Locke Lorde Blog Post See Canntrust Investigation: Risks Abound For Cannabis Companies In Highly Regulated Industry

Locke Lorde Blog Post See Canntrust Investigation: Risks Abound For Cannabis Companies In Highly Regulated Industry

Authored by holz | Aug 5, 2019

The Ontario Securities Commission (OSC) has opened an investigation into CannTrust Holdings, Inc., deepening the problems for the large Canadian cannabis company. CannTrust also announced that it will miss the deadline to file its interim financial reports for second quarter 2019.

CannTrust’s troubles began last month when regulator Health Canada alleged that CannTrust was engaged in unlicensed cultivation at its facilities. Specifically, Health Canada alleged that CannTrust was cultivating marijuana in five unlicensed rooms and put a hold on 5,200 kilos of dried cannabis (estimated value of $38.6 million) derived from those rooms. In response, CannTrust stopped all sales and shipments of its products on July 11, 2019 and fired its CEO Peter Aceto. Chairman Eric Paul resigned upon request of the board of directors. Now, the Joint Serious Offences Team from the OSC will be poring over CannaTrust’s financial records and looking for fraud, market manipulation, and other financial offenses. A securities fraud class action lawsuit filed against CannTrust on July 8, 2019 also remains pending.

U.S. cannabis companies would be wise to take heed of CannTrust’s predicament. There are several factors that place U.S. cannabis companies at increased risk of regulatory problems compared to their peers in other U.S. industries. First, the U.S. cannabis industry is highly regulated. Second, it is highly regulated by the individual states, each with their own—often complex—regulatory and licensing schemes. That means multi-state operators in the cannabis industry have to deal with a patchwork of rules and regulations. Third, there is intense pressure to increase market share as states come online quickly and demand for product soars. Take Illinois for example. Existing Illinois cannabis companies are going to have less than nine months to prepare for a market that will grow at least tenfold on January 1, 2020 when recreational marijuana becomes legal. Fourth, because of the newness and rapid expansion in the industry, the compliance departments of many cannabis companies are facing crushing workloads as they try to deal with legal issues as they arise. So you have multiple sets of complex regulations, intense competition to expand, and overwhelmed compliance departments evaluating risk. That is a potentially dangerous brew.

Our advice: slow and steady wins the race. U.S. companies should consider tempering their expansion goals to ensure that any expansion comes with adequate protections and safeguards. We recommend creating robust policies and procedures, internal audit operations to ensure compliance with applicable state rules and regulations, extensive due diligence as part of mergers and acquisitions, and obtaining outside counsel advice for key decisions and oversight.

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