Eds Note: This file was originally published on Oct. 11, 2018
Highlights
- Nearly three-quarters of the companies with U.S. operations failed to provide enough information to investors about the risks of operating in that country.
- Cannabis companies were responsive to regulators’ concerns, the CSA said, committing improve future filings
Just how risky is it to be a cannabis company in the United States? Riskier than some Canadian companies described to their investors, according to Canadian securities regulators.
That was one of many concerns expressed in Wednesday’s Staff Notice from the Canadian Securities Administrators, an umbrella group of provincial regulators. In the report, the first comprehensive regulatory review of the cannabis industry’s accounting and disclosures, Canada’s securities enforcers identified widespread disclosure problems. The cannabis companies were responsive to regulators’ concerns, the CSA said, committing improve future filings or re-filing past documents.
One area of concern: In the regulators’ views, nearly three-quarters of the companies with U.S. operations failed to provide enough information about the risks of operating in that country. In doing so, they failed to satisfy a February CSA staff notice on how to discuss U.S. operations. The CSA said 17 per cent of the companies with U.S. operations re-filed their most recent management’s discussion and analysis (MD&A) form.
Thanks to the Ontario Securities Commission’s disclosures, we can get a sense of just what the regulators expect. Four companies have re-filed recent MD&A’s since the February staff notice: Golden Leaf Holdings Ltd., MPX Bioceutical Corp., Nutritional High International Inc. and Quinsam Capital Corp. All trade on the Canadian Stock Exchange, owing to the TSX’s ban on listings of companies operating in the U.S. cannabis industry, and range in market value from $37-million (Quinsam) to $335-million (MPX).
Golden Leaf, which operates primarily in Oregon, provides an example. In its original quarterly filing May 30, its section titled “Risks Related to the Company’s Business” included a section called “U.S. Federal Regulation” (appended below). It also had a section, the fourth listed risk, called “Marijuana remains illegal under US Federal law” (appended below).
That was the bulk of the U.S.-related risk disclosure.
The new, revised MD&A, filed Sept. 7, now has a section headed “Risks Specifically Related to the United States Regulatory System” which is followed in bold by “Marijuana is illegal under U.S. federal law and enforcement of relevant laws is a significant risk” and “This MD&A involves an entity that is expected to continue to derive a portion of its revenues from the cannabis industry in certain states of the United States, a country in which cannabis remains prohibited by federal law.”
The federal and state-level U.S. disclosure that follows stretches 17 pages. The original MD&A filing totalled 23 pages; the new one is 43.
It includes a new table of the company’s material assets and investments and classifies them as “directly” involved in the U.S. cannabis business, “indirectly” involved or with an “ancillary” involvement. (The CSA says “ancillary industry involvement arises when an issuer provides goods and/or services not limited to financing, branding, recipes, leasing, consulting or administrative services to third parties who are directly involved in the U.S. marijuana industry.”)
A bullet-point list of risk factors that could affect the company’s results highlights the blunter language now expected. They include:
· The Company has several investments into businesses that operate in the U.S., where cannabis is federally illegal;
· The activities of the Company are subject to evolving regulation that is subject to changes by governmental authorities in Canada and the U.S.;
· Third parties with which the Company does business, including banks and other financial intermediaries, may perceive that they are exposed to legal and reputational risk because of the Company’s cannabis business activities;
· The Company’s ability to repatriate returns generated from investments in the U.S. may be limited by anti-money laundering laws;
· Under Section 280E of the Internal Revenue Code, normal business expenses incurred in the business of selling marijuana and its derivatives are not deductible in calculating income tax liability. Therefore, the Company will be precluded from claiming certain deductions otherwise available to non-marijuana businesses. As a result, an otherwise profitable business may in fact operate at a loss after taking into account its income tax expenses. There is no certainty that the Company will not be subject to 280E in the future, and accordingly, there is no certainty that the impact that 280E has on the Company’s margins will ever be reduced;
· Federal prohibitions result in marijuana businesses being potentially restricted from accessing the U.S. federal banking system, and the Company and its subsidiaries may have difficulty depositing funds in federally insured and licensed banking institutions. This may lead to further related issues, such as the potential that a bank will freeze the Company’s accounts and risks associated with uninsured deposit accounts. There is no certainty that Company will be able to maintain its existing accounts or obtain new accounts in the future.
The new filing also notes the February Staff Notice. Golden Leaf says it “views [it] favourably, as it provides increased transparency and greater certainty regarding the views of its exchange and its regulator of existing operations and strategic business plan as well as the Company’s ability to pursue further investment and opportunities in the United States.”
Appendix:
Golden Leaf - U.S. Federal Regulation:
Currently, there are 29 states of the United States plus the District of Columbia that have laws and/or regulations that recognize, in one form or another, legitimate medical uses for cannabis and consumer use of cannabis in connection with medical treatment. many other states are considering similar legislation. Conversely, under the U.S. Controlled Substance Act (the “CSA”), the policies And regulations of the Federal government and its agencies are that cannabis has no medical benefit and a range of activities including cultivation and the personal use of cannabis is prohibited. Unless and until Congress amends the CSA with respect to medical marijuana, as to the timing or scope of any such potential amendments there can be no assurance, there is a significant risk that federal authorities may enforce current federal law, and we may be deemed to be producing, cultivating or dispensing Marijuana in violation of federal law or we may be deemed to be facilitating the selling or distribution of drug paraphernalia in violation of federal law with respect to our current or proposed business operations. Active enforcement of the current federal regulatory position on cannabis may thus indirectly and adversely affect the Company’s future cash flows, earnings, results of operations and financial condition. The risk of strict enforcement of the CSA in light of Congressional activity, judicial holdings and stated federal policy remains uncertain.
Golden Leaf - “Marijuana remains illegal under US Federal law”:
Marijuana is a schedule‐I controlled substance under the CSA and is illegal under U.S. federal law. Even in those states in which the use of marijuana has been legalized, its use remains a violation of U.S. federal law. Since U.S. federal law criminalizing the use of marijuana pre‐empts state laws that legalize its use, strict enforcement of federal law regarding marijuana would likely result in our inability to proceed with our business plan.