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Politically Motivated Investigations of Legitimate Cannabis Businesses: One More Reason for Cannabis Operators to Return to the Black Market?

By Tracy A. Gallegos
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In June 2020, John W. Elias, a prosecutor in the United States Department of Justice’s Antitrust Division, testified to the U.S. House Committee Judiciary that investigations of cannabis mergers were pursued based on Attorney General William Barr’s personal dislike for the cannabis industry rather than legitimate antitrust issues. Specifically, Elias testified, among other things, that since March 2019, the Antitrust Division has conducted ten investigations of mergers in the cannabis industry. Further, Elias testified that, “While these were nominally antitrust investigations, and used antitrust investigative authorities, they were not bona fide antitrust investigations.” Elias went on to state that, with respect to a proposed $682 million merger between two cannabis companies, MedMen and PharmaCann, career staff in the Antitrust Division initially examined the transaction to determine whether there should be no investigation, a brief investigation or a full investigation. Upon conclusion of its review, career staff determined that “the cannabis industry appeared to be fragmented with many market participants in the states that had legalized the product.” Accordingly, staff concluded that the proposed combination between MedMen and PharmaCann was “unlikely to raise any significant competitive concerns.”

John W. Elias, DOJ whistleblower and acting Chief of Staff to the Assistant Attorney General

Notwithstanding the career staff’s determination, Attorney General Barr ordered the Antitrust Division to issue “Second Request” subpoenas. According to Elias’s testimony, a “Second Request” subpoena is a full investigation of a proposed merger. Moreover, Elias stated, “Across the entire American economy, the Antitrust Division performs the full Second Request investigation on around 1-2% of the thousands of mergers filed each year – ordinarily, only the most concerning deals.” Based on the foregoing, Elias testified that Attorney General Barr’s decision to pursue the MedMen/PharmaCann combination was based on his dislike for the cannabis industry rather than any legitimate antitrust concerns.

There are some immediate impacts to Attorney General Barr’s decision – not limited to the MedMen/PharmaCann merger but potentially reaching any cannabis companies considering a merger or similar transaction. For example, a politically motivated probe would more than likely result in a drop of stock prices for publicly trade cannabis companies. Moreover, non-bona fide antitrust investigations of cannabis businesses could result in proposed merger transactions eventually not coming to fruition.

However, Attorney General Barr’s decision could arguably have longer term and more widespread effects on the cannabis space, and could affect situations not involving mergers or other proposed business combinations. In particular, the fact that legitimate cannabis businesses that comply with all applicable laws are still subject to unwanted and unnecessary scrutiny conceivably could lead to something that regulators had hoped would be curbed through the legalization of cannabis for adult use: cannabis operators gravitating towards the omnipresent black market. Despite cannabis being legal in 33 jurisdictions for medicinal use and 11 jurisdictions for adult use, the black market continues to thrive for several reasons, one of them being that the cost of regulatory compliance is so significant. Attorney General Barr’s decision may have created another reason for cannabis operators to abandon their plans to continue operating as or become legitimate businesses and instead revert back to operating in the black market.

Indeed, Attorney General Barr’s decision is a concern for cannabis operators because it shows that, notwithstanding that any particular operator may be compliant with state and/or local regulations, it does not mean that such cannabis operator is going to be permitted to conduct “normal” business that a non-cannabis business would be able to conduct, simply because of the underlying nature of the business. Stated differently, following the rules does not mean that a cannabis business will be left alone by people in charge who simply do not like the cannabis space.

Attorney General William Barr

Cannabis operators are very mindful of being targeted because of the nature of their business, and having regulations in place with which they could and would comply provided them with some level of certainty that they would not be targeted, or so they thought. Particularly in states like California where the regulations are complex, current and aspiring cannabis operators tend to be very concerned about being compliant with cannabis regulations from the inception of their business operations, believing that being compliant will assist them in flying under the proverbial radar and not become targeted unnecessarily simply because they are in the cannabis space. Attorney General Barr’s decision may have taken away or, at the very least, significantly decreased, that level of certainty. His decision to investigate a proposed merger of two legitimate cannabis businesses sends the message that it does not matter if a cannabis business is being compliant, and that there are other, completely subjective reasons why its operations could be investigated. This makes it extremely difficult for current and aspiring cannabis operators to determine what actions they can take to avoid unwelcome investigations or other scrutiny. If a cannabis operator is unable to mitigate scrutiny by complying with rules, this raises the concern that cannabis businesses will go back to black market activity, not only because the cost of compliance is high, but because being compliant does not necessarily protect them.

