Legal Weed’s Regulation Mess

By Alex Halperin
Dec 23, 2019

To outward appearances, marijuana looks increasingly normalized. Expensively packaged weed, sleek dispensaries and the CBD obsession have recast the drug as sophisticated, even healthy. Since 2014, when the country’s first legal recreational cannabis market opened in Colorado, the industry has enjoyed extraordinary growth. Recreational use is now legal in 11 states, and medical is allowed in more than 30. Legal sales totaled more than $10 billion in 2018. Virtually all observers predict more states to go fully legal in the coming years and the industry to see rapid growth. But from a regulatory perspective, cannabis remains uniquely slippery. The industry operates largely in cash, since many companies can’t obtain bank accounts and other basic financial services. Marijuana also remains federally illegal, and the country’s illicit market is far larger than the combined, regulated state markets. As the industry grows wealthier and the large multistate companies compete to increase their footprint, the, regulatory issues are only getting thornier. Further complicating matters, each legal state has its own laws for regulators to enforce and cannabis companies to interpret. And there’s been little apparent help from Washington D.C. – – during neither the Trump nor Obama administrations.

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After Colorado and Washington state voted to legalize recreational in November 2012, the Obama administration had to decide whether to allow these states to set up regulated markets for a federally illegal drug. Its decision came in the form of an August 2013 Justice Department document known as the Cole Memo. Sent to U.S. attorneys in all states, it advised against prosecution for most violations—essentially allowing the state markets to open as long as they effectively enforced federal priorities like no sales to minors, no tolerance for marijuana impaired driving and keeping organized crime out of the industry. In January 2018, however, then-U.S. Attorney General Jeff Sessions rescinded the Cole Memo. In retrospect it looks like a symbolic gesture to express his personal disapproval of marijuana: The memo remains the closest thing to federal guidance on what’s expected of the legal states. Legal dispensaries seem to be very conscientious about not selling to kids, and stoned driving has not become a significant threat. But other Cole Memo requirements, such as warding off criminal involvement, are trickier. In October, two Soviet-born associates of Rudy Giuliani, President Trump’s personal lawyer, were indicted in a scheme to win the favor of politicians in Nevada and other states in order to enter the marijuana business. Thus far, the marijuana industry appears to be only tangentially related to Giuliani and the broader impeachment story; But a phrase in the indictment highlights a little-discussed but potentially enormous problem with the drug’s transition from illegal to legal enterprise. The indictment says Giuliani’s associates, Lev Parnas and Igor Fruman (and two others), “took steps to hide” the identity of an investor, a foreign national with “Russian roots,” due to the current political climate. (All four have pleaded not guilty.) Days after the indictment landed, Nevada Governor Steve Sisolak, a Democrat who supports legalization, launched a task force to “root out potential corruption or criminal influences,” in the state’s marijuana market. California and the city of Sacramento also said they would look into the matter after it emerged that one of the indicted men, a Ukraine-born U.S. citizen named Andrey Kukushkin was an officer in a Sacramento marijuana business. (Officials reportedly said there was no evidence of problems with the California licenses.) To prevent criminal networks from joining the industry, until 2019 Colorado required all direct and indirect investors in pot companies to be identified to the state regulator, the Marijuana Enforcement Division, and for each investor to go through a background check. But laws limiting public disclosure about marijuana investors make it difficult to determine how effectively the state is enforcing the rules. In October, WeedWeek reported new details surrounding an apparent 2013 investment of $140,000 in a Colorado marijuana start-up called Ebbu, from an individual who was never identified to state authorities. In a 2018 court filing, Ebbu co-founder Michael “Dooma” Wendschuh, who led the company’s fundraising efforts between 2013 and 2015, says Ebbu had a “longstanding policy” of helping investors put money into the company “without publicly revealing their identities.” To Wendschuh’s knowledge, the filing states, “this policy was not intended to avoid compliance with any state or federal laws but rather to help investors…concerned about the reputational issues associated with having their name on file,” as an investor in a marijuana company. Similar practices, Wendschuh’s filing states, are “common” among Colorado marijuana companies. (Ebbu’s former CEO Jon Cooper has denied violating any state or federal securities laws, according to a court filing.) Ebbu’s assets were acquired in October 2018 by Canopy Growth, one of Canada’s largest marijuana companies, in a cash and stock deal worth roughly $250 million. (Canopy and its largest shareholder, publicly-traded American liquor company Constellation Brands, did not respond to requests for comment.) Colorado regulators past and present decline to answer questions about Ebbu; They also decline to comment on the possibility of unidentified investors getting their money into the state’s roughly 1,500 other marijuana companies. By reputation, Colorado is among the best regulated legal markets. It isn’t just gangsters and Russians who might prefer their marijuana investments to be anonymous. Many individuals with capital to invest in start-ups also have professional and reputational reasons why they can’t be formally associated with a marijuana. For example, marijuana investments could potentially still cause problems for practicing doctors, lawyers and employees at publicly-traded companies.

