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Health Canada’s investigation into CannTrust Holdings Inc. and other coming-of-age issues in the domestic cannabis industry are becoming roadblocks to legalization of recreational marijuana in the U.S. market, according to industry experts, jeopardizing the growth plans at many Canadian companies.

Vaughan, Ont.-based CannTrust, which lists its shares on New York and Toronto stock exchanges, halted all cannabis sales last week after revealing federal investigators are probing the company for producing marijuana at unlicensed facilities. Analysts predict the company will face significant sanctions, potentially including cancellation of its cannabis production licences.

“We believe Health Canada must come down hard on CannTrust if it wants to maintain any credibility,” said analyst Greg McLeish of Mackie Research Capital Corp. as he terminated coverage of the company in a report on Monday. CannTrust stock price rose 19 per cent on Monday to close at $3.98 on the Toronto Stock Exchange. The company has three facilities in Canada and sold US$170-million of shares at US$5.50 each in May, working with Wall Street investment banks, then moved into the U.S. market in June by acquiring farmland in California.

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CannTrust’s regulatory issues, along with short-seller attacks on Aphria Inc. and supply problems that have plagued Canadian retailers since the federal Liberals legalized recreational cannabis last October, are now colouring the U.S. debate over legal marijuana, according to New York-based investment bank Cowen Inc.

At a conference Monday that followed the U.S. House of Representatives’ first-ever hearings on cannabis legalization last week, Jaret Seiberg of Cowen said Canada is considered a political pioneer in the sector. The Washington-based financial services policy analyst said problems in the country’s nine-month-old cannabis market, including the Health Canada investigation into CannTrust, are closely followed by U.S. policy-makers. “The more problems there are north of the border, the more it complicates the issue of legalization in the U.S,” he said.

Canadian analysts are also pumping the brakes on U.S. legalization in the wake of last week’s hearings at the House Judiciary Crime, Terrorism and Homeland Security subcommittee. Echelon Wealth Partners analyst Matthew Pallotta said Friday in a report: “Serious questions remain on how to best pursue reform, and whether there is sufficient support in the Republican-controlled Senate to advance cannabis policy.”

While U.S. federal restrictions on recreational cannabis are expected to remain in place for the foreseeable future, analysts expect more states to legalize marijuana, if only for the potential tax revenue. Cowen’s analysts said in a report: “Unlike the federal government, states cannot run deficits. With poor state finances, governors are looking for revenue wherever they can find it.”

Canada’s major cannabis companies and U.S. marijuana businesses that list their stock on a Canadian exchange have committed hundreds of millions of dollars to U.S. expansion strategies, in part on the expectation that Washington will eventually legalize marijuana.

Last week, Toronto-based Green Growth Brands Inc. agreed to acquired U.S. cannabis retailer Moxie for US$310-million, snapping up 250 stores in five states. Green Growth also sells cannabis products in the United States through a partnership with Designer Brands Inc., the parent company of DSW shoe stores (NYSE: DBI) and Abercrombie & Fitch Co.

In May, Canopy Growth Corp., Canada’s largest cannabis company, paid US$300-million up front for the right to buy a leading U.S. player in the sector, Acreage Holdings Inc., once cannabis production and sale become federally legal in the U.S. Acreage operates in 20 states, with 87 dispensaries and 22 cultivation sites. Canopy’s aggressive growth strategy and larger-than-expected financial losses prompted controlling shareholder Constellation Brands Inc. to terminate Canopy co-chief executive officer and co-founder Bruce Linton this month.

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