Attorney General Barr’s decision is likely not the only instance of a decision regarding cannabis businesses that was made notwithstanding existing statutes or regulations that do not support such a decision. In fact, since adult use became legal in certain jurisdictions it is not uncommon to see news discussing applicants for cannabis licenses who were denied licenses, notwithstanding that those applicants complied with all applicable laws and regulations. When applicants were denied even after complying with all rules and regulations, and when no other legitimate reason was cited for the denial, there is an indication that the denial was based on political or other personal feelings concerning the cannabis space. This not only potentially calls into question the integrity of the cannabis space, but again could lead cannabis operators back to the black market.

There are many costs of regulatory compliance for a cannabis operator, including, without limitation, high application and license fees, development and mitigation fees and exorbitant taxes. Other than the fees and taxes assessed on cannabis businesses, there are other expenses, such as the cost to construct a facility, security costs and the general operational costs that all businesses must pay, such as rent or payroll. What incentive does a cannabis operator have to expend significant resources – time, money and otherwise – to become a legitimate, licensed cannabis business if doing so does not provide any type of protection against investigations that are politically motivated or otherwise based on negative personal feelings toward the cannabis space? It may be that Attorney General Barr’s decision has given cannabis operators one more reason to reconsider going back to black market activity.

Nevada Lab License Suspended Amid Potency Results Investigation

By Aaron G. Biros
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Back in September, Nevada officials announced a state-wide investigation into how products with high levels of yeast and mold were sold in dispensaries and alleged that labs could possibly be manipulating potency numbers on certificates of analysis. Then in late November, regulators suspended the license for Certified Ag Labs, a cannabis testing laboratory based in Sparks, Nevada.

Nevada regulators issued a press release alleging that products tested at Certified Ag Labs “may be labeled incorrectly and could contain a different level of THC than what is listed on product packaging.” Randy Gardner, a managing member at Certified Ag Labs told the Las Vegas Review-Journal that investigators showed up to his lab in October twice to collect samples for follow up tests.

On November 18, a state notice posted on the door of the lab read, “Registration and License Suspended,” according to the Las Vegas Review-Journal.

After that, Gardner fired back. In a statement sent out shortly after, Gardner said they were accused of lying about THC test results to the Department of Taxation (the agency that regulates cannabis in Nevada).

“The state’s decision to suspend and potentially revoke our license came without warning,” says Gardner’s statement. “This accusation is as baseless as it is appalling, as we have been completely transparent with the state at all times. We take this matter very seriously, and based on my over 30 years of laboratory experience we believe these allegations unconscionable at best.”

“The state came in for their audit then came back and suspended our license without us having a chance to further clarify or refute their findings,” the statement reads. “We hope the state appreciates that a business and its employees’ livelihoods and reputations are at stake. We are pursuing our options and all legal and equitable redress will be on the table.”

The Department of Taxation, which isn’t releasing any more information currently, says they found “inaccurate and misleading” potency test results, once they tested the samples collected from Certified Ag Labs.

This isn’t the first time Nevada regulators have suspended lab testing licenses. When Nevada legalized adult use sales and the market became operational back in 2017, the state suspended a lab’s license in September of that year. Then in late 2017, Certified Ag Labs and another lab had their licenses suspended for “not following proper lab procedures and good laboratory practices,” according to Stephanie Klapstein, spokeswoman for the Department of Taxation. Those licenses were reinstated in January of 2018.

