During the past few months, the U.S. Securities and Exchange Commission (“SEC”) Division of Enforcement has continued to police the areas of the cannabis industry that roll over into the SEC’s jurisdiction.
In March, the SEC charged American Patriot Brands, Inc. (“APB”), a cannabis cultivation and distribution company, its CEO, other officers, and affiliated entities for their participation in a long-running scheme in which the company and its owners allegedly raised more than $30 million from more than one hundred investors across the country and siphoned off millions of investor dollars to enrich themselves. In a more recent case, in late May, the SEC obtained a temporary restraining order. It froze the assets of a purported Las Vegas-based cannabis products company after alleging that the company was operating a $60 million Ponzi-style scheme. The SEC alleged that “WeedGenics,” a d/b/a of Integrated National Resources, Inc. (“INR”), and its two owners made Ponzi-like payments and enriched themselves by millions. One owner served as INR’s primary investor relations representative, and the other owner served as INR’s vice president.
Regarding the APB case, in its complaint, the SEC claimed that since August 2016, APB, its CEO, COO, and CFO solicited investments based partly on “wildly inflated” revenue claims.. The SEC alleged that APB raised about $20 million from around 50 investors in its first offering. Examples of alleged misrepresentations include a claim that in 2016 revenues were $3.3 million, and earnings exceeded $1 million. In reality, gross revenue that year was only about $330,900, and its earnings were negative $9.6 million. In 2017, a company representative told one investor that its executives had agreed to be paid in stock and had not taken salaries in the past, when in fact, compensation paid that year to the three executives had “exceeded all of APB’s revenues from the sale of cannabis products,” according to the allegations. And a 2018 presentation emailed to investors included alleged dramatically overblown financial statements, claiming that APB had already raised $40 million from investors when it had yet to raise $17 million.
APB’s second offering, which started in July 2019 and ran through March 2020, saw the company net more than $3.2 million from 47 investors via a private placement. These offering materials suggested to investors that APB was poised to trade on an exchange, even though the company had been failing to file regular reports with the SEC. As a result, in the fall of 2019, the SEC suspended the company’s over-the-counter trading, and the company lost its SEC registration, making it ineligible for exchange listing. Two more offerings in 2021 and 2022 came against the backdrop of worsening financial struggles at APB as it was in default on its promissory notes, was hit with a nearly $680,000 judgment in favor of a creditor, and was sued by at least one investor. The company’s final pitch to investors included the purported claim that the company had produced “nearly 100,000 lbs. of flower” since an Oregon farm started operating. In reality, the farm had only produced a quarter of that the flower.
The SEC’s complaint further alleged that APB funneled millions in investor proceeds to the APB executives’ personal accounts and spent tens of thousands on the executives’ personal expenses. As a result, the SEC charged APB, the aforesaid officers, and certain subsidiaries with violating the antifraud provisions of the federal securities laws and named certain other affiliated entities as relief defendants that allegedly received millions in investor proceeds. The SEC, amongst other relief, is seeking disgorgement from the defendants and relief defendants and civil penalties from the defendants.
Turning to the recent WeedGenics / INR case, the SEC initially filed this action under seal on May 16, alleging that the defendants defrauded about 350 investors nationwide. The defendants allegedly told investors that the money would be used to develop or expand cannabis cultivation facilities in California and Las Vegas. The SEC further alleged that the cannabis facilities held out by WeedGenics never existed or were never owned by the company, despite the company issuing financial information and photographs of the alleged facilities to potential investors.
Rather, the SEC alleged that investor funds were used to buy luxury cars, real estate, jewelry, and adult entertainment. In addition, the owner vice president spent investor funds on his more public career as a rap musician. Further, according to the complaint, over $16 million was used to make Ponzi-like payments to other investors to give them the impression of returns.
As mentioned, the court granted the SEC emergency relief against WeedGenics / INR, the two owners, and several relief defendants; including a temporary restraining order, an order freezing their assets, and the appointment of a temporary receiver over WeedGenics / INR and the entity relief defendants. The SEC’s complaint further charged the defendants with violating the antifraud provisions of the federal securities laws and seeks disgorgement from them and the relief defendants and civil penalties from the defendants.
On June 8, 2023, the Judge for this matter froze additional bank accounts and assets by granting the SEC’s bid for preliminary injunctions on certain relief defendants, who allegedly received funds from the primary defendants. The Judge also issued an order that day to make the receiver that had been appointed preliminarily the permanent receiver.
- These recent cases, and the likely continued enforcement efforts, portend risks for companies operating in the cannabis space. Companies in the cannabis space, specifically those that are publicly traded, would be well-served by continuing to be mindful of their reporting and regulatory obligations. In particular, cannabis companies would be well-served by following practical best practices, including maintaining robust internal controls and compliance programs. To mitigate compliance risks associated with SEC enforcement, particularly in the cannabis space, it is crucial for cannabis companies to establish and maintain robust internal controls and compliance programs. These programs should be tailored to cannabis-specific risks, such as knowing your customers and vendors, complying with anti-money laundering provisions, and adapting comprehensive policies and procedures that address relevant legal and regulatory requirements. Cannabis companies would be well served by regularly reviewing and updating these controls and programs to ensure their effectiveness and alignment with evolving regulations.
- Engage in proactive risk assessments and monitoring: Cannabis companies should conduct proactive risk assessments to identify potential compliance vulnerabilities. This involves analyzing the company’s operations, financial reporting processes, and internal systems to identify areas of potential non-compliance with SEC regulations. Implement effective monitoring mechanisms, such as periodic audits and internal reviews, to detect and address compliance issues in a timely manner.
- Perhaps, most importantly, foster a culture of compliance and accountability: Cultivate a strong culture of compliance throughout the organization by promoting ethical behavior and accountability at all levels. Encourage employees to report potential compliance violations through anonymous reporting channels and establish a non-retaliation policy to protect whistleblowers. Regularly communicate the importance of compliance, provide training programs, and ensure that employees are aware of their responsibilities regarding SEC regulations. By fostering a culture of compliance, companies—whether in cannabis industries or otherwise—can reduce the likelihood of violations and demonstrate a commitment to upholding regulatory requirements.
While these tips are best practices for any company, they are particularly pertinent for companies in the heavily scrutinized cannabis space. The SEC’s enforcement efforts in the cannabis industry are not as far-reaching. They are not greeted with anywhere near the same level of consternation or fanfare as its aggressive efforts in the digital asset industry. Still, SEC enforcement continues to take its “watchdog” role very seriously for the expansively evolving cannabis industry. (See here for prior Foley & Lardner coverage of SEC settlement for accounting fraud against a cannabis company.)