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Cannabis Advocates Warn NY Regulator to Avoid Mistakes of New Jersey, Oregon

By:
Chris Gaetano
Published Date:
Nov 8, 2019
As New York continues to progress down the path of legalized adult-use cannabis, advocates from New Jersey and Oregon warned the governor's assistant counsel overseeing policy development in this area to use the benefit of hindsight and avoid the mistakes their own states made. 

Speaking on a panel at the Foundation for Accounting Education's Cannabis Conference on Nov. 6, Axel Bernabe, assistant counsel  to New York Gov. Andrew Cuomo for health, noted that cannabis businesses have significant problems accessing capital, at least partially due to banks that are hesitant to deal with them as a result of the federal prohibition on the product. Elana Tamas, a tax senior at Anchin Bloch & Anchin, moderated the panel, which focused on banking and operations. While adult-use recreational cannabis is not yet legal in New York, Bernabe said that he has already seen these problems in both the medical marijuana and hemp sectors, both of which currently are legal in the state. 

In order to ameliorate these issues, Bernabe said the state Department of Financial Services has already issued guidance that he said would provide as much of a safe harbor from state provisions and prosecutions for anyone who wanted to provide banking services to cannabis businesses within New York. He said the government is also working with state-chartered banks and credit unions to help them engage more in the sector, which he said has been a "limited success" so far. 

But he said he also understands, from observing other states that have legalized cannabis, that there are great challenges for "traditional legacy operators, or women and minorities or communities disproportionately impacted by the War on Drugs to benefit from participating in the market." These challenges includes matters such as getting licenses, but also reinvestment of tax revenue. With this in mind, he said that social equity is going to be one of the core pillars of New York's program. 

To this end, the legislation he is helping craft would limit the number of growers and dispensaries, as well as introduce a three-tier system, similar to the one in Washington state, so that growers and wholesalers cannot own dispensaries in order to prevent vertical integration and retain local community control. He also said that the program takes a decided interest in providing incubation for fledgling businesses in order to train people on how best to deploy their capital. 

Another panelist, Katye Maxson-Landis, founder and managing partner of Oregon's Moxy Accounting, asked whether New York intends to allow outside investment into the sector. She noted that his plan revolves around making the sector economically viable in order to attract investment while, at the same time, promoting social equity among marginalized populations. But she said that Oregon's experience with allowing outside capital has mainly resulted in the former overtaking the latter. While at first Oregon wanted to rely entirely on local capital and investment, the government realized that "there was no way this would get off the ground, and allowed this investment." 

"It diluted the equity capacity for made-in-Oregon and Oregon people to own their own business. Even though they technically were the license-holders, that money wiped equity off the table in a lot of ways," she said. 

While Maxson-Landis acknowledged that that New York has a lot more internal capital than Oregon, which might make the point moot, she advised Bernabe to keep her state's experiences in mind. 

Bernabe said, "That's a fair comment," but he added that "there is no intent to limit either publicly traded companies or out-of-state funds to come into the state." He noted that the prohibition on vertical integration can go a long way in heading off what happened in Oregon. At the same time, he acknowledged the challenges of coming up with a model that allows direct investment in dispensaries with local owners maintaining majority control of their own businesses, versus simply becoming franchisees to outside investors. He conceded that "we haven't cracked that, but that shows we're thinking about it." 

Maxson-Landis said the state might consider prohibiting these outside investors from owning more than 51 percent of the business, but Bernabe said it's easier to get around those sorts of restrictions than might be readily apparent. He has seen business models where a venture capital fund sets up dispensaries with only a 20 percent stake in each of them. While technically the dispensaries retain most of the equity control, actual control is more than just who owns what. 

"They have management service agreements with that dispensary, real estate agreements, branding agreements, and by then they've paid the owner a nominal sum, a fair sum, that looks good on paper but all the value is flowing back up from that dispensary to the venture capital. So we have to watch for that stuff," he said. 

