The Executive Order to Reschedule Cannabis: Implications for Businesses and Financial Institutions

Introduction to the Webinar

Welcome and Guest Introductions

• The host welcomes attendees and introduces the topic of discussion, emphasizing the importance of the upcoming conversation.

• Bob Hoben is reintroduced following a previous webinar, highlighting his expertise in cannabis law and recent developments since the December 18th executive order.

• Suiko, a cannabis law attorney with experience as an operator, is introduced. His unique perspective will contribute to discussions on cannabis regulation.

Housekeeping Details

• The session will last approximately 45 minutes, followed by a 15-minute Q&A segment for audience questions.

• Attendees are instructed to submit questions via the Q&A button rather than the chat feature for better organization.

Guest Backgrounds

Bob Hoben's Experience

• Bob discusses his extensive background as a pioneer in cannabis law, having founded one of the first dedicated cannabis law firms.

• He transitioned from practicing law to working as a fractional executive for international cannabis companies and co-founding Serust, focusing on credit ratings and banking compliance in the industry.

Suiko's Professional Journey

• Suiko shares his recent role at Cogent Law and his prior experience operating an outdoor cultivation facility in Massachusetts.

• He emphasizes his hands-on experience in building businesses within the cannabis sector, providing valuable insights from an operator's perspective.

Discussion on Cannabis Banking

Financial Regulation Insights

• The host introduces their own background as a financial regulator who has worked with banks offering services to cannabis businesses since 2014.

• Key areas of focus include helping banks start or expand their cannabis banking programs while ensuring compliance with regulations.

Executive Order Discussion

Overview of December 18th Executive Order

• The conversation shifts towards discussing President Trump's executive order regarding marijuana reclassification under federal law.

Cannabis Medical Efficacy and Rescheduling Efforts

Overview of Executive Order on Cannabis

• The executive order marks a significant effort to reclassify cannabis, the first since Nixon's administration in 1971. It acknowledges the medical efficacy of cannabis.

• A comprehensive memorandum from HHS recognizes scientific merit, suggesting that cannabis should no longer be classified as Schedule I, which indicates high potential for abuse with no medical benefit.

Process of Rescheduling Cannabis

• The president lacks unilateral authority to reschedule cannabis; it requires Congressional action or an administrative process initiated under the Biden administration.

• The process involves publication in the Federal Register, followed by a statutory period before hearings conducted by an Administrative Law Judge (ALJ).

Implications of the Executive Order

• The order aims to reschedule marijuana from Schedule I to Schedule III and suggests that CBD products should be reimbursed through Medicare for older Americans.

• It also calls for assessing all safe hemp derivatives, potentially leading to new regulations regarding hemp beverages.

Current Status and Future Considerations

• While the executive order does not immediately change marijuana's classification, it expedites the ongoing administrative process involving relevant agencies like HHS and FDA.

• This is only the second time in U.S. history that the government has recognized cannabis's medical benefits publicly.

Predictions and Strategic Planning

• There is uncertainty about when rescheduling will occur; however, there is optimism about its likelihood. Stakeholders are advised to prepare for both scenarios—rescheduled and non-rescheduled frameworks.

• Understanding distinctions between Schedule III regulations versus existing frameworks is crucial for companies regarding valuations, financial disclosures, and operational strategies.

Cannabis Rescheduling and Legislative Implications

Overview of Current Contracts and Agreements

• Discussion on the prevalence of brand licensing agreements, manufacturing, and toll processing contracts in the cannabis industry.

• Mention of Internal Revenue Code 280's implications if cannabis is rescheduled to Schedule 3, which would provide relief as it currently applies only to Schedule 1 and Schedule 2 substances.

Political Landscape and Predictions

• Inquiry into the likelihood of the rule-making process proceeding; optimism expressed regarding its advancement.

• Notable bipartisan agreement between President Biden and former President Trump on cannabis rescheduling, highlighting its political significance.

• Analysis of Biden's actions as both a policy step forward for the cannabis industry and a potential electoral strategy ahead of midterm elections.

