Where There's Smoke, There's Diligence Due in Cannabis Investing

Where There's Smoke, There's Diligence Due in Cannabis Investing

Investing in the marijuana business these days doesn’t require bags of cash or secret handoffs, but there are still risks, and experts advise looking before leaping into the new medical cannabis industry.

Mandatory risk disclosures have dissuaded some investors, and the fact that marijuana remains federally illegal complicates all aspects of the trade.

“Marijuana companies are not traded on the major U.S. exchanges because of it being illegal at the federal level,” said Randall L. Bynum, a lawyer at Dover Dixon Horne PLLC in Little Rock. He’s one of several Arkansas legal experts, financial advisers and securities officials preaching due diligence.

Robbin Rahman, a Little Rock attorney whose father is part owner of a cannabis dispensary coming to Conway, marveled at the legal contradictions. “The entirety of the U.S. cannabis industry exists in a quasi-legal system in which federal laws prohibit something that state laws now permit,” Rahman said. “Virtually any facet of a cannabis business is, at all times, violating some law — and yet we have a thriving U.S. cannabis market in 33 states and counting.”

Brian Gould, a financial adviser at Larry Root & Associates in Little Rock, gets guidance on the matter from Ameriprise Financial Services; the federal Securities & Exchange Commission; the Financial Industry Regulatory Authority Inc., a self-regulator for the broker-dealer industry; and the Arkansas securities commissioner.

Under Ameriprise’s guidance, “we cannot solicit [marijuana] stocks, and we can only accept trades for stocks traded on the secondary market [of the New York Stock Exchange] and covered by [Ameriprise] approved researchers.”

At least publicly, Gould said, the SEC is “staying resolutely in their lane and concentrating on the marketing and trading of these securities at the consumer level. FINRA’s concerns are from the broker side, ensuring that we don’t break SEC rules.”

State securities officials can halt the trading of a given stock under certain circumstances, but if a security is traded on a public exchange, states generally leave enforcement to federal authorities, Gould said. That means that if a client instructs him to trade in a certain cannabis stock, “that trade can be rejected [in Arkansas], but a client in another state may be able to purchase it.”

State “blue sky laws” require frank disclosures by all companies offering securities. Federal and state laws to protect the investing public emerged after the stock market crash of 1929 to ensure that investors receive full disclosures before risking their money. The laws’ name reflects the effort to shield citizens from “speculative schemes which have no more basis than so many feet of blue sky,” according to an examination of marijuana investment law by Robert McVay of Harris Bricken, an international law firm in Seattle.

“Every business, cannabis or otherwise, that seeks to raise money through either a debt or an equity offering must inform investors of its basic business plan … its financial projections and a list of risk factors,” McVay wrote.

The disclosures are intentionally frightening, to chase away the risk-averse. “For cannabis businesses, the risk factors look even scarier,” according to McVay. “They will say things like: ‘the federal government may raid us, seize all of our equipment and inventory, and arrest all of our employees, officers and investors, including you.’”

Even bold investors must do research, said Ann McDougal, the state’s deputy securities commissioner. “The recent change in Arkansas laws to allow for the sale of medical marijuana and creation of related businesses has created an intriguing topic that’s ripe for solicitation of investors,” McDougal said in an email. But she recommends checking investment prospects against the Arkansas Securities Department’s list of companies complying with state securities laws. “Another best practice is to verify the registration of a business … with the Arkansas Secretary of State’s office.”

As with other investments, Arkansans should be wary of high-pressure pitches, McDougal said.

Last week, Innovation Shares LLC began trading the first passively managed cannabis investment fund. Cannabis EFT (THCX) is trading on the NYSE Arca, an electronic securities exchange. The fund tracks the Innovation Labs Cannabis Index, 35 stocks in companies expected to grow with legal cannabis. Legal sales in the U.S. and Canada reached $6.9 billion last year, according to Arcview Market Research.

Erika Gee, a partner at Wright Lindsey & Jennings in Little Rock, said many would-be investors don’t realize that opportunities vary widely in different states. Compare Oklahoma, home to 3,400 licensed medical marijuana cultivators and 1,600 dispensaries, to Arkansas, with five cultivators and 32 dispensaries.

One area of opportunity is cannabis processing, she said, noting that the state does not plan to limit the number of processor licenses it will issue, “allowing you to do anything from operate a cannabis bakery on the corner to operate a huge plant manufacturing capsules, pills and patches.” She expects the state to start taking processing applications from companies early next year.

Rahman, of the Barber Law Firm in Little Rock, said legal complexities and regulatory hurdles aren’t the main obstacle for cannabis investors. “In my mind, the much larger impediment to cannabis investment in Arkansas is a very traditional, non-cannabis concern: the uncertainty of the investment and the potential for a return.”