CannTrust Meltdown Indicative Of Summer Of Scandal To Come

By Marguerite Arnold
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While you may not have heard of CannTrust Holdings so far, that is now about to change. A summer spectacle of double dealing and corporate greed has put this Canadian cannabis company on the global map.

Unfortunately, the current meltdown underway is indicative of more to come.

A Summary Of The Story So Far

CannTrust, a company which serves 72,000 Canadian patients and got into the game early, decided to do what it saw other companies doing all around them. That covers a lot of ground (good and bad at this point). Regardless, the most relevant recent twist to the saga came when the company hired a new CEO, Peter Aceto last October.

Aceto however, along with the now also fired co-founder and chair of the board Eric Paul, decided to continue growing and harvesting unlicensed product. Worse, this occurred while boasting in public of their productivity gains on the way to securing a hefty investment of capital this spring. $170 million. The grow rooms finally got their certification in April.

What is even more embarrassing however, is that this was a round led by the much-vaunted investors the industry has been courting assiduously for the past several years. Specifically, in this case? Institutional banks like Bank of America, Merrill Lynch, Citigroup, Credit Suisse Securities and RBC Capital Markets.

But that is “just” the North American hemisphere. The rather unfortunately named CannTrust (certainly at this point) also had a European footprint – notably Denmark. Unlicensed cannabis ended up there too, of course. Stenocare A/S, the company at the receiving end of the same, reported receipt of product from the unlicensed rooms on July 4.

As far as such things go, however, you have to give it to CannTrust company executives. In terms of setting standards if not benchmarks and “records”, they certainly seemed to have set a few, although probably not the ones they aspired to. If not, with certainty, their investors.

A Surprise Or Inevitability?

That said, for many who have been sounding warnings for at least a year, the 2019 Summer of Canadian Cannascandal is certainly starting to confirm what many have been saying for quite some time. This is not the first time a securities exchange, for one, has sounded the alarm. Deutsche Börse delisted the entire North American public cannabis industry last summer briefly. Then they revised their policy, reluctantly, after Luxembourg changed its stance on medical use. That said, they are still watching with a standing policy of bouncing any company that runs afoul of their rules.

The problems, issues and more bubbling at the center of this cannameltdown, in other words, are not limited to just one company or country.

And everyone knows it.

Accounting For Past Mistakes

For those who are counting, the value of all of that illegally grown CannTrust product is not insignificant. Estimates are floating in the CA$50-70 million range. The problem is, of course, nobody is sure what numbers to rely on. CannTrust employees knowingly provided inaccurate information to the new CEO if not regulatory body until a whistle-blower provided a few more details.

That said, for all of the hullabaloo, one thing this story also does is point a bright spotlight on the lax enforcement of even this pretty easy-to-understand regulation.

The question, however is, if CannTrust thought it could get away with this kind of blatent flouting of the rules, if not lax oversight, are there any other companies who might have also done similiar things?

After all, even the pesticide scandal of 2016 did not occur at just one company either.

Where Are The Proceedings?

This is a rolling story, which began to break at the beginning of last month when Health Canada issued a non-compliance order to CannTrust and impounded 5,200 kg of dried cannabis that was apparently grown in unlicensed grow rooms on July 3.

There have already been some jaw dropping revelations so far (beyond the executive decision to even go down this road in the first place) no matter how attractive pimping numbers was. Starting with things like fake walls being erected to hide the grow. And then of course pictures that have been all over social media of late, of the now departed CEO Aceto being photographed directly in front of said unlicensed rooms too.

As a result, the drama has continued to unfold in a highly predictable way.

By August 1, CannTrust Holdings, a Canadian cannabis company listed on both the New York and Toronto stock exchanges, was facing a “quasi-criminal investigation” by the Canadian Joint Serious Offenses Team. This is a coalition of law enforcement agencies including the Ontario Securities Commission, the Royal Canadian Mounted Police Financial Crimes Unit, and the Ontario Provincial Police Anti-Rackets Branch.

But CannTrust’s issues don’t end there. This is an international story that is just beginning. Government regulators in Europe if not elsewhere are paying attention.So are shareholders, and their lawyers.