Marijuana, Securities Law

Cutting Through The Haze Of Securities Laws And Marijuana

If you are going to take on investment in your cannabis business or invest in the cannabis business of someone else, you should ultimately seek to ensure compliance with all applicable securities laws.

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Capitalization of cannabis businesses still comes primarily from friends and family rather than from institutional investors. This happens in part because the federal Controlled Substances Act can lead to criminal liability for investors financing cannabis businesses. On top of this, many states preclude financial investments in cannabis businesses without first satisfying rigorous regulatory standards, often including state residency. None of this has stopped cannabis businesses from soliciting investments and then coming to my law firm for legal representation on their deals.

The problem is that most of these companies that come to us have little to no clue about securities law and by the time they reach out to us, they have already put themselves at risk for violating state or federal (usually both) securities laws. Many wrongly believe that the federal prohibition against cannabis means that securities laws do not apply to their ventures.

Federal and state securities laws are intended to protect investors. Federal securities acts were passed in 1933 and 1934 to make sure that investors receive full and fair disclosures from businesses before investing. If companies have made all required disclosures and registrations, the courts will generally stick the investors with the risks of their investments. But investors who have been lied to or not provided with sufficient information to understand the risks of their investments have many strong legal avenues against the company or individual that sold them the securities.

When working on anything investment-related — cannabis or not — the first question should always be whether it involves a security. The federal definition and statute on securities can be found here, and an example of a state law definition can be found here. In brief, securities are things like corporate stock, LLC membership units, and corporate bonds. Ultimately, securities are intangible rights to profit-sharing payments or guaranteed debt payments granted by businesses in exchange for money.

Securities laws are generally written to broadly require that a securities offering involve substantial registration and information filings unless it comes under one of many exceptions. Though the majority of small business securities offerings are exempt from massive formal filings, even those often require notice-type state and federal filings to ensure potential investors are informed. And even those offerings that do not require government registrations or notices still usually must make certain informational disclosures to investors about the business before they can seek investment.

At minimum, any cannabis business that seeks to raise money through a debt or an equity offering should provide its investors with its basic business plan, making clear what it intends to do with the capital it raises, its financial projections (including expected return window for the investor), and a list of risk factors that may lead the business to be unable to repay the investor. These risk factors are key, and they need to be drafted by experienced securities counsel. They are not boilerplate, as each business has its own risks.

The risk factors for cannabis business investment should, at minimum, make clear that both the cannabis business itself and the potential investor are subject to the federal Controlled Substances Act, and that “the federal government may raid the business, seize all of its equipment and inventory, and arrest all of the employees, officers, and investors, including you.”

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Though seemingly counterintuitive, notifying investors of the full extent of their risks should go a long way toward providing the cannabis company with legal protection down the unforeseeable road. The following are some other cannabis business risk factors that generally should be included in a cannabis business offering:

  • The potential for federal legal action against the relevant states regarding those states’ marijuana regimes;
  • The risk and extent of federal asset forfeiture;
  • The unpredictability of the marketplace, due in part to wavering consumer interest and competition from illegal sellers;
  • The unpredictability of onerous state and city tax rates;

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  • The unpredictability of state and city marijuana regulations; and
  • The costs of having to comply with robust marijuana regulations.

If you are going to take on investment in your cannabis business or invest in the cannabis business of someone else, you should ultimately seek to ensure compliance with all applicable securities laws.

Hilary Bricken is an attorney at Harris Moure, PLLC in Seattle and she chairs the firm’s Canna Law Group. Her practice consists of representing marijuana businesses of all sizes in multiple states on matters relating to licensing, corporate formation and contracts, commercial litigation, and intellectual property. Named one of the 100 most influential people in the cannabis industry in 2014, Hilary is also lead editor of the Canna Law Blog. You can reach her by email at hilary@harrismoure.com.

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