In 1996, the California legislature passed the Compassionate Use Act, allowing an individual to obtain a “caregivers license” to engage in the sale and distribution of marijuana to medically prescribed patients ((Compassionate Use Act of 1996, codified as amended Cal. Health & Safety Code § 11362.5.)). In the decades following, twenty-four states and the District of Columbia have set up systems for the sale and distribution of marijuana for medical or recreational purposes. ((NORML, State Info available at http://norml.org/states (last visited Oct. 19, 2015).)). While marijuana remains a banned drug under the federal Controlled Substances Act, the DOJ has stated the DEA will not pursue federal marijuana violations in states where the substance has been legalized. ((DOJ, Guidance Regarding Marijuana Enforcement (Aug. 29, 2013).)) Yet actual marijuana transactions represent only a portion of the $2.7 billion national cannabis industry that extends far beyond state-regulated dispensaries ((ArcView Market Research, The State of Legal Marijuana Markets (2015).)) As the “legal” marijuana industry continues to grow, both emerging companies and federal regulators are attempting to guide the ship through a sea of legal inconsistencies.
The SEC has attempted to reconcile apparent federal acquiescence with its own duty to protect investors. To date, there are at least fifty-five notable publically traded marijuana-related companies registered with the SEC ((Bloomberg Intelligence, Marijuana Market Index, http://www.bloomberg.com/graphics/2015-weed-index/ (last visited Oct. 19, 2015).)) The vast majority of marijuana-related stocks are traded on Over-The-Counter (OTC) exchanges. These exchanges are commonly occupied by volatile “penny-stocks” belonging to small-cap companies not subject to the same disclosure requirements as their larger counterparts trading on the NYSE and NASDAQ. ((SEC, Investor Alert: Marijuana-Related Investments, Office of Investor Education and Advocacy, (May 16, 2014), http://www.sec.gov/oiea/investor-alerts-bulletins/ia_marijuana.html.)) Following the legalization of recreational marijuana in Colorado and Washington in 2012, investors flooded OTC exchanges to invest in marijuana-related stocks, resulting in huge price fluctuations in shares of companies with little publicly available information. ((Paul R. Lamonica, CNN Money (April 17, 2015), http://money.cnn.com/2015/04/17/investing/marijuana-stocks-pot-gw-pharmaceuticals/.)). In May 2014, after suspending trading in five marijuana-related companies on charges of fraud and criminal market manipulation, the SEC issued an investor alert warning of the risks of investing in companies in the federally prohibited marijuana industry. ((SEC, Investor Alert: Marijuana-Related Investments, Office of Investor Education and Advocacy, (May 16, 2014), http://www.sec.gov/oiea/investor-alerts-bulletins/ia_marijuana.html.)). The SEC has since increased the level of disclosure required for public companies in the marijuana industry. While the SEC’s response has curbed the negative effects of penny-stock scammers luring uniformed investors caught in the frenzy of legalization, the increased scrutiny has created difficulties for legitimate marijuana-related businesses hoping to cash in on big public offerings.
The SEC’s increased disclosure burden on marijuana-related companies was apparent in its approval of Terra Tech’s public issuance of shares in 2015. The Nevada corporation primarily manufactures equipment for indoor agriculture, but recently created three fully-owned subsidiaries for the cultivation, wholesale, and retail sale of medical marijuana, legal in Nevada ((Terra Tech Corp., Registration of Securities (Form S-1) 6-9 (Dec. 24, 2014).)) While the SEC’s approval marked the first time the agency had allowed a company directly engaged in the cultivation and sale of marijuana to issue public shares, the SEC was not entirely complacent in its decision.
