United States: Investments In The Marijuana Industry Hold Potential For Significant Growth, Despite Some Uncertainty

Investors in marijuana-related companies witnessed several key developments in 2015 as the industry worked around initial obstacles, states refined regulatory frameworks, American public support of legalization increased, and banks and other service providers increasingly did business with marijuana companies. However, marijuana remains illegal at the federal level, and many investors will remain hesitant about making investments with growers in the U.S. until the federal government clarifies its position. In the meantime, many investors remain focused on businesses that provide products and services to growers or businesses in the Canadian market. That being said, with the market expanding as quickly as it is, even ancillary businesses have potential for significant growth, and investors and the media continue to closely monitor regulatory and other industry developments.

Developments at the Federal Level

Marijuana remains illegal under federal law, and while Congress and the executive branch have not legalized marijuana or rescheduled it from Schedule 1, they have taken steps to divert resources away from prosecution. In the Cole Memorandum of 2013, the Department of Justice ("DOJ") instructed federal prosecutors not to prosecute marijuana cases in states whose regulatory schemes meet specified regulation priorities. During 2014, when some federal prosecutors continued to pursue actions against vendors of medical marijuana in states that had legalized such sales, Congress included the Rohrabacher-Farr medical marijuana amendment in the end-of-year omnibus budget bill that stopped federal funds from being used to prevent states with medical marijuana programs from "implementing their own State laws that authorize the use, distribution, possession, or cultivation of medical marijuana."

In April 2015, a DOJ representative announced that the department interpreted the amendment to mean only that it was restricted from prosecuting states and that it did not forbid prosecution of individuals and medical marijuana companies. Representatives Rohrabacher and Farr disagreed, and the federal District Court in the Northern District of California in October held that the DOJ may not prosecute marijuana companies operating in compliance with state medical marijuana laws. The Cole Memorandum and Rohrabacher-Farr medical marijuana amendment are widely viewed as important steps toward legitimizing the industry, but do not resolve the ongoing conflict between state regulation and federal prohibition of marijuana. There were hopes that the budget bill for 2016 would take further steps to scale back federal prohibition. While it eliminated certain prohibitions on the hemp industry and re-enacted the Rohrabacher-Farr medical marijuana amendment, which had been set to expire, the bill failed to satisfy other hopes. For example, it did not end the ban on veterans affairs physicians discussing medical marijuana with veterans, nor expand the Rohrabacher- Farr medical marijuana amendment in a similar way to protect sales of recreational marijuana in states with established regulatory regimes, nor clarify banking access by state-regulated marijuana companies.

Developments at the State and International Levels

Notwithstanding the obstacles, marijuana legalization continues to spread, though the lack of uniformity among the state regimes is clear. For example, in Colorado, an entity that grows marijuana can, but is not required to, sell it via retail; in Washington state, one cannot do both; in New York state, retailers of medical marijuana must grow their own product (which may not be smoked); and in Washington, D.C., it is forbidden to sell marijuana directly.

California: With record-high support for legalization in California, the state is mobilizing for a legalization vote on recreational marijuana in 2016. In 2015, efforts focused on increasing regulation of the state's legal medical marijuana program, which dates back to the 1990s. Historically, California has not successfully limited access to those holding marijuana licenses, but in October, the state passed the Medical Marijuana Regulation and Safety Act. "This new structure will make sure patients have access to medical marijuana, while ensuring a robust tracking system," Gov. Jerry Brown stated. "This sends a clear and certain signal to our federal counterparts that California is implementing robust controls."

The new regulations are noteworthy from an investor's perspective because, among other reasons, for-profit companies may now obtain licenses to grow and sell medical marijuana, and cities and counties may now ban medical marijuana within their borders. The latter regulation originally had a March 1, 2016, deadline for localities to ban medical marijuana, causing a stir of activity throughout the state, this deadline has since been removed. As these new regulations take effect, California is also approaching a November 2016 vote for the legalization of recreational marijuana, and support is gathering around the initiative, named the Adult Use of Marijuana Act.

Ohio: In November, Ohio could have become the fifth state to legalize marijuana for recreational purposes, but voters rejected the Issue 3 referendum by a wide 64% to 36% margin. With estimates of potential sales reaching $1.1 billion, it might have been the biggest legal market yet in the U.S. The referendum faltered in part because of a controversial feature that would have created a monopoly for 10 marijuana providers. The organization ResponsibleOhio, which spent millions of dollars to support Issue 3 behind contributions from the 10 listed providers, introduced a campaign mascot named Buddie, raising concerns among voters that the industry would target children. Aiming to stop Issue 3 even if Ohioans had voted for it, dozens of state legislators supported Issue 2, which, by imposing additional burdens on any referendum that would create a monopoly, would likely have conflicted with Issue 3 had both passed. Ohio voters passed Issue 2, 52% to 48%. The stage is now set for another legalization attempt in 2016, with signatures being collected for the next ballot initiative.

