of dispensaries are those that have both recreational and medical cannabis laws, such as Colorado,
Oregon and Washington, and those that have had medical cannabis laws for a long period of time, such
as California. For example, according to the Rocky Mountain High-Intensity Drug Trafficking Area,
as of June 2017, in Colorado there were 491 cannabis dispensaries, compared to 392 Starbucks and
208 McDonald’s.
E-Commerce
E-commerce refers to the use of digital applications to enhance the cannabis shopping experience. For
example, a mobile application may facilitate the comparison of cannabis products and pricing or the
delivery of orders from local dispensaries. These applications are being developed by a host of market
participants, ranging from software development companies to retail dispensaries. Due to federal
restrictions, cannabis e-commerce transactions are currently conducted only intrastate. If and when
federal restrictions change to allow interstate cannabis commerce, we expect that home-delivery and
e-commerce services will increase significantly. E-commerce solutions with high consumer engagement
(such as those providing reviews and price comparisons for a broad selection of products) will help
retailers acquire and retain customers.
Sample E-Commerce Menus
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Cannabis Industry Segmentation
Distribution Services
Distribution services is emerging as a prominent subsegment of the cannabis industry; services in this
subsegment include wholesale distribution of cannabis products to retailers and production intermediaries,
as well as related transportation and logistics services. Historically, a high percentage of
product manufacturers have sold directly to retail dispensaries, and some of those manufacturers with
established “in-house” distribution channels are now leveraging their experience to offer distribution
services to third-party manufacturers.
Currently, distribution activities must be conducted only intrastate, and providers of distribution
services must comply with regulations related to “touching the plant,” including testing and taxcollection
requirements. As laws are changed to allow more interstate and international transportation,
purchasers will be able to compare products and prices on a national or international basis, and distributors
who provide superior product selections and transportation logistics should have significant
competitive advantage.
Distribution Opportunities
We believe opportunities in this segment include:
E-Commerce Distribution. The ability to accept electronic orders and deliver cannabis products
on demand represents an attractive distribution channel and growth opportunity. Companies that
provide digital retail platforms for cannabis products will benefit as consumers migrate to e-commerce
transactions.
Branded and Vertically Integrated Dispensaries. We believe that consumers will ultimately concentrate
their purchases with a small group of branded dispensaries that provide a distinct, consistent
and trusted retail experience and offer supporting e-commerce solutions. Dispensaries that integrate
vertically to offer their own branded products should achieve superior margins on those products.
High-profile Retail Locations. We see an opportunity for cannabis dispensaries to attract significantly
more customers by establishing storefronts in malls and other high-profile retail locations.
“Land Grab” of Desirable Locations. Companies able to navigate the licensing and real estate challenges
required to secure and operate multiple dispensaries in desirable locations should benefit from
existing high barriers to entry and capture significant market share.
Distribution Challenges
Challenges in this segment include:
Customer Acquisition and Retention. Like e-commerce businesses in other industries, providers of
e-commerce solutions in the cannabis industry face intense competition for customers who can easily
change vendor loyalties. Companies will be challenged to minimize customer acquisition costs and
retain customers.
Restrictive and Changing Regulations. Obtaining a state dispensary license or other type of distribution
permit typically involves a multi-month application process that requires the applicant to
demonstrate compliance with complex criteria. In addition to state laws and regulations, dispensaries
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and other distribution intermediaries are subject to county, municipal and other local regulations that
may restrict or even prohibit distribution activities. The success of any dispensary operator or distributor
depends on anticipating and complying with these regulations.
Tax Issues Related to Distribution. States and localities that legalize cannabis are focused on the
potential to generate tax revenue from the industry. Ambiguous, constantly changing and potentially
burdensome taxation rules may make it difficult for dispensary operators or distributors to remain in
good standing with licensing, regulatory and tax collection agencies and may negatively impact their
financial results.
Distribution Outlook
We expect dispensaries across the United States to increasingly seek to provide modern retail experiences
that are supported by e-commerce applications. We also expect that the most well-run dispensaries
will continue to generate significant cash flow at compelling margins. Dispensaries should be able
to gain advantage by producing their own products, by developing strategic or exclusive relationships
with specialty producers or by finding ways to generate customer loyalty. However, oversaturation
in the number of dispensaries in certain jurisdictions, such as Colorado, has led to a very competitive
environment, consolidation and moratoriums on issuing new local dispensary licenses by various
municipalities.
The distribution segment is subject to some of the strictest and most frequently changing regulations
applicable to the cannabis industry. While distribution opportunities may arise with changes
in law, some legislation may cause significant disruption. For example, the number of dispensaries
operating in the greater Los Angeles region is expected to decrease significantly in the short term as
California’s new cannabis regulatory agency begins its oversight and enforcement efforts in 2018.
The distribution services subsegment in the United States is still in its infancy and has experienced
a number of growing pains related to a lack of well-established distribution channels. For example, a
Nevada law generally requiring dispensaries to use third-party distributors proved troublesome when
dispensaries sold out of product within 48 hours after legal recreational cannabis sales commenced in
the state. As more distribution channels and points of contact are established, we believe that opportunities
for third-party distribution services companies will increase.
In certain legalized international markets, such as Germany and Uruguay, cannabis products
are sold primarily through existing pharmacy networks (Argentina plans to do the same). While
cannabis-derived pharmaceuticals may ultimately be distributed the same way in the United States,
we believe the future domestic distribution channels of other types of cannabis products will closely
resemble those of alcohol and tobacco products.
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n Consumer Products
Cannabis may be consumed in many different forms, which fall into three broad categories: flower,
concentrates and infused products. The most popular way to consume cannabis historically has been
to smoke the flower or “bud” from the cannabis plant, which can be done using a pipe, a hand-rolled
cigarette (often referred to as a “joint”) or a water pipe (often referred to as a “bong”). Cannabis flower
can also be vaporized and inhaled (using a product known as a “vaporizer”). The active compounds
in cannabis can be extracted and concentrated into oil or waxlike substances known as concentrates.
Concentrates, in turn, can either be vaporized and inhaled or infused into products known as “infused
products.” Infused products may be applied topically, such as lotions and creams, or consumed orally,
such as food and drinks (known as “edibles”), capsules, pills and tinctures.
When smoke or vapor from heated flower or a concentrate is inhaled, the active compounds travel
directly to the central nervous system and the physiological effects typically begin within one to five
minutes. When infused products are consumed orally, the active compounds are digested in the stomach
and metabolized by the liver before taking effect, typically in one to two hours. Compared to
inhaled products, infused products deliver a smaller relative amount of cannabinoids to the bloodstream,
but they produce longer-lasting effects.
Innovative companies continue to expand the universe of cannabis products, developing brands
with packaging that increasingly emphasizes education about the product’s effects and appeals to mainstream
consumers. Cannabis flower is currently the most widely sold form of cannabis, but concentrates
and infused products are gaining in popularity.
The following chart shows the combined relative sales by product category for Colorado, Oregon
and Washington (three states with relatively mature recreational and medical cannabis markets) for the
three months ended September 30, 2017.
Product Sales by Category: Q3 2017
14%
12%
51%
23%
Flower Concentrates Edibles Other
Source: BDS Analytics
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Cannabis Flower
Cannabis flower, or “bud,” is the most popular product among cannabis consumers. Cannabis flower
is usually green (although some varieties have a purple or orange hue), slightly sticky to the touch and
spongy in density. The flower has a strong, pungent aroma owing primarily to the trichomes on the
flowers, which contain the highest concentrations of cannabinoids and terpenes of any part of the
plant.
Branded Cannabis Flower
There are thousands of different cannabis varieties, each with its own cannabinoid and terpene
profile and corresponding aroma, flavor and potency. Leading cultivators are recognized each year in
contests and ceremonies for their indica, sativa and hybrid varieties. Award-winning varieties—which
are often given unique identifying names—frequently become the most in demand by consumers.
Popular varieties today include “Blue Dream,” “Gelato,” “OG Kush,” “Pineapple Express” and “Sour
Diesel.”
The flower of a typical cannabis variety produced for human consumption contains approximately
15% to 30% THC, approximately 0.1% to 1% CBD and nominal levels of other cannabinoids. Due
to advancements in cultivation techniques, THC levels in cannabis flower available today are generally
much higher than in the past.
Concentrates
Cannabis can be processed into a variety of concentrates, many of which are sold as finished products
for smoking or vaporizing and some of which can be infused into other products, such as edibles and
topicals. Concentrates include CO 2 oil, butane hash oil or “BHO,” shatter, wax, live resin, budder,
kief, ice water hash and rosin.
Concentrates are quickly becoming popular for a host of reasons. Some believe vaporizing or ingesting
concentrates are healthier methods of cannabis consumption than smoking plant material. Extracting
cannabinoids from the cannabis plant produces higher-potency dosing (THC content can exceed
80% in concentrates), enables custom formulations and flavor profiles, and facilitates consumption
that is more convenient and discreet than smoking. The concentration of specific cannabinoids varies
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across cannabis varieties and even across flowers from the same plant, which limits the accuracy of laboratory
tests conducted on a sample of plant material. Cannabis concentrates, however, are generally
homogeneous and their active elements can be more precisely measured and reported so as to facilitate
standardization of products and accurate dosing by consumers.
The following chart shows the combined relative sales by category of concentrates for Colorado,
Oregon and Washington for the three months ended September 30, 2017.
Concentrates Sales by Category: Q3 2017
18%
6%
8%
16%
35%
17%
Live resin Oils Other concentrates Shatter Vape oil Wax
Source: BDS Analytics
Concentrates are prepared with extraction techniques that fall into two general categories, solventbased
extraction and solvent-free extraction. Solvent-based extraction techniques include the use of
hydrocarbon, carbon dioxide (CO 2 ) or ethanol solutions to chemically isolate cannabinoids and other
active compounds. Solvent-based extraction can be performed relatively quickly and can produce high
yields and customized formulations, but requires the use of expensive equipment and skilled labor and
also may leave residual solvents in the resulting concentrate. Solvent-free techniques include the use of
filters, ice water or heat to physically separate parts of the cannabis plant with high cannabinoid concentrations.