He added that the state is also looking to use these outside investors to help local businesses through instituting a fund that will provide low-to-no-interest loans to social equity licensees. These "multistate operators with deeper pockets" will contribute to this fund as a condition for participating in New York's adult-use and medical market. 

Attorney Jessica F. Gonzalez, co-founding partner of Moyeno Gonzalez & Associates, noted that besides the plan itself, policymakers should be aware of who can afford to follow it. New Jersey does gives licenses to vertically integrated companies, and the result has been that of all of these licenses awarded by the state, "not a single one was from New Jersey." Part of the problem was the application process itself. The government required companies applying for a license to provide three years of audited financial statements, which she said "obviously" no startup actually has. This meant that the only ones that were able to do so were outside multistate operators, mainly Canada-based companies. 

"This route should not be happening, especially when the expectation is we want diversity and we want New Jersey residents and that's what we screamed at the top of our lungs for months, and none of those companies really fit the bill," she said. 

While the state has responded to those concerns by mandating that 15 percent of licenses must come from minority-owned businesses and 15 percent from either woman-owned or disabled veteran-owned companies, she was worried about how much impact this would have, as she has witnessed attempts to game the certification process. 
"The problem is you have to be certified by your state as a minority-owned or woman-owned company, and what I see is a lot of men are putting their wife on it to try and get those points. So I'm having a lot of issues with this, and am quite worried that when these percentages start coming in, I'm worried a lot of these companies who will be certified, the makeup won't be accurate," she said. 

She added that another attempt to rectify this issue in New Jersey is the issuance of "micro-licenses" which go to businesses with no more than 10 employees and 2,500 square feet of space; that do not process or cultivate more than 1,000 plants; and have 100 percent New Jersey ownership with 50 percent employed from the municipality they're operating from. However, the presence of the large multistate operations, combined with the growth restrictions placed on micro-license holders, means these businesses are rarely, if ever, sustainable and amount to a mere token effort. 

"They're telling all these minority and woman-owned companies, dangling these micro-licenses, and saying here's your way in, but the problem is I have not seen, and I'm not sure whether there has been, any sort of evidence whether these micro-licenses are even profitable. So what I'm seeing is these large multistate operations get the verticals or get full licenses, and then minority and women are really kind of being pigeonholed in these micro-licenses while there's still no evidence these are feasible," she said. 

Maxon-Landis said there are similar issues with micro-licenses in Oregon. In contrast to New Jersey, she said, micro-license holders in her state are able to go seamlessly back and forth between standard and micro-licenses in response to market conditions. She said she's seen growers respond to oversupply by dropping to the micro level to pay less in licensing fees and produce less as a way to manage expenses. A problem, however, is that not all micro-licensees are the same: there are the ones that are genuinely small local businesses, and then there are the ones backed by outside capital which insulates them from the problems experienced by the first group. The latter can quickly move out of the micro category, while the former cannot. 

"Those people doing well have out-of-state groups come in with those out-of-state investments and double in size because they're using other people's money: they still have a tax problem, they still have a cash flow problem, they still are paying tax on their expenses, but they're using other people's money to do it, so they run the game differently," she said. 

Gonzalez noted that determining who even gets that investment money, when there isn't access to banking services, can come down to race or gender factors, as evidenced from experiences with her own clients.

"I'm looking at my clients, who are really trying hard to do this correctly, who are trying hard to meet investors and get this funding, and they are not able to. Very, very different from my white male counterpart clients, who tell me 'money isn't an issue, my issue is human capital' and that's what they need. ... These two conversations are just so drastically different," she said. 

Bernabe said discussions like the one taking place on the panel are vital to crafting smart cannabis policy that keeps social equity, and social justice, in mind. At the same time, he said, the state will be relying heavily on CPAs, such as those at the conference, to provide guidance and services to those communities that had been disproportionately impacted by the drug war in order to facilitate the policies the state develops.

"We can't do it without you," he said. "Folks need to get involved for it to happen."