Last year, we discussed predictions of increased M&A activity in the cannabis sector, given the federal Liberal Government's push to legalize cannabis for recreational use. That push picked up steam earlier this year with the introduction of the Cannabis Act ( which we summarized here). When implemented, the Cannabis Act will legalize cannabis for recreational use in Canada. Part of the optimism for increased M&A activity in this space may have been due to perceived opportunities for United States / Canadian cross-border transactions, given the size of the U.S. market generally as well as perceptions of growing acceptance of cannabis use in the U.S., fueled by the legalization of cannabis for medical and/or recreational use by various states, including recently (and significantly), the state of California.
As many are aware however, cannabis for any use (except limited research purposes) remains illegal federally in the United States, and there remains considerable uncertainty as to whether or to what extent the current administration of the United States government will enforce the federal laws. This is because guidance previously issued by the federal U.S. Department of Justice under the Obama administration (known colloquially as the "Cole Memo") set out certain enforcement priorities which did not include enforcement against cannabis operations in states that have legalized cannabis and which have established strong and effective regulatory programs. However, these enforcement priorities can be changed or rescinded at any time.
Amidst the absence of clear guidance from the current administration of the U.S. federal government regarding its stance on the U.S. cannabis industry, on October 16, 2017, policy notices were issued by the Canadian Securities Administrators (CSA) as well as Canada's two largest stock exchanges: the Toronto Stock Exchange (TSX) and TSX Venture Exchange (TSXV). These notices provide the regulators' expectations regarding issuers engaged in activities in the U.S. cannabis industry. The notices are summarized in more detail below but, in short: while the CSA has taken a disclosure-oriented approach to issuers with exposure to the U.S. cannabis industry, both the TSX and TSXV have gone further, warning that issuers listed on their exchanges with exposure to the U.S. cannabis industry and that are conducting activities in violation of U.S. federal law may be subject to de-listing. This approach is in contrast to that taken by the Canadian Securities Exchange (CSE), which has been and continues to be receptive to issuers who have exposure to the U.S. cannabis industry, provided that the material risks to investors are adequately disclosed. The CSE expressed their support of the CSA's approach, which is in line with CSE's own approach.
The result will likely be a chill on any Canadian / US cross‑border M&A activity among issuers in the cannabis space that are listed or seeking a listing on either the TSX or TSXV, and may possibly result in additional listings on the CSE by issuers operating or seeking to operate in the U.S. cannabis industry.
CSA Staff Notice 51-352 – Issuers with U.S. Marijuana-Related Activities
The CSA recognize the conflict between the U.S. federal and state law relating to cannabis practices and activities, and noted that the Cole Memo is subject to change, rescission or alteration at any time. Given this, the CSA recognize that Canadian reporting issuers with exposure to the U.S. industry may face material consequences should U.S. federal law be enforced, and have reminded reporting issuers with exposure to the U.S. cannabis industry of their obligation to disclose all material facts and risks relating to such operations.
The CSA also provided specific disclosure expectations for reporting issuers with exposure to the U.S. cannabis industry, noting that the failure to adhere to such disclosure expectations may result in regulatory action being taken, including receipt refusals in prospectus offerings, requests for restatement(s) of non-compliant filings and, where warranted, enforcement action.
The CSA expect that reporting issuers with U.S. cannabis activities will clearly and prominently disclose the following in prospectus filings and other continuous disclosure documents:
- a description of the nature of the issuer's involvement in the U.S. cannabis industry;
- an explanation that cannabis remains illegal under U.S. federal law, and that approaches to enforcement is subject to change, with a discussion of the resultant risks;
- a discussion of whether and how the issuer's U.S. cannabis activities are conducted in a manner consistent with any U.S. federal enforcement priorities; and
- given the illegality of cannabis under U.S. federal law, a discussion of the issuer's ability to access private and public capital and what financing options are / are not available in order to support continuing operations.
In addition, the CSA has outlined additional disclosure expectations for issuers depending on whether they have direct, indirect or ancillary involvement in the cultivation or distribution of cannabis in the U.S.
For reporting issuers who are directly engaged in the cultivation or distribution of cannabis in the U.S. in accordance with a U.S. state licence, the CSA expects issuers to outline the regulatory framework(s) for the U.S. states in which they operate, and confirm the issuers' compliance with applicable U.S. state regulatory and licensing requirements, as well as discuss how the issuer monitors U.S. state regulatory compliance, describe internal compliance procedures, and disclose any material non‑compliance, citations or notices of violation received by the issuer.
For reporting issuers who are indirectly involved in the cultivation or distribution of cannabis in the U.S. (i.e., where the issuer has a non-controlling investment in an entity that is directly involved in cultivation or distribution of cannabis in the U.S.), the CSA expects the issuer to outline the regulations for U.S. states in which the issuer's equity investee operates, as well as provide reasonable assurance, through either positive or negative statements, that the investee's business is in compliance with applicable licensing requirements and the regulatory framework enacted by the applicable U.S. state(s). Reporting issuers who have only ancillary involvement in the U.S. cannabis industry (i.e., where an issuer provides goods and/or services to third parties who are directly involved in the U.S. cannabis industry) are also expected to provide reasonable assurance regarding compliance of the customer's or investee's business.
TSX Staff Notice 2017-009 and TSX Venture Exchange Notice to Issuers
The TSX and TSX Venture Exchange have stated that issuers listed on their exchanges that conduct business activities in violation of U.S. federal law are not complying with their listing requirements, and accordingly may be subject to a de-listing review. The TSX and TSX Venture Exchange have also stated that financial transactions involving proceeds generated by, or intended to promote, cannabis‑related business activities in the U.S. may be in violation of applicable money-laundering legislation. Business activities that TSX and TSX Venture Exchange have identified may be in violation of their exchange listing requirements include:
- direct or indirect ownership of, or investment in, entities engaged in activities related to the cultivation, distribution or possession of cannabis in the United States (U.S. Cannabis Activities);
- commercial interests or arrangements with entities engaged in U.S. Cannabis Activities, that are similar in substance to ownership of, or investment in, such entities; and
- ancillary services activities, consisting of:
- the provision of services or products specifically designed for, or targeted at, entities engaged in U.S. Cannabis Activities; and
- commercial interests or arrangements with entities engaging in the business activities described above.
Norton Rose Fulbright Canada LLP is a leader in providing legal services to clients operating in the cannabis space as well as other highly-regulated industries.
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