Generally, solvent-free extraction is inexpensive and can be performed without specialized
equipment, but it is also slow and labor-intensive and it typically results in low yields.
Hydrocarbon Extraction
Hydrocarbon extraction is a process whereby a hydrocarbon solvent (typically butane or propane)
chemically extracts cannabinoids, terpenes and other compounds from cannabis plant matter. The
solvent is then purged using heat and pressure, leaving a concentrated form of the extracted compounds.
Because hydrocarbon extraction involves a risk of explosion and usually leaves behind residual
solvents, regulations are becoming more restrictive in specifying where and how the process can occur
and prescribing acceptable levels of residual solvents in the resulting products. Concentrates prepared
through hydrocarbon extraction—including BHO, shatter and wax—are popular with some consumers
because hydrocarbon extraction generally preserves terpenes and the source plant’s aroma and
flavor.
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CO 2 Extraction
CO 2 extraction is a process whereby cannabis is introduced into a system of supercritical CO 2 (CO 2
at a pressure and temperature at which it exhibits properties of both a gas and a liquid). Cannabinoids
and other compounds dissolve in the supercritical CO 2 ; pressure is released, and the CO 2 then
evaporates, leaving a concentrated form of the dissolved compounds. CO 2 extraction is considered a
relatively safe and clean extraction process because CO 2 is nonvolatile, CO 2 concentrates are generally
free of residual solvents and CO 2 extraction kills mold and bacteria. CO 2 extraction is commonly used
to produce viscous CO 2 oil for vaporizer cartridges and low-terpene concentrates for infused products.
Ethanol Extraction
Ethanol extraction is a method used in a number of industries to extract essential oils and food flavorings
from plants. When used to produce cannabis concentrates, the process involves soaking cannabis
plant material in ethanol, which separates cannabinoids, terpenes and other compounds from the
plant matter. The solution is then heated until the ethanol is purged to acceptable levels. Ethanol is
generally much safer to use for extraction than hydrocarbons and is particularly useful for creating concentrates
with “whole-plant” compound profiles that mirror the source plant. Unfortunately, ethanol
also extracts certain plant compounds —particularly chlorophyll—that have undesirable aromas and
flavors.
Solvent-Free Extraction
Most solvent-free extraction techniques are inexpensive and do not require special training or equipment,
but they also tend to produce low yields. Kief, ice water hash and rosin are examples of concentrates
produced with solvent-free methods. Kief is a collection of trichomes that are separated from
cannabis flower by sifting the flower with specialized filtering screens. Ice water hash is a collection
of trichomes produced by stirring cannabis in ice water, filtering the mixture through a sequence of
increasingly fine screens, removing the trichome collection from the finest screens and allowing it to
dry. Rosin is created by heating and pressing cannabis plant material between parchment paper and
collecting the concentrate that oozes onto the paper.
Oil Concentrate (Cartridge) BHO Wax Rosin
Cannabis Concentrate Products
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Cannabis Industry Segmentation
Infused Products
Infused products are ingestible products that have been infused with cannabinoids and other active
compounds from the cannabis plant. There are two general categories of infused products: those consumed
orally, such as foods and beverages (known as “edibles”), capsules, pills and tinctures; and those
applied topically, such as lotions, balms and creams. Infused products may either be infused with
concentrates (that are prepared through one of the extraction techniques discussed previously) or prepared
with other infused products, such as cannabis-infused butter (a concentrate prepared by heating
cannabis in butter to release the active compounds, and then filtering out the plant material).
The following chart shows the combined relative sales by category of infused products for Colorado,
Oregon and Washington for the three months ended September 30, 2017.
Infused Products Sales by Category: Q3 2017
8%
2%
10%
44%
11%
25%
Candy Chocolates Tinctures Infused foods Pills Other
Source: BDS Analytics
Edibles
Popular edibles include infused candies, chocolates and beverages. The active compounds in edibles
are digested and metabolized by the liver before taking effect; typically, the time from ingesting to
onset of an effect is one to two hours, but the effect lasts longer than that resulting from inhaling
smoke or vapor. Edibles generally deliver body-focused effects, which may be preferred by consumers
seeking pain relief.
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Edibles: Chocolate, sparkling water, mints, candies, brownies, gummies
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Capsules and Tinctures
Capsules are cannabis concentrates with various cannabinoid profiles encapsulated in a gelatin coating
for easy swallowing. Capsules are digested and metabolized like edibles; typically, the time from swallowing
to onset of an effect is one to two hours. Tinctures are concentrates suspended in an alcohol
solution and are usually placed under the tongue using a dropper; effects generally begin within 10
to 15 minutes. Capsules and tinctures are preferred over edibles by some consumers who believe they
deliver more consistent dosing than edibles.
Capsules
Tincture
Topicals
Topicals are any form of product infused with cannabinoids and applied topically, such as lotions,
balms, creams, lubricants and transdermal patches. Topicals often include noncannabis ingredients,
such as essential oils or herbal extracts. They are commonly used for localized relief of muscle soreness
and inflammation and for relief of headaches and cramping.
Topicals
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Vaporizers and Accessories
Smoking or vaporizing cannabis flower or concentrates is the most popular method of cannabis consumption,
in part because the effects of inhaled cannabis smoke or vapor begin almost immediately.
Accessories used to smoke cannabis include glass, wood or metal pipes; glass or plastic water pipes
known as “bongs”; and cigarette papers used to roll “joints.” A vaporizer is a device that heats cannabis
flower or concentrate to a temperature at which its active compounds boil and can be inhaled as vapor.
Vaporizers are increasing in popularity faster than any other cannabis-consumption device, in some
measure because vaporizing is perceived by many as a healthier method of cannabis consumption than
smoking. Distinguishing features of a vaporizer include whether it vaporizes flower or concentrate, the
form of the heating mechanism, or “atomizer,” power output, battery efficiency, durability, reusability
(there are both refillable and disposable vaporizers) and design aesthetics. Hundreds of vaporizers are
marketed, ranging from simple to complex, including handheld vaporizers that retail for $10 to $500
and tabletop vaporizers that retail for $100 to more than $1,000.
Vaporizers
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Cannabis Consumers Using Vaporizers
In addition to smoking and vaporizing devices, an increasing variety of other cannabis-related
accessories are available, including personal storage and transportation products. Some of these products
focus on safety or discretion, such as childproof containers and smell-proof bags. Other products
are designed more for style, such as vaporizer pouches and tabletop storage containers intended as
decor. The market for both safety-focused accessories and style pieces is expected to grow as laws
and regulations increasingly impose requirements related to storage and transportation and as taboos
regarding cannabis use wane.
Accessories
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Pharmaceuticals
Cannabinoid-based pharmaceuticals are drugs containing cannabinoids or cannabinoid-like compounds
that are either derived from natural cannabis or chemically synthesized. A handful of such
drugs have been approved for use to treat certain medical conditions both in the United States and
elsewhere. Examples of cannabinoid-based pharmaceuticals that have been approved for use in various
countries include Marinol, Syndros, Cesamet and Sativex. Another cannabinoid-based pharmaceutical,
Epidiolex, has not yet been approved but could become the first medicine derived from the cannabis
plant to be approved by the U.S. Food and Drug Administration (FDA).
The drug Marinol is comprised of dronabinol (a synthetic THC) encapsulated with sesame oil in a
soft gelatin capsule. Marinol has been approved by the FDA for use in treating (i) anorexia associated
with weight loss in patients with AIDS and (ii) nausea and vomiting associated with cancer chemotherapy.
Marinol is a Schedule III controlled substance under the U.S. Controlled Substances Act
(CSA). Syndros is a drug that contains dronabinol in a liquid solution; it has been approved by the
FDA for use by adults in treating the same symptoms for which Marinol has been approved. Syndros
is a Schedule II controlled substance under the CSA. Forms of dronabinol have been approved for use
in jurisdictions outside the United States, including Canada and Denmark.
Cesamet is a drug made up of encapsulated nabilone, a synthetic cannabinoid similar to THC.
Cesamet has been approved by the FDA for use in treating nausea and vomiting associated with cancer
chemotherapy. Cesamet is a Schedule II controlled substance under the CSA. Forms of nabilone have
been approved for use in jurisdictions outside the United States, including Australia, Canada, Mexico
and the United Kingdom.
Sativex is a mouth spray used for treatment of spasticity caused by multiple sclerosis; it includes
THC and CBD derived from cannabis. Sativex was first approved for use in the United Kingdom in
2010, and has been approved for use in at least 30 countries (but not in the United States). Sativex is
manufactured by U.K.-based GW Pharmaceuticals and is generally recognized as the first prescription
drug in the world to include plant-based cannabinoids. The cannabis extract used in Sativex is a Schedule
I controlled substance under the CSA.
Pharmaceuticals
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Epidiolex is an oral formulation of cannabis-derived cannabidiol, or CBD, intended to treat severe
forms of childhood epilepsy. Epidiolex has not been approved for use in any country, but the drug’s
manufacturer, GW Pharmaceuticals, recently submitted a New Drug Application for Epidiolex to the
FDA, which is an important step toward FDA approval in the United States. If approved by the FDA,
Epidiolex would be the first FDA-approved prescription drug derived from cannabis. The cannabis
extract used in Epidiolex is considered to be “marijuana,” a Schedule I controlled substance under the
CSA. Therefore, even if Epidiolex were approved by the FDA, Epidiolex would need to be rescheduled
and excepted from the “marijuana” definition before it could be lawfully prescribed in the United
States.
