shopping: Where the Problems Lie

Lab shopping for potency analysis isn’t new, but it has become more prevalent with the increasing demand for high-potency flower over the last couple of years. Sadly, many producers submit valid, certified COAs to the California Bureau of Cannabis Control (BCC), which show two to three times the actual potency value.

At InfiniteCAL, we’ve purchased products from dispensary shelves and found significant discrepancies between the analysis we perform and the report submitted to the BCC by the producer. So, how can this happen? Several factors are creating the perfect storm in cannabis testing.

Problems with Potency

Many consumers still don’t understand that THC potency is not the only factor in determining quality cannabis, and they are unwittingly contributing to the demand for testing and analysis fraud. It is alarming for cultivation pioneers and ethical labs to see producers and profit-hungry testing facilities falsifying data to make it more appealing to the unaware consumer.

Basically, what’s happening is growers are contacting labs and asking, “I get 30% THC at this lab; what can you do?” When they see our COA reporting their flower tested lower than anticipated, they will go to another lab to get higher test results. Unfortunately, there are all too many labs that are willing to comply.

I recently saw a compliant COA that claimed that this particular flower was testing at 54% THC. Understanding cannabis genetics, we know this isn’t possible. Another product I reviewed claimed that after diluting an 88% THC distillate with 10-15% terpenes, the final potency test was 92% THC. You cannot cut a product and expect the potency to increase. Finally, a third product we reviewed claimed 98% total cannabinoids (while only looking at seven cannabinoids) with 10% terpenes for a total of 108% of the product.

These labs only make themselves look foolish to professionals, mislead laymen consumers and skirt under the radar of the BCC with basic mathematical errors.

The Pesticide Predicament

Frighteningly, inflating potency numbers isn’t the most nefarious testing fraud happening in the cannabis industry. If a manufacturer has 1000 liters of cannabis oil fail pesticide testing, they could lose millions of dollars – or have it retested by a less scrupulous lab.

Photo: Michelle Tribe, Flickr

As the industry continues to expand and new labs pop up left and right, cultivators and manufacturers have learned which labs are “easy graders” and which ones aren’t. Certain labs can miss up to ten times the action level of a pesticide and still report it as non-detectable. So, if the producer fails for a pesticide at one lab, they know four others won’t see it.

In fact, I’ve had labs send my clients promotional materials guaranteeing compliant lab results without ever receiving a sample for testing. So now, these companies aren’t just tricking the consumer; they are potentially harming them.

An Easy Fix

Cannabis testing is missing just one critical factor that could quickly fix these problems – checks and balances. The BCC only needs to do one of two things:

Verifying Lab Accuracy

InfiniteCAL also operates in Michigan, where the Marijuana Regulatory Agency (MRA) has already implemented a system to ensure labs are maintaining the highest testing standards. The MRA will automatically flag all COAs which test above a certain percentage and require the product to be retested by multiple labs.

labsphotoLabs are required to keep a back stock of material. So, when test results come back abnormally high from Lab A, then Labs B, C and D are commissioned to retest the material to compare data. If Lab A reports 40% THC, but the other labs all report 18%, then it’s easy to see Lab A has made an error.

Secret Shopping

By simply buying products off the shelves and having them blind-tested by other labs, it would be simple for the BCC to determine if the existing COA is correct. They already have all the data in Metrc, so this would be a quick and easy fix that could potentially solve the problem overnight.

For example, at InfiniteCAL, we once purchased 30 samples of Blue Dream flower from different cultivators ranging in certified COA potencies from 16% to 38%. Genetically, we know the Blue Dream cultivar doesn’t produce high levels of THC. When we tested the samples we purchased, nearly every sample came back in the mid-teens to low 20% range.

Labs Aren’t Supposed to Be Profit Centers

At InfiniteCAL, we’ve contacted labs in California where we’ve uncovered discrepancies to help find and flush out the errors in testing. All too often, we hear the excuses:

  • “If I fix my problem, I’ll lose my clients.”
  • “I’m just a businessman who owns a lab; I don’t know chemistry.”
  • “My chemist messed up; it’s their fault!”