Administrative Process Insights

• Explanation of the administrative pathway for rescheduling: publication in the Federal Register followed by an ALJ hearing.

• Anticipation that legal challenges may delay implementation despite expectations for progress within four months.

Executive Orders and Hemp Industry Considerations

• Clarification that there will be no new comment period following previous feedback favoring cannabis rescheduling; focus shifts to next steps in the process.

• Reference to executive orders directing continuation of prior rule-making efforts related to hemp definitions, indicating ongoing legislative attention.

Challenges Facing Hemp Legislation

• Discussion on controversial aspects surrounding hemp versus marijuana regulations; acknowledgment of lobbying efforts influencing executive orders.

• Highlighting impending legislation that could restrict hemp extracts, with potential lawsuits anticipated if political solutions are not reached before enforcement begins.

Understanding Schedule 3 Implications for Marijuana Operations

Compliance Challenges in New York

• The discussion begins with a focus on how marijuana operations, particularly in states like New York, can comply with Schedule 3 regulations. The speaker questions the feasibility of compliance for dispensaries compared to cultivators and manufacturers.

Contextual Complexity of Regulations

• It is noted that while cultivators and manufacturers may find it easier to register as Schedule 3 operators with the DEA, dispensaries face significant challenges in fitting into this framework.

Impact of Internal Revenue Code 280E

• The conversation highlights that the primary impact of changes related to marijuana regulation revolves around Section 280E of the Internal Revenue Code, which affects tax liabilities for cannabis businesses operating outside federal law.

Federal Legality and Operational Risks

• Despite potential changes, any operation outside the DEA/FDA framework remains federally illegal. This raises concerns about operational risks and liabilities associated with deferred taxes under Section 280E.

Banking Perspectives on Cannabis Operations

• The implications of Section 280E extend into banking discussions, where operators struggle with cash flow due to tax liabilities. Many are not paying their tax obligations, complicating financial operations within the industry.

Hemp Industry Conundrum

• The complexities surrounding hemp banking are discussed, emphasizing that banks initially viewed hemp as less risky but now face challenges due to regulatory uncertainties affecting infused hemp products.

Future of THC Products in Retail Spaces

• A critical point is made regarding THC-infused beverages; they cannot be sold through conventional retail outlets unless they meet specific medicinal use criteria. This limits market access for certain products derived from hemp.

Legislative Efforts and Industry Needs

• Current legislative efforts aim to extend deadlines related to hemp product regulations. Farmers require clarity and support to continue producing compliant products essential for various consumer goods in the market.

This structured overview captures key insights from the transcript while providing timestamps for easy reference back to specific parts of the discussion.

Implications of Cannabis Regulation Changes

Overview of Schedule 3 Substance Regulations

• The transition of cannabis from a Schedule I to a Schedule III substance has significant implications for its production, sale, and regulation.

• This change could lead to practical benefits in areas such as bankruptcy, banking, and lending within the cannabis industry.

Impact of Section 280E on Cannabis Operators

• Currently, cannabis operators cannot take ordinary business deductions due to Section 280E, affecting their financial statements and cash flow.

• If Section 280E is repealed or modified under the new regulations, operators may gain the ability to deduct expenses, potentially improving their financial health.

Tax Implications and Operator Behavior

• There is skepticism about whether operators are currently paying taxes; many accountants advise treating tax liabilities as unfunded future obligations.

• Some larger multi-state operators reportedly owe substantial back taxes (around half a billion dollars), while smaller dispensaries appear more compliant with tax payments.

Banking and Lending Opportunities

• Interest from banks and credit unions in lending to cannabis businesses is increasing; this could create a more competitive environment for financing.

• Current high-interest rates (20%+) from private lenders are unsustainable for many cannabis operators; there’s hope that traditional banks will offer better rates.

Future of Commercial Lending in Cannabis Industry

• Banks need to determine their comfort level with lending to the cannabis sector; successful depository services alone won't sustain them financially.

• Refinancing high-interest loans could significantly benefit the industry by lowering costs for operators. Platforms like Seust aim to mitigate risks associated with commercial lending in this space.