Consumer Products Opportunities
We believe opportunities in this segment include:
Consumer Product Brands Focused on Health and Wellness. We believe there is a substantial opportunity
for companies to develop leading brands of cannabis-based health and wellness products. Marketing
a broad line of such products under a common brand should provide a competitive advantage.
Direct E-Commerce Distribution. The e-commerce market for cannabis products is expected to
expand and consumer awareness of product options is expected to increase, enabling more consumer
product companies to sell their products directly to consumers through online purchasing platforms
rather than selling only through wholesale.
Advanced Vaporizer Functionality. Vaporizer technology has advanced rapidly in recent years, a
trend we expect to continue. In the future, vaporizers may be able to identify the composition and
potency of the product being consumed, monitor consumption and dosing of the product, or reorder
the product at the push of a button.
Specialty Formulations. We believe that scientific knowledge about the relationships between specific
cannabinoid formulations and targeted health conditions will continue to improve, and markets
will be created for highly specialized products developed to relieve particular symptoms.
FDA Approval and CSA Rescheduling. If Epidiolex is approved by the FDA and rescheduled under
the CSA to permit lawful prescriptions to be written within the United States, it would be the first federally
legal cannabis-derived drug in the country. Such a precedent could result in a significant increase
in the use of cannabis by consumers as medicine, and it could also be followed by similar approvals in
the United States for other cannabis-derived drugs.
Consumer Products Challenges
Challenges in this segment include:
Marketing and Customer Loyalty. As more products become available to consumers through dispensaries
and e-commerce solutions, consumer product providers may need large marketing budgets
to drive product awareness and customer loyalty.
Wholesale and Retail Distribution. Providers of cannabis products may struggle to develop wholesale
and retail distribution relationships because of the breadth of products being marketed. Providers
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should seek to develop strong relationships with a large number of dispensary operators, directly or
through a distributor, in order to obtain preferred shelf placement.
FDA Approval: Risk, Time and Expense. Assuming that cannabis-derived drugs will eventually be
permitted to be sold in the United States, considerable time and expense will be spent by manufacturers
to obtain FDA approval and bring approved products to market. There is no guarantee that
investments of significant time and money into research, development and clinical trials will result in
FDA approval of cannabis products.
Product Liability Claims. Companies may be exposed to various product liability claims associated
with human consumption of cannabis products. Consumer claims that products cause injury or illness,
include inadequate instructions for use or warnings concerning health risks, or cause possible side
effects or interactions with other substances may be expensive to defend or settle.
Consumer Products Outlook
We believe that there are significant market opportunities for well-recognized brands to develop in
various categories of consumer products, particularly in flower, concentrates, edibles and vaporizers.
In addition, we believe that there are opportunities for companies targeting niche applications for the
pet industry. Many companies will struggle to create strong brands because the consumer products
segment generally has low barriers to entry and is currently oversaturated. As the cannabis industry and
legal environment develop, we expect that national brands will emerge from companies with large marketing
budgets, operational scale and reputations for quality, and that large alcohol, tobacco, consumer
products and pharmaceutical companies will play a larger role in this segment.
n Business Solutions
The business solutions segment of the cannabis industry comprises business software, such as seedto-sale
tracking solutions, and business services, such as legal, compliance, operational consulting and
financial services. Software and services providers in this segment generally do not “touch the plant”
and do not require cannabis-related permits or licenses.
Business Software
Software solutions tailored to the cannabis industry are present throughout the cannabis supply chain.
Although solutions from other manufacturing and retail industries are used in the cannabis industry,
industry-specific solutions are emerging as some of the most popular. Some companies provide point
solutions that target bottlenecks in the supply chain, while others offer broad platforms that consolidate
multiple capabilities. Industry-specific software applications exist and are being developed in the
following areas: cultivation cycle management; concentrate production management; infused product
manufacturing management; product testing and compliance; retail operations (including point-ofsale,
inventory, tax reporting and compliance solutions); mobile, e-commerce and delivery applications;
supply-chain management; customer relationship management; and management reporting and
business intelligence.
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Cannabis Software Platforms
Business Services
The business services market includes (i) operational consulting, including facility planning, construction
and security; (ii) financial services, including accounting and payment-processing services;
(iii) legal, compliance and other professional advisory services; (iv) temporary and full-time staffing
services; (v) real estate services; and (vi) industry events and conferences. These services are typically
provided by professional services firms; some of these firms focus solely on the cannabis industry while
others serve a broad range of industries.
Business Solutions Opportunities
We believe opportunities in this segment include:
Industry-specific Solutions. As the cannabis industry emerges, there will be a significant market
opportunity for providers of solutions tailored for the industry. Point-solution providers may be acquisition
targets if larger companies enter the market in the future.
Integrated Platforms. We believe that integrated “seed-to-sale” solutions will be ideally positioned.
“Big Data” Analytics. We believe that there is an attractive opportunity to develop and license
industry datasets. Such datasets should provide strategic advantages to organizations that establish
substantial reach early and may also be licensed more broadly to enhance targeting, services, cross-sales
and product development.
Business Solutions Challenges
Challenges in this segment include:
Development and Deployment Risk. Due to the time and investment required to develop software
products and the emerging nature of the cannabis industry, there is a risk that developed applications
may not be effective or widely adopted. In addition, certain segments of the cannabis industry are more
mature than others; this disparity may present challenges in developing solutions that support cohesive
and scalable business models.
Low Barriers to Entry. Numerous sectors of the business services market are becoming increasingly
crowded.
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Business Solutions Outlook
The cannabis industry presents a significant market opportunity for software and services providers
because of the large number of potential new clients and the need for industry-specific solutions. In
particular, we believe that substantial opportunities exist for providers of industry-specific, platform
and “big data” solutions. We also believe that financial, legal and compliance service providers that have
developed knowledge of the cannabis industry are well positioned for growth. Similar to the production
segment, large software and services companies serving traditional industries have been reluctant
to enter the cannabis market due to concerns over the regulatory landscape. While this dynamic has
created a short-term opportunity for some smaller companies, as the regulatory environment becomes
clearer we expect competition in this segment to increase significantly as large companies enter the
market.
n Digital Media
The digital media segment of the cannabis industry includes digital content, networking and directory
platforms. Digital media providers do not “touch the plant” and generally do not need a cannabisrelated
license or permit. Digital media focused on cannabis is a niche sector within the broader digital
media market. Companies in this segment compete for viewers and subscribers and generally draw
revenue from content licensing fees, service fees, advertisement fees and subscription fees. They provide
a broad range of content and networking tools, including news related to the cannabis industry and
legalization efforts, humor and entertainment focused on the cannabis-user demographic, traditional
media and branding services, social networking tools that allow users to share pictures and information
related to their cannabis activities, and business directory tools that connect industry participants.
Cannabis Digital Media
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Digital Media Opportunities
We believe opportunities in this segment include:
Premium Content. We believe that opportunities exist to establish industry-specific publications
and media platforms for both the business-to-business and business-to-consumer markets that are
viewed as the legitimate voices of the industry.
Mobile Applications. E-commerce and digital media applications are well positioned for mobile
deployment within the cannabis industry. We expect a proliferation of mobile applications, even in the
early stages of the industry.
Enabling Technology. Continued development of core and shared technology platforms remains
an opportunity for digital media companies seeking to provide a better user experience. Technologies
that provide targeted experiences should enable digital media companies to realize greater returns on
investments.
Digital Media Challenges
Challenges in this segment include:
Limited Number of Advertisers. Broad, general-market advertisers are not commonly participating
in the cannabis industry due to concerns about legal compliance and mass-market perception. As a
result, companies are currently competing for limited advertising revenue targeted at the cannabis-user
demographic.
Venues. Established digital media companies—such as Facebook, Google, Twitter and Yelp—limit
the activities of cannabis-focused media companies on their sites in accordance with company policies.
This creates opportunities for niche publishers in the near term, but we believe that, ultimately, large
media companies will view cannabis as a mainstream industry.
Digital Media Outlook
The opportunity for cannabis-oriented digital media is substantial. We believe that companies with
well-executed strategies will emerge as the recognized voices of the industry and will be relied on by
consumers for a wealth of information from product recommendations to industry news. As regulatory
constraints relax, we expect the currently disparate and fragmented digital media services segment to
consolidate into integrated publishing, mobile and e-commerce offerings. However, as stated previously,
we believe that digital media companies focused solely on the cannabis industry will eventually
face considerable competition from —but may be logical acquisition targets for—traditional media
companies.
© 2017 Ackrell Capital, LLC | Member FINRA / SIPC 59

CHAPTER IV
U.S. Legal Landscape
The legal landscape for the cannabis industry in the United States continues to be characterized by
conflict between federal prohibition and the steady advance of state legalization. According to federal
policy, Americans can access tobacco, alcohol and prescription drug products that kill thousands each
year, but they cannot access cannabis because it is a dangerous drug with no currently accepted medical
application in the United States (notwithstanding the federal government holds a U.S. patent for
methods of treating diseases with cannabinoids). Meanwhile, 46 U.S. states permit some use of cannabis
products as medicine by adults or children, and 8 of those states have laws that regulate cannabis
like alcohol.
The U.S cannabis industry has proven adept at navigating this federal-state conflict and is experiencing
rapid growth despite it. Moreover, we believe that federal policy will move (and may already be
moving) in a new direction—one that would facilitate federal approval of cannabis-derived drugs and
ultimately, we believe, give rise to a regulatory and political environment in which the U.S. Congress
could fully legalize both medical and recreational cannabis.
In this chapter, we summarize three categories of state cannabis laws and examine certain federal
laws and policies that impact the cannabis industry, including federal laws related to drug and food regulation,
banking and finance, and intellectual property. Finally, we offer our views about how the cannabis
legalization trend and related developments likely lead to a federally legal U.S. cannabis industry.
