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California Chaos – Not Only do California’s Cannabis Regulations Make Banking Cannabis Businesses Almost Impossible, They Squandered a Perfect Opportunity to Embrace Regulatory Innovation

There is a big push in the FinTech/RegTech (SupTech) space to digitize regulations. One of the biggest hurdles to doing so, however, is the “Jenga Tower” of existing regulations and regulated entities’ systems that would certainly topple over if you tried to replace any single analog piece with a new digital piece.

But what if you didn’t have a legacy regulatory regime – or even a legacy industry – that didn’t have existing regulations and systems?  You wouldn’t have the Jenga Tower problem at all.

The US (state-by-state) cannabis or marijuana regimes are a perfect example of an industry and regulatory regime that is being built from the ground up. Given that few states have put in a regime, now is the time to act … you have a clean slate: it’s a perfect environment to prove the  hypothesis that regulations can be digitized.

California might be the best example of squandering a great opportunity to create a fully digitized, harmonious regulatory regime for its nascent cannabis regime. But it may be too late for California … as I’ve written on LinkedIn, they couldn’t have a designed a more complicated, anti-business and anti-banking regulatory regime if they had tried. What evidence do I have to make that statement?

Under the California cannabis legislation – the Medicinal and Adult Use Cannabis Regulation and Safety Act, or MAUCRSA – there are three main government agencies that regulate different parts of the industry:

  1. the Bureau of Cannabis Control (Bureau) is the lead agency. The Bureau is charged with licensing, regulation, and enforcement of the following types of commercial cannabis businesses: distributors, retailers, microbusinesses, temporary cannabis events, and testing laboratories.  The BCC’s regulations are in Title 3 of the California Code of Regulations.
  2. the Manufactured Cannabis Safety Branch, a division of the California Department of Public Health (CDPH), is responsible for regulating and licensing manufacturers. The CDPH regulations are in Title 17.
  3. CalCannabis Cultivation Licensing, a division of the California Department of Food and Agriculture (CDFA), is responsible for licensing cultivators and implementing the Track-and-Trace system. The CDFA’s regulations are in Title 16.

Rather than provide a single, public-facing agency that best serves cannabis businesses and consumers, which would require the multiple government regulators and regulatory agencies to cooperate and collaborate in the background in order to make it easy for the businesses and consumers, those government agencies decided to serve themselves and their needs, and force businesses and consumers to navigate multiple agencies. They know it’s a problem (see below) but decided it wasn’t in their best interests to do what is in the best interests of Californians.

One of the issues may be found in the membership of the California Cannabis Advisory Committee, a 22-person committee created to advise these agencies (and the Governor’s office): none of the twenty-two represent technology/fintech/financial services (half the committee is made up of representatives from the cannabis industry, labor organizations, and social/community equity groups). The Subcommittee on Licensing Application (which, by the way, should be the plural “applications” because there are three different applications, depending on the type of cannabis business) is chaired by a policy analyst from a labor organization and neither of its members appear to have strong technology, regulatory, fintech, or financial services backgrounds. So perhaps it simply didn’t occur to the CAC members, or any of the 39 State Government people listed on the CAC website (including the Governor) to consider a digitized regulatory regime and to have a single Application and single definition of “owner” of a cannabis business …

But the CAC has been busy, and issued its 2018 report on January 8th. Here are some excerpts:

“The overarching reality after one year of legal cannabis sales is that the regulatory process to licensure insufficiently incentivizes unlicensed businesses to seek licensure and insufficiently de-incentivizes the illegal unlicensed underground market in order to effectively ‘protect public health and safety while ensuring a regulated environment for commercial cannabis activity.’ The variety of issues contributing to this include, but are not limited to, the following: equity issues, small business issues, microbusiness issues, excessive regulatory burden, banking issues, enforcement issues, compassionate use issues, public education issues, taxation issues, regulatory fragmentation issues.”

That may be a Government Committee Hall of Fame sentence. I’ve read that sentence 11 times and still can’t follow it, but I think what they’re trying to write is that “we’ve made the licensing requirements so onerous and complicated, and the taxes so high, that there’s little if any incentive for unlicensed cannabis businesses to get licensed.” (they make that point in other places – pages 3, 30, and 31). See https://www.bcc.ca.gov/about_us/documents/cac_annual_report_2018.pdf

And as to excessive regulatory burden:

“Excessive Regulatory Burden — Small businesses are having difficulty emerging from their historically underground status due to the inability to modify regulations to meet local conditions, the fragmentation of regulations among the different agencies and local jurisdictions, and the amount of upfront capital required to comply with the regulations.

  • The dual nature of the licensing process (i.e., state and local) has created a bottleneck in licensing at the local municipal level where unless a local municipality actually issues a license, permit, or other authorization, businesses are not able to apply for a state license. Therefore, as willing and able as the state agencies are to issue licenses, unless a qualified applicant has successfully navigated the licensing process at the local level, the state agencies are left out of the process.
  • The majority of local municipalities are either not issuing licenses or are slow in rolling out their cannabis programs. Of the municipalities issuing licenses, most are not issuing retail licenses.
  • Patchwork ordinances at the local level is creating a patchwork system that is not always in line with state requirements and is lacking in uniformity on a statewide level.”