Commercial Lending and Financial Tools in Cannabis Industry

Overview of Financial Tools

• Discussion on evaluating candidates for commercial lending based on financial health, highlighting the robustness of specific programs like Seat Trust.

Banking Compliance and Credit Risk

• Emphasis on the dual focus of banks: compliance with regulations and assessing credit risk, which is crucial for lending decisions.

Tax Liabilities and Agreements

• Insight into tax liabilities related to tolling, manufacturing agreements, brand royalty agreements, and their implications under sections 280E and 471/263A.

Impact of Brand Royalties on Profitability

• Analysis of how brand royalties can significantly affect net profit margins; a $16 million revenue example illustrates potential profit differences due to accounting practices.

Regulatory Perspectives on Cannabis Banking

• The importance of maintaining good relationships with regulators; better valuations from cannabis bankers can enhance regulatory satisfaction.

Understanding Section 280E's Implications

Operator Perspective on Rescheduling

• Operators need to consider how lifting section 280E will impact their financial reporting and overall business structure.

Challenges in Financial Reporting

• The disconnect between GAP compliant financial statements and actual operational costs such as brand royalties complicates investor disclosures.

Strategies for Managing Tax Liabilities

• Many companies adopt a wait-and-see approach regarding audits, leading to higher tax liabilities than available cash; careful planning is essential.

Structuring Deals Post-280E

• Recommendations for restructuring deals involving brand royalties to improve financial clarity once section 280E is lifted.

Understanding Deal Structuring and Its Implications

The Importance of Simplifying Deal Structures

• Simplifying deal structures, such as focusing on net sales, allows for easier calculations compared to assigning values to each raw material, which complicates cost assessments and revenue tracking.

• A simplified approach aids in resolving disputes regarding contract terms, making operational tracking and financial reporting more manageable.

Financial Reporting and Valuation Considerations

• The implications of simplifying deals can enhance accounting perspectives, potentially leading to improved company valuations by making financial data more comprehensible.

• It is crucial to consider factors beyond 280E regulations, including bankruptcy risks and access to capital markets, which significantly impact banking relationships.

Banking Perspectives on Cannabis Legislation

• A question arises about whether the movement towards Schedule 3 makes it more likely for safe banking legislation to pass. There are conflicting views on this momentum's urgency.

• Some believe that the current trajectory supports the passage of safe banking acts; others argue that urgency has diminished due to recent developments.

Legal Risks in Banking Cannabis Operations

• The speaker expresses skepticism about the perceived legal risks associated with banks serving cannabis businesses, noting a lack of prosecution history against banks or credit unions in this context.

• Historical evidence suggests minimal risk for banks involved in cannabis banking; regulatory compliance can actually support law enforcement efforts through proper reporting mechanisms.

Challenges in Legislative Progress

• The discussion highlights three circles of risk: compliance/BSA risk, reputational risk (considered small), and legal risk related to commercial lending practices.

• Despite previous optimism about the Safe Banking Act passing, ongoing legislative stagnation raises doubts about future progress.

• The Senate has consistently been a roadblock for cannabis-related legislation despite multiple House approvals; changes within party leadership may influence future outcomes.

Economic Implications of Cannabis and Psychedelics

Discussion on Legislative Dynamics

• The likelihood of legislative progress in the Senate is higher, despite its elite nature, as members may align with presidential interests.

• Acknowledgment of time constraints leads to a shift towards addressing audience questions.

Lessons from Cannabis for Psychedelics

• Inquiry into what lessons from cannabis legislation can be applied to psychedelics, especially in New Jersey where recent laws have been enacted.

• The speaker suggests that psychedelics reform will likely follow the trajectory set by cannabis reform.

Distinctions Between Industries

• The speaker emphasizes that the psychedelics industry differs significantly from the marijuana industry, likening them to "apples and oranges."

• Psychedelic models focus on therapy and service provision rather than product sales, which aligns more closely with FDA standards compared to cannabis legislation.