If you own a lab, you are responsible for quality control. We are not here to get rich; we are here to act as public safety agents who ensure these products are safe for the consumer and provide detailed information about what they choose to put in their bodies. Be professional, and remember you’re testing for the consumer, not the producer.

Learning from the First Wave Part 2: California’s Cannabis Supply Chain and Vertical Integration, with a Grain of Salt

By Todd Feldman
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Part One of this series took a look at how the regulated cannabis market can only be understood in relation to the previous medical market as well as the ongoing “traditional” market. Part Two of the series describes how regulation defines vertical integration in California cannabis, and conversely, how vertical integration can address some of the problems that the regulations create. But first:

A Grain of Salt

Take the conventional wisdom about vertical integration with a grain of salt. Expected benefits may not materialize under the current circumstances:

  • Overall, the business environment is highly challenging due to extensive regulation, over taxation, insufficient retail capacity and competition from the “traditional” market. As a result, integrating businesses upstream or downstream may mean capturing losses, not profits.
  • The three major types of cannabis activity span three major industrial sectors: raw materials (i.e., cultivation), manufacturing and service (distribution, testing and retail). As a result, a vertically integrated company needs to carry out very different types of activity, which require very different types of core competencies, equipment and facilities.
    • Developing core competencies is especially challenging because each of the major cannabis sectors is still evolving.
    • Realizing the benefits of vertical integration requires an additional core competency in cross-sector operations.

 Regulations Define the Supply Chain

California’s regulations define the cannabis supply chain by defining both the individual links (licensees) and the relationships between those links. Therefore, an understanding of vertical integration must be grounded in an understanding of the underlying regulatory definitions.

The regulatory definition of each link is extensive. For example, each licensee is tied to a specific facility, and must have its own procedures for production, inventory control, security, etc. When the links are strung together, this definition tends to preserve operational redundancies, and impede operational integration.

Overall, the relationships between the links are primarily defined in terms of preserving the chain of cannabis custody. On top of that, regulations define very specific (and very consequential) links between certain licenses, as discussed below.

A Taxonomy of Links

There are currently 26 types of cannabis license in California, 25 of which can be vertically integrated:

  • Cultivation – 14 licenses, including 4 sizes each for Indoor (up to 22,0000 sf), Mixed Light (up to 22,000 sf) and Outdoor (up to 1 acre), as well as Nursery and Processor (drying, trimming and packaging/labeling). Note that cultivation licenses are the only licenses that restrict the scale of activities.
  • Manufacturing – 5 licenses, including volatile extraction, non-volatile extraction, everything but extraction (i.e., infusion) and packaging/labeling.
  • Testing (Type 8), for testing cannabis according to state standards prior to sale. The owner of a testing license cannot own any other type of license.
  • Distribution (Type 11), acts as the gateway between cultivation and manufacturing on the one hand, and retail on the other. The distributor’s gateway status is entirely an artifact of regulation – cannabis must be officially tested before it is sold to a consumer, and only a distributor can order the official test. All products must stay in a “quarantine” area at the distributor until they pass testing. Products that fail testing must be destroyed if they cannot be remediated.
  • Transport (Type 13), which can move cannabis between licensees (with a narrow exception). This license does not allow for official testing.
  • Storefront Retail (Type 9), which is the best license to have, and the hardest one to get.
  • Delivery Retail (Type 10), for delivery services that are subject to the vagaries of software platforms and the intransigence of local authorities.
  • Microbusiness (Type 12), which allows the licensee to carry out cultivation (up to 10,000 square feet), non-volatile manufacturing, distribution and retail.
  • Event Organizer

Self-Distribution – A Case of Useful Integration

You may gather from the previous section that shoving a gratuitous and mandatory distributor into the middle of the supply chain creates problems for cultivators and manufacturers. Savvy operators solve this problem by getting a distribution license. This allows the cultivator or manufacturer to:

  • Pick the time and place for the testing of its cannabis products.
  • Avoid paying someone else for the storage of cannabis products as they await test results or purchase.
  • Reduce transport costs (particularly if the distributor is near the other operations).
  • Sell directly to retailers.

