Cannabis Law

With reclassifying proposal for cannabis, companies are seeing green

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On May 16, the Biden White House Office of Management and Budget signed off on a proposal for the reclassification of marijuana, paving the way forward from a Schedule I drug to a Schedule III drug. (Image from Shutterstock, adjacent image from Shutterstock)

The smoke is finally clearing on decades of stigma. On Thursday, the White House Office of Management and Budget signed off on a proposal for the reclassification of marijuana, puffing the way forward from a Schedule I drug to a Schedule III drug.

As a Schedule I drug under the Controlled Substances Act, marijuana is defined by the Drug Enforcement Administration as a drug “with no currently accepted medical use and a high potential for abuse.” It’s in the same category as heroin and methamphetamine. The proposal suggests classification changes for the first time in history, putting it in the same category as acetaminophen with codeine, steroids and testosterone.

Rescheduling a controlled substance includes a formal rulemaking procedure that includes public notice, an opportunity to comment and an administrative hearing, according to a May 16 news release from the U.S. Department of Justice.

“The DOJ is finally recognizing that draconian cannabis laws need to change to catch up to science and the majority of Americans,” said Democratic U.S. Senate Majority Leader Chuck Schumer in a social media post on X, formerly known as Twitter, following the announcement.

In 2023, 70% of adults said they support legalization of marijuana, according to a Gallup poll. This was the highest level recorded. In 2000, 31% approved.

It’s been a long-awaited move that, if finalized, is expected to make significant waves in the marijuana industry, affecting everything from tax rates to mergers and acquisitions and legislative changes.

The most immediate effect will have to do with mergers and acquisitions, says Douglas Berman, a professor at the Ohio State University Moritz College of Law and the executive director of the school’s Drug Enforcement and Policy Center.

“It will have all these businesses rechecking their business models and thinking, ‘Will this be a good time to combine with another company, to get into new markets, and to get into opportunities in the medical space where recreation has dominated?” Berman says.

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With marijuana labeled a Schedule I drug, those in the business have difficulties with the traditional banking system. Loans from FDIC-insured banks have been unavailable, and most private equity and venture funds stayed clear of the cannabis industry, leading marijuana companies to rely on alternative financing sources.

Then there was the escrow issue. Cannabis mergers and acquisitions deals didn’t allow for part of the purchase price to be placed in escrow, and insurance companies, nervous about federal penalties, didn’t offer the same coverage.

Adding to the mergers and acquisitions failure is the fact that marijuana laws were constantly changing, with contradictory laws throughout various states. For example, in most states, it’s illegal to transfer your cannabis license independently of the business, so the transfers could only happen via equity sales.

With the new reclassification, there’s the hope that the Secure and Fair Enforcement Regulation Banking Act Banking Act will be passed, allowing FDIC-insured banks to serve the marijuana space. The SAFER Banking Act allows financial institutions protection to work with state-sanctioned marijuana businesses. It has passed the U.S. House of Representatives seven times but repeatedly stalled out in the Senate.

“Some of the resistance is from prohibitionists but also from folks who worry, reasonably, that when big finance enters the picture, all the small companies will be wiped out,” says Benjamin Varadi, an assistant professor at the Vermont Law and Graduate School who specializes in social equity regulation in the cannabis industry.

One of the notable impacts of federal prohibition has been a proliferation of small businesses in the cannabis space, Varadi adds.

“If we truly believe local entrepreneurship is the lifeblood of our American economy, states might do well to better preserve the interests of local stakeholders as truly big money enters the picture, before consolidation redefines the entire landscape,” Varadi says.

Models certainly exist. In Vermont, cannabis businesses are limited in the aggregate number of licenses that they can have. Many states have adopted tiered license structures that can satisfy market demand primarily through smaller firms, according to Varadi. While imperfect, social equity models also provide technical support and funding to small businesses, so that they have options other than selling to the higher bidder.

Realistically speaking, if the proposals are implemented, bigger marijuana companies will likely buy smaller ones, and we may see more partnerships and teamwork among companies, says Jamie Wright, founder of the Wright Law Firm in Los Angeles.

There could be plenty of other positive repercussions for the cannabis companies.

With the proposed rescheduling, the cannabis companies could increase their profitability, and they will be able to take deductions when they spend on regular business expenses. At the moment, they can’t even take deductions for charitable donations.

Also, legal marijuana sellers will be eligible for tax credits and deductions. Under the current tax code, they are not and can pay as much as 70% of annual revenue in taxes, according to the Marijuana Policy Project, a legalization advocacy group.

Another dynamic likely to follow on the heels of rescheduling—though not directly tied to rescheduling—will be a significant influx of capital into the industry. Institutional investors including big banks, pension funds and large investment managers will likely be more inclined to invest, says Lincoln Eckhardt, who co-leads the cannabis practice at FTI Consulting, a business consultancy.

Cannabis companies may also have major exchanges, such as the Nasdaq and the New York Stock Exchange.

“Uplifting will provide greater liquidity in [a] publicly traded cannabis company’s stocks, resulting in more efficient price discovery,” Eckhardt says. “The expectation is this will result in revaluing U.S.-based cannabis companies materially higher.”

Experts are divided, however, as to how the rescheduling will affect the 24 states that already legalized recreational marijuana and the 14 additional states that allow medical marijuana.

Joshua Horn, a partner at Fox Rothschild who co-chairs its cannabis practice group, says much will be determined when we see rescheduling more tangibly.

According to Horn, there are two schools of though. Rescheduling could open the door for adult use throughout the country because marijuana will no longer be a controlled substance, and all facets of the industry will have great access to the capital markets and to reform of Section 280E of the Internal Revenue Service Code. Currently, Section 280E prohibits tax deductions for businesses that engage in trafficking of Schedule I or Schedule II drugs.

Or Section 280E may only benefit the medical cannabis industry. If that was to happen, companies that are in both markets may face challenges addressing that dichotomy, Horn says.

“It is difficult to predict which of the two schools of thought may become reality,” he adds.

Another reality could be legal challenges from interest groups committed to fighting cannabis reform.

That’s what Smart Approaches to Marijuana, a nonpartisan political organization opposed to marijuana legalization, plans on doing. The group objects to the marijuana reclassification on the grounds that marijuana fails the statutory criteria of a Schedule III drug because it has no approved use from the U.S. Food and Drug Administration, and it has a high potential for abuse, says Luke Niforatos, the executive vice president of Smart Approaches to Marijuana.

Niforatos says when the Biden administration issued a notice of proposed rulemaking, Smart Approaches to Marijuana planned on activating its grassroots and coalition partners to subject comments addressing the harms of marijuana use. And if the administration issues a final rule rescheduling marijuana to Schedule III, they will take legal action, Niforatos says.

But for now, the smoke is settling, and the industry is calling it a win.

“Far too many lives have been upended because of a failed approach to marijuana, and I’m committed to righting those wrongs,” President Joe Biden said in a recorded video Thursday. “You have my word on it.”

See also:

Attorney general moves to reclassify marijuana as lower-risk drug

Budding cannabis law courses are growing—but not fast enough

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