Cannabis Industry Faces First Test By Federal Regulators

The vaping epidemic created a crisis for the cannabis industry. Federal regulators can point to this epidemic as a reason to ban THC, CBD, and vaping products as a public health risk. At a minimum, the regulatory pendulum will swing and produce a significant number of new laws and regulations.

So what is the industry’s playbook for moving out of crisis mode and getting back to business?

1. Acknowledge the Problem

The cannabis industry must acknowledge that it is facing a crisis. Industry leaders should join the efforts to quickly identify the cause of the illnesses, and help structure appropriate standards to protect the public. Under current circumstances, federal and state regulators are mixing together cannabis, CBD and vaping into one bucket of risk. The regulator’s solution may treat one or all with the same regulatory response.

The cannabis industry should help regulators define the issue, and differentiate between legal market products versus black market activity. The cannabis industry should avoid the pitfalls of becoming entangled in unsettled questions surrounding hemp-based CBD products and vaping technologies. Regulators should keep the three product lines separate and develop isolated regulations that address the unique risks posed by each industry.

2. Help Structure a National Response

State’s rights allow the cannabis industry to grow and innovate independent of the federal government. The downfall of this regulatory structure is that each state and local municipality develops its own regulatory response. The multitude of new laws and regulations that will be enacted in response to the vaping crisis will increase the overall operating costs for the industry. The industry should use this opportunity to do the right thing. Help develop national standards that address public health before the federal government does it for you. A national standard is easier to incorporate into an enterprise compliance program and ultimately more cost-effective.

3. Proactively Address Related Issues

Competition between the cannabis and hemp industries continues to grow as both fights for limited real estate, regulatory restrictions, and consumers. The regulated cannabis industry should proactively review product offerings such as CBD infused products, gummies, among others, to address potential public safety issues. The cannabis industry can start a consumer education program to offer suggestions on safe product use and how to limit consumption by minors.

This crisis will force CBD into a regulated environment. The CBD hemp industry should address the fundamental issues around testing, product disclosure, and labeling requirements. The CBD industry might benefit the most from a self-regulatory organization that will oversee compliance with a framework that addresses the risk posed by the industry. By proactively creating an SRO with teeth, the states may be able to push back on efforts by the FDA to completely ban CBD products.

The cannabis industry will make it through this period. However, the industry should learn its lessons and be prepared for the next one.

DEA Increases Cannabis Production Quota to 3,200 kilograms

The US Drug Enforcement Agency is proposing to significantly increase the quota of cannabis that can be produced legally for use in research from 2,450 kilograms in 2019 to 3,200 kilograms in 2020. Under its rules, the DEA can approve companies to mass-produce Schedule 1 drugs for use in legitimate medical or scientific research. The number of individuals that are registered with the DEA to conduct research has also increased from 384 in 2017 to 542 in 2019.

The DEA establishes the quotas to avoid diversion of Schedule 1 drugs into the black market. The quotas are based on estimates of actual medical needs by reviewing the waste during the previous 2 years, the amount of waste across the nation, whether inventory is accumulating, and projected demand. The DEA receives input in this process from other government agencies including the FDA, CDC, and HHS. The increase in the number of registered researchers means that the total amount of marijuana cultivated for research purposes must also increase.

Companies can apply with the DEA to cultivate the marijuana that is used for research purposes. If approved, the companies may not engage in any other activities. The DEA evaluates that applications by ensuring that the company complies with all laws and regulations and that the company has sufficient controls to prevent diversion. The DEA will only register the number of applicants needed to maintain a steady supply of marijuana that is needed for research.

The DEA received 33 applications to date and expects to begin the Notice of Applications. Due to a large number of applicants, the DEA worked with the Department of Justice and other federal agencies to revise internal policies and procedures related to the marijuana grower program. The DEA will replace the 2016 marijuana grower policy with the new robust rules.

How Quickly Will State Cannabis Regulators Respond to the THC & CBD Vape Product Illnesses?

The CDC and FDA are working with state governments to investigate the cause of 450 cased of lung illnesses in 33 states that have resulted in five deaths to date. The CDC indicates that many of the persons with the mystery lung illnesses used vaping products that contain THC or CBD.

The FDA released a statement warning consumers to avoid vape products that contain THC until the cause of the illnesses has been clearly identified. The FDA indicated that many of the products contained Vitamin E acetate, which is used in topical products with limited research on the effects of inhalation.