The bottom line is that vertical integration in California cannabis is useful as a means to an end, as opposed to an end in itself. Therefore, cannabis operators should carefully consider how vertical integration will benefit their core business before incurring the risks and expenses associated with an additional license.

This article is an opinion only and is not intended to be legal advice.

Learning from the First Wave Part 1: How Law Shapes the California Cannabis Industry

By Todd Feldman
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As a cannabis lawyer, I spend a lot of time thinking about the ways that regulations affect a cannabis company’s bottom line. Since I’m in California, the ways are many.

In late 2017 I became the chief compliance officer for an Oakland startup that carried out delivery, distribution, cultivation and six manufacturing operations. A big part of my job was preparing my company, along with several equity cannabis companies, for California’s First Wave of cannabis licenses.

For the most part, First Wave licensees came from California’s essentially unregulated medical cannabis market, and/or from California’s by-definition unregulated “traditional” market. When California began issuing licenses in January 2018, many First Wavers were unprepared because their businesses practices had evolved in an unregulated market. A big part of my job was to help them adapt to the new requirements. As a result, I saw the regulations, and the effects of regulations, in sharp relief.

Regulation touches virtually every aspect of the legal cannabis industry in California. So anyone who wants to understand the industry should have at least a basic understanding of how the regs work. I’m writing this series to lay that out, in broad strokes.

Some key points:

  • The regulated market must be understood in relation to the previous unregulated (medical) market as well as the ongoing traditional market.
  • Regs define the supply chain.
  • Regs are designed to ensure product safety and maximize tax revenue.
  • Many regulations mandate good business practices.
  • Local enforcement of building, health and safety codes tends to be zealous and costly.

A Tale of Three Markets

California’s regulated cannabis market can only be understood in relation to the medical market that preceded it, and in relation to the traditional market (illegal market) that continues to compete with it.

The Before Times

California’s legal medical cannabis market goes back to 1996, when the Compassionate Use Act passed by ballot measure. One fact that shaped the medical market was that it was never just medical – while it served bona fide patients, it also served as a Trojan horse for adult-use (recreational) purchasers.

Another fact that shaped the medical market was a near complete lack of regulation. On the seller’s side, you had to be organized as a collective. On the buyer’s side, you had to have a medical card. That was it.

Meanwhile, the cannabis supply chain was entirely unregulated. This tended to minimize production costs. It also meant that a patient visiting a dispensary had no way of verifying where the products had been made, or how.

The Regulated Times

Licensing under the Medical and Adult-Use Cannabis Regulation and Safety Act (the “Act”) began on January 1, 2018. It was the beginning of legal adult-use cannabis in California. It was also the beginning of the Regulated Times, as the Act and accompanying 300-plus pages of regulations transformed the legal cannabis market.

 For example:

  • The Act defines the cannabis supply chain (as a series of licensees).
  • Across the supply chain, the internal procedures of cannabis companies are subject to review by state agencies;
  • Cultivators and manufacturers cannot sell directly to a dispensary – they must go through a distributor;
  • All cannabis must be tested for potency and a long list of contaminants by a licensed testing laboratory before it may be sold to consumers;
  • And beginning in 2019, all licensees were required to participate in the California Cannabis Track and Trace (CCTT) program, which is designed to track all cannabis from seed to sale.

Just as importantly, the Act establishes a dual licensing system – that is to say, in order to operate, a cannabis company needs a local permit (or other authorization) as well as a state license. In fact, local authorization is a prerequisite for a state license. And your local jurisdiction will have its own rules for cannabis that apply in addition to the state rules, up to and including a ban on cannabis activities.

Needless to say, operating in the Regulated Times is a lot more complicated and expensive than it was during the Before Times.

Especially when you consider the taxes. For example, in the City of Los Angeles, sale of adult-use cannabis is taxed at 10%, which means that any adult-use purchase in L.A. gets a 34.5% markup:

  • 15% state cannabis excise tax, plus
  • 10% Los Angeles Adult Use Cannabis Sales tax, plus
  • 5% sales tax.