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n U.S. State Law
Of the 51 jurisdictions comprising the 50 U.S. states and the District of Columbia, 47 have enacted
at least one law that permits the manufacturing, distribution, dispensing or possession of cannabis or
concentrates. These laws fall into three general categories:
• 29 U.S. states and the District of Columbia have enacted medical cannabis laws that permit
the production and possession of cannabis or concentrates for use in treating a broad range of
qualifying medical conditions.
• 19 U.S. states have enacted narrow CBD/limited laws that permit possession of small amounts
of low-THC/high-CBD cannabis concentrates for use in treating a few serious medical conditions—in
particular, severe forms of childhood epilepsy.
• 8 U.S. states have enacted recreational laws that permit the commercial production and sale of
cannabis to adults for recreational and other uses.
Some states have passed more than one of these laws, and some state laws do not fall clearly into
any one of these categories. Florida and Delaware have both medical cannabis and CBD/limited laws.
Every state that has enacted a recreational law has also passed a medical cannabis law. A District of
Columbia law that permits adults to grow and consume cannabis is often cited as a recreational law;
however, we do not characterize it as such because it does not permit the commercial production and
sale of cannabis. The following map of the United States shows states with medical cannabis laws,
CBD/limited laws or recreational laws (a state with more than one of these laws is represented on the
map by its most permissive law).
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U.S. State Cannabis Laws (January 2018)
© 2017 Ackrell Capital, LLC
Recreational Law Medical Cannabis Law CBD/Limited Law
Alaska
California
Colorado
Maine
Massachusetts
Nevada
Oregon
Washington
No Recreational,
Medical Cannabis
or CBD/Limited Law
Idaho
Kansas
Nebraska
South Dakota
Arizona
Arkansas
Connecticut
Delaware
Florida
Hawaii
Illinois
Maryland
Michigan
Minnesota
Montana
New Hampshire
New Jersey
New Mexico
New York
North Dakota
Ohio
Pennsylvania
Rhode Island
West Virginia
Vermont
Alabama
Georgia
Indiana
Iowa
Kentucky
Louisiana
Mississippi
Missouri
North Carolina
Oklahoma
South Carolina
Tennessee
Texas
Utah
Virginia
Wisconsin
Wyoming
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An exhaustive review of each jurisdiction’s laws is beyond the scope of this report; instead we discuss
issues commonly addressed by each category of cannabis laws.
Medical Cannabis Laws
In 1996, California enacted the first medical cannabis law of any U.S. state, followed in the late 1990s
by Alaska, Maine, Oregon and Washington. Since the beginning of 2000, 24 more states and the
District of Columbia have passed medical cannabis laws that permit the production and possession of
cannabis or concentrates for use in treating a broad range of qualifying medical conditions.
A state medical cannabis law permits a patient, with a doctor’s recommendation, to use cannabis to
treat any qualifying medical condition designated by the law. It is illegal for a doctor to “prescribe” a
Schedule I controlled substance under the U.S. Controlled Substances Act (CSA), so medical cannabis
laws typically require a doctor’s “recommendation” rather than a prescription. Some medical cannabis
laws require a written recommendation, while others allow an oral recommendation. States may impose
a variety of other requirements or restrictions on a doctor or patient relating to medical cannabis access,
such as patient registration with a state medical cannabis registry, submission of a patient’s fingerprints
or prohibition of use by convicted felons or certain government employees (for example, firefighters).
The number and nature of qualifying conditions included in medical cannabis laws vary widely.
Some laws designate relatively few or highly specific medical conditions, while other laws include many
conditions or highly subjective conditions, such as chronic pain. Some medical cannabis laws also
give doctors discretion to recommend cannabis for conditions not specifically designated. In aggregate,
across all medical cannabis laws in the United States, cannabis is legally recognized as a form of
therapy or medicine for more than 50 qualifying conditions. Common qualifying conditions include
Alzheimer’s disease, amyotrophic lateral sclerosis (ALS), anorexia, arthritis, cachexia, cancer, chronic
pain, Crohn’s disease, epilepsy, glaucoma, hepatitis C, HIV/AIDS, inflammation, migraine, multiple
sclerosis (MS), nausea, nervous system degeneration, Parkinson’s disease, post-traumatic stress disorder
(PTSD) and spasms.
Some medical cannabis laws restrict the form of cannabis or the means of consumption. For example,
Pennsylvania’s medical cannabis law, enacted in 2016, prohibits smoking or vaporizing cannabis
flower, prohibits the incorporation of cannabis into foods by anyone other than the patient or the
patient’s caregiver, and authorizes cannabis to be dispensed only in certain concentrated forms.
Medical cannabis laws generally permit cannabis cultivation and distribution by a state-licensed
cultivator or dispensary, by a qualified patient or by a designated caregiver of the patient. A qualified
patient or the patient’s designated caregiver generally may grow only an amount of cannabis deemed
sufficient for the patient’s personal use. Some medical cannabis laws permit patients or caregivers to
grow cannabis only if they cannot practically obtain it by other means. For example, certain states
permit patients to grow cannabis only if they reside more than a specified distance from the nearest
licensed dispensary. Some states allow qualified patients and designated caregivers to collectively or
cooperatively aggregate their cultivation activities.
State-licensed cultivators and dispensaries must satisfy various licensing requirements related to
health, safety and security. In states that permit or require vertical integration, a licensee may be part
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of a single cultivation and dispensing enterprise. In other states, a licensed cultivator may be permitted
to sell to unaffiliated licensed dispensaries or delivery services, which then retail medical cannabis to
patients.
Each state has its own rules about whether medical cannabis activities may be engaged in for profit.
In states where caregivers and qualified patients collectively or cooperatively aggregate their cultivation
and distribution efforts, participants generally are allowed to charge amounts necessary to recover the
reasonable costs associated with those activities but may not operate for profit. In states that allow
licensed cannabis activities, such as cultivation and dispensing, the organizations engaged in those
activities generally may seek to earn a profit.
CBD/Limited Laws
From 2014 through 2017, a total of 19 U.S. states enacted CBD/limited laws that generally permit
possession of small amounts of low-THC/high-CBD cannabis concentrates for use in treating a few
serious medical conditions. Most of these laws limit qualifying medical conditions to severe forms of
epilepsy or seizure disorders, but some laws designate a moderately broader set of conditions.
Most CBD/limited laws allow CBD use by children. Many of these laws were enacted in the context
of high-profile stories about CBD treatments for children with severe seizure disorders, and the
laws have been given names like Carly’s Law (Alabama), Haleigh’s Hope Act (Georgia) and Julian’s Law
(South Carolina). Charlotte’s Web is a low-THC/high-CBD cannabis strain named for Charlotte Figi,
a young Colorado girl whose parents treat her seizure condition with CBD oil. Her case was featured
in Dr. Sanjay Gupta’s popular CNN special, Weed.
In general, each CBD/limited law establishes a narrow legal framework for use of low-THC/
high-CBD cannabis concentrates. Certain CBD/limited laws designate only one or several producers
of permitted cannabis concentrates; in some cases, these producers include a state university or research
institution. Other CBD/limited laws establish no legal framework for the production or distribution of
permitted products and merely provide a narrow affirmative defense for state-law cannabis possession
and use charges.
Recreational Laws
In 2012, Colorado and Washington voters passed the first laws in the United States (and the world) to
permit the commercial production and sale of cannabis to adults for recreational and other uses. Alaska
and Oregon passed similar recreational laws in 2014. And in the November 2016 elections, four more
states—California, Maine, Massachusetts and Nevada—passed recreational laws. (Of the five recreational
laws included on November 2016 ballots, only Arizona’s law did not receive voter approval.)
State recreational laws permit adults aged 21 years or older to legally purchase and use cannabis
sold by state-licensed commercial businesses. There are no state residency requirements for adult consumers,
and out-of-state visitors with valid proof of age may legally purchase cannabis, giving rise to
“cannabis tourism” in states with extensive dispensary networks like Colorado, Oregon and Washington.
Cannabis typically may not be consumed in public spaces or private establishments open to
the public, such as parks and restaurants. Recreational laws also generally permit adults to cultivate a
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limited number of cannabis plants (typically, 4 to 6) for personal use. (Washington is an exception,
however, and makes personal cultivation a felony unless it is done by a person registered in the state’s
medical marijuana database.) Unlike state medical cannabis laws, which may restrict the form of cannabis
products available, recreational laws permit production and sale of most common forms of cannabis
products, including a wide variety of flower, concentrates and infused products.
State recreational laws designate state agencies to issue commercial cannabis licenses and regulate
participants in the cannabis supply chain. Some of these agencies are newly established specifically to
regulate cannabis, such as California’s Bureau of Cannabis Control (BCC) or Massachusetts’s Cannabis
Control Commission. Others are existing state agencies (and typically oversee tax or alcohol matters),
such as Nevada’s Department of Taxation or Oregon’s Liquor Control Commission. These agencies
also may regulate state medical cannabis industries, as do Colorado’s Marijuana Enforcement Division,
Washington’s Liquor and Cannabis Board and California’s BCC.
State regulatory agencies issue separate licenses for different types of commercial cannabis activities.
Common categories of licenses include cultivation, production, manufacturing, distribution, transportation,
laboratory testing and retail. A state may further provide for multiple types of licenses within a
category. For example, California’s recreational law provides for 12 types of cultivation licenses, which
vary according to factors such as the size of a cultivation facility and indoor or outdoor cultivation.
Most states allow companies to hold licenses in multiple categories, thereby allowing vertically integrated
cultivation, manufacturing and retail businesses. Washington is an exception—in most cases, a
business is prohibited from holding licenses across categories. Even states that allow vertical integration
typically prohibit the holder of a laboratory testing license from holding licenses in other categories.
