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The cannabis industry’s hopes and dreams are predicated on a simple goal: legitimacy.

Before Ottawa legalized marijuana and after, pot-sector pioneers took pains to talk about their products as if they were describing natural foods and vitamins. Their message: Canada is becoming a global leader, offering the very finest cannabis to a welcoming public under the highest corporate and regulatory standards.

CannTrust Holdings Inc. has been front and centre among the best-known players, promising consumers and investors legitimacy on par with pharmaceuticals and consumer products. Now, its alleged misdeeds risk pushing the cannabis sector a few steps backward toward an era best associated with Cheech and Chong.

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The very idea that – as a former employee charged in a bombshell interview with The Globe and Mail this week – the company would hide thousands of pot plants behind phony walls in an attempt to fool Health Canada raises thorny questions about whether the industry is indeed ready to take its place in polite society.

Pot stocks plunge as CannTrust woes cast shadow over cannabis sector

CannTrust CEO Peter Aceto, who built an image as corporate innovator, now faces biggest test

CannTrust has stopped all sales of its cannabis products as Health Canada investigates the alleged illegal growing in unlicensed rooms, which were hidden from cameras, presumably to get a jump on building up inventory to meet contractual obligations. It took the step after provincial wholesalers in Ontario and Alberta stopped selling CannTrust products. There is even speculation the regulator could pull the company’s licence for a move that was not only bad, it was bush-league.

It’s a rapid fall from grace for a company that had exemplified the industry’s growing acceptability, led by a former retail banker.

Since the scandal erupted on Monday, CannTrust shares have lost almost half their value. Recall that the Vaughan, Ont.-based producer was an early test case for Wall Street, which has approached the sector gingerly because selling cannabis remains a federal crime in the United States, even as it has been legalized in several states.

U.S. financial-services giants Bank of America, Citigroup and Jefferies LLC were among the underwriters of a US$170-million CannTrust share offering in May, with the stock priced at US$5.50 a share. The shares sank another 17 per cent on Friday to sell for US$2.58 on the New York Stock Exchange (the company’s TSX-listed shares also closed 17 per cent lower).

The banks sold both institutional and retail investors on the shares and are now surely fielding angry calls from clients asking about legitimacy. At least five U.S. law firms have said they are recruiting plaintiffs for class-action lawsuits related to the mess.

It’s tempting to say that this is a one-off misadventure and investors should keep their eyes firmly focused on the industry’s long-term potential to supply recreational and medical markets at home and abroad. That may be true, and indeed no other licensed producers are currently suspected of a similar sleight of hand.

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But numerous examples abound in which investors fled a sector en masse when scandal enveloped a key company. Not that hiding pot plants is even close to being in the same league as salting Indonesian gold samples, but it’s important to note the Bre-X Minerals fraud created a chill that hit all junior miners in the 1990s after a massive bull run.

In this case, the rest of the sector is getting swept up. The Horizons Marijuana Life Sciences Index ETF has shed 8.6 per cent this week.

At the very least, CannTrust’s woes will focus renewed attention on producers’ executives and boards of directors as investors and regulators seek to get a handle on just who is minding the greenhouses. It is a young industry, built by entrepreneurs, many of whom saw the potential for lucrative expansion but may not have had the management and corporate-governance experience expected in large, widely held public companies.

Certainly, Constellation Brands Inc., which spent $5-billion for a major stake in Canopy Growth Corp., showed last week it wants more traditional corporate discipline at the country’s biggest cannabis player by terminating its colourful and outspoken founder, Bruce Linton, as chairman and co-chief executive.

Now that CannTrust has erected a makeshift wall of worry, the rest of the major cannabis companies have a tougher task ahead convincing consumers, regulators and the global financial world that they are indeed ready for the mainstream.

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