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How Securities Law Affects Your Cannabusiness

Securities law and investing in cannabusiness

When filing an application for a cannabusiness facility license from the state, the Marijuana Regulatory Agency (MRA) requires a copy of the LLC’s Operating Agreement or corporation’s Bylaws. This is to review how the company is structured. Additionally, common practice in this industry is to place a disclaimer on the front page of the document or inside stating that:

The membership interests are not registered as securities and should not be treated as securities.

The importance of reviewing securities law

When reviewing the draft of their governing documents, many people skip past this paragraph entirely. Either that or they skim it, therefore barely understanding its meaning. However, securities law holds a major impact on how you structure your business. If done improperly, this can result in criminal liability, steep fines, refunds of amounts paid by investors or a total loss of your business. Many businesses often have a business contract attorney take a look over important documentation so that nothing is missed and all documentation is accounted for, protecting the business.

If you’re thinking about creating a company and later securing investors, you may engage in the sale of a security. Furthermore, you should retain a law firm with specialized knowledge of the securities laws affecting your business. However, registering securities is an expensive, time-consuming and complicated process.

This is why we recommend first seeing if you’re engaging in a sale of a security. Additionally, you should also check if you meet an exception to avoid entangling your marijuana business in securities laws.

How do you know if you are engaging in a sale of a security?

Determining what constitutes a security should remain one of your first considerations. You should consider this any time you’re looking for investment or acquiring a business entity or interest. Certain items such as stocks and bonds can easily be characterized as securities; however, the classification of other non-typical financial instruments is difficult and involves complex legal issues. Stocks can be a big leap to take with any industry, however, with the proper research and data the right ones can be found. Looking out for Bitcoin Prime Betrug (Bitcoin scams) and any other red flags will help keep money secure and safe.

To avoid costly securities complications, you’ll need to determine whether your action qualifies as a “security.” Section 2(1) of the Securities Act of 1933 and the Section 102(c) of the Michigan Uniform Securities Act provide basic definitions for the term “security.” The definitions include the typical items (e.g., stocks and bonds) and also non-typical items such as “investment contracts.” The latter is defined as a catch-all provision for other forms of investments.

Investor contracts under the Howey test

Investment contracts aren’t defined by statute. However, in 1946, the U.S. Supreme Court developed a test to determine what constitutes an investment contract called the Howey test. Under the Howey test, an investment contract involves:

  1. An investment of money
  2. In a common enterprise
  3. With an expectation of profits
  4. Come solely (or primarily) from the efforts of others.

Some of the more common scenarios in which a cannabis company may engage in the offer or sale of a security are discussed below:

  • Stock as a Security: A common stock issuance by a cannabis corporation is the most basic example of a sale of a security.
  • Notes as Securities: Both the Securities Act of 1933 and the Michigan Uniform Securities Act includes the term “note” in their definition of a security.
  • Limited Liability Company Interests as Securities: Treating LLCinterests as securities is largely unsettled under federal law. Generally, the LLC’s structure provides guidance on whether proof of investor membership interest is a security. Member-managed LLC interests are unlikely to be deemed securities due to the control and management of the company’s members.

Oppositely, manager-managed LLCs are more likely to have their LLC interests classified as securities due to the lack of control and management by their members. This determination is generally made on a case-by-case basis; the stronger the managerial control over the business, the more likely membership interest is classified a security.

If it’s a security, how can I avoid issues with securities law?

Federal and state securities laws generally apply to a company’s offer or sale of any security. This requires the company to either:

  1. Register” the security with the Securities and Exchange Commission (SEC) and/or the applicable states
  2. Rely on an exemption allowing the transaction to occur without registration

Registration is a time consuming and expensive process that ultimately results in a company “going public”. For many cannabusinesses, “going public” is not a desirable or practical option in this highly regulated industry. As a result, most cannabusinesses that engage in an offer or sale of securities likely rely on registration exemptions.

Available exemptions under securities law

There are a number of exemptions available on the federal and state levels. You should discuss with an international business attorney on whether your investment strategy meets an exemption as they know all the relevant laws. Many exemptions revolve around the number of investors involved in the transaction, the amount of total investment, and whether the company is going public.

If your company structures the investments to meet an exemption, you may forego the registration process and file a form with the appropriate agency. Failure to do either though causes your cannabusiness to experience liability and therefore, creates a legal minefield after the fact.

Rather than register the securities or face penalties with the Securities Exchange Commission (SEC), you may speak with a business attorney before you sell LLC shares or membership interest. Furthermore, you can plan ahead and structure your deal to meet an exemption.

Barton Morris
Barton Morris has been providing high-quality legal representation in the area of state and federal criminal defense for more than 20 years.
The Cannabis Legal Group has been providing our clients professional and quality legal assistance in all aspects of representation for years.

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