Significantly, the SEC refused Terra Tech’s request for acceleration, which would have waived the 20-day waiting period and allowed the company to issue its shares immediately. ((Gregory J. Millman, SEC Allows Pot Dealer to Register Stock Shares, Wall Street Journal (Jan. 28, 2015), http://blogs.wsj.com/riskandcompliance/2015/01/28/sec-allows-pot-dealer-to-register-stock/.)). Terra Tech’s issuance was underwritten, meaning the company had agreed to sell its shares to an underwriting bank to be sold subsequently on an exchange. The SEC almost always grants acceleration for underwritten issuances. ((Id.)) In fact, the SEC had granted acceleration to Terra Tech in prior issuances, but this was before the company was directly engaged the cultivation and sale of marijuana, and only sold indoor agriculture equipment to independent cultivators. ((Compare Terra Tech Corp., Registration of Securities (Form S-1) (Jan. 21, 2014) and Notice of Effectiveness (Form S-1) (Jan. 24, 2014) with Terra Tech Corp., Registration of Securities (Form S-1) (Dec. 24, 2014).)) The decision suggests the SEC has drawn a line between marijuana-related companies and companies directly engaged in the marijuana business. ((See Robert McVay, Marijuana and the SEC, Canna Law Blog (Feb. 8, 2015) http://www.cannalawblog.com/marijuana-and-the-sec/.)). Regardless, the denial of an acceleration request for an underwritten issuance will make it difficult for any marijuana-related companies hoping to attract an underwriter for a public issuance, a practical prerequisite to have shares listed on major stock exchanges like the NYSE or NASDAQ.
According to the attorney advising Terra Tech, the SEC felt acceleration of the company’s issuance did not meet the requirement that such action be in the “public interest.” ((Gregory J. Millman, SEC Allows Pot Dealer to Register Stock Shares, Wall Street Journal (Jan. 28, 2015), http://blogs.wsj.com/riskandcompliance/2015/01/28/sec-allows-pot-dealer-to-register-stock/; see also 17 C.F.R. § 230.461(b) (2010).)). The SEC’s correspondence with Terra Tech, which focused heavily of the risks of its marijuana cultivation business, sheds light in the agency’s concerns. The final registration statement includes a lengthy list of marijuana-associated risks, including risk of federal prosecution and legal uncertainties inhibiting the company’s ability to obtain necessary permits and banking services. ((Terra Tech Corp., Amended Registration Statement (Form S-1) 4-7, 13-23 (June 28, 2015).)). The grim recitation of potential federal death knells would cause most investors to think twice before putting money in any marijuana-related company.
Uncertainty surrounding federal marijuana law will likely continue to make public equity an unattractive financing option for emerging companies in the marijuana industry. However, where federal law has been clarified, marijuana-related companies have experienced capital markets success. Last year, after Congress defunded DEA interference with medical marijuana businesses and the Obama administration repealed barriers to cannabis research, ((Consolidated and Continuing Appropriations Act, Pub. L. No. 113-235, § 538, 128 Stat. 217 (2014); Announcement of Revision to the DHHS Guidance of Procedures for the Provision of Marijuana for Medical Research, 80 Fed. Reg. 35960 (June 23, 2015),)), several biotech companies specializing in cannabis-derived medical treatments experienced immensely successful public offerings ((See Jon C. Ogg, Is Cannabis Biotech Zynerba the Hottest Post-IPO of 2015?, 24/7WallStreetSt.com (Aug. 10, 2015) available at http://247wallst.com/healthcare-business/2015/08/10/is-cannabis-biotech-zynerba-the-hottest-post-ipo-of-2015/; Debra Borchardt, GW Pharmaceuticals Stocks Responds to Cannabis Drug Milestones, Forbes (April 27,2015), available at http://www.forbes.com/sites/debraborchardt/2015/04/27/gw-pharmaceuticals-stocks-responds-to-cannabis-drug-milestones/.)). Other companies in the marijuana industry continue to attract private investment from Venture Capital firms and notable wealthy individuals, including Pay-Pal co-founder Peter Thiel, Netflix co-founder Mitch Lowe, and rap mogul Snoop Dogg. ((See David Pierson, Venture Capital Firm Gives Marijuana Industry A Shot of Credibility, LA Times (Jan. 28, 2015), available at http://www.latimes.com/business/la-fi-founders-fund-marijuana-20150109-story.html)). The success of these companies and others could give much needed legitimacy and stability to the legal marijuana industry, lowering the risk of investment and perhaps persuading the SEC to relax its current level of scrutiny. Ultimately, if public equity is to become a viable option for marijuana-related emerging companies to raise capital, both the industry and federal law must develop a clearer picture.
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- SEC Regulation of Public Marijuana-Related Companies - October 26, 2015