Cannabis Musings - June 21, 2023
The problem of licensed cannabis operators selling into the illicit market, and a very silly idea.
Friends – welcome back! So much, and yet so little, happened while we were on break. During that time, I was quoted in SFGATE about the state of the industry as California cannabis tax revenues continue to fall, and the Cannabis Media Council (disclosure: I’m an Advisor) issued its very excellent Guidelines for Responsible Cannabis Advertising to empower media and cannabis brand collaboration.
One of the more curious events during the brief hiatus was the filing of a lawsuit against prominent California-based cultivator, Glass House. As was widely-reported in industry news outlets, Catalyst Cannabis Co. alleged in its suit that Glass House sold product into the illicit market through “burner distros” (state-licensed distributors that then resell to unlicensed buyers).
On its face, this lawsuit is sheer chutzpah. A cursory review of the complaint suggests that Catalyst doesn’t actually know whether Glass House is actually doing what’s been alleged. During my 24 years of legal practice, I spent maybe 6 months in litigation before pivoting to corporate/finance, so I honestly can’t tell whether Catalyst’s complaint will survive a motion to dismiss (which gets rid of the case based on law, rather than facts) or demurrer (an even weirder procedural motion that challenges the sufficiency of the complaint), or if they’ll get to discovery (forced disclosure of information), but I do know that they didn’t state any actual, direct evidence of these activities.
And yet, the problem called out by the lawsuit is very real. (Disclaimer - I have absolutely, positively no idea if Glass House is engaging in any of these kinds of activities, directly or indirectly, and I don’t want anyone to read these Cannabis Musings as my suggesting or alleging that it is. Really. It’s purely a narrative device.) The diversion of legally-grown products into other states is a large problem for the industry. I’ve heard this complaint too many times to ignore, that unnamed licensed producers are selling into the illicit market to stay afloat. Branded products are stocking the shelves of unlicensed dispensaries in New York City, and although it’s unclear if they’re genuine products or knock-offs (or both), the inventory is coming from somewhere (maybe it’s also coming from states like Oklahoma, where the market is reportedly oversupplied by 32 times (see page 17)).
To me, this is an unfortunate example of the failure of both federal and state cannabis policy and regulation (with sincere apologies to readers of these Cannabis Musings in government positions), from the lack of interstate commerce (a perennial favorite of ours), to a dearth of effective enforcement, to the uneconomic nature of being a plant-touching company, yada yada yada. The unlicensed/illicit/illegal market continues to dominate, yet many of the same laws and policies that make possible the sale of safe, licensed cannabis (while not poking the bear that is the Department of Justice (one of the reasons states don’t allow interstate commerce)) have had the unintended consequence of bolstering the illicit market – the very market that licensed cannabis is supposed to replace (c.f., sesame seed regulation (h/t to today’s Money Stuff)).
(As a historical note, the illicit alcohol market didn’t survive the repeal of Prohibition over the long term. This was due to a number of factors, including targeted enforcement and the move by bootleggers into the licensed market. Thanks to my co-Adjunct Professors and regulatory lawyers extraordinaire, Rebecca Stamey-White and Erin Kelleher for that background).
Is it any real surprise then that struggling cultivators/operators would choose to sell product into the illicit market, with its high volumes, lack of taxes and testing costs, and nearly limitless total addressable market?
And yet, if this is indeed being done by licensed operators, it’s not only unethical and illegal (not legal advice, but practical guidance nonetheless), it’s also unsustainable. We’ve talked before about the fact that compliance remains paramount for any company in this industry, as well as the need for the industry to take control of its image and change the narrative (incidentally, something the Cannabis Media Council is working to do). The tolerance for such tsores (which is actually much lower than it was five years ago) will continue to wear thin as more financial firms, auditors, boards, and partners enter the space. Those operators that do work hard at being fully compliant will similarly lose patience. Plaintiff lawyers would love to bring shareholder lawsuits against public cannabis companies if given the chance.
It’s also a good reminder that the licensed industry exists solely as a matter of grace on behalf of the federal government. To me, anything as noticeable as a state-licensed operator actually selling material amounts of cannabis into the illicit (unlicensed) market, across state lines, will certainly not help the narrative with Congress, and could antagonize the very agencies that continue to not enforce federal law (see, poke--->bear above).
The current state of affairs for the industry es passt azei wie a chazer a zottel (it fits just like a saddle on a pig). It remains stuck in the event horizon between legality and illegality, with the engine stalling, the parking brake engaged, and the radio tuned to the local smooth jazz station. Something has got to give.
On a totally unrelated note, how has no one yet pitched their cannabis business as an AI play in order to raise stupid amounts of money? (Let me know if you want help with that idea – Hauser Advisory is here to assist.)
Be seeing you!
Hauser Advisory provides advice and strategy on business lifecycle events and cannabis industry navigation, tapping into a deep, national network and twenty-five years of dealmaking and capital markets experience.
© 2023 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form.
Be seeing you!
Hauser Advisory provides advice and strategy on business lifecycle events and cannabis industry navigation, tapping into a deep, national network and twenty-five years of dealmaking and capital markets experience.
© 2023 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form.