On October 16, 2017, the Canadian Securities Administrators (CSA) and the Toronto Stock Exchange (TSX) released staff notices regarding their respective treatment of issuers with cannabis-related activities in the United States.
Canadian reporting issuers with U.S.-related cannabis activities have long been uncertain of their treatment by the CSA and the TSX given the conflict between U.S. federal and certain state laws regarding the regulation of cannabis and related business activities. While a number of U.S. states have legalized cannabis-related activities to various degrees, such activities remain illegal under U.S. federal law, where cannabis continues to be a Schedule I drug under the U.S. federal Controlled Substances Act. Confusing the matter further, the U.S. Department of Justice previously issued guidance indicating that it will generally not enforce federal prohibitions in any U.S. state that has authorized this conduct so long as such states have implemented a strong and effective regulatory program. This guidance is also contrary to the current U.S. administration’s view and statements regarding cannabis. This confusing state of affairs is illustrated by the varied approaches taken by the CSA and TSX, as further described below.
CSA DISCLOSURE REQUIREMENTS
In CSA Staff Notice 51-352 – Issuers with U.S. Marijuana-Related Activities, the CSA endorsed a disclosure-based approach and set out their expectations regarding disclosure for issuers that currently have, or are in the process of developing, cannabis-related activities in U.S. states where such activities have been authorized within a state regulatory framework. This approach is premised on the assumption that issuers’ cannabis-related activities are conducted in compliance with the current laws and regulations of a U.S. state and the understanding that the U.S. federal government’s forbearance approach (despite not having the force of law) to the enforcement of federal laws remains in place. Again embedding a level of regulatory uncertainty, the CSA explicitly added that they reserve the right to re-examine their view if the U.S. federal government’s forbearance approach were to change.
The CSA expect that the disclosure will be “clearly and prominently” disclosed in prospectus filings and continuous disclosure filings such as annual information forms and management’s discussion and analysis. In addition, the CSA state that the same disclosure should be included in an issuer’s listing statement or other documents related to a reverse takeover or spinoff transaction that allows such issuer to enter the capital markets. Issuers that do not provide the disclosure may be subject to regulatory action, including refusal of a receipt in the context of prospectus offerings, request for restatements of non-compliant filings, and referral for appropriate enforcement action.
All Issuers with U.S. Cannabis-Related Activities
All issuers with U.S. cannabis-related activities are expected to:
- Describe the nature of the issuer’s involvement in the U.S. cannabis industry and, based on the nature of such involvement, provide the supplemental disclosure noted in the subheadings below
- Explain that cannabis remains illegal under U.S. federal law and that the approach to enforcement of U.S. federal laws against cannabis is subject to change
- Discuss the resultant risks of cannabis remaining illegal under U.S. federal law, including the risk of adverse enforcement action
- State whether and how the issuer’s U.S. cannabis-related activities are conducted in a manner consistent with any U.S. federal enforcement priorities
- Discuss the issuer’s ability to access both public and private capital and indicate what financing options are available and unavailable in order to support continuing operations given the illegality of cannabis under U.S. federal law.
Issuers with Direct Involvement in Cannabis Cultivation or Distribution in the U.S.
Issuers that directly engage in the cultivation or distribution of cannabis in accordance with a U.S. state licence will be required to:
- Outline the regulations for U.S. states in which the issuer operates and confirm how the issuer complies with applicable licensing requirements and the regulatory framework enacted by the applicable U.S. state
- Discuss the issuer’s program for monitoring compliance with U.S. state law on an ongoing basis and outline internal compliance procedures
- Disclose any material non-compliance as well as material citations or notices of violation.
Issuers with Indirect Involvement in Cannabis Cultivation or Distribution in the U.S.
Indirect involvement may be considered to arise where an issuer has a non-controlling investment in an entity that is directly involved in the U.S. cannabis industry. Such issuers are required to:
- Outline the regulations for the U.S. states in which the issuer’s investees operate
- Provide reasonable assurance, through either positive or negative statements, that the investees’ business complies with applicable licensing requirements and the regulatory framework enacted by the applicable U.S. state.
