Fraud Risks in the Cannabis Industry
February 08, 2023
By David Sumner, CPA, CFF
Growth has been rapid in the cannabis industry and the list of states that have legalized medicinal and/or recreational use continues to grow. Rapid growth is frequently associated with increased risks, including the risk of fraud. Following – in no particular order -- are some of the largest fraud risks related to the cannabis industry:
- Product Misrepresentation: This type of fraud occurs when a producer or distributor misrepresents the quality or content of its products. The THC (tetrahydrocannabinol, the psychoactive component of cannabis) or CBD (cannabidol, derived directly form the hemp plant) content of a product is one specific example that can be misstated intentionally or unintentionally. Another example is improper disclosure of the other related compounds – such as contaminants or other additives -- in a product.
- Supply Chain Fraud: Counterfeiting and substitution of products are risks facing any industry with a complex supply chain, and the cannabis industry is no different. This can have a negative impact on the quality of products and the reputation of the industry.
- Financial Fraud: This includes cash theft, manipulation of financial reports, and other types of fraud. Many cannabis companies are smaller organizations without the sophisticated internal control environments that exist in more mature industries. Also, since credit cards cannot be used for sales of cannabis, large amounts of cash may be on hand and unintentionally left unprotected.
- Money Laundering: Due to federal restrictions on cannabis, the industry is cash-intensive and thus vulnerable to money laundering concerns. It is important that a cannabis entity understand their anti-money laundering (AML) responsibilities so that they don’t jeopardize their already limited access to financial institutions.
- Diversion of Product: Despite the state-level approval of the distribution of cannabis products, the black market for cannabis still exists. An employee could divert cannabis products to the black market for personal financial gain.
It is critical to the ongoing success of the cannabis industry, as well as individual companies, to have effective fraud detection and prevention controls and procedures. Fraud awareness training for all employees is a very cost-effective method, as is having a sincere and consistent anti-fraud “tone at the top.” Other anti-fraud measures include regular audits, background checks on employees, and implementing anti-fraud financial controls.
The cannabis industry faces increased risk of fraud due to its rapid growth; instances of fraud not only harm a specific entity but pose a risk to consumers and the reputation of the industry as a whole.