Surviving the Cannabis Bubble

Lessons Learned from the Crypto Bubble

Michael James
Sep 24, 2018 · 3 min read

The rapid expansion and legalization of the cannabis industry has created what some are referring to as a gold rush mentality. The use of such terms as “gold rush” in the same sentence as “stocks” causes the Securities and Exchange Commission’s (SEC) antenna to rise and start scanning for possible fraudulent activity. While there are fraudsters in the market, well intentioned entrepreneurs can find themselves caught up in a regulatory investigation by failing to fully understand or comply with the state and federal regulations. The crypto market is a great place to look for recent examples of how the cannabis industry can avoid years of regulatory inquiries and large legal bills. In the end, the growth of the legalized marijuana industry will depend on the industry’s ability to follow the rules and develop credibility.

Raising Capital: Businesses generally raise capital by selling securities. The Securities and Exchange Commission (SEC) oversees the sale of securities to the public. The SEC’s mandate is to protect investors by making sure that investors are aware of all of the risks of investing in the company through disclosures made in the company’s offering documents, and to ensure that company insiders are not fraudulently selling securities in a pump and dump scheme.

Recently, some companies raising money through Initial Coin Offerings (ICOs) did so prior to understanding how regulators would treat ICOs. Markets were booming and someone was making money. The SEC and the CFTC quickly responded by issuing alerts warning investors, initiating enforcement investigations and working with state regulators to ferret out fraud. The crypto market pushed the envelope with the regulators, and in return, the industry lost credibility with the regulators.

For Cannabis businesses, the markets are being to rise sharply and millionaires are being made. However, disclosing all known risks to investors can be tricky as the industry is nascent and marijuana is still criminalized at the federal level. There are also risks at the state level as regulators move through the implementation stage and try to establish strong enforcement in order to reinforce compliance with regulations. The SEC has already brought several enforcement actions for the fraudulent sale of marijuana securities, and issued an alert to investors warning them of the investment risks. The cannabis is at a pivotal point in establishing credibility with the SEC. The cannabis industry should itself ferret out the fraud and help the SEC to eradicate the scammers.

Cannabis businesses can also establish credibility by obtaining investments from only those people are sophisticated enough to understand the risks and that everything can be lost in a moment. Investors should be informed, in great detail, about the regulatory risk associated with the offering, the business activities and the nascent state regulatory regime. Finally, Cannabis businesses should rely on competent counsel to guide them through the successful issuance of securities and continued compliance with disclosure obligations.

Failure to Comply with State Regulatory Requirements: State regulators actively protect state residents by overseeing and regulating potentially fraudulent business activities. Failure by a business to comply with state regulations can result in significant penalties and inability to do business in a state.

Recently, New York announced in a Crypto Exchange Report that 10 crypto exchanges were engaged in questionable activities. The issuance of the report again highlights the fact that the crypto market has pushed forward in states without implementing appropriate safeguards for resident consumers. The activist state regulatory regime, where there is not federal oversight, has the power to implement a heightened level of regulations needed to protect state residents.

Cannabis businesses should be actively involved in structuring the state regulatory regime so as to address the risks to consumers, employees and communities. Once licensed, cannabis businesses should not only implement their own compliance system, but they should also monitor other market participant activities and report those that can impact the industries reputation. The cannabis industry should focus on estabishing a marketplace that is transparent, fair and mitigates the risk of black market activity. Working with the regulators is the only way to create a legitimate marketplace that has the credibility that the cannabis industry deserves.