Note that the distributors must collect the excise tax from the retailer, so the 15% markup is not necessarily visible to the consumer. Similarly, consumers are generally unaware that there is a cultivation tax of $9.65 per ounce (or about $1.21 per eighth) of dried flower that the distributor has to collect from the cultivator.

Theoretically, all of this might be unproblematic if licensed retailers were only competing with each other. Which brings us to:

The Traditional Market

The traditional market is the illegal market, which is to say, the untaxed and unregulated market.

Legalization of adult-use cannabis was supposed to destroy the traditional market, but it hasn’t. As of early 2020, the traditional market was estimated to be 80% of the total cannabis market in California. This is not surprising, since the traditional market has the advantages of being untaxed and unregulated.

The traditional market has a pervasive negative effect on the legal market. For example, the traditional market tends to depress prices in the legal market and tends to attract talent away from the legal market. Some of these effects will be discussed in the following articles.

This article is an opinion only and is not intended to be legal advice.

California Suspends Almost 400 Licenses

By Cannabis Industry Journal Staff
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On November 1st, the Bureau of Cannabis Control (BCC) sent notices to 394 businesses in California that their licenses will be suspended until they comply with certain traceability system requirements. This story was first reported by John Schroyer at Marijuana Business Daily.

On Wednesday, November 6th, the number of licenses suspended dropped to a total of 385, including 63 retailers, 61 delivery services, 47 microbusinesses, 185 distributors and 29 transportation licenses. That’s almost 5% of all the cannabis business licenses in California.

According to Alex Traverso, spokesman for the BCC, licensees were given plenty of opportunities to fix their errors. Businesses were given notice that they needed to enroll in Metrc within five days following their provisional licensing. The BCC gave those businesses a reminder roughly three months ago and sent an additional warning in late October regarding the deadline.

It’s a relatively easy fix for those trying to get back in compliance. The rationale behind suspending the licenses is that those businesses need to undergo a mandatory traceability system training so they know how to use Metrc and get credentialed. Enroll in the Metrc system, get credentialed and your license should be restored.

“It’s relatively simple to get your license out of suspension,” Traverso told KPBS News. “These are growing pains. I think we knew it was going to be a process and it was going to take some time, and that it was going to be an adjustment period for a lot of people who have been doing things one way for some time now.”

Traverso added that about 80 businesses enrolled in the Metrc system as soon as they received the notice that their license is suspended. Those licenses should be restored to active shortly, Traverso said.

Heavy Metals Testing: Methods, Strategies & Sampling

By Charles Deibel
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Editor’s Note: The following is based on research and studies performed in their Santa Cruz Lab, with contributions from Mikhail Gadomski, Lab Manager, Ryan Maus Technical Services Analyst, Laurie Post, Director of Food Safety & Compliance, and Charles Deibel, President Deibel Cannabis Labs.

Heavy metals are common environmental contaminants resulting from human industrial activities such as mining operations, industrial waste, automotive emissions, coal fired power plants and farm/house hold water run-off. They affect the water and soil, and become concentrated in plants, animals, pesticides and the sediments used to make fertilizers. They can also be present in low quality glass or plastic packaging materials that can leach into the final cannabis product upon contact. The inputs used by cultivators that can be contaminated with heavy metals include fertilizers, growing media, air, water and even the clone/plant itself.

The four heavy metals tested in the cannabis industry are lead, arsenic, mercury and cadmium. The California Bureau of Cannabis Control (BCC) mandates heavy metals testing for all three categories of cannabis products (inhalable cannabis, inhalable cannabis products and other cannabis and cannabis products) starting December 31, 2018. On an ongoing basis, we recommend cultivators test for the regulated heavy metals in R&D samples any time there are changes in a growing process including changes to growing media, cannabis strains, a water system or source, packaging materials and fertilizers or pesticides. Cultivators should test the soil, nutrient medium, water and any new clones or plants for heavy metals. Pre-qualifying a new packaging material supplier or a water source prior to use is a proactive approach that could bypass issues with finished product.