State laws give significant power to counties and municipalities to impose zoning and permitting
requirements that may severely restrict or prohibit cannabis activities. California requires a state-license
applicant to demonstrate it has all permits, licenses and approvals required under local law, and many
California cities and counties have effectively banned the recreational cannabis industry. Massachusetts
allows towns that voted “No” on the state’s recreational law to ban cannabis businesses through
December 2019 and requires other towns that wish to prohibit cannabis businesses to do so through
a local ballot initiative.
Each state has chosen to levy significant taxes on the recreational cannabis industry, and some state laws
authorize local governments to levy additional cannabis-related taxes. Nevada imposes a 15% excise tax on
cannabis wholesales by cultivators and a 10% excise tax on retail sales. Oregon and Massachusetts charge
a state excise tax of 17% and 10.75%, respectively, and each state authorizes local governments to levy up
to another 3%. Washington originally imposed a 25% excise tax on cannabis sales at each of three different
points in the supply chain—grower to processor, processor to retailer and retailer to consumer—but now
charges a single 37% tax on retail sales. California imposes a 15% excise tax. All state and local cannabisspecific
excise taxes are in addition to normal state and local sales tax. Although the possibility of generating
significant tax revenue is one reason state governments have embraced legal cannabis, some
proponents of legalization argue that high tax rates will keep consumer prices high and discourage
consumer transition to legalized markets.
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State governments continue to adjust recreational cannabis regulations in an effort to create favorable
industry conditions and address health and public safety concerns. State-licensed recreational
cannabis businesses must comply with a host of requirements related to security (such as video surveillance,
alarm system requirements and owner/operator criminal background checks), product diversion
(particularly seed-to-sale tracking requirements), product safety and quality (including product
labeling requirements and potency and contaminant testing), and general business operations (such as
restrictions on advertising and compliance with energy and environmental standards).
n U.S. Federal Law
Current federal law effectively prohibits all cannabis use and all commercial cannabis activity in the
United States. Producing, selling and possessing cannabis are federal crimes. No cannabis-derived drug
has ever been federally approved for use in treating any medical condition. Otherwise legitimate business
transactions conducted by cannabis companies—and their banks, for those who can access banking
services—are legally suspect. Certain intellectual property and bankruptcy protections critical to
many U.S. businesses are not available to cannabis companies. Cannabis companies pay federal income
tax at effective rates significantly higher than other businesses.
Despite official prohibition, federal policies and laws recently passed by the U.S. Congress have
carved out a limited space in which the state-legal cannabis industry has managed to thrive. Enforcement
policies published by the U.S. Department of Justice (DOJ) have unofficially invited cannabis
business to proceed if certain conditions are respected. The U.S. Department of the Treasury (DOT)
established reporting policies that create room for banks to service the cannabis industry. Federal budget
legislation has prevented allocated funds from being used to prosecute conduct that complies with
state medical cannabis laws.
Recent developments indicate that the federal government may be pursuing policies and practices
that create space for cannabis research and approval of cannabis-derived drugs. In particular, the U.S.
Drug Enforcement Agency (DEA) adopted a new policy in 2016 designed to increase the number of
DEA-registered cannabis cultivators (there has been only one such cultivator for nearly 50 years). And
the U.S. Food and Drug Administration (FDA) is reviewing a New Drug Application (NDA) submitted
in October 2017 for what could be the first ever cannabis-derived pharmaceutical approved by the
federal government.
The following chart shows three general areas of federal law that impact the cannabis industry—food
and drug regulation, banking and finance, and intellectual property—as well as specific
laws and federal policies related to each of the areas discussed later in this chapter.
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Federal Laws and Policies Impacting the Cannabis Industry
Controlled
Substances
Act
Justice
Department
Cole Memo
Bank Secrecy Act
and Financial
Transaction
Laws
Rohrabacher-
Blumenauer
Amendment
Treasury
Department
FinCEN Memo
Agricultural
Act
of 2014
DRUG
AND FOOD
REGULATION
Federal Laws
and Policies
Impacting the
Cannabis
Industry
BANKING
AND
FINANCE
Securities
Law
Bankruptcy
Law
Food, Drug,
and
Cosmetic Act
INTELLECTUAL
PROPERTY
Internal
Revenue
Code
© 2017 Ackrell Capital, LLC
Patent
Act
Plant
Variety
Protection
Act
Trademark
Act
Controlled Substances Act
The Controlled Substances Act (CSA) is a federal law enacted in 1970 that places strict legal controls
on the manufacture, distribution, dispensing and possession of any controlled substance listed on one
of five schedules established by the CSA. The CSA is enforced primarily by the U.S. Drug Enforcement
Administration, an agency of the U.S. Department of Justice. A controlled substance may be manufactured,
distributed or dispensed in accordance with the CSA only by a person properly registered
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with the DEA. Any person that manufactures, distributes, dispenses or otherwise possesses a controlled
substance in violation of the CSA is subject to civil and criminal penalties.
The CSA schedules are numbered I to V. Schedule I substances are subject to the strictest controls,
and Schedule V substances are subject to the least restrictive controls. A controlled substance is listed
on a particular schedule according to four factors:
(i) The substance’s potential for abuse.
(ii) Whether the substance has a currently accepted medical use in treatment in the United
States.
(iii) Whether the substance is accepted as safe to use under medical supervision.
(iv) The degree of physical and psychological dependence that may result from abuse of the
substance.
Upon enactment in 1970, the CSA assigned each controlled substance to a specific schedule. The
U.S. Congress may legislate a controlled substance’s addition to or removal from a CSA schedule. The
CSA also provides a regulatory framework for a substance to be added to or removed from a schedule;
such change generally involves a recommendation by the U.S. Department of Health and Human
Services (DHHS) and concurrence with that recommendation by the DEA. The U.S. Food and Drug
Administration, an agency of the DHHS, is charged with making certain safety-related determinations
used in DHHS scheduling recommendations.
Schedule I controlled substances are those found by the U.S. Congress or the DEA and the DHHS
to have a high potential for abuse, to have no currently accepted medical use in treatment in the United
States and to have a lack of accepted safety for use under medical supervision. Current Schedule I substances
include marijuana, THC, heroin, ecstasy, LSD and peyote. Unlike Schedule II through Schedule
V controlled substances, which can be prescribed by a doctor, the CSA does not allow prescriptions
to be written for Schedule I controlled substances.
Marijuana
Marijuana has been a Schedule I controlled substance since enactment of the CSA in 1970. The CSA
defines “marijuana” as
all parts of the plant Cannabis sativa L., whether growing or not; the seeds thereof; the
resin extracted from any part of such plant; and every compound, manufacture, salt, derivative,
mixture, or preparation of such plant, its seeds or resin. Such term does not include
the mature stalks of such plant, fiber produced from such stalks, oil or cake made from
the seeds of such plant, any other compound, manufacture, salt, derivative, mixture, or
preparation of such mature stalks (except the resin extracted therefrom), fiber, oil, or cake,
or the sterilized seed of such plant which is incapable of germination.
The parts and derivatives of the cannabis plant that are excluded from the CSA definition of
marijuana have industrial uses and generally contain little or no THC. Non-marijuana cannabis
products—commonly known as hemp products—including rope, clothing, animal feed and soap,
are not subject to control under the CSA. The CSA does not restrict such non-marijuana products
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from being imported into the United States. However, because the production of such non-marijuana
products ordinarily involves possession of the entire cannabis plant, including parts deemed marijuana
under the CSA, the CSA effectively prohibits such production in the United States without DEA
registration.
Tetrahydrocannabinol (THC)
In addition to and separate from marijuana’s listing on Schedule I, tetrahydrocannabinol 1 (THC) has
been listed on Schedule I since the CSA’s enactment in 1970. From 1970 until 2003, DEA regulations
defined THC for purposes of its separate Schedule I listing as including only “synthetic equivalents”
of the THC found in the cannabis plant. In 2003, the DEA purportedly amended this regulatory
definition of THC to include both synthetic equivalents of THC and THC occurring naturally in the
cannabis plant. In its 2004 holding in Hemp Industries Association v. DEA, the U.S. Court of Appeals
for the Ninth Circuit enjoined DEA enforcement of this purported amendment and held that the
THC listed separately from marijuana on Schedule I includes only synthetic THC and that any THC
occurring naturally within the cannabis plant is controlled under the CSA only if it falls within the
CSA definition of marijuana.
Penalties for CSA Violations
Federal penalties for violating CSA provisions regarding marijuana or THC include fines and imprisonment.
CSA violations may also result in federal seizure of cash and other assets related to the violations.
CSA penalties may apply to cannabis businesses that violate the CSA and also to individuals who own
or operate such businesses based on attempt, accomplice, conspiracy and criminal enterprise provisions
included in the CSA.
New DEA Registration Policy
For nearly 50 years, only one cannabis cultivation site in the United States has operated with the
required DEA registration. The site is operated by the University of Mississippi under a contract with
the National Institute on Drug Abuse to supply the country’s entire stock of federally legal cannabis,
which is used exclusively for research. In August 2016, the DEA announced a new policy designed
to increase the number of DEA-registered cannabis cultivators and permit-registered cultivators to
grow cannabis for privately funded commercial drug development projects. The DEA announcement
acknowledged the increasing interest in conducting cannabis research related to commercial pursuits,
and indicated that the best way to satisfy the increased demand was to increase the number of
DEA-registered cultivators. The DEA has since accepted at least 25 applications for registration but has
not issued any new registrations.
1
CSA Schedule I uses the plural form “tetrahydrocannabinols” to describe a category of substances that includes chemical derivatives
and isomers. This report adopts the more commonly used singular form, “tetrahydrocannabinol.”