The health departments in many states including California, Colorado, Connecticut, Ilinois, Indiana, Michigan, Minnesota, New York, Oregon, Washington, and Wisconsin issued warnings to residents and offered tips on how to avoid becoming ill. The common themes on how to keep safe across the states and the FDA include:

  • Don’t buy THC or CBD vaping products off of the street;

  • Avoid THC vaping products until the investigation is concluded; and

  • Don’t make your own vape products.

The tremendous concern around public safety at the state level may ultimately reverberate into additional regulations directly targeted at vaping products. As THC and CBD products are, for now, governed by state law, the question is how quickly will the state regulators respond to these health concerns and how draconian will the regulatory response be.

The FDA’s Acting Commission, Ned Sharpless M.D., issued a statement in July on its efforts to regulate the e-cigarette market including the issuance of recommendations that require manufacturers to consider factors when designing an e-cigarette including how the e-liquid is heated, the aerosol is generated and transmitted to the user.

We would expect the state cannabis regulators to lean heavily on the FDA’s recommendations for e-cigarettes in future rulemaking initiatives due to the FDA’s expertise in understanding the risks associated with e-cigarettes and the regulations that can keep the public safe.

We also see a heavy focus on testing recently with recalls in Colorado and Michigan. Last week, Michigan recalled four vaping products that tested positive for heavy metals and arsenic. State regulators will most likely amend testing requirements after the cause of the vaping illnesses is determined.

Cannabis and CBD vaping product brands should review their manufacturing and purchasing processes to ensure there are strong controls to identify and prevent unsafe products. Manufacturing processes, including recipes, should be reviewed for ingredients that are not typically in vaping products. Companies should also pay close attention to the quality of hardware provided by third-party providers and whether they meet the FDA’s recommendations for e-cigarettes.

Most importantly, the industry should be concerned about public safety issues and proactively take a deeper look at non-vaping products. CBD product manufacturers should be especially diligent as CBD is not subject to the same rigorous testing standards as cannabis.

The industry is at a pivotal point. State regulators must show the federal government that it has the expertise and enforcement mechanisms to produce safe products. We believe that the current vaping crises will further entrench the state product silos, and it may ultimately prevent CBD products from being offered outside of a state-regulated cannabis framework.

DEA Plans to Adopt Marijuana Growing Rules

The Drug Enforcement Agency announced that it intends to adopt rules for growing marijuana that will be used in medical and scientific research. The DEA will adopt these regulations prior to approving applications from companies to manufacture bulk quantities of marijuana. Notice was provided so that companies can withdraw previously submitted applications in light of the new rules or if the DEA’s approval of the application is no longer needed as hemp is now legal.

Companies can register as a manufacture bulk quantities of marijuana for DEA registered researchers. If approved, the growers may not engage in any other activities. The DEA evaluates that applications by ensuring that the company complies with all laws and regulations, and that the company has sufficient controls to prevent diversion. The DEA will only register the number of applicants needed to maintain a steady supply of marijuana that is needed for research.

The DEA received 33 applications to date, and expects to begin the Notice of Applications. Given the large number of applicants, the DEA worked with the Department of Justice and other federal agencies to revise internal policies and procedures related to the marijuana grower program. The DEA will replace the 2016 marijuana grower policy with the new robust rules.

The DEA’s rules will be a first set of federal regulations that oversee the cultivation of marijuana. We will soon see whether they closely resemble the USDA’s regulations for hemp cultivation, and whether the states will adopt the rule’s requirements.

Credit Unions Are Warned Against Providing Services to CBD Companies

The hemp industry celebrated this week when it was reported that credit unions could provide financial services to hemp-related businesses. A closer look shows that the National Credit Union Association warned credit unions against opening accounts for CBD companies.

The NCUA encouraged “credit unions to thoughtfully consider whether they are able to safely and properly serve lawfully operating hemp-related businesses.” Credit unions are small banks that generally lack the resources and expertise to handle industries that are complex and require heavy due diligence. Under the NCAU’s guidance, Credit unions must perform due diligence and analyze whether the activities of hemp or CBD business are lawful under federal, state and municipal laws.

So, what is a lawfully operated hemp-related business?

  1. An intrastate hemp business that complies with the State’s CBD laws, and industrial hemp program under the 2014 Farm Bill until the USDA implements the 2018 Farm Bill.

    Issue: Hemp and CBD are still illegal in some states and cities.

  2. A company, including manufacturers, distributors, shippers, and retailers of hemp derived products, that are or will be subject to, and complies with, state or FDA regulations related to the production, sale and use.

    Issue: This analysis becomes complicated quickly for any company that is engaged in interstate commerce. For example, New York only permits the in-state sale of CBD products that are manufactured by state-licensed processors. Thus, a credit union would need to analyze a company’s financials to ensure that CBD revenues generated in New York were only from CBD products lawfully manufactured in the state. State guidance to date suggests that it is difficult if not impossible to sell CBD generally on an interstate basis.

