Canada

Want to Avoid CannTrust's Fate? Adopt These 5 Good Governance Practices

CannTrust Holdings announced yesterday that Health Canada is investigating compliance violations at its manufacturing facility in Vaughan, Ontario. The company’s board of directors has initiated an internal investigation to determine the root cause of the problem and to initiate remediation steps. Investor’s reacted negatively to this news causing the stock price to collapse.

The company’s credibility is in tatters as news emerges from the internal investigations that are being performed as a result of compliance violations that were revealed in July.

On Friday, the company announced that KPMG was withdrawing audits from 2018 and the first quarter of 2019. KPMG’s decision was driven by the information revealed from the company’s Special Committee’s investigation as well as information that caused the firing of CEO, Peter Aceto, at the end of July.

The company also indicated that it was unclear what impact the Health Canada investigations would have on the value of its inventory and biological assets. In a separate announcement, CannTrust revealed that it will not sell or ship product from the Vaughan, Ontario facility until Health Canada’s investigation has concluded.

Health Canada’s most recent investigation shows significant compliance violations and a lack of internal controls. The company failed to obtain appropriate regulatory approval prior to making changes to its operating procedures and to the facility. The regulator also found that the firm’s operating procedures did not meet the regulatory requirements.

CannTrust is facing a serious situation that may result in the company’s sale, or even worse, shuttering. So, what are the lessons that CannTrust can provide to the cannabis industry?

1) Shareholders do not easily forgive. It is easy for shareholders to sue a company over a lost investment. Like any relationship, investors must trust that senior management will protect them. News of a regulatory violation may indicate that the company is playing fast and loose, which puts the company and its assets at risk. Investors that do not trust a company or senior management will sell the stock to protect as much of their investment as possible. Investors value honesty and information that can be relied upon.

2) Good governance can save your company. Everyone needs a boss including the CEO. The board of directors is charged with protecting investor interests by being fully engaged and keeping an eye on the big picture. The board must monitor high risk areas such as financial reporting and regulatory compliance for anomalies or other warning signs. By including independent board members, a company can demonstrate to investors that it values a fresh eye on the company to ensure that it has adequate controls and a culture of compliance.

3) Create a culture of compliance. A culture of compliance is worth its weight in gold. Culture can help a company mitigate the risk associated with internal threats posed by employees. Employees must be supervised and trained on the risks facing the company and how the employee’s actions can either exacerbate or mitigate this risk. A rogue senior management team can cause fast and loose practices to leach through an organization leading to the failures witnessed at CannTrust. Investors want a culture of compliance that will protect their investment.

4) Test, test, test. Companies must test operating procedures and controls to make sure they work. Operating procedures are designed to instruct employees on how the business is operated in a way that mitigates risk. By reducing risk, a company can ensure it maintains the value of its inventory and services and provides trustworthy financial statements. Companies that periodically test the controls and processes that are used in the operating procedures can demonstrate their effectiveness of the control framework to the board of directors and regulators.

5) A penny saved may cause a company to be lost. Recent news reports reflect a growing impatience by investors on the return on investment of the cannabis industry. Company’s that cut costs associated with maintaining effective controls and compliance will not be rewarded. As with CannTrust, companies that do not take good governance seriously will simply go away.

CannTrust Shows Why Compliance Matters for Cannabis Industry

CannTrust Holdings Inc. stock dropped 48% after a news report by Bloomberg indicated that regulators found unlicensed grow rooms and provided them false and misleading information. Within five (5) days, the company lost over $174 million in market value. CannTrust may be the first, but it will not be the last, commercial cannabis business to suffer investor backlash after a regulatory infraction or be the party of a class-action investor lawsuit.

Cannabis businesses should learn from this event and perform an internal review of existing risk, governance and compliance controls around the procurement of cannabis, especially in states with cannabis shortages. A CannTrust employee interviewed by Bloomberg stated that the company was cutting costs and corners, indicating a lack of controls and culture of compliance.