Issuers with Material Ancillary Involvement in Cannabis Cultivation or Distribution in the U.S.
Issuers that provide goods or services, including financing, branding, recipes, leasing, consulting or administrative services, to third parties who are directly involved in the U.S. cannabis industry are required to provide reasonable assurance, through either positive or negative statements, that the applicable customers’ or investees’ business complies with applicable licensing requirements and the regulatory framework enacted by the applicable U.S. state.
The CSA acknowledge that different exchanges, such as the Canadian Securities Exchange and the TSX, apply different listing requirements but note that investors should be aware that a successful listing does not have a cleansing effect on the legality of an issuer’s U.S.-related cannabis activities under U.S. federal law.
TSX WARNS OF POSSIBLE DELISTING OF ISSUERS WITH U.S. CANNABIS- RELATED BUSINESS ACTIVITIES
In contrast to the CSA’s central focus on disclosure, TSX Staff Notice 2017-0009 makes clear that TSX listing of issuers that are engaged in activities relating to the cultivation, distribution or possession of cannabis in the U.S. (U.S.-Related Cannabis Entities) raises serious policy concerns for the TSX over illegality and potential exposure under U.S. federal money laundering legislation. In short, the TSX has formally concluded that issuers operating in violation of U.S. federal law regarding cannabis are not acting in compliance with the TSX’s listing requirements and such issuers should proactively address any gaps in compliance with the TSX requirements. The TSX notice also stresses that it has the discretion to initiate a delisting review of issuers engaged in activities that are contrary to the TSX requirements.
The TSX identified the following subject business activities as examples that may violate U.S. federal law, in order of concern:
- Direct or indirect ownership or investment in U.S.-Related Cannabis Entities
- Commercial interests or arrangements with U.S.-Related Cannabis Entities that amount in substance to ownership or investment
- Providing services or products that are designed for, or targeted at, U.S.-Related Cannabis Entities
- Commercial interests or arrangements with entities engaging in any of the foregoing businesses.
While the TSX recognized the U.S. federal government’s forbearance approach to the enforcement of federal laws, it also emphasized that such guidance does not have the force of law and can be revoked or amended at any time.
The TSX intends to select issuers for in-depth reviews based on their continuous disclosure records. In the context of reviews of listed issuers in the cannabis sector, the TSX expects to group issuers into two categories: (i) U.S.-Related Cannabis Entities and (ii) issuers that engage in ancillary service activities for U.S.-Related Cannabis Entities. The TSX expects to contact any listed issuers identified for a more comprehensive review by the end of 2017, which provides affected issuers with a short grace period to correct any non-compliance (for example, through divestiture or spin-off of U.S. assets or commercial arrangements) in order to avoid a formal delisting review.
Issuers that may potentially become subject to delisting, or other regulatory action such as a halt or suspension, are strongly encouraged to assess the materiality and timing of becoming subject to a formal or informal review process by the TSX. Issuers should diligently evaluate each stage of discussion with the regulators to continuously assess the appropriate time to provide investors with disclosure of a material change, if any, as well as assess possible breaches or adverse triggers that any imposed regulatory action may cause under existing debt, streaming or other financing arrangements, material leases and contracts, supply and distribution agreements, joint ventures and acquisition agreements. Delisting may also lead to adverse consequences for existing investors, including loss of liquidity, potential disqualification of securities as investments qualified for registered plans, negative impacts on stock price and potential exclusion from institutional portfolios or investment fund and exchange-traded fund holdings. While the TSX strongly recommends that applicants and listed issuers considering engaging in cannabis-related activities in the United States consult with the TSX, we also advise that potentially affected issuers proactively contact the TSX to commence discussions in short order.
Given the changes adopted by the CSA and the TSX, issuers would be well advised to seek legal advice to understand the relevant rules and new disclosure requirements and to determine the relevant securities law considerations.