A Lawyer’s View on the Cannabis Industry

EA:

Great, great. Well, Andrew, when did you first start servicing cannabis clients?

AC:
So I've been a trial lawyer for over 30 years, and in the course of that representation I was engaged by a group of west coast operators in a litigation matter, basically a transaction over the sale of several licenses in the Midwest that went bad. One of the parties was located in New York and I was engaged to represent the group in that matter.

EA:
And over time, what are some of the bigger changes you've seen in the industry?

AC:
Well, for us in New York and New Jersey, the big changes that we really didn't expect a recreational adult use at all. While we had a medical market that had been open since the late 2017, 2018, the expectation with Governor Cuomo in charge was that we were really never going to get adult use recreational cannabis. So for us, I think the biggest change is the fact that we went from no expectation of recreational adult use to a market that's emerging before our eyes.

EA:
And your group also services clients in the psychedelics' industry. How did the group move into that area of the industry?

AC:
Well, one of my managing partners, Matt Rappaport, keeps his eye on the marketplace and what's happening. And we had a conversation about six or seven months ago and he just said, "Well, where's the future going? Cannabis is going to go where it's going, but psychedelics may be an area that we should focus on." We were already talking about it and thinking about it and with my background, it was something that I was always interested in. We just made a conscious effort to move into that space because there really aren't anybody or any firms on the East Coast that are focused on psychedelics at all.

EA:
So here's an interesting question. We always hear about whether or not cannabis will be legalized at the federal level, state level, states have been legalizing one by one. Do you think cannabis or psychedelics will be legalized first?

AC:
It's funny you asked that question. We talk about that and I think about that a lot. I actually do think psychedelics is moving on a different track and probably is going to pass cannabis in the near future. And the reason for that is multifaceted. Number one, the FDA has already acknowledged several psychedelics as being breakthrough therapy, that is psilocybin and MDMA, both of which are Schedule one drugs at present. We have a Schedule three drug, ketamine, which is while arguably a psychedelic, which is already legal, a Schedule three allows it to be administered by a physician, but it's available. And the last component is the fact that peyote has already received a religious exemption from the Supreme Court, which means that it's allowed to be used in Native American rituals. We put all that together, and to be honest with you, it doesn't make sense to keep at least psilocybin and MDMA in a Schedule one.

So to me, it's likely, since they've already acknowledged one of the components necessary for anything to stay in Schedule one is not being relevant with regard to those two psychedelics that they're going to have to move those out of Schedule one at some point.

EA:
The banking industry, let's talk about banking for a second. The banking industry has been through a lot of late with the issues Signature Bank and Silicon Valley have had, and banking for the cannabis industry has never been easy. What effect will the current banking environments have on the industry?

AC:
Well, I look at the banking industry as really a function of compliance. It's not that banks, or at least not all banks, can't lend, or at least let's back up two components of banking, depository and lending. On the depository side, banks can get into the industry. They just have to set up a compliance program and it's hard, and they're worried about things like Bank Secrecy Act. The way I see banking is that if something were to happen, for example, safe banking was passed, let's say. I think that moves the industry forward very quickly. But we've been working with some banks, mainly smaller county chartered, federal credit unions who want to develop banking programs and start to at least be a depository bank in cannabis.

EA:
It seems that the banks in this industry tend to be the smaller state chartered banks or the credit unions and those are, there might be one or two larger banks, but mostly you see the smaller banks in the industry. Now let's talk about New York. How has New York handled legalization as compared to other states? Did they mishandle it? Did they do what you expected them to do? How did the legalization work compared to other states?

AC:
So I don't think that New York handle it poorly. I think actually if they modeled it after any state, it was probably after Washington State. But the way I look at the way a New York elected to move into the adult use recreational space, and I compare it to New Jersey, neighboring states with two of the most different approaches. New Jersey on the backs of existing MSOs, all vertically integrated out-of-state residences. And that's who they elected to move the adult use recreational market forward. New York chose a very different path and elected to use social equity justice involved individuals who have some discernible business background in moving it forward. We've all had hiccups. I'm not sure at this point in time we can assess who had a better approach, but I think at the end of the day, New York's approach has been designed or intended to result in a far more equitable marketplace.