  3. A hemp or CBD company that passes due diligence, and its business activity is legal and allowed under federal, state and local laws.

    Issue: Credit unions will need to understand how a business generates revenue and whether it complies with state law. This level of analysis would make it virtually impossible for a credit union, given its limited resources, to safely and properly serve CBD companies.

The NCUA’s warning raises more concerns about the role that the USDA and FDA will have in the continued growth of the CBD industry. Based on the statements made in this guidance, we would expect that national banks will take a closer look at CBD companies and possibly stop all services until the FDA adopts regulations.

A more likely ending may be that CBD begins to look a lot more like the cannabis industry.

Vape Product Manufacturers Pose a Huge Risk to Cannabis Brands

The New York State Department of Health issued a health advisory to inform state residents that using vaping products that contain THC can be dangerous. New York indicated that ten (10) residents between the ages of 18 - 49 were hospitalized after they used vaping products that contained THC and other substances. New York is working with the Center for Disease Control (CDC) to investigate the causes.

The CDC reports that there are potentially 94 cases in 14 states that occurred from June 28, 2019, to August 15, 2019. Cases are being reported in Wisconsin, Illinois, California, Indiana, and Minnesota primarily in teenagers and young adults. The CDC indicates that there is no conclusive evidence that an infectious disease is causing the illnesses.

In April 2019, the Michigan Marijuana Regulatory Agency announced that it found lead in vape cartridges during testing. Michigan warned consumers of the risks associated with vaping and cited a study on the dangers of e-cigarettes conducted by the John Hopkins Bloomberg School of Public Health. The study indicates that chronic use of a contaminated e-cigarette can cause lung, liver, immune, cardiovascular and brain damage. The study tested the e-cigarette devices of 56 daily users, including the e-liquid and aerosol, for heavy metals. Researchers found heavy metals in the aerosol produced by e-liquid heated through coils. Almost half of the samples contained lead concentrations that were higher than the health standards issued by the Environmental Protection Agency.

It is clear that e-cigarettes and vaping products will be heavily regulated in the near future. The FDA’s Acting Commission, Ned Sharpless M.D., issued a statement in July on its efforts to regulate the e-cigarette market including the issuance of recommendations that require manufacturers to consider factors when designing an e-cigarette including how the e-liquid is heated, the aerosol is generated and transmitted to the user.

Brand building is the name of the game in the cannabis industry right now. Companies are developing recipes, products and marketing materials that are designed to win over consumers. One of the biggest risks for a brand is an event that will hurt its image or reputation such as a recall or consumer safety issue. Given the recent health reports, cannabis companies should take steps to ensure vaping products are safe for consumers.

Cannabis manufacturers that produce vaping cartridges or other vaping products and retailers should take the following steps:

  • Perform a third-party risk assessment on the vaping product supplier. The risk assessment should identify whether the supplier is in compliance with the FDA’s recommendations for responsible manufacturers and whether the design of the vape product may cause lead contamination or other safety issues.

  • Ensure that effective health and safety procedures are used for the extraction of THC products and in the cartridge filling process.

  • Test the vaping products and cartridges thoroughly for contaminants in the device and the aerosol.

  • Require the supplier to notify you before it makes changes to the design or materials used in manufacturing the vaping products.

  • Request research related to the safety of products safety and any possible risks.

  • Document the rationale for determining that the vaping product is safe and routinely test to ensure that the controls are still effective.

Companies that are developing brands should ensure that appropriate due diligence is performed for all suppliers that can impact the company’s operations or reputation. The review should occur on a periodic basis, and auditing rights will help ensure that the vendor’s representations are accurate. By vetting suppliers, companies can ensure the brand’s integrity and reputation.

New State Hemp Laws Will Challenge Expansion of National CBD Brands

The 2018 Farm Bill was expected to open the CBD market and provide legal certainty that CBD was not cannabis. The victory was short. The state’s implementation of the 2018 Farm Bill and the FDA’s stance on CBD has increased the regulatory risk associated with the inter and intrastate sale of CBD products.

The 2018 Farm Bill and the FDA left it to the states to figure it out the next steps in developing a retail CBD market. This state-by-state approach has made a complicated situation even more complicated.

As each state enacts legislation to implement the 2018 Farm Bill, the state regulators and law enforcement agencies are left to struggle with how CBD should be classified and regulated. The good news is that the states are affirmatively asserting positions with regards to the legal sale of CBD oil. The bad news is that the answers vary greatly with little uniformity from state-to-state. The end result is a patchwork that prevents a national approach to the manufacture and distribution of CBD products.