None of these should have been surprises, and many of them are self-inflicted. As to “the fragmentation of regulations among the different agencies”, they admit that “The need for licensees to interact with three separate regulatory agencies (Bureau, CDPH and CDFA) is burdensome. Increasing coherence by providing one single point of contact would be advantageous for business operators. Current regulatory agency structure and oversight is over complicating licensing processes without clear enough direction and authority.”

Granted, the CAC cannot legislate or regulate, but can only make recommendations to the legislators and regulators.

The best example of the excessive regulatory burden – and something that could practically block many banks from banking cannabis businesses even if the Feds get around to providing some legal and regulatory clarity – is the multiple definitions of “owner” from the three different regulations (see below). There are subtle, major, and minor differences, between the three, and all have some terrible language (for example, the word “any” in the phrase “any of the following” means one, some, or all (according to Merriam Webster)). It makes no sense to have different definitions of “owner” depending on the type of license, particularly where many businesses have multiple license types. Also, in addition to having different definitions of “owner”, the Applications are all different.

It’s madness. California has squandered an opportunity to have a 21st century regulatory regime for a 21st century industry. But if they were trying to deter banks from providing products and services to the commercial cannabis industry, they seem to have succeeded.

California State Agency California Regulation Regulated Cannabis Business Type(s) Definition of Owner
Department of Public Health California Code of Regulations, Title 17
Division 1 Chapter 13.
Manufactured Cannabis Safety
SUBCHAPTER 1.  General Provisions and Definitions
Manufacturers §40102. Owners and Financial Interest Holders.
(a) An owner shall mean any of the following:
(1) Any person that has an aggregate ownership interest, other than a security interest, lien, or encumbrance, in a commercial cannabis business of 20 percent or more;  (A) If the owner identified in subsection (a)(1) is an entity, then the chief executive officer and members of the board of directors of the entity shall be considered owners.
(2) The chief executive officer of a commercial cannabis business;
(3) If a non-profit entity, each member of the Board of Directors;
(4) Any individual that will be participating in the direction, control, or management of the licensed commercial cannabis business
(5) The trustee(s) and all persons that have control of the trust and/or the commercial cannabis business that is held in trust
Department of Food and Agriculture CALIFORNIA CODE OF REGULATIONS TITLE 3. FOOD AND AGRICULTURE DIVISION 8. CANNABIS CULTIVATION CHAPTER 1. CANNABIS CULTIVATION PROGRAM Cultivators § 8103. Owners and Financial Interests Holders.
(a) “Owner” means any of the following:
(1)  A person with an aggregate ownership interest of twenty (20) percent or more in the person applying for a license or a licensee, unless the interest is solely a security, lien, or encumbrance;
(2)  The chief executive officer of a nonprofit or other entity;
(3)  A member of the board of directors of a nonprofit;
(4)  An individual who will be participating in the direction, control, or management of the person applying for a license.
(b)  An owner who is an individual participating in the direction, control, or management of the commercial cannabis business includes any of the following: (1)  A partner of a commercial cannabis business that is organized as a partnership; (2)  A managing member of a commercial cannabis business that is organized as a limited liability company; (3)  An officer or director of a commercial cannabis business that is organized as a corporation.
Bureau of Cannabis Control BUREAU OF CANNABIS CONTROL
TEXT OF REGULATIONS
CALIFORNIA CODE OF REGULATIONS TITLE 16
DIVISION 42. BUREAU OF CANNABIS CONTROL
Distributors
Testing Labs
Retailers
Microbusinesses
Cannabis Events
§ 5003. Designation of Owner
(a) All applicants for a commercial cannabis license shall have at a minimum one individual who meets the definition of “owner” under Business and Professions Code section 26001(al) and who will submit the information required of owners under section 5002 of this division.
(b) “Owner” means any of the following:
(1) A person with an aggregate ownership interest of 20 percent or more in the person applying for a license or a licensee, unless the interest is solely a security, lien, or encumbrance.
(2) The chief executive officer of a nonprofit or other entity.
(3) A member of the board of directors of a nonprofit.
(4) The trustee(s) and all persons who have control of the trust and/or the commercial cannabis business that is held in trust.
(5) An individual entitled to a share of at least 20 percent of the profits of the commercial cannabis business.
(6) An individual who will be participating in the direction, control, or management of the person applying for a license. Such an individual includes any of the following: (A) A general partner of a commercial cannabis business that is organized as a partnership. (B) A non-member manager or managing member of a commercial cannabis business that is organized as a limited liability company. (C) An officer or director of a commercial cannabis business that is organized as a corporation.
(c) When an entity is an owner in a commercial cannabis business, all entities and individuals with a financial interest in the entity shall be disclosed to the Bureau and may be considered owners of the commercial cannabis business. For example, this includes all entities in a multi-layer business structure, as well as the chief executive officer, members of the board of directors, partners, trustees and all persons that have control of a trust, and managing members or non-member managers of the entity. Each entity disclosed as having a financial interest must disclose the identities of persons holding financial interests until only individuals remain.