EA:
I think right now New York actually has three legal dispensaries in the city but not more than that, which is hard to believe when you walk down seventh Avenue south of Penn Station, you see a dispensary on every corner. We're starting to see law enforcement act against unlicensed dispensaries, and this is so important considering, licensed dispensaries, more of them are expected to open soon. What does New York plan to do differently from other states that had these similar issues?

AC:
Well, New York, unlike other states, is not taking an approach, basically build it and it will self-adjust. It's not going to happen. The problem New York faces is the same as others, which is they need to figure out a way to move unregulated into regulated, or at least create one unified regulated market. The problem that I see with New York is that by not taking any action, when we saw the emergence of this unregulated market in a way we haven't seen anywhere else, and when I say haven't seen anywhere else. We had an unregulated market, which historically has been under the radar and underground. So through a course of events, we have a New York market that emerged first through a gifting scheme, which they thought was, or arguably called a safe harbor. Then a club cannabis scene, kind of like what Empire did by creating an admission type of concept.

And then when everybody, other opportunistic individuals saw that the state was not, and the city wasn't doing anything to prevent that. These opportunistic individuals got into the marketplace and started to open up brick and mortars and just sell it out in the open. The problem that we have now is that we have an emerged submarket of about 15 or 1600 operators. They weren't operators who were already in the space. These were people who had no relationship, passion or otherwise to the plant, saw an opportunity and then they got into the unregulated market. So the problem we have now is in addition to an existing, unregulated, illicit or black market. We now have a submarket of people who had never been involved in cannabis historic, but we still have to address and accept the fact that they're there and hope or try to move them into the regulating space.

EA:
How hard is it for a licensed cannabis company to compete against an unlicensed legacy operator?

AC:
So you said unlicensed legacy operator. To compete against an unlicensed legacy operator who's been operating in this space for perhaps 10, 20 or more years and has pretty good supply chain with a very high quality product and a delivery service built in. It's going to be very, very difficult because the quality of the product in New York while getting there is not quite there yet. We simply don't have the climate or the genetics. And the fact of the matter is, Legacy have been doing it for a long time now. Legacy is different than some of the other unregulated components of the market. No passion or no relationship to the plant, and the quality is not necessarily always there. They don't understand their market. So I think there's two different components to that, but it's still very difficult.

EA:
At the end of 2022, we had what was referred to as Biden's Marijuana pardon. What's the status of that? What did this legislation or proposed legislation do and what didn't it do?

AC:
Well, the legislation, or the statement better, didn't really do anything. All it did was basically expunge the records of low level possession federal criminals, of which there were none incarcerated at the time. The bigger question was what impact did his statement or request that the FDA in conjunction with the DEA revisit the classification of cannabis as a Schedule one drug? The fact of the matter is little has been done. When they spoke to Merrick Garland as recently as last week about the status, he indicated that they were still in the scientific study stage to determine whether or not cannabis met the criteria to stay in Schedule one. The bigger concern was Merrick Garland's other statement, which was that they were working on a policy statement as it related to cannabis, and that policy statement would be something close to what's contained in the Cole Memo.

Now, number one, Biden never requested a policy statement from Merrick Garland or the Attorney General's office. And number two, to basically come out with a policy statement and says, "We're going to follow the Cole Memo," which is effectively don't ask, don't tell, is really not the solution that anybody's looking for from the Biden Administration.

EA:
Besides taxes, we won't talk about taxes now. What other pitfalls exist for the new cannabis business person?

AC:
Well, the pitfall is basically the people don't understand that cannabis businesses are like other businesses, which require a bunch of different components in order to be successful. Things like standard operating procedures, employee relations, human resources. We have a lot of pieces where we're asking people who don't have a whole lot of business experience to go in and successfully run a business in a marketplace that's incredibly ultra-competitive. Basically, we have retailers who can't sell their own brand, are competing directly with other retailers, and the bottom line is there's going to be ways that the successful retailers are going to identify as keys to success, such as employee training, budtender training, branding in this space, and compliance with standard operating procedures and operational support.

EA:
So is it safe to say that cannabis businesses or business owners need to run their business the way other businesses would run their businesses?

