New York listing exposes CannTrust to greater legal challenges in U.S.

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When CannTrust Holdings Inc. listed its shares on the New York Stock Exchange in February, it gained access to a huge pool of investors and more trading activity for its shares.

It also exposed itself to the potential of greater trouble in the U.S. legal system, from class-action lawsuits in U.S. courts and to the actions of that country’s securities regulators. One of those hazards is already coming into play.

CannTrust revealed in July that it grew cannabis in large sections of its facility in Pelham, Ont., that had not yet been licensed by the federal regulator, Health Canada. The unlicensed cultivation took place between October, 2018, and March of this year. CannTrust has suspended sales of cannabis, and the industry is waiting to see whether Heath Canada will suspend the company’s licence.

Thursday, the company disclosed it is also the subject of an Ontario Securities Commission probe. The Joint Serious Offences Team, a partnership among the OSC, the RCMP’s Financial Crime Program and the Ontario Provincial Police Anti-Rackets Branch, is conducting the investigation under OSC direction, commission spokesperson Kristen Rose said Thursday.

During its period of the unlicensed growing operations, CannTrust applied for and received its NYSE listing. In May, the company hired a syndicate of U.S. and Canadian banks and sold US$195-million of shares. Former Chairman Eric Paul, who resigned in July, and board member Mark Litwin, sold US$34.5-million as part of that offering via an investment vehicle called Cannamed Financial Corp.

Cannamed also sold $6-million of CannTrust shares starting on Nov. 16 of last year – the day Mr. Paul responded to an internal e-mail that detailed the illegal growing – and continuing through mid-December.

As investors weigh the potential effects of the company’s recent news, some law firms are taking an interest.

Non-U.S. companies that trade on their home exchanges and do not seek U.S. listings are generally shielded from the greatest liability in class-action lawsuits and are not a high priority for U.S. regulators when something goes wrong, even if a U.S. investor may have suffered losses, according to lawyers and professors of law with expertise in cross-border matters.

But CannTrust’s choice to list in the U.S. opened a door to greater challenges.

“Everyone wants to run to the U.S., but we do warn companies, ‘They don’t mess around in the U.S., the [Securities and Exchange Commission] Enforcement division there is very serious and very robust, and when you list in the U.S., you agree to jurisdiction in the U.S.’” says Cheryl V. Reicin, a Torys LLP partner who works in New York and Toronto. “The approach of the SEC traditionally is much more aggressive. I mean, people go to jail. Remember Martha Stewart? She went to jail for much less than what’s being alleged here.”

The SEC declined to comment for this article.

When asked Tuesday by The Globe and Mail if he was concerned about increased liability due to CannTrust’s NYSE listing and the sale of shares in the U.S., interim chief executive officer Robert Marcovitch said: “We have broad-based concerns. Our biggest concern, frankly, is working with Health Canada to bring the company into full regulatory compliance.” (Mr. Marcovitch made his comments before the company learned of the OSC investigation.)

CannTrust used exemptions under what’s called a “multijurisdictional disclosure system” to prepare its stock-offering documents for the May sale in accordance with Canadian, not U.S. disclosure requirements. CannTrust warned U.S. investors in the stock-sale prospectus that they may have difficulty getting any civil action enforced against the company because of its status as an Ontario corporation.

Still, U.S. class-action law firms have not been dissuaded. Several have issued news releases saying they’re investigating the matter, pursuing an action or otherwise representing investors. The law firm Pomerantz LLP and Robbins Geller Rudman and Dowd LLP, the two firms with the most class-action securities settlements in 2018, according to Institutional Shareholder Services, have both announced their interest in CannTrust. In Canada, Strosberg Sasso Sutts LLP said its counsel is involved in a proposed class action for non-U.S. holders of CannTrust’s Toronto Stock Exchange-listed shares.

“Absent the New York listing, it’s unlikely they would have been pursued in the U.S. in the way they’re being pursued now,” said Michael Robb, a lawyer with Toronto firm Siskinds LLP, which specializes in class-action lawsuits.

Since the Feb. 25 NYSE listing, investors have traded about 3.3 million CannTrust shares each trading day in New York, versus about 2.3 million each day in Toronto, according to Bloomberg data. That type of volume is more than sufficient to interest the U.S. law firms, Mr. Robb said.

Mr. Robb says Ontario law restricts civil liability for “secondary market” purchasers – investors who buy shares on an exchange, from another investor – to 5 per cent of a company’s market capitalization if there is a material misrepresentation in a prospectus. No such limit exists in the United States. “They don’t have the benefit of that cap.”

And, perversely, a company that manages to increase its market capitalization by virtue of a U.S. listing and additional trading demand, also increases its exposure, he says. (Mr. Robb says his firm is looking at the CannTrust situation and has spoken to investors, but has not made any public declaration of its intentions.)

Ms. Reicin also cited the higher level of U.S. trading volume as a reason why the SEC might want to take a significant role in any inquiries or investigation into CannTrust.

“I think the OSC and the SEC will probably have to figure out how they’re going work together on this,” she said. “I would say the OSC probably wants to take a leading role because it’s a Canadian company … they were primarily responsible for reviewing the disclosure. Then again, the SEC is still new to cannabis, so I suppose they’re going be very interested because they want to know what happened here and how do they make sure it doesn’t happen going forward?” she told The Globe and Mail Thursday.

With files from Mark Rendell