The successive legalization of adult recreational use of marijuana in four states—Colorado, Washington, Oregon and Alaska—and the District of Columbia, as well as legalization of marijuana for medical use to varying degrees in 23 states, has triggered the interest of potential private equity investors who are seeking to claim an early stake in a growing industry with potentially high returns. Altogether, nearly half of the states in the US have legalized the use of marijuana to some degree for medical and/or recreational purposes, each state with its own set of restrictions. The legal marijuana industry has been valued at $1.5 billion in 20131, $2.7 billion in 20141, $3.5 billion in 20151, and is projected to reach $8 billion by 2018.2 Furthermore, several ballot and legislative actions are currently being planned with respect to legalization of marijuana in 2016 in a number of states.3 According to one industry research group, 14 states are projected to pass new adult recreational use laws by 2020.4 Nevertheless, while the industry and its anticipated potential growth may create excitement, investors should be cognizant of the various legal risks involved in investing in the industry, especially since the laws surrounding cannabis seem to be continuously in flux, involve federal versus state considerations, and are not likely to be consolidated in the near future.

Federal law - Illegality and Uncertainty

The US federal government’s position regarding the legality of marijuana is not consistent with state-level legalization developments, causing confusion as to the legal implications for the cannabis industry. At the federal level, marijuana is still classified as a Schedule I substance, along with heroin, LSD, peyote, and ecstasy, under the federal Controlled Substances Act (CSA) of 1970.5 According to the CSA, Schedule I substances have (a) no currently accepted medical use in the US, (b) a lack of accepted safety for use under medical supervision, and (c) a high potential for abuse.6

In the landmark case Gonzales v. Raich7, the US Supreme Court upheld Congress’ power under the Commerce Clause under the Constitution to prohibit purely intrastate cultivation and possession of marijuana, even where a state approves its use for medicinal purposes. As such, businesses that engage in any form of commerce in the marijuana industry, whether as manufacturers, distributors or dispensaries, as well as individuals who purchase and use marijuana-derived products, remain subject to possible federal prosecution and seizure of assets. The risk for a private equity investor is that federal enforcement could lead to dissolution or discontinuance of operations, leaving investors with no recourse to recover their funds. Given the illegality of marijuana under federal law, private equity investors should also be aware that investing in a marijuana-related business may violate the federal antimoney laundering statutes, 18 U.S.C. §1956 and §1957.8

The US Department of Justice under the Obama administration has published several guidances9regarding marijuana enforcement and the interpretation of the CSA in light of state-level legalization efforts and the ensuing legal uncertainty, the most recent of which, also known as the “Cole Memo”10published on August 29, 2013, reflects the administration’s approach to state reform. The Cole Memo clarified that it will not challenge state laws and will generally rely on state and local enforcement agencies to address marijuana activity as long as marijuana sales do not conflict with the following eight federal enforcement priorities to:11

  1. Prevent distribution of marijuana to minors;
  2. Prevent revenue from the sale of marijuana going to criminal enterprises, gangs, and cartels;
  3. Prevent diversion of marijuana from the state where it is legal under state law in some form to other states;
  4. Prevent state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity;
  5. Prevent violence and the use of firearms in the cultivation and distribution of marijuana;
  6. Prevent drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;
  7. Prevent the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
  8. Prevent marijuana possession or use on federal property.

The US Congress has also shown some signs that it prefers to defer to state or local enforcement agencies regarding the regulation of state-legal medical marijuana. The bipartisan spending bill passed by Congress in December 2014 and then renewed in December 2015 included a section, also known as the Rohrabacher-Farr Medical Marijuana Amendment (the Amendment), which prohibits the Department of Justice from expending any federal funds to prevent each of the District of Columbia and 32 other listed states from implementing its own district or state laws that authorize the use, distribution, possession, or cultivation of medical marijuana.12 On October 19, 2015, in U.S. v Marin Alliance for Medical Marijuana (MAMM), the US District Court for the Northern District of California held that under the Amendment, the Department of Justice’s permanent injunction against MAMM’s distribution of medical marijuana could only be enforced against MAMM insofar as that organization is in violation of state laws that authorize the use, distribution, possession, or cultivation of medical marijuana.13

While the guidance in the Cole Memo and the Amendment reflect the Obama administration’s level of deference to state laws, investors should be reminded that guidance is not law and that the Amendment will expire when the current fiscal year concludes on September 30, 2016, if not renewed by the next congressional spending bill.14 The congressional spending bill for the fiscal year ending September 30, 2016 does not preclude a federal prosecutor or a state attorney general from pursuing violators of the CSA who use, distribute, possess or cultivate marijuana for non-medical purposes.

