The Current Legal Status of Marijuana in the United States and Canada

I have received a number of questions relating to the legal status of marijuana in the US and Canada, the primary question being has it really been legalized? So below is a brief discussion – while the industry seems to still be in its infancy, more has happened in the industry in the United States from a regulatory perspective, so there is a greater focus on the US rules. Canada I would expect would take the US regime into consideration in implementing its own rules relating to MJ.  I point out that this is a very general discussion for your reference and should be used only as a starting point. Please contact me directly for more detailed information at klalani@lalanilaw.com.

United States

In most US states, the possession and use of marijuana (MJ) is illegal. However, the legal landscape around MJ is changing. Four states have passed legislation legalizing the use, possession, sale, cultivation and transportation of marijuana (MJ) for recreational purposes, in particular Washington State, Colorado, Oregon and Alaska.  The people of Washington D.C. have approved the legalization of MJ for recreational use, however, whether legislation will be implemented in this regard remains to be seen. Several other states have passed legislation legalizing the use of MJ for medicinal purposes and decriminalizing the possession of smaller amounts MJ, for example California, Maine, Maryland and some others; while certain other states have passed legislation legalizing the use of MJ for medicinal purposes only, for example Arizona, Delaware, Hawaii and others. Surprisingly, there is no formal regulation around the use of MJ for medicinal purposes in Washington State currently, although this is expected to change soon.

MJ laws vary significantly from state to state. In states where MJ has been legalized, there generally are robust regulatory schemes in place, requiring licenses to grow, process and sell MJ and MJ based products. These MJ businesses are continually monitored for compliance with applicable rules and are heavily taxed relative to other businesses. In addition, MJ businesses may be disallowed certain business deductions under state tax laws available to other businesses generally, as well as under the federal Income Tax Code. This makes it relatively costly to run a MJ business.

At the federal level, the use, possession, sale, cultivation and transportation of MJ is illegal. MJ is a Schedule I drug under the federal Controlled Substances Act. However, the federal government has issued guidance indicating the circumstances in which it likely would not prosecute people for running an MJ business, effectively in those states that have robust regulatory schemes in place around MJ (see the Cole memo put out by US Deputy Attorney General James Cole in February 2014). Nonetheless, there are no guarantees that the DEA will not shutdown operations in states that have implemented robust regulatory schemes as contemplated in the Cole memo, as seen in Washington State recently.

In California, where possession of smaller amounts of MJ has been decriminalized, the DEA has made an effort to shut down MJ operations. California does not currently have a regulatory scheme in place around MJ to the dissatisfaction of the federal government. There is currently a case pending before a California court challenging the listing of MJ in Schedule I of the Controlled Substances Act. However, it seems that to remove it completely as a Schedule I drug would severely limit the federal government’s power to prosecute MJ crimes generally. It will be interesting to see how the federal regulatory scheme develops. Currently, however, there are no guarantees against federal enforcement or prosecution relating to MJ.

Industrial hemp is also considered illegal federally, with the exception of growing it for research purposes but only in certain states that have allowed institutions to conduct this type of research. The reason being that industrial hemp still falls within the definition of “marijuana” in the Controlled Substances Act. It is also considered illegal currently in certain states, including Washington State (where MJ has been legalized but industrial hemp falls outside the definition of “marijuana”), although a number of other states have passed legislation allowing it.  Nonetheless, people are hopeful that this will change soon and that the growing of industrial hemp will be freely allowed in the United States.

CBD and related cannabinoids are also illegal federally despite numerous claims that CBD is legal. CBD and other cannabinoids fall within the definition of “marijuana” in the Controlled Substances Act as a “resin” of the cannabis sativa plant. However, there is a bill before Congress to exclude CBD and therapeutic hemp from the definition of MJ in the Controlled Substances Act, which would effectively legalize it. We are keen for this given the highly therapeutic value of CBD in particular.

So it seems that the regulation of the MJ industry is evolving as the industry itself evolves from its infancy. As more states pass legislation moving toward the legalization of MJ, it is expected the government federally will do the same. California currently does not have a formal regulatory scheme in place relating to MJ, but this is expected to change in 2016 as the federal election gains momentum. In fact a number of states are expected to pass legislation legalizing MJ that year. Currently, however, there are no guarantees against federal prosecution.

Canada

Marijuana is illegal in Canada and every Province of Canada and one may use, possess, sell, cultivate or transport marijuana only with permission from the federal government, in particular a license from Health Canada is required. You can’t import it or export it, without a license from Health Canada. It’s illegal in every Province of Canada, despite the fact that the police may not fully enforce the rules relating to MJ.