We have analyzed each state’s requirements with regards to the retail sale of CBD products. Some states treat CBD as cannabis, as they have assumed the FDA’s position that it is a drug, and require the products to be sold through dispensaries. Other states require that the retail stores selling CBD and the products be registered with the state. Finally, some states permit the legal sale of CBD products without restrictions.

It is clear that CBD manufacturers and retailers will soon be subject to numerous additional regulations related to manufacturing standards, testing and packaging, and labeling. This next year will be a challenge for national brands that are aggressively seeking market share.

We have provided summaries below of how 9 different states are currently regulating the retail sale of CBD products.

California: California assumes the FDA position on CBD, which legislation is expected to change during this legislative session. CBD may only be purchased from a cannabis dispensary and may not be added to food or beverages.

Texas: There are significant limitations on the importation, manufacture, and sale of consumable hemp products including CBD. Texas will not permit CBD to be manufactured in the state until the hemp plan is approved by the USDA. Retail stores may continue to sell CBD that was in its inventory prior to the effective date of the Department of Health’s rules. Imported CBD must be manufactured in accordance with the state’s hemp plan that has yet to be approved by the USDA

Kentucky: Hemp-derived CBD products are legal in Kentucky pursuant to 40 KRS 218A.010(27)

Louisiana: Retailers must register with the Louisiana Office of Alcohol and Tobacco Control and comply with packaging and labeling requirements.

Maine: Maine enacted legislation that allows CBD to be added to food and beverages in the state.

Nebraska: The Nebraska Hemp Farming Act removed hemp extracts from the state’s Controlled Substance Act. The state’s attorney general has not updated prior opinions. The state is still analyzing the impact of the new legislation on the retail sale of CBD oil.

North Carolina: The sale of smokable hemp is prohibited as it is considered to be marijuana. The state sent a letter to manufacturers and retailers in February indicating that it assumes the FDA’s position on CBD and considers it a drug that may not be added to human food or animal feed.

Ohio: The possession of CBD oil is illegal unless purchased from a medical marijuana dispensary. Retail sales are limited to medical marijuana dispensaries.

South Carolina: Attorney General issued an opinion that questions the retail sale of CBD. Stores are pulling CBD products due to raids as a result of AG’s opinion.

Will the FDA's Response To Curaleaf Set the Standard for On-Line CBD Sales?

The Food and Drug Administration issued a warning letter to Curaleaf, Inc. to stop selling CBD products that are unapproved and misbranded drugs within 15 days. The FDA reviewed Curaleaf’s social media accounts during April and June 2019, and determined that the products were “intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease and/or intended to affect the structure or any function of the body.”

Curaleaf sold the CBD products, including a lotion, pain-relief patch, tincture and disposable vape pen on its own website as well as Twitter and Facebook, which the FDA considered to be interstate commerce. Curaleaf updated its Facebook cover photo a day after receiving the letter to remove products that included words on the label that reflect an effect on the body such as relieve, revive, and uplift. However, these photos are still available in the archives and in the Facebook feed.

Curaleaf, Inc. is a public company that is listed on the Canadian Stock Exchange and can be purchased by US investors on the OTC market. In its response to the FDA on July 26, Curaleaf indicated that the company was in the process of reviewing its social media sites and that the company discontinued the products in question. Curaleaf’s stock has rebounded after initially falling to close at $7.40 on July 23, 2019.

The FDA is clearly making a statement by issuing a warning letter to such a large industry player. The question is whether the FDA will be satisfied with the steps Curaleaf has taken. This is a big risk with significant ramifications for the company. The FDA’s stance will set the standard in the CBD industry for what will be considered acceptable online marketing standards. The industry will be holding its breath.

What the Senate Banking Hearing on the SAFE Banking Act Really Means

The Senate Banking Committee held a hearing on July 23, 2019, on the lack of financial services available to the cannabis industry and the challenges this creates. The hearing shifted the conversation around cannabis at the federal level to one of support and concern. The Chairman of the Senate Banking Committee, Senator Crapo who is a Republican from Idaho, opened the hearing with a statement that voiced his concern that federal regulators are choking off the ability for lawful businesses, such as the cannabis industry, to obtain banking services.

Senator Cory Gardner from Colorado and Senator Jeff Merkley from Oregon spoke about the safety issues that exist in their states that are caused by the lack of banking services. Senator Gardner stated that the situation is untenable as hundreds of millions of dollars in cash are being driven in cars through the state.