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U.S. Department of Justice: The Cole Memo
A memorandum published by the DOJ in August 2013 (Cole Memo) provides guidance to DOJ attorneys
and federal law enforcement about prosecuting cannabis-related federal offenses. The Cole Memo
asserts that marijuana is a dangerous drug, that illegal distribution of marijuana is a serious crime which
provides revenue to criminal enterprises and that the DOJ is committed to enforcing marijuana-related
violations of federal law. The Cole Memo also notes, however, that the DOJ is committed to using
its limited investigative and prosecutorial resources to address the most significant threats in the most
effective, consistent and rational way.
The Cole Memo guides DOJ attorneys and federal law enforcement to focus on the following
eight enforcement priorities when considering prosecutions for marijuana-related CSA violations (and
also, according to a Cole Memo update issued in February 2014, when considering prosecutions for
marijuana-related violations of the federal money laundering statute, the unlicensed money transmitter
statute and the Bank Secrecy Act):
1. Preventing distribution of marijuana to minors.
2. Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs and
cartels.
3. Preventing the diversion of marijuana from states where it is legal under state law in some
form to other states.
4. Preventing state-authorized marijuana activity from being used as a cover or pretext for the
trafficking of other illegal drugs or other illegal activity.
5. Preventing violence and the use of firearms in the cultivation and distribution of marijuana.
6. Preventing drugged driving and the exacerbation of other adverse public health consequences
associated with marijuana use.
7. Preventing the growing of marijuana on public lands and the attendant public safety and
environmental dangers posed by marijuana production on public lands.
8. Preventing marijuana possession or use on federal property.
The Cole Memo notes that whether marijuana-related conduct implicates any of these enforcement
priorities should be a primary question in considering prosecution and that in states with legalized
marijuana and effective regulatory systems, conduct in compliance with state law is less likely to
threaten these priorities.
The Cole Memo has provided some comfort to those operating state-legal cannabis businesses that
do not interfere with the enumerated enforcement priorities. However, the Cole Memo merely reflects
internal guidance within the DOJ and does not create a legal defense for any violation of federal law.
During the January 2017 Senate confirmation hearings for current U.S. Attorney General Jeff
Sessions, in a discussion about the enforcement priorities outlined in the Cole Memo, Mr. Sessions
acknowledged the “problem of resources for the federal government” and stated that he thought some
of the enforcement priorities were “truly valuable in evaluating cases,” but he also stated that he would
not commit to never enforcing federal law.
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Rohrabacher-Farr Amendment
The Rohrabacher-Farr amendment, first passed by the U.S. Congress and signed into law by President
Obama in 2014, prohibits the DOJ from using federal funds to prevent a state from “implementing”
state laws that authorize the use, distribution, possession or cultivation of medical marijuana.
Following the amendment’s initial 2014 enactment, the DOJ indicated that it did not plan to arrest
state regulators for “implementing” a state’s medical marijuana laws but would continue to prosecute
individuals involved in state-law compliant medical marijuana activity because, in the DOJ’s view, the
amendment did not apply to prosecutions against individuals.
The DOJ’s interpretation of the Rohrabacher-Farr amendment was rejected by a Ninth Circuit
District Court in its 2015 ruling in United States v. Marin Alliance for Medical Marijuana, and again by
the Ninth Circuit Court of Appeals in its 2016 ruling in United States v. McIntosh. The Ninth Circuit
Court of Appeals held the Rohrabacher-Farr amendment prohibits DOJ from spending funds subject
to the amendment on the prosecution of individuals who fully comply with state medical marijuana
laws. The court noted a state’s “implementation” of medical marijuana laws necessarily involves “giving
practical effect” to those laws, and that DOJ prosecution of individuals complying with those laws
prevents the state from giving the laws practical effect.
The Rohrabacher-Farr amendment generally applies only to DOJ funds made available pursuant
to the federal budget legislation in which the amendment is included, and therefore must be
renewed periodically with budget legislation to remain effective. The Rohrabacher-Farr amendment
was recently renewed in December 2017 as part of an emergency aid package that remains effective
until mid-January 2018. (With the retirement of Representative Samuel Farr from the U.S. Congress
in 2016, the Rohrabacher-Farr amendment is now also referred to as the Rohrabacher-Blumenauer
amendment; we use this name elsewhere in this report.)
Agricultural Act of 2014
The Agricultural Act of 2014 (Farm Bill) authorizes institutions of higher education and state departments
of agriculture to cultivate industrial hemp, CSA controls notwithstanding, if (i) the industrial
hemp is cultivated for purposes of research conducted under an agricultural pilot program or other
agricultural or academic research and (ii) the cultivation is allowed under the laws of the state in which
such institution of higher education or state department of agriculture is located and such research
occurs.
The Farm Bill defines “industrial hemp” as the cannabis plant and any part of such plant, whether
growing or not, with a THC concentration of not more than 0.3 percent on a dry weight basis.
Industrial hemp, like any cannabis plant, may comprise both marijuana (as defined in the CSA) and
non-marijuana. But the Farm Bill creates an exception to CSA controls on marijuana, so cultivation in
accordance with the Farm Bill of marijuana that qualifies as industrial hemp does not violate the CSA.
The following table summarizes the legal relationship between marijuana (as defined in the CSA)
and industrial hemp (as defined in the Farm Bill).
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U.S. Legal Relationship between Marijuana and Industrial Hemp
Non-Industrial Hemp
Cannabis plant and all parts and
derivatives except industrial hemp
Marijuana
Cannabis plant and all parts and
derivatives except non-marijuana
• Manufacture, distribution, dispensing
and possession controlled under CSA
• No Farm Bill exception to CSA
Non-Marijuana
Mature stalks; fiber made from mature stalks;
oil or cake made from seeds; compounds,
manufactures, salts, mixtures, preparations
or derivatives of the foregoing parts and
derivatives (except resin extracted from mature
stalks); sterilized seeds
• No CSA controls
• Farm Bill exception to CSA moot
Industrial Hemp
Cannabis plant and any part with THC
concentration not more than 0.3% on
a dry weight basis
• Manufacture, distribution, dispensing
and possession controlled under CSA
(but subject to Farm Bill exception)
• Farm Bill exception to CSA controls:
state-legal cultivation by an institution of
higher education or a state department
of agriculture for research
• No CSA controls
• Farm Bill exception to CSA moot
Industrial hemp can be used to produce CBD oil, an extract of the cannabis plant with a high
concentration of cannabidiol (CBD) but little or no psychoactive THC. CBD oil is believed to have a
range of medicinal benefits and therapeutic applications. Some have argued that the Farm Bill federally
legalizes the production and sale of CBD oil. However, it is unclear whether CBD oil produced from
industrial hemp is itself considered industrial hemp (the CSA defines marijuana by reference to the
cannabis plant, parts of the plant and derivatives of the plant, whereas the Farm Bill exception to the
CSA defines industrial hemp by reference only to the plant and parts of the plant, but does not mention
derivatives). Even if CBD oil is considered industrial hemp and may be lawfully produced under
the Farm Bill, only institutions of higher education and state departments of agriculture are authorized
to produce it, and then only for purposes of agricultural or academic research; thus the Farm Bill likely
does not create a CSA exception broad enough for large-scale commercial production and distribution
of CBD oil within the United States.
Federal Food, Drug, and Cosmetic Act
The Federal Food, Drug, and Cosmetic Act (FD&C Act) is a federal law enacted in 1938 (and since
amended multiple times) that authorizes the FDA to regulate the safety and effectiveness of drugs and
medical devices and the safety of food, tobacco products and cosmetics. The FD&C Act prohibits the
“adulteration or misbranding” of any drug, medical device, food, tobacco product or cosmetic (which
the act generally refers to as “articles”) in interstate commerce and prohibits interstate commerce in any
such adulterated or misbranded article. The FD&C Act also prohibits the “introduction or delivery for
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introduction into interstate commerce” of any drug, medical device, food, tobacco product or cosmetic
undertaken without the required FDA approval, permit or registration.
An article that includes cannabis or a cannabis derivative could conceivably qualify as a drug, medical
device, food, tobacco product or cosmetic (or a combination). For example, a skin lubricant infused
with cannabis extract and intended to relieve muscle pain may be both a cosmetic and a drug, and a
prefilled device used to administer a metered dose of vaporized THC for treating nausea may be both
a medical device and a drug. Industry dialogue regarding the FD&C Act and the FDA tends to focus
on cannabinoid-based drugs and the potential for certain cannabis products to be regulated as food or
a related category of products known as “dietary supplements,” and we expand on both topics in the
following discussion.
Drugs
Generally, the FD&C Act defines a “drug” as any one of the following:
(i) Any article recognized in the official U.S. Pharmacopoeia, U.S. Homeopathic Pharmacopoeia
or National Formulary.
(ii) Any article intended for use in the diagnosis, cure, mitigation, treatment or prevention of
disease in humans or animals.
(iii) Any article (other than food) intended to affect the structure or any function of the body
of humans or animals.
(iv) Any article intended as a component of any of the foregoing.
The FDA oversees the manufacturing of drugs by inspecting domestic and foreign manufacturing
plants, by sampling drugs from retail stores, distribution warehouses and manufacturing plants and by
evaluating complaints and reports of defects from consumers and health care professionals. The FD&C
Act generally prohibits a company from introducing a drug into interstate commerce without the FDA
having first approved the drug as safe and effective for treating a specified medical condition.
FDA approval of a drug as safe and effective for treating a specified medical condition generally
involves the following steps:
(i) The drug’s manufacturer performs laboratory and animal tests to determine how the drug
works and whether it is safe enough to test on humans.
(ii) If the manufacturer determines the drug is safe enough to test on humans, then the manufacturer
submits for FDA review an Investigational New Drug (IND) application.
(iii) Upon review of the IND application, if the FDA determines the drug is safe enough to test
on humans, then the FDA approves the manufacturer to proceed with human clinical trials.
(iv) The manufacturer performs a series of human clinical trials and submits the resulting data
for FDA review in the form of a New Drug Application (NDA). Upon review of the NDA,
if the FDA determines the drug’s benefits outweigh its known risks and the drug can be
manufactured in a way that ensures a quality product, then the drug is approved as safe and
effective for treating the specified medical condition.
