Canadian marijuana companies that operate south of the border are facing new worries about legal exposure in the United States after the Department of Justice took steps toward enforcing federal law banning cannabis.
U.S. Attorney-General Jeff Sessions on Thursday moved to rescind an Obama-era policy that allowed states to let cannabis be grown, sold and used within their borders, handing the decision of when to enforce federal cannabis law to prosecutors in each state.
The change cast fresh uncertainty over the entire industry, raised new questions about Canadian securities regulations surrounding the sector and took a bite out of the valuations of some of Canada's largest public marijuana companies.
It is still unknown how federal law will now be enforced under Mr. Sessions, if this will result in any charges or whether federal law will end up being applied unevenly across states.
"It's not really clear how this is going to play out," said Charles Alovisetti, a lawyer at Vicente Sederberg LLC, which is based in Colorado.
"We don't know there's going to be a crackdown. We also don't know that there's not going to be. We have to wait and see."
The Sessions' memo came mere days after California began allowing the sale of recreational marijuana and amid a stunning surge in pot stocks.
An exchange-traded fund that tracks the Canadian cannabis sector rose more than 25 per cent over four days from Dec. 28 to Jan. 3, as retail investors jumped in and out of stocks. On Thursday, the industry-wide rally took a pause, with shares plunging.
The move by Mr. Sessions caught the market off guard, but investors shouldn't be all that surprised. In regulatory filings, companies raised the chance that previous guidelines could be revoked at any time and detailed the legal risks they could face by doing business south of the border.
The rules governing cannabis in the United States have long been murky. Certain states have allowed the drug to be grown, sold and used in some forms, even though it is still an illegal substance under federal law. In 2013, the Department of Justice tried to add clarity by instructing that federal resources should not be used to prosecute cases against those complying with state law where marijuana is permitted.
While this policy – referred to as the Cole Memo – wasn't law, it provided people who opened cannabis businesses in the United States with a certain amount of cover because, as long as they were within state law, federal enforcement action against them was seen to be unlikely. Many have since gone public in Canada, raising millions from retail investors who are looking to cash in on evolving policy toward the drug.
In the past, the U.S. Congress has passed spending bills that do not earmark federal funds for prosecuting offences involving medical cannabis that comply with state law. The current bill is set to expire on Jan. 19.
However, during the past year, Mr. Sessions had signalled that the federal policy around marijuana could evolve, saying that he believed cannabis to be a dangerous gateway drug and was against its legalization for recreational use.
The Cole Memo was cited in the October guidelines for public cannabis companies issued by the Canadian Securities Administrators.
The CSA said that marijuana firms doing business in the United States can raise money in the Canadian public markets, as long as they disclose the legal risks they face to their investors. The Ontario Securities Commission, which spearheaded the new disclosure policy, declined to comment on Thursday.
"It'll be interesting to see what the CSA does in the coming days and weeks, given what is now seeming like at least a partial shift in policy by the U.S. federal government," said Jonathan Sherman, a securities lawyer at Cassels Brock & Blackwell LLP.
The CSA's approach sharply differed from the sweeping ban the Toronto Stock Exchange and TSX Venture Exchange, both owned by TMX Group Ltd., have placed on companies that have U.S. cannabis assets.
But it also breathed life into another stock market called the Canadian Securities Exchange, which allows these U.S. firms to list and trade their shares on its market with ample disclosure of any legal risks.
The CSE has become a hotbed for cannabis stocks, racking up a roster of 56 pot listings, 17 of which have operations in the United States. In December, a whopping 70 per cent of all trading volume on the CSE came from this sector.
The legal risk of operating in the United States was a major concern this summer after The Globe and Mail reported that the Canadian Depository for Securities Ltd. was contemplating a policy shift that would see it refuse to settle trades in a small group of cannabis firms with U.S. assets.
CDS, which is owned by TMX, controls the plumbing behind the equity markets, ensuring that when investors make trades, the cash and securities wind up where they should. Such a ban would make it virtually impossible to trade these securities.
TMX said in November that it's still deciding whether it should keep clearing these trades, adding that it is speaking to regulators and other Canadian markets.
"We are working toward a solution that will see CDS continue to provide clearing and settlement services to the securities," said Richard Carleton, chief executive officer of CNSX Markets Inc., which operates the CSE.
Those fears over clearing subsided near the end of 2017. But now, Mr. Sessions's one-page memo is spurring those questions again.
On Thursday, cannabis investors rushed to the exits, selling the shares of firms with U.S. exposure, such as Aphria Inc., whose stock dropped 14 per cent. The company, which is based in Leamington, Ont., has stakes in licensed producers that serve the medical markets in Arizona and Florida, two states that have eased restrictions on cannabis.
The future of its stock listing on the TSX has also been in doubt. In October, the TSX said that any firm violating U.S. federal drug law is breaching its listings policies and could be delisted, even if is following the rules of a U.S. state.
The equities of three of the four largest marijuana producers in Canada by market capitalization – Canopy Growth Corp., Aurora Cannabis Inc., and MedReleaf Corp. – tanked on Thursday even though these companies say they don't do any business in the United States.
Shares of Canopy, Aurora and MedReleaf fell 10 per cent, 8 per cent and 9 per cent, respectively.
In the long term, companies without U.S. investments say this confusion south of the border is actually good for their business.
"This is likely to be good for leading Canadian companies in the sector," said Cam Battley, an executive vice-president at Aurora.
"It will continue to drive U.S. investors to Canada. And we will not be bumping into U.S. competitors" both in Canada and overseas, he added. Aurora is among several Canadian players that are expanding into new countries, such as Germany, Australia and Denmark.