MJ is regulated in Canada under the Marijuana for Medical Purposes Regulations of the federal Controlled Drugs and Substances Act. It is considered a Schedule 2 drug and the possession of smaller amounts of MJ (less than 30 g) without a license is a lesser offense that generally will not result in jail time. However, one can obtain it for medicinal purposes with a prescription from a licensed healthcare practitioner.

There has been discussion about the federal government legalizing MJ for recreational use, but nothing official has been released from the government so far. With an election coming in 2015, the legalization of MJ is expected to be a significant issue. Justin Trudeau and the Liberal Party have indicated a willingness to legalize MJ if elected. Legalizing MJ would legalize the use of CBD which has been shown to be highly therapeutic for people suffering from ailments such as arthritis (which has been an issue in my family). So long live Justin Trudeau!

Shareholder Solicitations – Can a US public company sidestep proxy solicitation rules?

Here is a scenario that seems to occur more than occasionally. A US public company looking to conserve cash wants to undertake a corporate action in a quick and cost effective manner. Let’s say the company is incorporated in Nevada and wants to conduct a reverse split of its stock.

Under the Nevada rules, the company would be required to obtain approval of a majority of its shareholders for the action. So company officers call shareholders and ask them to consent to the action by signing a resolution approving the action, and the company thereby obtains majority shareholder approval for the proposed action. The company then proceeds to comply with the SEC`s disclosure requirements by filing with the SEC and delivering an Information Statement on Schedule 14C to all shareholders advising them of the action.

In these circumstances, the company would be offside the SEC’s proxy solicitation rules. Whenever a company is seeking shareholder approval by soliciting consents, a Proxy Statement on Schedule 14A is required to be delivered to shareholders containing required information prior to the solicitation.  Rule 14a-1(l) under the Exchange Act defines a “solicitation” for purposes of the proxy rules as:

Ÿ- any request for a proxy whether or not accompanied by or included in a form of proxy;

– any request to execute or not to execute, or to revoke a proxy; or

Ÿ- the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.

As a result, any time an issuer requests a shareholder to consent to an action, it is soliciting that shareholder’s approval and, accordingly, the issuer must comply with Schedule 14A’s proxy solicitation requirements. That means preparing, filing with the SEC and delivering a proxy statement to shareholders prior to obtaining consents.

It would appear, then, that any time a company contacts a shareholder for approval of an action it is caught by proxy solicitation rules, so in what circumstances would an Information Statement on Schedule 14C be used to disclose a corporate action already approved by shareholders.

A determination in this regard generally depends upon the facts and circumstances surrounding a corporate matter requiring shareholder approval. Generally, so long as there is no “solicitation” a company would not be violating proxy solicitation rules. For example, where a company`s officers hold a majority of the company`s outstanding voting stock, and no shareholders are contacted for approval of a corporate action, the company could likely proceed by way of filing with the SEC and delivering an Information Statement on Schedule 14C to shareholders after the required shareholder approval of the action has been obtained. Or where management and a large shareholder are involved in negotiating a matter requiring shareholder approval and collectively hold a majority of the company`s outstanding voting stock, no shareholders would need to be “solicited” and the company could likely proceed in the same way.

Hopefully you find this information useful and save some money not having to re-file with the SEC to comply with the SEC’s proxy solicitation rules. If you would like to discuss this further, please feel free to contact me at klalani@lalanilaw.com.

Raising Capital Under Rule 506(c)

US securities rules prohibit companies from the use of “general solicitation” in the United States when raising capital privately. Under its mandate to protect investors, the SEC has indicated that there must be a sufficient nexus between a company and an investor in a private offering such that the investor has access to material information about a company to be able to make an informed investment decision. Under a general solicitation, whereby a company seeks out investors through newspaper ads, blast emails, over the internet or other similar means, this nexus would generally not exist and a company may be deemed to be conducting a “public offering” outside of prescribed rules.

Given continued economic concerns in the United States, the US Jumpstart Our Business Startups Act (JOBS Act) was passed with bipartisan support by Congress and signed into law by President Obama and came into effect in September 2013.  The Jobs Act mandated amendments to Rule 506 of Regulation D under the US Securities Act of 1933, which is meant to facilitate capital formation for growing companies.

Rule 506, and particularly Rule 506(b), is relied upon heavily by companies raising capital in the US. Rule 506(b) permits sales to an unlimited number of “accredited investors”, which makes the process of raising capital substantially easier for companies. So long as investors meet the definition of an accredited investor (essentially a high net worth person), Rule 506 provides a safe harbor for sales by a company to these investors up to an unlimited amount. However, Rule 506(b) prohibits the use of general solicitation in finding investors.

To implement the change mandated by the JOBS Act, the SEC added a new Rule 506(c) which permits the use of general solicitation by a company in identifying investors for an offering of its securities. Under Rule 506(c), companies can actively seek out new investors, subject to the following conditions:

  • All purchasers of the securities must be accredited investors; and
  • The issuer must take “reasonable steps” to verify that all purchasers are accredited investors.