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A drug generally may not be marketed for treating a condition other than a condition for which the
FDA has found the drug to be a safe and effective treatment; however, most FDA-approved drugs can
be prescribed by doctors to treat other conditions (so-called “off-label” prescriptions).
Nonprescription or over-the-counter drugs can be marketed after receiving FDA approval through
the NDA process or by conforming the drug to an existing over-the-counter “monograph” (a “recipe
book” indicating acceptable ingredients, doses, formulations and labeling) established by the FDA.
Cannabinoid-Based Drugs
Several drugs containing synthetic cannabinoids or cannabinoid-like compounds have been approved
by the FDA. Marinol, a drug comprised of dronabinol (a synthetic THC) encapsulated with sesame oil
in a soft gelatin capsule, was approved by the FDA in 1985 for treatment of nausea and vomiting associated
with cancer chemotherapy in patients who have failed to respond adequately to conventional
antiemetic treatments. It was later approved, in 1992, for treatment of anorexia associated with weight
loss in patients with AIDS. Syndros, a drug comprised of dronabinol in a liquid solution, was approved
by the FDA in 2016 for treatment of the same symptoms for which Marinol was approved. Cesamet,
a drug comprised of encapsulated nabilone (a synthetic cannabinoid similar to THC), was approved
by the FDA in 1985 for treatment of nausea and vomiting associated with cancer chemo therapy in
patients who have failed to respond adequately to conventional antiemetic treatments.
Each of the drugs Marinol, Syndros and Cesamet was placed on CSA Schedule II within one to
two years after its initial FDA approval (Marinol and Syndros were rescheduled from Schedule I upon
recommendation of the DHHS, and Cesamet’s placement on Schedule II was its initial CSA classification).
Schedule II through Schedule V substances can be prescribed by a doctor, but the CSA does not
permit prescriptions for Schedule I substances, so removal of an FDA-approved drug from Schedule I
is required before the drug can be prescribed legally.
The FDA has not approved any drug derived from the cannabis plant. However, two such drugs,
Sativex and Epidiolex (both manufactured by U.K.-based GW Pharmaceuticals), have advanced
through certain stages of the FDA approval process. Sativex is a mouth spray used for treatment of
spasticity caused by multiple sclerosis; it includes THC and CBD derived from cannabis. Epidiolex
is an oral formulation of cannabis-derived CBD intended to treat severe forms of childhood epilepsy.
Human clinical trials have been conducted with both drugs, and although an NDA has not been submitted
for Sativex, an NDA for Epidiolex was submitted to the FDA in October 2017. If approved by
the FDA, Epidiolex would be the first FDA-approved pharmaceutical derived from cannabis.
Foods and Dietary Supplements
Generally, the FD&C Act defines “food” as (i) any article used for food or drink for humans or animals,
(ii) chewing gum, and (iii) any article used as a component of any of the foregoing. The FD&C Act
defines a “dietary supplement” generally as either (i) a product intended to supplement the diet that
contains certain dietary ingredients (including vitamins, minerals, herbs, botanicals, amino acids, or
other substances used by humans to supplement the diet by increasing the total dietary intake) or (ii) a
product intended for ingestion in tablet, capsule, powder, softgel, gelcap, or liquid form and labeled as
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a dietary supplement but not represented for use as a conventional food or as a sole item of a meal or
the diet. A dietary supplement generally is deemed to be a food under the FD&C Act.
The FD&C Act does not require foods or food labels to be pre-approved by the FDA, but it does
give the FDA broad authority to regulate the safety of food and food labels and to prevent interstate
commerce in adulterated or misbranded food. Facilities engaged in manufacturing, processing, packing
or holding food for consumption in the United States are required to be registered with the FDA.
The FD&C Act requires most foods to bear nutrition labeling and requires food labels that bear
nutrient content claims and certain health messages to comply with specific requirements. The FDA is
authorized to enforce safety and labeling regulations by conducting inspections, sampling, recalls and
seizures, and by pursuing injunctions and criminal prosecutions.
Cannabis-Based Foods and Dietary Supplements
The FDA has published guidance (most recently updated in August 2017) concluding that (i) the
FD&C Act does not permit foods to which THC or CBD have been added to be sold in interstate
commerce and (ii) any product containing THC or CBD is not a dietary supplement. For this conclusion
to be legally correct, based on the FD&C Act provisions cited by the FDA, it would need to be
demonstrated that neither THC nor CBD were marketed in or as a food or as a dietary supplement
before the occurrence of certain approvals and clinical investigations of drugs that include THC (e.g.,
Marinol) or CBD (e.g., Sativex or Epidiolex). The FDA publication does not demonstrate that neither
THC nor CBD were marketed in or as a food or as a dietary supplement before such occurrences and
merely states that the FDA is “not aware of any evidence that would call into question” its conclusion.
The FDA’s conclusion has not been subject to any legal challenge, and it remains unresolved whether
certain cannabis-based products, particularly hemp-derived CBD products, might be regulated by the
FDA as foods or dietary supplements rather than as drugs.
FDA Policy and Enforcement
In December 2016, the FDA published a document titled Botanical Drug Development; Guidance for
Industry that discusses several areas in which, due to the unique nature of botanical drugs, the FDA
believes it is appropriate to apply regulatory policies that differ from those applied to nonbotanical
drugs. The guidance discusses challenges inherent to botanical drugs, including challenges related to
ensuring therapeutic consistency, and suggests certain steps to address those challenges. The guidance
was published only months after the DEA announced a new policy designed to increase the number
of DEA-registered cannabis cultivators and permit-registered cultivators to grow cannabis for privately
funded commercial drug development projects. These parallel developments indicate to some that the
federal government is opening a pathway to federal approval of cannabis-derived drugs.
The FDA has the legal authority under the FD&C Act and related regulations to significantly disrupt
the state-legal cannabis industry in the United States. The FDA has issued warning letters during
the past several years to distributors of hemp-based CBD products but has not broadly enforced federal
law against the cannabis industry. A cannabis-focused publication on the FDA website states that
in deciding whether to initiate federal enforcement, the FDA may consult with its federal and state
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partners and consider many factors, including FDA resources and threats to public health. Beyond
this statement, the FDA has not published detailed guidance about its cannabis-related enforcement
priorities.
Bank Secrecy Act and Other Federal Laws
Regarding Financial Transactions
Financial transactions in connection with cannabis-related CSA violations may implicate federal laws
other than the CSA itself, including the federal money laundering statute, the federal unlicensed money
transmitter statute and the Bank Secrecy Act (BSA).
The federal money laundering statute imposes penalties on any person who conducts or attempts
certain financial or monetary transactions involving the proceeds of a “continuing criminal enterprise”
(a term, used in the CSA, that arguably encompasses many cannabis businesses). Violations of the
federal money laundering statute may result in fines equal to twice the value of the property involved
in the transaction (or $500,000, if greater) and imprisonment for up to 20 years.
The federal unlicensed money transmitter statute makes it illegal for any person to operate or own
a money transmitter business that involves the transportation or transmission of funds known to have
been derived from or intended to promote or support criminal violations of the CSA. Violations of the
law may result in fines and imprisonment for up to 5 years.
The BSA requires banks and other financial institutions to maintain certain records and to file
certain reports deemed useful in criminal, tax or regulatory proceedings or in government intelligence
and counterterrorism activities. Federal regulations under the BSA require financial institutions to
file with the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of
the Treasury charged with administering the BSA, a suspicious activity report (SAR) if the financial
institution knows, suspects or has reason to suspect that a transaction conducted or attempted by, at or
through the financial institution involves or is an attempt to disguise funds derived from illegal activity,
is designed to evade BSA regulations or lacks an apparent lawful purpose. Financial institutions and
their principals are subject to civil and criminal penalties for violations of the BSA.
U.S. Treasury Department: The FinCEN Memo
In coordination with the February 2014 Cole Memo update, FinCEN published a memorandum
(FinCEN Memo) outlining how banks and other financial institutions can, consistent with their BSA
obligations, provide services to marijuana-related businesses. The FinCEN Memo directs each financial
institution to consider its own business objectives and the risks associated with offering a particular
product or service when considering whether to commence or continue a customer relationship with
a marijuana-related business. The memorandum emphasizes the importance of due diligence and outlines
a procedure for filing SARs for such businesses.
The FinCEN Memo guides financial institutions to conduct a due diligence review of a customer’s
business that includes an evaluation of whether the customer relationship implicates (or would implicate)
any Cole Memo priority and also includes the following investigations:
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1. Verifying with the appropriate state authorities whether the business is duly licensed and
registered.
2. Reviewing the license application (and related documentation) submitted by the business for
obtaining a state license to operate its marijuana-related business.
3. Requesting from state licensing and enforcement authorities available information about the
business and related parties.
4. Developing an understanding of the normal and expected activity for the business, including
the types of products to be sold and the type of customers to be served (for example, medical
versus recreational customers).
5. Ongoing monitoring of publicly available sources for adverse information about the business
and related parties.
6. Ongoing monitoring for suspicious activity, including for certain red flags described in the
FinCEN Memo.
7. Refreshing information obtained as part of customer due diligence on a periodic basis and
commensurate with the risk.
The FinCEN Memo also guides financial institutions to file various SARs with FinCEN regarding
customers engaged in marijuana-related businesses. According to the memorandum, an institution
should file (i) a “Marijuana Limited” SAR for each customer it believes does not violate state law or
implicate any Cole Memo priority, (ii) a “Marijuana Priority” SAR for each customer it believes violates
state law or implicates any Cole Memo priority, and (iii) a “Marijuana Termination” SAR if the
institution decides to terminate a customer relationship in order to maintain an effective anti–money
laundering compliance program. The FinCEN Memo outlines certain “red flags” that tend to indicate
which type of SAR filing is appropriate; red flags include the inability of a customer to demonstrate
compliance with state law or deposits of amounts of cash inconsistent with its tax returns.