AC:
Well, they need to try, subject to the limitations that we're all aware of, such as 280E in the inability to take normal business deductions that are otherwise available basically to the rest of the planet or at least the country. And it makes it very challenging to be successful in this space.

EA:
Can you explain what a CARD license is? And card stands for Conditional Adult-Use Retail Dispensary. Can you explain what it is and how it works?

AC:
Sure. So the CARD license program was a program that evolved out of the Marijuana Regulation and Taxation Act. It actually wasn't stated in the act and nobody knew what was specifically contemplated by the act, but the way it rolled out was an effort to try to jumpstart the marketplace. So we already had hemp growers who are now moving from hemp into the cannabis space, and then we allowed them to limited processing, and then we allowed the hemp growers who apply for processing license to actually get processing licenses cannabis. So now we needed a retail side to support the grow and processing side. The way they decided to do that was to create this CARD license, which established certain very specific eligibility requirements. This is different than grading requirements, which is what we saw across the country. The eligibility requirements for the CARD license require the applicant to have a qualifying cannabis conviction and also a 10% or more ownership interest in a business that's shown a net profit for two years.

Those two factors alone obviously will not determine ultimately the success of an individual and his ability or her ability to operate a business. The other component was the not-for-profits that were eligible into the CARD program. So we have as a program that's designed to move the process forward by giving, creating a retail marketplace to sell cannabis that's already being grown and processed by formerly hemp growers. And now we have that marketplace being operated by certain very limited individuals who qualified under the CARD program.

EA:
Besides tax ramifications, how does the illegality or legality of cannabis on the federal level affect how a cannabis company operates?

AC:
Well, because it's federally illegal, means that we don't have the ability to use interstate commerce. Interstate commerce is a way for us to better control a supply chain. So that means basically that where we have states that have shown an ability to grow cannabis successfully, either because they've been doing it longer, they have genetics that go back further or they're simply in a better climate. And other states that may have a stronger retail market, where every other business, you can use economies of scale and you can use interstate commerce to set up supply chains that minimize cost. In cannabis, we don't have that. Every state regulates itself. Every state has to have every component of the supply chain within that state, which increases costs to the cannabis retail side.

EA:
How different are the laws at each state or any state laws universal?

AC:
There's universal concepts, but there's no universal state or universal laws. For example, there are some states that require vertical integration, and then most states that prohibit it. There are some states that are similar to other states in the way they think about setting up this marketplace. For example, Illinois had historically been basically the champion of setting up a method to protect and ensure that social equity applicants were given an opportunity to emerge in the marketplace, to acquire interest in cannabis in the marketplace, and to be successful. Unfortunately, where cannabis comes, lawsuits follow, and that put a little bit of a damper on the emergence of the Illinois marketplace. But the states that are emerging more recently are more focused on social equity as being a huge component of the way they structure the laws and the way they roll out the adult use recreational marketplace.

EA:
I often use this as an example. When I go into a store in New York City or California and I buy a Diet Coke, it's the same product, and we often take that for granted. Will we ever see a national brand in the cannabis space? And I guess that's going to probably depend on interstate commerce also.

AC:
Well, yes and no. I think we already start, we're already starting to see certain brands evolve on a national level, such as Berner Cookies. That company's been one of the most successful in rolling out a product which is consistent. It's hard because while the genetics may be available, the grow part is not. So genetics without the perfect climate is not going to result in the same product. And in addition, in certain marketplaces, you're going to have a larger or increased likelihood of having to grow indoors increased costs, smaller scale, perhaps a craft product, which increases the cost. So there's a lot of components to that question.

EA:
And right now, I think I mentioned earlier, I think we have three legal dispensaries in New York, pull out your crystal ball. How many do you expect to see at the end of 2023 and at the end of 2024?

AC:
End of 2023, I think we have three, we had a fourth just opening in Queens City proper, maybe two or three throughout the state, Schenectady, Binghamton, Just Breathe. I'm optimistic that by the end of 2023, we'll probably have, I want to say 25 to 30. I think the challenges are challenges that we're just recognizing now, which is really what's going to impede the progress. And one of those challenges, even in instances where New York being unique in the way New York City proper is basically all in cannabis. There's no opt-ins and opt-outs, it's created a large mass. The problem is that the restrictions associated with houses of worship, schools, community facilities, in addition to the restrictions between retail sites, has now created somewhat of a limit of available space.

