The marijuana industry is in a 'catch-22'

Last week, the nascent marijuana industry in California scored a huge victory: The Department of Justice dropped its four-year attempt to shut down Harborside Health Center, the largest medical marijuana dispensary in the country.

But the industry still faces “monumental challenges” to doing business, Aaron Herzberg, an attorney and a partner at California-based Calcann Holding Corporation, a medical marijuana property and licensing company, told Business Insider.

On one hand, the DOJ’s move to drop the case against Harborside may indicate a “shift in attitude” about marijuana from the Obama administration, but “they haven’t said so directly,” Stanford Law professor Robert MacCoun told Business Insider. “Of course, we don’t really know whether policies will shift under the next president.”

The chief problem with the marijuana industry boils down to a states’ rights issue. While numerous states have legalised marijuana, either for medical or recreational use, the drug remains illegal at the federal level, leaving many companies vulnerable to investigations.

The federal Controlled Substances Act classifies marijuana as a Schedule I drug, defined as a substance or chemical with no accepted medical use and a high potential for abuse. On the other hand though, four states have already legalised recreational marijuana — Colorado, Washington, Alaska, and Oregon — and almost half permit medical marijuana.

“If they say states can do this, the federal government just needs to get out of the way and let states do this,” Herzberg said. “But frankly, I don’t think it’s a priority for too many federal politicians.”

The Department of Justice “will continue to exercise its discretion in deciding where and how to enforce the Controlled Substances Act,” a DOJ spokesperson told Business Insider.

Harborside Health Center marijuana(AP Photo/Jeff Chiu)Harborside Health Center employee Gerard Barber stands behind medical marijuana clone plants at Harborside Health Center in Oakland, California.

The legal discrepancies also cause financial roadblocks.

To start, federal law 280E on the Internal Revenue Code prevents both medical and recreational marijuana businesses from certain benefits given to other legal businesses. Because of the law, the Daily Beast reported, marijuana businesses may pay as much as 70% in federal taxes.

Under 280E, any business that engages in the distribution of Schedule I or II controlled substances are barred from tax deductions, like for leasing property or paying salaries, that other legal business are allowed to take. The provision was originally set up as a punitive measure against cocaine and heroin dealers, according to Herzberg.

In addition to 280E, banks must comply with federal regulations and often won’t take on clients in the marijuana industry for fear of legal repercussions. A federal court even refused access to a master account for The Fourth Corner, a credit union set up by Colorado’s state government to help dispensaries access banks.

That shuts many marijuana business out of financial institutions and forces them to operate on an all-cash basis, which makes tasks like paying taxes and keeping track of revenue difficult.

“Where this is limiting is with institutional capital,” Morgan Paxhia, a partner at Poseidon Asset Management, a cannabis-focused hedge fund, told Business Insider. “They’re very interested, but they’re prevented from investing because of compliance.”

Much of Poseidon’s investments come from high-net worth individuals or family offices that have higher risk tolerance than institutional investors like banks, according to Paxhia.

“Partners at venture capital or private equity firms are using their own capital, rather than firm assets,” he said. “They’re not waiting for the federal government, they’re participating in any way they can.”

There are a lot of people — and a lot of money — waiting on the sidelines to jump into the burgeoning industry. But as long as these banking issues persist and marijuana remains classified as a Schedule I drug, the industry will face immense challenges from the federal government.

“They deny you the very basic tools of doing business,” Herzberg said. “It’s a catch-22, and it can only be solved by the federal government.”

Now, the country now looks to California as the next battleground. State residents will likely have a chance to vote on full legalization on November 8. What happens could serve as a model for other states.

“I think we’ve seen improved perceptions around cannabis, but it still feels like there’s a long way to go, ” Emily Paxhia, Morgan’s sister and also a partner at Poseidon, told Business Insider. “In California, it’s obviously going a lot faster.”

The vote continues what started in September 2015 with California’s Medical Marijuana Regulatory Safety Act (MMRSA). MMRSA allows medical marijuana businesses in California to operate for-profit in the state and set up various requirements and systems for operation.

Prior to MMRSA, medical marijuana businesses operated on shaky legal foundations, leaving an open door for the DOJ to build a case against Harborside. While the Compassionate Use Act of 1996 allowed for medical marijuana use, the law did not specifically permit medical marijuana providers to profit from the sale of marijuana and marijuana products, like edibles and synthetics.

“The feds have said that they would only go after places operating in conflict with their state medical cannabis regulatory system,” Amanda Reiman, a lecturer at Berkeley’s School of Social Welfare, told Business Insider via email. “Harborside was operating in compliance with Oakland’s regulations, but there were no rules at the state level. This left them vulnerable to federal interference.”

Aside from protecting medical marijuana businesses, MMRSA could also provide the framework for recreational marijuana in California as well.

“MMRSA [took] important steps toward rationalizing many features of the whole supply chain for medical marijuana in California, and it could serve to smooth the a transition toward a legal recreational market,” MacCoun said.

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