FinCEN periodically publishes information about marijuana-related SAR filings made by depository
institutions. From the February 2014 FinCEN Memo publication through June 30, 2017,
FinCEN received a total of 33,692 marijuana-related SAR filings from a total of 390 banks and credit
unions. The following graphs based on FinCEN data show the number of monthly Marijuana Limited,
Marijuana Priority and Marijuana Termination SAR filings for this period and the number of banks
and credit unions making such filings.
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Monthly Marijuana-Related SAR Filings
1600
1400
1200
1000
800
600
400
200
0
Q2 2014 Q4 2014 Q2 2015 Q4 2015 Q2 2016 Q4 2016 Q2 2017
Limited Priority Termination
Depository Institutions Making Marijuana-Related SAR Filings
350
300
250
200
150
100
50
0
Q2 2014 Q4 2014 Q2 2015 Q4 2015 Q2 2016 Q4 2016 Q2 2017
Banks
Credit Unions
Source: Financial Crimes Enforcement Network
The upward trend in the frequency of marijuana-related SAR filings, as well as the growing number
of depository institutions making such filings, indicate cannabis businesses increasingly are accessing
the federal banking system despite federal law.
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The California State Treasurer’s Cannabis Banking Working Group—a panel convened by California
State Treasurer John Chiang that includes representatives from the cannabis industry and financial
institutions, and government tax collection, law enforcement and regulatory agencies—issued a report
in November 2017 on the cannabis industry’s banking challenges. In the report, the State Treasurer’s
Office stated that the cannabis industry’s lack of access to banking services is one of the biggest threats
to the success of the state’s recreational cannabis law, which is scheduled for implementation starting
in January 2018. Based on the working group’s findings, the State Treasurer’s Office recommended the
following four actions:
1. Implementation of safer, more effective, and scalable ways to handle the payment of taxes and
fees in cash that minimize risks to stakeholders.
2. Development by the State of California and local governments of a data portal of compliance
and regulatory data to be made available to financial institutions that bank cannabis businesses.
3. Conduct a feasibility study of a public bank or other state-backed financial institution that
provides banking services to the cannabis industry.
4. Establish a multistate consortium of state government representatives and other stakeholders
to pursue changes to federal law in order to remove the barriers to cannabis banking.
The State Treasurer’s Office also stated it was apparent that a definitive solution to the cannabis
banking quandary will remain elusive until the federal government removes cannabis from its official
list of dangerous drugs or the U.S. Congress approves safe harbor legislation protecting financial institutions
that serve cannabis businesses from federal penalties.
Federal Securities Law
The U.S. securities markets and industry participants are regulated principally under two federal laws:
the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act).
The Securities Act regulates the offer and sale of securities by issuers, and the Exchange Act regulates
securities firms, stock exchanges, reporting by publicly traded companies and investing and trading
practices of investors. The Exchange Act also establishes the Securities and Exchange Commission
(SEC), a federal agency charged with enforcing federal securities laws.
Federal securities laws are intended to facilitate capital formation, maintain fair and efficient markets,
and protect investors. The laws are based on a philosophy of disclosure: issuers of securities
generally are obligated to completely and truthfully disclose material information to investors and
the market, and failure to satisfy that obligation may result in civil or criminal penalties. Information
generally required to be disclosed includes audited financial statements, discussions of risks applicable
to the issuer and investors in its securities, and details of conflicts of interest faced by the issuer’s officers
and directors.
Federal securities laws related to private offerings provide fewer investor protections than laws
related to public offerings and generally assume investors in private offerings can “fend for themselves.”
An issuer of securities in a private offering is not subject to the same extensive reporting requirements
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as publicly traded companies, but ordinarily will market its securities using a private placement memorandum
(PPM) that includes information similar to some of the information required to be disclosed
by publicly traded companies. An issuer in a private placement is subject to liability under federal securities
laws for misrepresentation or fraudulent statements made in a PPM or otherwise in connection
with the private offering.
By all indications, federal securities laws do not prohibit companies engaged in federally illegal
cannabis activities from raising capital through the issuance of securities, nor do they prohibit industry
participants like stock exchanges and investment banks from performing their ordinary market functions
in connection with such companies. The SEC has allowed the registration and sale of securities
offered by companies engaged in federally illegal cannabis activities and the trading of those securities
on multiple U.S. stock markets. Although the SEC has on occasion suspended trading in some of
these securities, those suspensions generally have been due to alleged violations of securities regulations
rather than unlawful cannabis activities.
A cannabis company offering or selling securities must comply with federal securities laws—like
any other issuer—by making required notice or registration filings and by providing truthful material
information to investors. Any discussion of risks delivered to investors, whether required by securities
laws or volunteered by the issuer as part of a private offering, should include a thorough discussion of
the unique risks posed by operating a cannabis business engaged in federally illegal conduct. For an
example of some of these risks, refer to Chapter IX, Cannabis Industry Risk Factors.
Federal Bankruptcy Law
Bankruptcy is a legal proceeding by which a debtor resolves its debt obligations and creditors are
afforded certain rights in the debtor’s assets in full or partial satisfaction of the debts owed to them. In
the United States, bankruptcy is governed primarily by the Bankruptcy Reform Act of 1978 (Bankruptcy
Code). Bankruptcy proceedings are conducted primarily by federal bankruptcy courts and generally
involve administration of a debtor’s assets either by a court-appointed trustee or by the debtor
with approval and oversight of the court. Bankruptcy can be voluntary (initiated by the debtor) or
involuntary (initiated by creditors). Bankruptcy provides certain rights and protections to the debtor
and the creditors and is intended to fairly and finally resolve debts so the parties can pursue other
affairs.
Debtors whose assets relate to federally illegal cannabis activity, as well as their creditors, generally
are not eligible for bankruptcy protection for two reasons: First, federal courts refuse to appoint
trustees to administer or take control of unlawful assets or business operations. Second, pursuant to
an equitable doctrine known as “unclean hands,” federal courts typically decline to honor creditor
claims that arise from knowingly transacting with a debtor in furtherance of unlawful activity. A federal
bankruptcy court in Arizona invoked both these reasons in its 2015 decision in In Re Medpoint Management,
LLC; details of this case follow.
Medpoint Management, LLC (Medpoint) managed the cultivation and business operations of a
state-legal Arizona medical cannabis dispensary. Medpoint defaulted under various loan and consulting
agreements directly related to its dispensary activities, and the four creditors under those agreements
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filed a petition for involuntary bankruptcy. The bankruptcy court dismissed the petition, stating it
would not assign a trustee “to administer drug tainted assets for the benefit of creditors who assumed
the risk of doing business with an enterprise engaged in violations of federal law.” Federal courts in
California, Oregon, Colorado and Michigan have applied the same rationale to dismiss bankruptcy
proceedings involving illegal cannabis-related assets.
State law alternatives to federal bankruptcy that may be available to cannabis businesses and their
creditors include an assignment for the benefit of creditors (ABC) and receivership. An ABC is a statelaw
process for the orderly and controlled liquidation of a debtor’s assets through a neutral, third party
administrator. Receivership is a remedy whereby a court appoints a receiver to take possession of and
protect property for the benefit of all concerned parties. In the state of Washington, for example, at
least one medical cannabis business is reported to have successfully concluded a receivership process.
Internal Revenue Code
The Internal Revenue Code (IRC) defines gross income to include “all income from whatever source
derived”; this definition has been interpreted by the Internal Revenue Service (IRS) and the U.S.
Supreme Court to include income derived from unlawful activities. Consequently, cannabis businesses
that violate the CSA and other federal laws related to cannabis nonetheless must file federal income tax
returns and pay federal income tax.
A business generally computes its taxable income in two steps. First, the business computes its gross
income by subtracting from its gross receipts the cost of goods sold (COGS), which includes the cost of
acquiring, constructing or extracting a physical product that is to be sold. The subtraction of COGS to
compute gross income is premised on constitutional grounds and cannot be changed by federal statutes
or IRS regulations. Second, the IRC “allows” a business to deduct from gross income all ordinary and
necessary business expenses, which generally include all business expenses other than COGS, such as
employee salaries, payments to contractors, marketing costs, insurance premiums, and the cost of rent
and utilities. But there are exceptions to this “allowed” deduction. One such exception is provided by
IRC section 280E (Section 280E).
Section 280E disallows any deduction or credit for any amount paid or incurred in carrying on
a “trade or business” that consists of unlawful “trafficking” in a Schedule I or Schedule II controlled
substance. Although Section 280E does not prevent a cannabis business from subtracting COGS to
compute gross income, it may prevent the deduction of all other business expenses for purposes of
computing taxable income. As a result of Section 280E, businesses in the cannabis industry may have
effective tax rates significantly higher than other businesses subject to federal income tax.
The scope of Section 280E, as it applies to U.S. cannabis businesses, is the subject of recent and
ongoing federal court cases. The U.S. Tax Court has adopted the view (a view endorsed by the U.S.
Supreme Court) that a “trade or business” is any activity entered into with the dominant hope and
intent of realizing a profit, and it has indicated in multiple rulings that dispensing or buying and selling
marijuana involves unlawful “trafficking” in a Schedule I controlled substance.
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A trade or business that consists of unlawful cannabis trafficking may comprise a separate division
of a single taxpayer, as was found by the U.S. Tax Court in its 2007 decision in Californians Helping
to Alleviate Medical Problems, Inc. v. Commissioner, in which case Section 280E does not prevent the
taxpayer from deducting business expenses attributable to other lawful trades or businesses it conducts.
Or, all of a taxpayer’s activities may constitute a single trade or business subject to 280E even though