Nevertheless, while there is uncertainty regarding how the federal government will interpret and enforce the CSA going forward, perhaps the Compassionate Access, Research, Expansion, and Respect States Act (CARERS) of 2015, a comprehensive piece of federal medical marijuana legislation introduced in the US Congress, may help to settle the state-federal conflict over the legality of medical marijuana. The CARERS Act would have farreaching impacts, including: (a) allowing state programs to continue without federal interference; (b) transferring marijuana from Schedule I to Schedule II of the CSA; (c) removing cannabidiol from the definition of marijuana; and (d) creating access to banking services for legal marijuana businesses.15

State laws - Variations and Uncertainty

Interested investors should also be aware that a patchwork of varying state laws makes a one-size-fitsall approach to investment decisions impossible. For recreational marijuana, differences across state laws where there is any recreational legality include the amount of marijuana that an individual can possess, number of plants one can grow for recreational purposes, and license application requirements.16Furthermore, for a particular state that has at least in some part legalized marijuana, it is possible that not every governing authority is on board with the legalization. For example, although Oregon has legalized adult recreational use, dozens of cities and counties in Oregon have banned or put moratoriums on marijuana sales.17

For medical marijuana, differences across the 23 states that have legalized marijuana for medical use to some degree include restrictions with respect to the amount of marijuana that patients may possess, number of plants they may grow for medical purposes, whether dispensaries are allowed, the types of medical conditions legally treatable with marijuana, and whether other states’ medical marijuana cards are recognized.18 States also vary on the forms of medical marijuana they allow. For instance, many states allow marijuana-derived products with cannabidiol (CBD), a compound that possesses anti-inflammatory, antioxidant, anti-anxiety, and anticonvulsant effects that can help to treat diseases such as epilepsy, PTSD, schizophrenia and multiple sclerosis, but restrict marijuana-derived products with tetrahydrocannabinol (THC), a compound that induces psychoactive effects.19

Private equity investors should also be aware of potential criminal liability depending on their own state laws. Investors located in states where marijuana remains illegal may be at risk of prosecution under state conspiracy, aiding and abetting laws and money laundering statutes, and may be at risk of losing their investments or proceeds under state criminal and civil forfeiture laws.20

Investor Compliance Requirements

Investors interested in an equity stake in marijuana businesses may be required to comply with certain state requirements, such as residency requirements, and financial and criminal background checks. Equity investors in marijuana businesses may be required to meet specific criteria in order for a business to apply for and maintain a license to conduct business in the marijuana industry. With respect to private equity funds that invest in marijuana businesses in states where such investments are legal, analyses should be conducted in each such tate to determine the applicability of such state’s compliance requirements to the general partner, passive limited partners and the fund managers. The following table summarizes residency requirements for owners or investors in marijuana businesses in the four states where adult recreational marijuana use has been legalized:

Click here to view table.

Other Considerations

(1) Financial Institutions

Financial institutions have been reluctant to provide services to marijuana-related businesses. Thus, on February 14, 2014, to allay their concerns of violating the CSA, US Treasury’s Financial Crimes Enforcement Network (FinCEN) published guidance intending to (a) clarify how banks can provide services to marijuana-related businesses consistent with their Bank Secrecy Act obligations, (b) enhance the availability of financial services for marijuanarelated businesses, and (c) enhance the financial transparency of marijuana-related businesses.30

The FinCEN guidance also discusses appropriate customer due diligence and thorough risk analysis to be conducted by financial institutions, and creates a three-tiered system for filing Suspicious Activity Reports (SARs) for marijuanarelated businesses. For example, financial institutions must use the following labels when filing SARs based on their reasonable belief as to whether the business implicates one of the Cole Memo priorities: “Marijuana Limited” for a business that does not implicate a Cole Memo priority, “Marijuana Priority” for a business implicating one or more of the Cole Memo enforcement priorities, and “Marijuana Termination” for when a financial institution terminates a relationship with a marijuana-related business.31

In conjunction with the February 14, 2014 FinCEN guidance, the Department of Justice also published guidance on the same day as the FinCEN guidance regarding marijuana-based financial crimes. It clarified that if a bank offers services to marijuana-related businesses whose activities do not implicate any of the eight enforcement priorities outlined in the Cole Memo, then prosecution may not be appropriate.32 The February 14, 2014 FinCEN guidance and Department of Justice guidance, and further developments, such as the Marijuana Businesses Access to Banking Act of 2015, which has been introduced and is pending before Congress, were created to protect financial institutions that provide financial services to marijuana-related businesses.33

However, nothing in the February 14, 2014 FinCEN guidance and Department of Justice guidance precludes investigation or prosecution, even in the absence of implicating one of the eight Cole Memo priorities, and providing financial services to marijuana-related businesses still remains illegal under federal law. Furthermore, on January 5, 2016, a federal judge in Denver rejected a Colorado credit union’s bid to force the Federal Reserve Bank of Kansas City to grant it a master account to serve Colorado’s legal marijuana businesses, on the grounds that the master account would violate federal law.34 Because of risk aversion tendencies by financial institutions, the marijuana industry is still driven primarily by cash transactions.35 As such, these businesses are unable to reap the potential benefits of loan services or credit cards, and must incur costs and expenses for security, such as safes, armored vehicles and security guards to prevent theft.