You add into that the fact that every space isn't available because certain landlords won't lease to cannabis and other landlords feel restricted because their lender technically could default them if they lent into cannabis, even though it's state legal. The bank that loaned the money for the mortgage or took a mortgage in exchange for loaning the money to buy the property. Those mortgages have significant restrictions as to the use that landlord can make of the property.

EA:
And under New York State law, I believe local municipalities have an option to opt in or opt out of allowing adult use retail dispensaries or onsite consumption lounges. They can't opt out of usage, but they can opt out of retail dispensaries. And I think approximately 10% of the cities across New York state and about one third of the municipalities in the state have opted out right now. And those that opt in can opt out, and those that opt out can they change their mind and opt in. How important does this and what effect does this have on the particular municipality?

AC:
Well, if you look at the way New York has rolled out the program and the opt-outs, if we want to take Long Island as an example, we only have four towns that didn't opt out. We have the town of South Hampton, Brookhaven, Babylon, and Riverhead. Effectively, South Hampton has its own issues because it's next door to the Shinnecock Nation. So the way it works is that, if you opt out, you're opting out of all benefits, including the tax incentives created through the emergence of this adult use recreational market. So the key to success of this market, and the key to success of having it roll out in a fiscally robust way is to have some towns, municipalities, cities, opt back in. And we look at, for example, the most likely to opt back in sooner is going to be Long Beach. City of Long Beach has a right to do it.

They're situated in a way where it gives them maximum benefit and opportunity to capture a significant part of the market since they have access. And they're a bit of a financial crunch, they have a pretty big deficit that they have to solve, and their constituents are not going to, or the residents are not going to really be tolerate increased taxes.

EA:
Andrew, for my last question. You are teaching a class through Hofstra Law School on the cannabis law. Tell us a little bit about that, and how interesting is that and how rewarding that is for you?

AC:
So I can't even tell you. It's hard for me to explain how satisfying, gratifying teaching that class is. Regardless of the fact that I had historically wanted to be a law school professor, we'll start, fast-forward. My goal in building out a curriculum and selling it to the administration was because I thought that they should be paying attention to this market that's emerging before our eyes. There's going to be a significant demand for lawyers both in-house and in the marketplace generally. So my goal in teaching the class was to give them a historical background about cannabis to use the regulatory piece of cannabis in a very productive and constructive way. We actually reviewed the proposed regulations for the available license types, including advertising label and marketing regs, and we provided comments, written comments to OCM.

So we gave them a perspective from my students eyes, and the last part was the business side. So I wanted to give the students information and knowledge that would allow them to move out of law school. They're all 3L's because there was such a demand for the class that I had 17 students on the waiting list, and because they prioritized 3L's over 2L's, no 2L's were able to get into the class. I wanted to give them enough background so they could be relevant when they left law school, went to their firm or were looking for jobs, and I believe I did that.

EA:
How many students are in your class?

AC:
I closed admission at 25 because I didn't want to have to grade on a curve. Three students unfortunately dropped the class, I had 22, but the fact that they dropped, I still had students on the waiting list. Unfortunately because the drop ad was late in the semester, some students were still concerned that they couldn't catch up if they were able to get into the class. So I have 22 students in the class.

EA:
Is this your first semester doing it?

AC:
First semester teaching the cannabis law. They had a class entitled The Law and Business in Marijuana that they taught for one semester back in 2017. But as you can imagine, that class was very different. It basically followed a cannabis business on the medical or RO side, which included all verticals through infancy to maturity. So I basically rebuilt or built a curriculum and a syllabus from scratch and made it or tagged it to the existing market and the way the market was emerging.

EA:
That's great. Andrew, thank you for joining me this afternoon, and thanks for listening to CannaCast. As part of the EisnerAmper podcast series. Visit eisneramper.com/cannabis with more information and podcasts. Also, please visit www.frblaw.com for more information about Andrew and the law firm Falcon Rappaport & Berkman LLP. Join us for our next EisnerAmper podcast, we will discuss other budding issues.

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