All investors under Rule 506(c) must be accredited investors. This falls within the SEC’s purview of protecting investors as accredited investors are presumably sufficiently sophisticated in making investments and can look out for themselves. Verifying that a person meets the requirements to be considered an “accredited investor”, however, is no easy task.

The SEC adopted a “principles-based” method for determining whether the verification steps undertaken by an issuer are reasonable under Rule 506(c) determined on the basis of the “facts and circumstances” surrounding an offering and a particular investor. While there is a non-exclusive list of methods that can be used to satisfy this requirement., the SEC set out four specific verification methods deemed to constitute “reasonable steps”.

  • Nature of the Purchaser. Reasonable verification steps would differ depending on the category of accredited investor in which the purchaser falls. For example, relatively little verification would be required where the purchaser is an accredited investor by virtue of its being a registered broker-dealer. By contrast, more extensive verification would be required for natural persons, whose accredited investor status is based on either income or net worth.
  • Information about the Purchaser. Issuers could review or rely on the following types of information, which depending on the circumstances may or may not be sufficient verification in and of themselves: (i) publicly available information in regulatory filings, such as an executive’s compensation as reported in his or her employer’s proxy statement filed with the SEC, or a tax-exempt organization’s assets as reported in its Form 990 filed with the IRS, (ii) third-party information that is reasonably reliable, such as an individual’s pay stubs or publicly available information about the average compensation earned at the purchaser’s workplace by persons at his or her position, (iii) verification of the person’s status as an accredited investor by a third party if the issuer has a reasonable basis for relying on this source.
  • Nature of the Offering. An issuer that solicits purchasers through media accessible by the general public or by widely disseminated email or social media solicitations would need to take greater measures to verify accredited investor status than an issuer that limits its solicitations to pre-screened investors. Where the solicitation is made available to the general public, purchaser questionnaires and self-certifications would be insufficient verification.
  • Terms of the Offering. If the minimum investment is sufficiently high that only accredited investors could reasonably be expected to invest that amount, the additional verification required would be limited. The release indicates that in this situation it may be sufficient for the issuer to verify that the investment is not being financed by the issuer or a third party.

Specific steps an issuer may take in the verification process as indicated by the SEC are:

  • Reviewing copies of forms filed with the IRS that report net income, such as Forms W-2 or 1099. The issuer must review IRS forms for the two most recent years and obtain a written representation from the prospective investor that he or she has a reasonable expectation of attaining the necessary income level for the current year.
  • Reviewing bank or brokerage statements or third-party appraisal reports to verify the purchaser’s assets and a credit report to verify liabilities, in each case dated within the prior three months, and obtain a written representation from the prospective investor that all liabilities have been disclosed.
  • Obtaining a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant (or other reliable third party) that, within the prior three months, such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor and has determined that the purchaser is an accredited investor.
  • If a person has purchased securities as an accredited investor in a previous Rule 506(b) offering by the issuer and continues to hold such securities, the issuer may continue to treat such person as an accredited investor if it obtains a certification from the person that he or she still qualifies as an accredited investor. However, this method is only available if the previous Rule 506(b) offering was made before the effective date of Rule 506(c). However, the SEC has indicated that an issuer does not lose the ability to rely on Rule 506(c) for an offering if a person who does not meet the criteria for any category of accredited investor purchases securities in the offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor at the time of the sale of securities. Exactly what this means looks to be determined on a case by case basis. We keep an eye out for additional guidance.

It seems quite evident then that the verification process can be involved and there is no guarantee that the steps undertaken will be considered sufficient in meeting the requirements for verification. A deeper concern is if there is a mistake in the verification and a person later turns out not to be accredited, the issuer may not able to rely on other exemptions for the offering. For example, the statutory private placement exemption otherwise provided by Section 4(a)(2) of the Securities Act or the safe harbor provided by Rule 506(b) could not be relied upon, as these are conditioned on the absence of general solicitation.

However, the SEC has indicated that an issuer does not lose the ability to rely on Rule 506(c) for an offering if a person who does not meet the criteria for any category of accredited investor purchases securities in the offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor at the time of the sale of securities. Exactly what this means looks to be determined on a case by case basis. We keep an eye out for additional guidance.

Terms And Conditions Of Use

All content provided on this blog is for informational purposes only. Lalani Law Corporation makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site.

Lalani Law Corporation will not be liable for any errors or omissions in this information nor for the availability of this information. Lalani Law Corporation will not be liable for any losses, injuries, or damages from the display or use of this information.

These terms and conditions are subject to change at anytime with or without notice.