Testing Strategies

The best approach to heavy metal detection is the use of an instrument called an Inductively Coupled Plasma Mass Spectrometry (ICP-MS). There are many other instruments that can test for heavy metals, but in order to achieve the very low detection limits imposed by most states including California, the detector must be the ICP-MS. Prior to detection using ICP-MS, cannabis and cannabis related products go through a sample preparation stage consisting of some form of digestion to completely break down the complex matrix and extract the heavy metals for analysis. This two-step process is relatively fast and can be done in a single day, however, the instruments used to perform the digestion are usually the limiting step as the digesters run in a batch of 8-16 samples over a 2-hour period.

Only trace amounts of heavy metals are allowed by California’s BCC in cannabis and cannabis products. A highly sensitive detection system finds these trace amounts and also allows troubleshooting when a product is found to be out of specification.

For example, during the course of testing, we have seen lead levels exceed the BCC’s allowable limit of 0.5 ppm in resin from plastic vape cartridges. An investigation determined that the plastic used to make the vape cartridge was the source of the excessive lead levels. Even if a concentrate passes the limits at the time of sampling, the concern is that over time, the lead leached from the plastic into the resin, increasing the concentration of heavy metals to unsafe levels.

Getting a Representative Sample

The ability to detect trace levels of heavy metals is based on the sample size and how well the sample represents the entire batch. The current California recommended amount of sample is 1 gram of product per batch.  Batch sizes can vary but cannot be larger than 50 pounds of flower. There is no upper limit to the batch sizes for other inhalable cannabis products (Category II).

It is entirely likely that two different 1 gram samples of flower can have two different results for heavy metals because of how small a sample is collected compared to an entire batch. In addition, has the entire plant evenly collected and concentrated the heavy metals into every square inch of it’s leaves? No, probably not. In fact, preliminary research in leafy greens shows that heavy metals are not evenly distributed in a plant. Results from soil testing can also be inconsistent due to clumping or granularity. Heavy metals are not equally distributed within a lot of soil and the one small sample that is taken may not represent the entire batch. That is why it is imperative to take a “random” sample by collecting several smaller samples from different areas of the entire batch, combining them, and taking a 1 g sample from this composite for analysis.

References

California Cannabis CPA. 12/18/2018.  “What to Know About California’s Cannabis Testing Requirements”. https://www.californiacannabiscpa.com/blog/what-to-know-about-californias-cannabis-testing-requirements. Accessed January 10, 2019.

Citterio, S., A. Santagostino, P. Fumagalli, N. Prato, P. Ranalli and S. Sgorbati. 2003.  Heavy metal tolerance and accumulation of Cd, Cr and Ni by Cannabis sativa L.. Plant and Soil 256: 243–252.

Handwerk, B. 2015.  “Modern Marijuana Is Often Laced With Heavy Metals and Fungus.” Smithsonian.com. https://www.smithsonianmag.com/science-nature/modern-marijuana-more-potent-often-laced-heavy-metals-and-fungus-180954696/

Linger, P.  J. Mussig, H. Fischer, J. Kobert. 2002.  Industrial hemp (Cannabis sativa L.) growing on heavy metal contaminated soil: fibre quality and phytoremediation potential. Ind. Crops Prod. 11, 73–84.

McPartland, J. and K. J McKernan. 2017.  “Contaminants of Concern in Cannabis: Microbes, Heavy Metals and Pesticides”.  In: S. Chandra et al. (Eds.) Cannabis sativa L. – Botany and Biotechnology.  Springer International Publishing AG. P. 466-467.  https://www.researchgate.net/publication/318020615_Contaminants_of_Concern_in_Cannabis_Microbes_Heavy_Metals_and_Pesticides.  Accessed January 10, 2019.

Sidhu, G.P.S.  2016.  Heavy metal toxicity in soils: sources, remediation technologies and challenges.   Adv Plants AgricRes. 5(1):445‒446.