Financial Implications and Industry Overlap

• Discussion on financial implications for industries beyond growers and dispensaries, such as psychedelic guides using cannabis in their practices.

• Noted rapid momentum around psychedelics following cannabis legalization indicates strong political will and public interest, particularly regarding PTSD treatment for veterans.

Banking Challenges in Psychedelic Sector

• Current banking institutions are not engaging with the psychedelic industry; there is no mention of banks discussing financing options for this sector yet.

• Anticipation of a long wait for federal regulatory frameworks that could facilitate banking services within the psychedelic space.

Legislative Updates on Cannabis Rescheduling

• Recent Senate actions include removing amendment language related to President Trump's executive order on rescheduling cannabis; implications remain uncertain amidst potential government shutdown discussions.

• Commentary reflects ongoing political maneuvering among Republicans regarding prohibitionist policies and their impact on future legislation surrounding cannabis reform.

Discussion on Cannabis Policy and IRS Liabilities

Conservative Republican Influence on Cannabis Legislation

• The speaker discusses the conservative Republican mentality regarding financial or policy changes, indicating that there will be numerous amendments proposed by Republicans in the spending bill.

• Reference to Mitch McConnell's successful inclusion of a hemp ban in previous legislation highlights the political maneuvering involved in cannabis policy.

Rescheduling Process for Marijuana

• The speaker predicts that the rescheduling process for marijuana will begin in late spring but may face delays due to litigation or procedural issues.

• Even if marijuana is rescheduled to Schedule III, subsequent litigation from anti-cannabis politicians is expected, indicating ongoing challenges ahead.

Future Projections and Political Dynamics

• The speaker expresses confidence that significant movement regarding cannabis policy will occur by 2026, despite potential delays.

• Discussion about the current administration's top-down influence suggests that Trump's decisions heavily impact GOP members' alignment with cannabis policies.

IRS Liabilities Post-Rescheduling

• A question arises about advice for operators facing substantial IRS liabilities after potential rescheduling; cash flow management is emphasized as crucial for success in cannabis operations.

• Operators are advised to negotiate directly with the IRS regarding disclosed liabilities, highlighting the importance of understanding one's financial situation.

Implications of Section 280E

• Clarification that there is currently no proposal suggesting retroactive relief from Section 280E tax liabilities following rescheduling; operators should not expect immediate changes.

• Mention of MSOs like True Leaf challenging IRS taxation under 280E indicates some progress has been made, though specifics remain complex and require legal guidance.

Cannabis Industry Insights and Legal Considerations

The Complexity of Retroactive Relief in Cannabis Law

• A cogent argument against retroactive relief for Schedule III cannabis is presented, emphasizing the lack of clarity in legal practices surrounding this issue.

• Small operators seeking retroactive relief face competition from larger operators who have significantly more at stake, potentially involving hundreds of millions to billions of dollars.

• Large companies could leverage financial gains from tax relief to expand internationally or consolidate operations across the U.S., highlighting their substantial stakes in these legal matters.

Tax Implications and Legal Advice

• Henry Wikowski, a notable lawyer in the Bay Area, successfully litigated against the IRS regarding cannabis taxation and identified exceptions under Section 280E related to Cost of Goods Sold (COGS).

• Operators should carefully model their 280E tax liabilities when entering manufacturing agreements to avoid overlooking significant financial implications that could affect their business economics.

Risk Management for Financial Institutions

• Financial institutions are advised to maintain strict loan limits concerning cannabis-related deposits and loans as part of risk management strategies.

• Regulators expect banks to demonstrate reasonable limits on cannabis exposure within their portfolios, even though no specific regulations dictate these limits.

Future Outlook on Cannabis Rescheduling

• Skepticism exists regarding potential movement towards rescheduling cannabis by 2026; however, there is optimism about progress despite anticipated litigation hurdles.

• Political dynamics may influence timelines for rescheduling efforts, with concerns that actions taken might be politically motivated ahead of elections.

Closing Thoughts on Cannabis Banking

• The discussion concludes with an emphasis on the importance of understanding executive orders related to cannabis banking and ongoing developments in legislation affecting the industry.