The Senators also focused on the individual hardships faced by industry employees including the loss of bank accounts, credit cards the inability of cannabis employees to obtain a mortgage. The hearing also highlighted the impact on ancillary service providers such as plumbers, electricians, and union members.

Both Senators demanded that the federal government respect the state’s rights to develop a lawful cannabis industry. Senator Cory Gardner thoughtfully stated that the federal government must recognize the majority of citizens support cannabis and it is the one issue that the country can unite around. Senator Gardner remarked that we are a government of the people and the people have changed their point of view with regards to this issue. 

The tone of the hearing along with sentiment expressed in Senator Crapo’s statement reveal that Congress is finally listening. The tables may be turning in a positive manner for the cannabis industry.

So what is the SAFE Banking Act and how will it help the cannabis industry?

Under the Act, banks can provide financial services to the cannabis industry, and federal regulators may not initiate an action against the bank because cannabis is classified as a Schedule 1 drug. The banking regulator, FinCen, must also revise guidance to the banks within 6 months of the law’s effective date as to the type of activity a bank should report to it as suspicious or indicative of money laundering.

The SAFE Banking Act is a great start to bringing the cannabis industry into the mainstream commercial market. The devil will be in the details as to how federal regulators will treat the legacy money that will be brought into the banking system. Cannabis businesses should ensure to have appropriate documentation as to the origin of all investments and revenues. All new investments should be vetted to ensure that an audit trail exists to demonstrate that the money is derived from legal sources.

The Senate Banking Hearing was remarkable in that both sides of the aisle appear to be uniting around cannabis. Republicans will have a hard time arguing that state rights don’t matter. Democrats will be able to provide their constituents with a win that has been in the wings for a long time. A remarkable outcome in a contentious political environment.

What Does Public Data Reveal About the Medical Cannabis Industry?

Medical cannabis programs are expanding as state regulators increase the number and types of conditions that qualify persons for medical cannabis, especially in that states that approve anxiety or general pain management as qualifying conditions. As the number of patients increases, the production and sales capacity required to meet this demand must also expand. Recently, New Jersey announced that it was accepting applications for new dispensaries and cultivators. Missouri will also begin to accept applications on August 3rd.

State regulators utilize various licensing strategies to control the implementation and growth of the medical cannabis industry. The state licensing strategies can be 1) a vertically integrated approach used by Florida (recently deemed unconstitutional), 2) state-level license caps (Illinois, New Jersey, Utah) or 3) city-level license caps (Michigan). License caps are maintained through legislation or by limiting the time period during which the state will accept applications.

State regulators often provide transparency about the overall growth of the medical cannabis market and the competitive landscape. State websites make available information about the total market size (patients and caregivers), the number of competitors (dispensaries and cultivators), retail sales numbers, and tax revenues if applicable.

This information can be used by prospective licensees to assess the viability of the cannabis business and determine future revenues. Medical licenses in states with caps on production and sales can be more valuable given the higher patients per license than those that allow open enrollment and caregivers such as Oklahoma and Michigan.

For example, a review of information from a limited number of states with medical cannabis programs shows that Oklahoma has the highest patients per capita at 3.9% as compared to the state with the lowest patients per capita, Ohio, at 0.30%. Although Oklahoma has a high patient percentage rate, it has no cap on the number of manufacturing or retail operations. As a result, the state has 1,673 licensed dispensaries and 3, 559 licensed cultivators. This means that there are currently 92 patients per dispensary if all licensed dispensaries become operational.

Believers in the free market will approve of Oklahoma’s strategy to let the market decide the appropriate level of inventory and sales outlets in the state. The low fees and reasonable regulations made Oklahoma the wild west of cannabis. However, Oklahoma license holders will need plenty of capital to face off the heavy competition and the steep cost of building out cannabis businesses. Even if Oklahoma adopts adult-use, the total population is almost 4 million people, which is much smaller than Michigan, another state with no cap, which has a population of 10 million people. Michigan may have more upside but it is challenging to find a city that will permit a medical dispensary.

Oklahoma’s record number of cultivators also poses a risk of diversion to other states as a means of recouping the investment. Oregon is facing this issue as the state has 6.5 years of inventory. Cannabis business owners will need appropriate controls to ensure that excess inventory is disposed of in a legal manner. Dispensaries and cultivators will need to assess what impact an inventory glut will have on cannabis pricing and overall profitability as the ability to sell cannabis to a nearby state requires federal legalization.

The transparency provided by state regulators is crucial for the industry, and for the remaining states that will enact medical cannabis programs in 2020. Analyzing the available data can help firms increase returns on capital investment, and provide states with a roadmap for the implementation of a successful industry.