Colorado Issues Guidance on Public Company Ownership Ahead of Rulemaking

The Colorado Department of Revenue announced that it will release proposed rules in early August to implement HB 19-1090, which allows publicly traded companies, and unlimited investors from outside of Colorado, to invest in and own marijuana businesses as of November 1, 2019. Until that time, the state regulator also released guidance on prohibited and permitted capital raising transactions.

House Bill 19-090 repealed the ban on investors in marijuana businesses that are publicly traded companies, as well as the 15 person limit on the number of out-of-state investors. The new law is complex and requires companies to disclose information about controlling beneficial owners, indirect financial interest holders, and affiliates. Colorado’s cannabis regulator must evaluate whether these entities qualify as a suitable license holder.

Below are some key highlights on the guidance provided prohibited and permitted transactions ahead of the November 1, 2019 effective date.

Prohibited Transactions:

  • Licensees may not enter into agreements that would result in a transfer of ownership or trigger the submission of an application to the state as required under HB 19-090 including transactions with public companies or transactions that require disclosures and suitability determinations for passive beneficial owners or indirect financial interest holders. Entities may enter into a letter of intent or other non-binding agreement to engage in a transaction after November 1, 2019. The licensee may not accept a deposit or other form of payment under the agreement.

Permitted Transactions:

  • Licensees may raise capital from passive financial beneficial owners or other indirect financial interest holders that falls below the disclosure and suitability approval limits. Licensees are required to use reasonable care to ensure that the financial beneficial owners and indirect financial interest holders are not prohibited from holding a license. Colorado’s proposed rules outline a process that licensees must use.

Colorado Bill Allows Publicly Traded Companies to Own Marijuana Businesses

Colorado House Bill 19-1090 would allow publicly traded companies, and unlimited investors from outside of Colorado, to invest in and own marijuana businesses. If enacted, the new law would provide much needed capital to the rapidly maturing industry that is not available through traditional financing means.

House Bill 19-090 repeals the ban on investors in marijuana businesses that are publicly traded companies, and repeals the 15 person limit on the number of out-of-state investors. The proposed amendments require controlling beneficial owners to make certain disclosures, and proposes a process for the cannabis regulator to evaluate the suitability of these investors.

Below are some key items about HB 19-1090 that cannabis businesses should consider when publicly commenting on the proposal.

  • Publicly traded companies and non-public investors should carefully review the bill as it provides the Colorado cannabis regulator with significant flexibility. Public companies must disclose officers, directors and controlling beneficial owners. Non-public companies must also disclose passive beneficial owners. The cannabis regulator may require a disclosed person to undergo a suitability evaluation before an application is filed. The bill should be amended to include concrete factors that the cannabis regulator uses during the suitability determination, and the bill should incorporate an appellate process.

  • Controlling beneficial owners may be prohibited from becoming a licensee and are subject to additional obligations. A controlling beneficial owner is a person that owns 10% of the stock in the marijuana business. The legislation does not indicate why the 10% ownership threshold is indicative of control. The 10% threshold should be (1) increased to the standard 25% beneficial ownership of outstanding securities in a licensed marijuana business, and (2) the threshold should be calculated on the basis of voting power. A 25% beneficial ownership threshold is currently used by the securities regulator FINRA to evidence of control of a broker-dealer. However, only voting shares are used as that is the power to direct the business. The legislation should also be clarified to ensure the ownership threshold only applies to a licensed marijuana business.

  • A controlling beneficial owner may be prohibited from holding a license if he / she is a bad actor under Rule 506(d) of the Securities Exchange Act of 1933, as amended. The SEC applies this “bad actor” analysis to control persons or those soliciting investment funds. A control person under Rule 506(d) is a beneficial owners that hold 20% of the voting stock. The bill should make clear that, for purposes of the bad actor analysis, only beneficial owners that own at least 20% of the voting stock will be covered by this provision.

  • A risk of integrating the federal securities law requirements into the current bill is that the cannabis regulator may use different interpretations. The bill should simplify by removing unnecessary references to the federal securities laws or indicate that federal interpretations apply. For example, the amendments allow the state cannabis regulator to use a licensee’s recorded information such as sales and inventory to investigate whether a violation of securities laws occurred. We recommend a revision that would require the cannabis regulator to refer such matter to the Colorado State or US Federal securities regulators.

  • The amendments require publicly traded company to provide the cannabis regulator with all SEC and regulatory filings and provide general obligations with regards to the securities. Again, the legislation should specify the cannabis regulator’s authority with regards to the receipt of the information, and prevent the cannabis regulator from becoming of a quasi- securities regulator.