Canada and Mexico: The northern and southern neighbors of the U.S. also made headlines in 2015 relating to recreational marijuana. Canada has had medical marijuana regulations since 2003, prompted by the Supreme Court of Ontario ruling that patients with certain medical conditions had the constitutional right to medical marijuana. Important for investors and the industry, Canada's regulations have been enforced in a relatively clear manner. In October, with the election of Prime Minister Justin Trudeau, who has repeatedly called for the end of prohibition, Canada increasingly appears to be on the path to full legalization of recreational marijuana.

Meanwhile, on Nov. 4, the Mexican Supreme Court ruled that growing, possessing and smoking marijuana recreationally is legal under a theory of individual autonomy. This does not mean that marijuana is now widely available in Mexico. The ruling was limited to the named plaintiffs, and Mexico has not legalized medical marijuana, so it has no regulations yet in place. But the court decision offers one potential path for expanded access as discussions increase worldwide.

Banking Developments

Following guidance by the Treasury Department's Financial Crimes Enforcement Network ("FinCEN") that banks could offer services to marijuana companies whose activities were considered low priority, marijuana companies have had slightly improved access to banking services, although as a general matter continue to have difficulties maintaining accounts. In the absence of more definitive federal action, some states have drafted legislation to enable marijuana credit unions. Such legislation, however, has so far failed to overcome federal restrictions on providing either FDIC insurance or a Federal Reserve master account to financial institutions servicing the marijuana industry, without which marijuana companies are unable to access check clearing, electronic fund transfers and other interbank services. Indeed, Marijuana Business Daily reported in December that 70% of plant-touching businesses do not have a bank account, and accounts are frequently terminated. A Freedom of Information Act request revealed that, as of January 2015, 3,157 marijuana-related Suspicious Activity Reports had been filed by 374 individual financial institutions, with nearly half being "Marijuana Termination" reports indicating closure of an account. So while at least some established banks — possibly regional banks and credit unions — are providing services to marijuana companies, until the government acts more definitively, banking access will continue to be limited.

Insurance Developments

It appears from media reports that some carriers are already providing commercial coverage in this space. Although the FinCEN guidance to financial institutions described above does not apply to insurance companies expressly, it is possible that the federal government could expect insurers to be guided by it, and a number of the principles set forth in the guidance have analogues in the insurance business.

We are not aware of any particular legal guidelines — whether from the federal government, any state insurance regulator or any standard-setting body such as the National Association of Insurance Commissioners — governing the provision of insurance to businesses engaged in legal marijuana-related activities. In the absence of such guidance, and with marijuana remaining illegal in many states as well as at the federal level, it is possible that an insurance policy written to a policyholder in the U.S. purporting to cover risk associated with marijuana-related activities would be determined to be unenforceable or even unlawful under the laws of such states or of the U.S. However, notwithstanding the challenges, the development of the industry (and therefore data that can be used in making underwriting determinations) and the pricing power in a less competitive market suggest the trend toward provision of at least some types of coverage may continue.

Intellectual Property Developments

Companies have continued their efforts to build and defend their brands by utilizing both federal and state protections. Trademark applications that include the term "marijuana" in the goods and services description have risen from 20 in 2012 to 200 apiece in 2014 and 2015, while issued registrations have correspondingly risen from 12 to 33. States where marijuana has been legalized have also seen an increase in trademark applications. In Colorado there are approximately 700 trade names and 200 trademarks registered that include the word "marijuana" or a synonym. Additionally, the USPTO has not rejected and continues to review multiple marijuana plant patent applications that have been submitted.

Looking Ahead in 2016

Companies — and their investors — continue to face a myriad of risks associated with uncertainty over future regulatory developments concerning the marijuana industry. Companies with SEC-registered securities frequently reference risk factors, including ongoing federal prohibition; potential criminal and civil penalties; a reliance on additional states legalizing medical and recreational marijuana; increasing mobilization of groups and individuals opposed to legalization; banking difficulties; difficulties accessing bankruptcy courts; the rapid changes in the industry; and lack of access to adequate capital — most of which apply equally to privately held companies.

Notwithstanding the risks, investment in the marijuana industry has continued to escalate. It remains to be seen how much will be clarified through 2016, and the federal issues will depend in no small part on the U.S. presidential election. As large states like California and Ohio prepare for legalization initiatives, it is clear that there will be increasing pressure on the federal government to clarify its position on issues such as banking access. As these issues become incrementally clearer, and barring any significant policy change at the federal or key state levels, the trend toward increasing liberalization and associated comfort levels of investors seems likely to continue, with the tipping point still being the resolution of the federal-state conflict.

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