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The arrival of marijuana companies with national ambitions has created a new set of regulatory challenges. Several states have created ownership restrictions and quotas on cannabis licenses, in part to nurture native businesses. In several of these states, issues have arisen surrounding arrangements known as management agreements. These deals resemble the way chain hotels often don’t own their hotels and instead license their brand and operations procedures to the property owners, according to Kris Krane, president of cannabis consultancy 4Front. In March, the Boston Globe’s Spotlight team reported that two multistate cannabis companies—Acreage Holdings and Sea Hunter Therapeutics, part of the conglomerate Tilt Holdings ) — appeared to control more than the three recreational dispensary licenses allowed by the state. (To the Globe, both companies denied bending or breaking the rules.) After the Globe’s story ran, Massachusetts regulators confirmed an investigation, which is ongoing, into these management agreements. It could boil down to a question of what constitutes control of a business. Krane, of 4Front suggested if Massachusetts found Acreage to be in violation it could sue the state in response. Acreage declined to comment to WeedWeek on the suggestion, but a spokesperson said the company is cooperating with regulators. A Tilt Holdings spokesperson said the company “believes the agreements are within regulatory guidelines” but is “reworking” them. Similar controversies surrounding management agreements have arisen in medical marijuana states Maryland, Ohio and Pennsylvania. In June, Philadelphia Inquirer reporter Sam Wood wrote Pennsylvania state lawmakers, “weren’t prepared for creative arrangements that well-financed marijuana companies are using to control more permits than the law intended.” The same could almost certainly be said for other legal states. Part of the issue, observers say is that state regulators are perpetually strapped for resources. Further burdening them, their role involves public safety and in some cases ensuring a state market runs smoothly, in addition to enforcement. The question then of what effective regulation looks like becomes hazy. In California, where the situation is especially daunting, roughly two-thirds of the state’s $12 billion in annual cannabis sales take place outside the regulated market. Asked about these issues by WeedWeek, three lawyers with cannabis clients made similar arguments that legal states are making a great deal of progress. While there may be gaps, they essentially argued that legalization is a regulatory success story, and that most of the shortcomings will be ironed out in coming years, much in the way alcohol is now regarded as well-regulated. Considered broadly, this is probably true. But the argument overlooks a key aspect of the marijuana industry. Unlike other industries, marijuana legalization stems from decades of aggressive police tactics and prosecutions which disproportionately punished racial minorities. Its widely believed — and enshrined in some state and local laws — that those communities deserve to enjoy the wealth arriving with legalization. Thus far these efforts have yielded limited success. How well the industry is regulated now could have an immense influence on who gets rich. Alex Halperin (@alexhalperin) is the editor and publisher of WeedWeek. He lives in Los Angeles. Correction: This story initially said the Boston Globe’s reporting led Massachusetts authorities to open an investigation. The investigation began before the Boston Globe story ran.