Sequoia Analytical Labs Caught Falsifying Results

By Aaron G. Biros
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Last month, Sequoia Analytical Labs admitted that they falsified hundreds of pesticide tests for batches of cannabis products. The Sacramento-based laboratory faked data on 22 different pesticide tests for more than 700 batches over a period of four months.

According to a notice posted on Sequoia’s website, the skewed results were originally found due to a “faulty instrument” but “it was further discovered” that the lab director knew about it and was fraudulently posting the results in order to hand out certificates of analysis. The lab director in question has since been fired and Sequoia voluntarily relinquished their state license.

Joe Devlin, Sacramento’s chief of cannabis enforcement, told KCRA3 News “We’re going to be taking a look at suspending or possibly revoking their permit.” He followed that up with saying that California needs more testing labs. “The shortage of labs has really created a bottleneck in the supply chain across the state,” says Devlin. There are only 43 licensed laboratories in the state of California as of this time, and just three of those are in Sacramento.

The Bureau of Cannabis Control (BCC), the regulatory authority overseeing the cannabis testing market in California, has not commented on this story, but they did reach out to distributors who had sent batches to Sequoia for testing. “Any cannabis goods from these batches, returned by consumers to the retailer, must be destroyed,” reads the BCC letter. “Any cannabis goods returned from a retailer’s inventory or remaining in your inventory may be destroyed, or may be re-sampled and re-tested after obtaining approval from the Bureau. Any cannabis goods from these batches may not be released to a retailer without re-sampling and re-testing.”

Sequoia Analytical Labs posted two notices on their homepage, one was a letter to their clients informing them of the fraud and the other is that BCC letter to distributors doing the same. “Management and ownership were horrified to learn about this severe breach of a very important safety regulation,” reads the notice. “We have voluntarily surrendered our license to do COA testing to the BCC while we make the required corrections. We are already hard at work making the needed changes to the instrument and revamping procedures so that we may get our license reinstated January 1.”

As of today, the lab’s license has not been reinstated.

Two Recalls Hit California Cannabis Market

By Aaron G. Biros
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Just weeks ago, the first voluntary cannabis product recall occurred under California’s new regulations. According to an article on MJBizDaily.com by John Schroyer, the recall for their vaporizer cartridges affects almost 100 dispensaries in California.

Bloom Brands, the company issuing the voluntary recall, mentioned in a press release that batches sold between July 1-19, 2018 were contaminated with the pesticide Myclobutanil and therefore does not meet the Bureau of Cannabis Control (BCC) standards. Below is an excerpt from the press release:

We are working closely with the BCC to remedy this issue and expect clean, compliant products to be back on shelves in three weeks…. At Bloom, we are continuing to work with the BCC and other partners to ensure that the space is properly regulated and safe for all customers. Transparency and safety remain our top concerns and we will provide updates as additional information becomes available. We apologize for any concern or inconvenience this serious misstep has caused. We thank you for your continued trust and confidence in our products.

Then, just days later, Lowell Herb Co. issued a voluntary recall on their pre-rolls. First reported by MJBizDaily.com, it appears the products initially passed multiple lab tests and was cleared for retail sales. Weeks after the batch passed tests, a laboratory reversed its decision, saying the products failed to pass the state’s testing standards. The contaminant in question was not mentioned.

The CCIA post calling out the BCC
The CCIA post calling out the BCC

Many seem to think these recalls are a product of the BCC’s unrealistic expectations in their lab testing rules. In a Facebook post days ago, the California Cannabis Industry Association called out the BCC for their unworkable rules. “The BCC has set testing standards that are nearly impossible to meet,” reads the post. “As a result recalls like this will be the norm and the industry will suffer a bottleneck in supply. Testing standards need to be realistic, not impossible.”

On July 13, California issued the first draft of their proposed permanent regulations, which would update and change the current emergency regulations. The proposed action levels for a batch to pass a pesticide test can be found on pages 105 and 106. The state’s regulatory bodies are holding public meetings on the proposed rules throughout August and stakeholders can also submit comments via email.