An effective risk and compliance framework, along with a culture of compliance, protects an organization and its shareholders. Senior leadership must be familiar enough with the day-to-day operations to understand what risks are on the horizon and how to help the company head them off. This involves assessing the organization’s daily activities and processes to determine the types of events, that if they occurred, would stop business operations, prompt regulators to investigate, cause unfavorable headlines, or make consumers avoid your brand.

Senior leadership also sets the tone at the top for the expectations for the company’s vision, strategy, and growth. The company culture and the quality of senior management are imperative to ensuring that employees understand the rules of the road. The internal threats posed by employees are just as great as those posed by the potential contamination of a cannabis harvest.

If interested in cutting costs, cannabis businesses may utilize technology to automate as many processes as possible. Companies can utilize technology such as governance, risk, and compliance platforms to assess risk, document its processes and controls used to mitigate the risk and test whether they work. The automation helps contain headcount and creates a central repository for institutional knowledge, which is important in a high growth industry that is staffing up quickly.

The CannTrust regulatory disclosure is a wake-up call for the cannabis and hemp industries. The industry has matured and is being held to public market standards. The cannabis industry must ensure that it continues to mature by adopting public market governance and risk frameworks and controls. Market value can be erased overnight. However, well run companies establish culture and controls to prevent this from happening.

CANADA ISSUES ADVERTISING WARNING

Canada posted an informational bulletin for licensed producers discussing the restrictions on cannabis advertisements and the corresponding penalty for non-compliance.  Canada's Food and Drug Act (FDA) prohibits advertisements for food or drugs as a treatment or cure for certain diseases published by the government.  In addition, labeling and advertisements must not produce a false impression as to the product's character, value, quantity, composition, merit or safety.  

Licensed producers should seek guidance from local counsel to ensure that advertisements and labeling comply with the FDA as penalties can range from $250,000 to $5,000,000, or to a term of imprisonment ranging from six months to two years, or to both.

Advertising Prohibitions on Cannabis - Information Bulletin
www.canada.ca/en/health-canada/services/drugs-medication/cannabis/licensed-producers/advertising-prohibitions-cannabis-information-bulletin.html


CANADA ISSUES IMPORT / EXPORT BULLETIN

Canada issued an informational bulletin on the import and export of marijuana by licensed producers.  The bulletin indicates that licensed producers may import or export marijuana in very limited circumstances such as importing starting materials or exporting a unique strain for research purposes.  Licensed producers will not be able to export cannabis to foreign markets where recreational use is legal.

Licensed producers that are seeking to import or export marijuana must file an application.  When determining whether to grant the application, the Canadian government will consider several factors including Canada's obligations under international treaties; whether it is consistent with applicable regulations; whether the receiving country has issued an import permit; and the risks to public safety.

Import and Export of Marijuana by Licensed Producers - Information Bulletin
www.canada.ca/en/health-canada/services/drugs-medication/cannabis/licensed-producers/policies-directives-guidance-information-bulletins/import-export-cannabis-licensed-producers-information-bulletin.html

ONTARIO CANNABIS STORE PICKS SUPPLIERS

The Ontario Cannabis Store (OCS) has announced that it will be ready to open its online store doors on October 17 for home delivery.  OCS entered into supply agreements with 26 licensed producers to provide cannabis products including the following companies.

  • 7ACRES/The Supreme Cannabis Company

  • AgMedica Bioscience Inc.

  • Aphria Inc.

  • Aurora Cannabis Enterprises Inc.

  • Beleave Kannabis Corp.

  • Broken Coast Cannabis Ltd.

  • CannTrust Inc.

  • Canopy Growth Corporation

  • Emblem Cannabis Corporation

  • HEXO Operations Inc.

  • Hiku Brands Company Ltd.

  • Maricann Inc.

  • MedReleaf Corp.

  • Natural MedCo Ltd.

  • Northern Green Canada Inc.