Investor interest in the cannabis industry continues to climb as the marijuana movement goes mainstream, but cannabis-related securities remain incredibly risky in light of federal prohibition. Under the Federal Securities Act, an individual or business entity must register with the Securities Exchange Commission prior to offering securities for sale in the United States. An unregistered securities offering is often called a private placement, as the offer is only available to qualified, high-net worth investors who satisfy certain income threshold requirements.
In theory, federal securities laws are designed to protect less sophisticated investors from falling prey to get-rich-quick schemes. If a securities offering is not exempt from SEC registration, then the issuer of the securities must disclose specific information to prospective investors in order to prevent less knowledgable investors from fraud. The disclosure requirements are mandatory for registered securities, but not unregistered securities that are exempt from registration under Regulation D. Although unregistered securities offerings are not available to the general public, offerings pursuant to Regulation D require the filing of a specific form disclosing the nature of the investment.
As a result, investment in the industry is fraught with risk and uncertainty, as private placements are not subject to the extensive disclosure requirements necessary for registered securities offerings. Additionally, private placements generally involve the issuance of restricted securities, meaning there are limitations on the sale and transfer of unregistered securities obtained via private placement. Private placements are not subject to mandatory disclosure requirements that otherwise apply to securities offerings, although the specific disclosures required depend on the perceived “sophistication” of the investor, i.e. their net-worth and annual income.
In any industry, unregistered securities offerings are not a safe bet, but the cannabis industry is even more problematic for potential investors given the state-specific legal, regulatory, and policy environment. For example, the state of Washington prohibits non-residents, both individuals and entities, from financing, controlling, or receiving net profits from Washington-licensed cannabusinesses. As a result, many investors are looking to cash in on the ancillary side of the business in Washington state by offering seed-to-sale tracking technology, lighting fixtures, and other grow operation services.
I often talk with clients and interested investors looking to cash in on the billion dollar industry, as they generally assume that early investors in the industry will reap the rewards of their investment in the long-term. However, federal prohibition has prevented the industry from achieving economies of scale, so the perceived economic potential of the industry is perhaps less certain than many suggest. Not if but when, federal legalization occurs, the cost of cannabis will inevitably drop dramatically as firms can finally achieve economies of scale and reduce the regulatory compliance costs associated with state-specific regulatory requirements.
Until legislation occurs at the federal level, state legislatures will remain the architects of legalization, so it is important to recognize their role in shaping the marijuana market. For example, home-grow provisions will ultimately limit the growth of the industry in the long-term as individuals supply their own products to reduce costs. Right now, the state of New Jersey is considering two bills that would legalize recreational cannabis, one that includes a home-grow provision, and one that does not. For investors interested in the long-term viability of the industry, the inclusion of a home-grow provision is significant as far as the potential of the New Jersey recreational market. However, there seems to be little discussion from lawmakers as far as the potential market, and tax revenue, implications of including a home-grow provision. For those interested in the long-term impact of legalization, the inclusion of home-grow provisions in state legislation is a significant consideration.
For those looking to invest outside of the United States, it only makes sense to look forwards Canada as the United States certainly lags behind in terms of legalization, as well as innovation. Although each Canadian province retains control over the regulation of securities offerings, it is certainly easier to invest in securities offered just across the border, and until recently, that’s where most investment in the industry was focused. In light of Canada’s plan to legalize the sale of adult-use cannabis sometime this year after August, it seems that investor interest will only continue to increase. However, it is incredibly important to remain up-to-date on the political and economic factors that will inevitably impact the long-term investment potential of the Canadian cannabis market.
The cannabis industry was hardly of interest to investors just a few years ago, so the rapid increase in cannabis-related investments is concerning for several reasons. Just last month, TD Ameritrade’s CEO made note of the “pronounced” increase in crypto-currency and cannabis-related stocks. As the budding new industry continues to attract investor interest, it is important to consider the short and long-term risks of investing in this nascent industry. As these and other variables come into play, it is important to understand exactly what your short and long-term investment plans.