(2) Issues of Transportation

Interstate transportation of marijuana is prohibited under the CSA, and this includes transportation among states that have legalized marijuana such as Washington and Oregon.36 In fact, the US Drug Enforcement Administration has provided a chart that explains the penalties for trafficking marijuana.37Thus, marijuana must be consumed in the same state of purchase and cannot be transported from a producer in one state to a distribution or retailer in another. Furthermore, there are legal implications of transporting marijuana within a particular state. First, if marijuana is illegal within a particular state, transportation of marijuana will also be illegal in that state.38 In states that have legalized marijuana to some degree, the laws regarding transportation are different for individual users and for marijuana businesses, with requirements differing from state to state.39

(3) No Tax Benefits

Investors should be reminded that due to the Schedule I status of marijuana under the CSA, a number of standard tax exemptions for businesses do not apply to sales of marijuana under the Internal Revenue Code § 280E.40 As such, businesses can legally deduct only the cost of goods sold and cannot legally deduct significant business expenses such as employee wages, rent, health insurance premiums, utility costs and advertising.41 Thus, while a typical business pay taxes on net profits, marijuana-related businesses should pay taxes on their gross income. Furthermore, states may impose various excise and sales taxes on the sale of marijuana and marijuana infused products. For example, Colorado imposes 15 percent marijuana excise tax, plus 10 percent retail marijuana special sales tax, plus 2.9 percent retail and medical marijuana sales tax.42

(4) Restricted Advertising Opportunities

Marijuana-related businesses may be limited in their marketing and advertising options, given that television networks can be subject to legal prohibitions with regards to transmitting advertisements to promote the sale of marijuana. Section 843 of the CSA prohibits using “communications facilities” to transmit advertisements for the sale of Schedule I drugs such as marijuana.43 Despite the legalization of marijuana in Colorado, the first television commercial advertising the sale of recreational marijuana scheduled to air on Denver-based ABC affiliate KMGH was pulled at the last minute due to concerns about the lack of clarity around federal regulations that prohibit marijuana advertising on television.44While the Federal Communications Commission (FCC) has not yet issued any guidance or rulings with respect to marijuana advertisements, it is possible that the FCC will not renew a broadcaster’s license the following year if a broadcaster has committed a felony by violating Section 843 of the CSA.45Therefore, broadcasters may continue to show reluctance with regards to airing advertisements promoting the sale of marijuana on television.

Furthermore, marijuana-related businesses may face restrictions with regards to using the U.S. Postal Service to distribute advertisements. For example, a notice issued by the Portland, Oregon, District Mailing Requirements Office, US Postal Service on November 27, 2015, wrote: “If an advertisement solicits the mailing of controlled substances such as marijuana, it would violate USPS mailing standards. Marijuana is classified as a Schedule I controlled substance…. CSA § 843(c) does make it unlawful to place an ad in any publication with the purpose of seeking or offering illegally to receive, buy, or distribute a Schedule I controlled substance…. If an advertisement advocates the purchase of clinical marijuana through a Medical Marijuana Dispensary, it does not comply with CSA § 843(c).”46 This notice effectively ended any distribution of any marijuana advertisement through this local office in Oregon. While it is unclear whether this notice affects other US Postal Service offices in other states, since the notice did not directly come from US Postal Services headquarters, advertising efforts via the postal service in other states may be obstructed in the future.

(5) Intellectual Property

Under the US trademark laws, federal trademark registration can be granted only in connection with goods and services lawfully regulated by commerce.47 Thus, the US Patent and Trademark Office (USPTO) has consistently refused to register marijuana-related trademarks, given the illegal status of marijuana under the CSA. However, the USPTO may trademark ancillary products (e.g., noninfused foods and candies sold in dispensaries) that are not related to the production and dissemination of marijuana.48 Further, a business may protect its brand by registering its trademark with one or more states where marijuana is legal and where its brand or logo actually qualifies for a trademark, as long as it does not infringe any other trademarks.49


In sum, there is a range of legal issues in the marijuana industry that warrant careful consideration by potential investors, including private equity investors. Investing in the legal marijuana industry requires an understanding of the implications of the most recent changes to laws and regulations, proposed bills, other publications by federal or state authorities, and court cases. In particular, in 2016, potential investors should stay abreast of the status of bills under discussion in Congress, such as the CARERS Act of 2015 and the Marijuana Businesses Access to Banking Act of 2015 (as mentioned above), and the status of pending marijuana legalization bills in several states, including Massachusetts, California, Maine, Arizona, Nevada, Vermont and Rhode Island.50