DOJ Guidance Paves Way For Marijuana Stocks

by: Individual Investment Strategist

(Editors' Note: This article discusses micro-cap stocks. Please be aware of the risks associated with these stocks.)

My last article detailed legal considerations and complications for companies involved in marijuana and peripheral industries such as Medical Marijuana, Inc. (OTCPK:MJNA); Hemp, Inc. (OTCPK:HEMP); MediSwipe, Inc. (MWIP.OB); Tranzbyte Corp. (OTCPK:ERBB); Growlife Inc. (OTCPK:PHOT); Medbox, Inc. (MDBX.PK); Terra Tech Corp. (OTCQX:TRTC); Rapid Fire Marketing, Inc. (OTCPK:RFMK); and GW Pharmaceuticals Plc. (OTCPK:GWPRF) among others and advised investors accordingly. Since then there have been many advances domestically and internationally in legislation and guidance that will influence how these companies can now develop.

Federal Guidance for Marijuana Legalization and State Regulation

The most important of these advances came at 11:50am PDT today (8/29/2013) when James Cole, Deputy Attorney General for the Department of Justice released guidance for federal enforcement agencies and prosecutors. This release comes as a long awaited response to the laws enacted by Colorado, Washington, and the growing number of states legalizing medicinal marijuana. While this is excellent news, details are always important. Currently the DOJ is not going to challenge state laws that conflict with federal legislation, but instead lays the groundwork for states to form self regulating entities while still providing for federal intervention.

The new memorandum issued by the DOJ gives guidance to all federal enforcement agencies where "civil enforcement and criminal investigations and prosecutions, concerning marijuana in all states" is concerned.

In previous memoranda issued in 2009 and 2011, Congress made public its determination that marijuana is a dangerous substance. Under the guidance provided at that time, which is still in effect, it was determined that enforcement of federal laws to prosecute the seriously ill or their caregivers was not an efficient use of federal resources. For enforcement purposes there was a distinction made between the ill and large scale for-profit enterprises; under federal guidance at the time, the latter of the two were still targets for federal enforcement and prosecution. This distinction was made because illegal distribution and sale of marijuana provides a significant source of revenues for large scale criminal enterprises, gangs, and cartels; the logical reasoning is that the terminally or seriously ill are not going to fund those organizations if purchasing from a legitimate source while innumerable enterprises have been influenced and aided these types of organizations.

The guidance issued today clearly states that the DOJ is committed to enforcing the Controlled Substances Act (CSA). In light of the growing number of conflicting state and federal laws, the DOJ will prioritize use of its limited resources accordingly and will focus enforcement and resources, including prosecution, on people or organizations whose conduct interferes with any one or more of the following eight priorities regardless of state law:

  1. Preventing the distribution of marijuana to minors
  2. Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels
  3. Preventing the diversion of marijuana from states where it is legal under state law in some form to other states
  4. Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity
  5. Preventing violence and the use of firearms in the cultivation and distribution of marijuana
  6. Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use
  7. Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands
  8. Preventing marijuana possession or use on federal property

State Responsibilities, Company Guidelines, and Federal Enforcement

The DOJ "rests on its expectation that states and local governments that have enacted laws authorizing marijuana-related conduct will implement strong and effective regulatory and enforcement systems that will address the threat those state laws could pose to public safety, public health, and other law enforcement interests." In the same release, it also briefly details those expectations laying the groundwork each state should consider when forming its own enforcement and regulatory system. To be effective, the DOJ believes that each state should develop their individual systems with the following considerations:

  • It must be effective on paper and in practice
  • It must not undermine federal enforcement priorities
  • States must dedicate their own resources to implement and enforce it
  • It must prevent trafficking to states where marijuana is illegal
  • It must prohibit access by minors
  • It must replace illegal activities that fund criminal enterprises with a tightly regulated market where revenues are tracked and accounted for

If state enforcement and regulatory efforts do not sufficiently comply with these mandates the federal government may seek to challenge the regulatory structure itself in addition to continuing to bring individual enforcement actions including, criminal prosecutions, focused on those harms.

There is also guidance to federal prosecutors stating that they should consider multiple factors when determining if they should prosecute businesses. The prosecutors should not solely consider the size or commercial nature of a marijuana based business. Instead they should factor in all available information, compliance with the state regulatory system, review on a case by case basis, and finally determine if the entity or regulatory system under which it operates is counterproductive to federal enforcement priorities.

In the words of the DOJ, this release is meant only as a guide going forward and does not alter federal law or reduce their ability to enforce federal law. All rights are reserved to continue enforcing federal laws going forward regardless of state law. The Department of Justice also states that the guidance released today does neither provides legal defense to federal legislative violations or civil/criminal violations, nor does it create any rights enforceable by law in any civil or criminal matter. Threats to federal priorities will result in federal enforcement action. Important federal interests will continue to be pursued accordingly.

Based on the preceding information, we can deduce a few points that should be kept in mind regarding the legal risk of public companies within the marijuana/cannabis industry. The federal government is reserving the right to preempt state law and continue enforcing federal law irrespective of state statutes. Cannabis/marijuana, THC, or derivatives are still illegal and will continue to be illegal under federal law. If states can enact a strong regulatory system that effectively mitigates the threat created by the size and nature of business ventures and the result is in accordance with federal projections, then all federal intervention will likely be kept to a minimum.

Under the previous premise there are a few changes I would expect to see from current companies:

  • Increased Transparency - Even though there is no guarantee of safety from enforcement of federal statutes, to not increase transparency at this point will probably increase the position of a company on the federal enforcement radar
  • Partnerships with State Agencies - though states should maintain a separation of business and government affairs, partnerships will be required in order to outline a functional structure that will not violate federal mandates
  • Attraction of Talent - let's face it, many of the public companies are barely getting off the ground and run by individuals with little or no experience in management or in management of large enterprises
  • Management Turnovers - if any of the companies are engaged in "shady" operations are concerned about the lifespan and growth of their organizations, there might be a plethora of unexpected resignations within the near future

The Bottom Line

The bottom line for investment guidance from me has not changed much in regard to any current or future companies operating in today's legislative environment. Investors should still do their own due diligence. Investors should also accept that even though the news release and guidance issued today is groundbreaking, this is a very high risk industry still and any company could face all of the potential setbacks afforded by law (outlined in my previous article).

On the other hand, there has never been more of a golden road for these companies. They now know the guidelines as set forth by the federal government and how they can position themselves to operate with the best chance of success from a legal standpoint. The market will likely see some of these companies take the lead by becoming respected counsel for state agencies and helping to further a complete legalization effort. With increased transparency, public companies will also attract a different group of investors. All of this could lead to some very profitable organizations out of the current group.

I will continue to look for companies that exhibit some of these characteristics and base my investment decisions accordingly. More importantly, as the legal and regulatory structure within the states begins to form and mature, I suggest keeping an eye out for signs of well established companies preparing to enter the marijuana industry.

Disclosure: I am long OTCPK:ERBB, OTCPK:HEMP, OTCPK:RFMK, MWIP.OB, OTCPK:MJNA, OTCPK:PHOT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.