One of the things that happened both in the lead up to and in the wake of the October 2018 legalization of cannabis-based products in Canada is that a number of Canada-based cannabis companies listed their shares on U.S. securities exchanges. From the outset, D&O insurers have regarded the cannabis companies as a distinct risk and as a tough class of business. Earlier on, there were relatively few claims to substantiate these concerns. However, there have now been a number of securities class action lawsuits filed against U.S.-listed Canadian companies, with the latest lawsuit filed just this week.
The Latest Lawsuit
The latest lawsuit involves CannTrust Holdings, Inc., an Ontario-based producer and distributor of medical and recreational marijuana. CannTrust’s shares trade on the New York Stock Exchange. On July 10, 2019, a CannTrust shareholder filed a securities class action lawsuit in the Southern District of New York against the company, its CEO and CFO. The complaint purports to be filed on behalf of persons who acquired CannTrust securities between November 14, 2018 and July 5, 2019. A copy of the plaintiff’s complaint can be found here.
On July 8, 2019, the company disclosed that Health Canada fount that the company’s greenhouse facility in Pelham, Ontario was non-compliant with certain cannabis-related regulations. As a result of the alleged non-compliance, Health Canada placed a hold on 5,200 kg of dried cannabis harvested from the unlicensed rooms, along with an additional 7,500 kg the company voluntarily held until the facility becomes compliant. According to the complaint, the company’s shares fell more than 22% in response to this news.
The complaint alleges that the defendants made false or misleading statements or failed to disclose: “(1) that the Company was growing cannabis in its Pelham greenhouse while applications for regulatory approval were still pending; (2) that the Company’s Pelham greenhouse did not comply with certain regulations; (3) that as a result, the Company was reasonably likely to face an inventory hold by Health Canada until the Pelham facility becomes compliant with the applicable regulations; (4) that, as a result, the Company’s customers would face shortages and would likely seek product from CannTrust’s competitors; and (5) that as a result of the foregoing, Defendants’ positive statements about the Company’s business, operations, and prospects were materially false and/or misleading and/or lacked a reasonable basis.”
The complaint alleges that the defendants made these misrepresentations or omissions in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the putative class.
Prior Lawsuits against Canadian Cannabis Companies
CannTrust is just the latest U.S.-listed Canadian company to get hit with a U.S. securities class action lawsuit.
For example, as I discussed in a prior blog (here), in September 2018, Canadian cannabis producer and distributor Cronos Group was hit was a securities class action lawsuit in the Southern District of New York. The Cronos Group lawsuit alleged that the company and certain of its directors and officers misled investors about the size of its distribution agreements.
In addition, as discussed here, in October 2018, shareholders filed securities class action lawsuits in the Central District of California and in the Southern District of New York against Canadian-based Cannabis e-commerce company Namaste Technologies, Inc. and certain of its directors and officers. The complaints alleged that the certain of the company’s executives engaged in a transaction with the company that was not arm’s-length.
And as discussed here, in January 2019, shareholders filed a securities class action lawsuit in Southern District of New York against Liberty Health Services, a Canadian-based cannabis production and distribution company, alleging that the company had engaged in series of allegedly fraudulent transactions with an affiliated entity in order to benefit both companies’ insiders.
To be sure, not all of the cannabis companies that have been hit with securities suits are Canadian-based. For example, as discussed here, in May 2019, shareholders filed a securities class action lawsuit in the District of Maryland against India Globalization Capital, Inc. and certain of its directors and officers. ICG is based in the U.S. state of Maryland. The investors’ complaint alleges company insiders sold their personal holdings in the company’s stock after the company’s share price surged following its announcement that it intended to produce a cannabiodal (CBD) infused beverage. The company’s share price soon plunged when it came to light that the supposed beverage product was not developed to a commercial stage and indeed potentially could not be produced at all due to legal constraints.
However, while not all of the cannabis companies that have been sued have been Canadian, there have in fact now been a number of Canadian-based cannabis companies that have been hit with U.S. securities class action lawsuits.
Just because a lawsuit has been filed does not mean that the lawsuit is meritorious. The lawsuit against CannTrust appears to be a good illustration of this principle. The lawsuit cannot survive a motion to dismiss unless the Court finds that the plaintiffs’ allegations create a strong inference that the defendants made the alleged misrepresentations or omissions with scienter. Allegations of scienter in the CannTrust complaint are pretty hard to find.
The one thing that I will say about the CannTrust complaint, arguably by contrast with the other cannabis-related securities suits, is that the CannTrust lawsuit seems to have more than the other lawsuits to do with the fact that the company is in a cannabis-related business. Most of the allegations against the other cannabis companies that have been hit with securities suits involve alleged misconduct that might arise at any company; there is nothing about the allegations against the companies that has to do with the fact that the companies are in the cannabis business. By contrast, the allegations in the CannTrust complaint relate directly to the fact that the company’s basic operations involve growing cannabis and that in Canada growing cannabis is highly regulated and subject to government supervision. The other lawsuits, by contrast, may say more about what kind of company and company management might be attracted to the cannabis business.
One of the reasons that D&O insurance underwriters view cannabis companies as a tough class of business has to do with the legal and regulatory uncertainty surrounding cannabis as a product. In the U.S. for instance marijuana is legal for recreational purposes in a number of state but not in all states and not at the federal level. In Canada, there are a variety of legal and regulatory environments in the various provinces. There are also questions and concerns about the cannabis businesses’ access to banking services and their need to handle large amounts of cash. Interestingly, while the underwriter’s concerns relate to these challenging issues, none of the lawsuits I described above are based on these issues or concerns.
In any event, the new lawsuit against CannTrust provides an example of the kinds of claims that can arise in connection with cannabis-related businesses. As the industry develops and evolves, there undoubtedly will be further questions and further claims. The emergence of these issues and claims should help underwriters as the developing guidelines to try to underwriting these kinds of risks. The claims should also help the companies’ insurance advisors as the companies attempt to manage and transfer their risks.
One final note is that this lawsuit represents yet another example of an event-driven securities suit, in which a company that experiences an adverse development in its operations gets hit with a securities suit. An unexpected regulatory setback is one of the more common types of events that gets translated into an event-driven securities suit.