On October 16, 2017, the Canadian Securities Administrators ("CSA") and the Toronto Stock Exchange ("TSX") each delivered a long-awaited clarification of its position to issuers with ongoing business activities in the United States relating to the cultivation, possession or distribution of cannabis. The clarifications have been hotly anticipated by Canadian issuers in the cannabis sector eager to tap into the burgeoning cannabis market in the United States.
Since the Trudeau Liberals won a majority in the 2015 federal election, the landscape surrounding cannabis use in Canada has been steadily changing. The current landscape is set for a tectonic shift: the Government of Canada has set a goal of July 1, 2018 for implementation of An Act respecting cannabis and to amend the Controlled Drugs and Substances Act, the Criminal Code and other Acts, which will regulate possession and commercial activity involving cannabis for medical or unqualified adult use.
In the United States, the legal landscape surrounding cannabis use is comparatively hazy. Although an increasing number of states have legalized cannabis for medical or unqualified adult use, cannabis remains a Schedule I controlled substance and is illegal under U.S. federal law. The U.S. federal government has previously indicated that it would forebear from prosecuting federal drug related offences involving cannabis for activities that are carried out in compliance with applicable state laws. However, this administrative position does not have the force of law and can be revoked or amended at any time. This anomalous regulatory environment creates significant legal risk for cannabis producers and other companies in the cannabis ecosystem, particularly with respect to interstate commerce and federal anti-money laundering legislation.
The hazy regulatory environment in the United States has caused headaches for a number of Canadian cannabis companies in recent months. The TSX, eager to ensure its issuers conduct their businesses with integrity and that the best interests of securityholders are observed, has turned away potential issuers to its exchange where that issuer is engaged in cannabis-related business activities in the United States. The TSX has also occasionally invoked its discretion to discourage current TSX-listed issuers from engaging in cannabis-related business activities in the United States.
Frustrated by the TSX’s ad hoc approach for dealing with issuers engaged in cannabis-related activities in the United States, Canadian cannabis issuers have bemoaned that the lack of consistency in application and the undefined strategy has caused harm by precluding them from engaging in potentially lucrative opportunities in the United States.
The CSA Notice
CSA Staff Notice 51-352 ("CSA Notice") urges issuers to carefully consider the critical importance of the current legal and regulatory environment in the United States and prescribes a specific framework for a disclosure-based approach to cannabis-related business activities by issuers in the United States. The CSA’s approach is based on the presumption that any cannabis-related business activities engaged in by issuers are undertaken only where such activities are legal at the state level, with the implicit understanding that cannabis remains illegal at the federal level. The focus of the CSA’s disclosure framework is, therefore, aimed at providing disclosure with respect to how an issuer is compliant with state-level cannabis regulation.
Under this disclosure framework, the specific disclosure required by an issuer is determined by its level of involvement in the cannabis industry. Involvement is categorized in four separate levels:
- All issuers with U.S. cannabis-related activities. All issuers with cannabis-related activities in the United States are required to (a) disclose the nature of the issuer’s involvement in the cannabis industry in the United States, (b) describe the current regulatory environment for cannabis in the United States, including disclosure of the potential risks if the current regulatory environment changes, (c) state how the issuer’s cannabis-related business activities are compliant with existing U.S. federal enforcement priorities, and (d) comment on the issuer’s ongoing ability to access the capital markets in order to continue its operations.
- U.S. cannabis issuers with direct involvement in the cultivation or distribution of cannabis. Direct involvement by an issuer arises where the issuer, or a subsidiary that is controlled by the issuer, is directly engaged in the cultivation or distribution of cannabis. At this level, issuers are required to (a) describe state-level regulations applicable to the issuer’s operations and confirm how the issuer complies with such regulations, and (b) disclose the issuer’s program for monitoring ongoing compliance with applicable state laws, including disclosure of any material non-compliance and well as material notices of violations.
- U.S. cannabis issuers with indirect involvement in the cultivation or distribution of cannabis. Indirect involvement by an issuer arises where the issuer has a non-controlling investment in an entity that is directly engaged in the cultivation or distribution of cannabis. At this level, issuers are required to (a) describe the applicable regulations for U.S. states in which the issuer’s investee operates, and (b) provide reasonable assurance that the investee’s cannabis-related business is in compliance with regulatory requirements in each applicable state.
- U.S. cannabis issuers with material ancillary involvement. Ancillary involvement by an issuer arises where the issuer provides goods or services to third parties that are directly involved in the cultivation or distribution of cannabis, such as lighting and irrigation systems, recipes, administrative services and project financing. At this level, issuers are required to provide reasonable assurance that the applicable customer’s cannabis-related business is in compliance with regulatory requirements in each applicable state.
Under the CSA Notice, issuers at all four levels of involvement in the cannabis ecosystem are expected to provide the required disclosure and such disclosure is expected to be clearly and prominently disclosed in prospectus filings and other periodic disclosure documents, such as annual information forms and management discussion and analysis. The CSA Notice also captures issuers that enter the Canadian capital markets through reverse-takeovers also, requiring that listing statements include the required disclosure.
Issuers who do not provide appropriate disclosure will be subject to regulatory action, including the refusal to issue a receipt in the context of a prospectus offering, the restatement of non-compliant filings and enforcement action.
The CSA indicates that it will periodically re-examine the disclosure regime prescribed by the CSA Notice based on any changes to the U.S. federal government’s forbearance-based enforcement approach to cannabis in the United States.
The TSX Bulletin
The TSX Bulletin seeks to provide clarity regarding the application by the TSX of existing policy requirements applicable to TSX-listed issuers engaged in cannabis-related business activities in the United States. Specifically, the TSX points to Section 306, Section 325 and Part VII of the TSX Company Manual (the "Requirements") as the existing policy requirements prohibiting TSX-listed issuers from engaging in cannabis-related business activities in the United States. The TSX Bulletin notes that TSX-listed issuers with business activities that violate U.S. federal law regarding cannabis are not compliant with the Requirements. The TSX Bulletin characterizes “business activities” as including (a) direct or indirect ownership of, or investment in, entities involved in the cultivation, possession or distribution of cannabis in the United States, (b) commercial interests or arrangements with entities involved in the cultivation, possession or distribution of cannabis in the United States that are similar in nature and substance to ownership or investment in such entities, (c) providing services or products that are specifically designed for use by, or targeted to, entities involved in the cultivation, possession or distribution of cannabis in the United States, and (d) indirect commercial arrangements with entities engaging in any of the following activities.
The TSX Bulletin notifies issuers that, in the context of continued listing review of listed issuers in the cannabis sector, the TSX expects to group its listed issuers into two categories: the first category will include issuers whose business activities involve the cultivation, possession or distribution of cannabis in any jurisdiction. The second category will include issuers that provide ancillary goods and services to entities that are involved in the cultivation, possession or distribution of cannabis. The TSX Bulletin indicates that both categories of issuers can expect to be contacted for a comprehensive review by the end of the year and recommends that, in the interim, issuers “proactively work to address gaps in their compliance with the Requirements”.
The TSX Bulletin closes with a stark warning: issuers not complying with the Requirements could face a delisting review.