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Cannabis CannTrust taps McCarthy, appoints U.S. sporting goods executive to lead special committee investigation

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The board of CannTrust Holdings Inc. has hired Bay Street law firm McCarthy Tétrault LLP and appointed U.S. sporting goods executive Robert Marcovitch to lead a special committee that is investigating how the company illegally grew 12,700 kilograms of cannabis in unlicensed facilities, and who knew about it.

Federal inspectors from Health Canada are auditing Toronto-based CannTrust after discovering the company grew cannabis in five unlicensed rooms over a five-month period in its greenhouse in Pelham, Ont. Sanctions could range from penalties for management to the cancellation of the company’s cannabis production licences, which would effectively shut down the business. CannTrust’s stock price has dropped about 40 per cent since it disclosed the regulatory issues on July 8.

The special committee is also expected to hire an investment bank to advise it on how to proceed. The shares closed up more than 2.6 per cent on Thursday after a speculative media report about early efforts to find a buyer for the company or its assets.

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However, a source close to the company, to whom The Globe and Mail has granted anonymity because they were not authorized to speak to the media, said there is little chance it would sell major assets until it is clearer what penalties Health Canada will impose.

Potential deals or management overhauls will depend largely on the special committee, made up of four independent directors of the company led by Mr. Marcovitch, the Seattle-based former chief executive of K2 Skis and Ride Inc. The committee also includes John Kaden of New York-based Navy Capital, Shawna Page, a former banker with Merrill Lynch Canada, and retired accountant Mark Dawber.

CannTrust is a major Canadian cannabis supplier, with more than 70,000 medical marijuana clients. In addition to facilities in Pelham and Vaughan, Ont., the company has applied for Health Canada permits on an outdoor cultivation facility in B.C. While at least one Bay Street investment bank is trying to win business by arranging bids for the company’s assets, some rival producers are leery of potential liabilities.

In addition to the regulatory proceeding, more than a dozen U.S. and Canadian law firms have launched proposed class-action suits on behalf of investors against CannTrust.

CannTrust’s market capitalization on Thursday was about $540-million.

“We believe that Health Canada must make an example out of CannTrust,” analyst Greg McLeish of Mackie Research Capital Corp. said in a research note. “If Health Canada does not come down hard on the company, it will set a bad precedent for other ‘law abiding’ industry participants.” Mr. McLeish stopped publishing research on CannTrust on Monday, saying “management has lost credibility.” He said the company’s ability to grow cannabis in B.C. is now in doubt, as it still needs Health Canada approvals and must plant marijuana by Aug. 5 if it wants reach its goal of harvesting outdoor plants in 2019.

Earlier this month, CannTrust disclosed it grew cannabis in five unlicensed rooms at the Pelham facility between October of last year and this March. In April, the company said it received Health Canada permits for the five rooms. In May, CannTrust sold US$200-million of stock priced at US$5.50 a share – its shares now trade at half that price. Chairman Eric Paul and the Litwin family, long-time backers of the company, sold US$30-million of CannTrust stock as part of that offering.

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The timing of events could prove crucial in class-action lawsuits. The six investment banks that sold CannTrust stock in May were working with a company that had received Health Canada permits for all its Ontario cannabis production facilities, and if they are pulled into class-action lawsuits, they are expected to say they did their due diligence. As part of the deal, lawyers for CannTrust and its banks warned that the company would struggle if it ran into regulatory problems.

In a prospectus filed as part of May’s stock sale, CannTrust said: “The ability of the company to obtain, sustain or renew any such licences and permits on acceptable terms is subject to changes in regulations and policies.” The company went on to say: “The failure of any governmental authority to issue or renew such licences or permits upon acceptable terms would have a material adverse impact upon the company.”

The company recruited former banker Peter Aceto as CannTrust CEO in October. The company is tightly controlled, with Mr. Paul and members of Litwin family largely calling the shots at the board level. The company’s largest shareholder is CannaMed Financial Corp., which is co-owned by Mr. Paul and the Litwin family.

Most of CannTrust’s directors were appointed by CannaMed, which had a monopoly on board appointments for a year after the company went public in the spring of 2017 through a voting trust with key shareholders.

CannTrust also has a service agreement with Forum Financial Corp., a private equity company owned by Fred Litwin, whose son Mark Litwin is on the CannTrust board. As part of the agreement, Forum provides CannTrust with “various managerial, operational and administrative services, including services related to the corporation’s continuous disclosure and reporting requirements,” according to company filings.

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