Notwithstanding its relative infancy, the cannabis industry has attracted more than its fair share of charlatans and snake-oil salesmen seeking to defraud unsuspecting investors, prompting an untold number of securities fraud lawsuits. Now, operators who choose to market supposed health benefits of cannabis and derivative products may find themselves defending such claims as well.
Ubiquitous deceptive investment practices in the cannabis industry prompted the Securities and Exchange Commission to issue an “investor alert” in September 2018, advising the investing public about how to identify and avoid investment scams and market manipulation. The SEC warned the investing public to be on the lookout for, among other things, unlicensed and unregistered sellers; guaranteed returns, especially when accompanied by minimal risk; and unsolicited offers (such as opportunities presented via social media, email, text or phone call). Market manipulation — artificially inflating or deflating stock prices through the spread of false information — may be more difficult to identify, but simple diligence regarding trading history (including whether the SEC ever suspended trading activity), abrupt changes to corporate ownership or form and/or press releases that seem implausible, may reveal such a fraudulent scheme. Similar warnings were subsequently issued by FINRA and the North American Securities Administrators Association, as well as larger brokerage houses such as TD Ameritrade.
Less than a year later, this past August, a securities fraud class action lawsuit in the market manipulation category was brought against Curaleaf (CURLF), a “medical and wellness” cannabis operator publicly trading on the Canadian Securities Exchange. The lawsuit was filed in the Eastern District of New York on behalf of investors who purchased shares of Curaleaf between November 21, 2018 and July 22, 2019 and who allege that the company made false and/or misleading statements, as well as failed to disclose material adverse facts about the company’s business and prospects in order to increase the value of its stock. Specifically, the class of investors allege, among other things, that Curaleaf made unsubstantiated health claims in the marketing and sales of unapproved new and/or misbranded medicine, dietary supplements and animal medicine. Prior to the lawsuit, Curaleaf had received a warning letter from the FDA to remove such offending statements from its marketing materials, the news for which caused its stock price to drop 7.27%.
Just a few months earlier, Curaleaf had been celebrated for having successfully completed the acquisition of Cura Partners Inc.’s Select Brand for nearly $1 billion in stock, resulting in the world’s largest cannabis company measured by sales (approximately $205 million in annual revenue, combined). Shortly thereafter, Curaleaf announced plans to acquire Chicago-based Grassroots, formerly the largest privately owned, vertically integrated multi-state operator. According to its website, Curaleaf maintains a presence in 12 states, with 48 dispensaries, 14 cultivation facilities and 13 processing facilities. Following the Grassroots acquisition, Curaleaf will gain a solid foothold in Illinois, the nation’s fifth-most populous state, which just legalized adult-use cannabis, and its portfolio will expand to 19 states, with 131 dispensary locations, 20 cultivation facilities and 26 processing facilities.
Curaleaf has sought additional time from the court to respond to the class action. There are a host of defenses available to a securities fraud defendant. In all likelihood, Curaleaf will seek dismissal on a variety of procedural grounds, including whether the claims were advanced with the sufficient level of particularity, or whether the case was brought in the proper venue, with sufficient jurisdiction and/or notice. Curaleaf may allege that the plaintiffs failed to sufficiently plead the various elements of a securities fraud claim, including, for instance, that the alleged “false” claims were immaterial, did not induce the investors to purchase stock, or that Curaleaf did not act with necessary knowledge that actions or conduct was wrongful, or intended to deceive, or proximately cause plaintiffs’ damages. To this end, Curaleaf could maintain that it acted in good faith, based upon prevailing anecdotal evidence, consistent with the manner by which many cannabis operators market their medicine and/or products for sale and/or that any decline in stock price is consistent with market conditions in a volatile, new market rife with enforcement actions and regulatory shifts.
The impact, if any, this lawsuit will have on Curaleaf and investor confidence in publicly traded cannabis companies in general, remains to be seen.
Regardless, defending a class action securities fraud lawsuit is no trivial feat and may cost hundreds of thousands of dollars, if not millions. To avoid the same fate, cannabis operators must not make any unproven health claims about the supposed medical efficacy of their products. This, according to the FDA, means claims that cannabis (including CBD) can effectively treat serious diseases and conditions — including those for which medical cannabis may properly be recommended under state law — such as epilepsy, anxiety, depression, cancer, etc. Marketing materials must be scrutinized to avoid reference to a relationship between a specific substance and a reduced risk of a disease or condition, including patient testimonials. While cannabis-related health claims may seem pervasive in the marketplace, add securities fraud to the list of risks to avoid, together with FDA enforcement action, rebrands, recalls, fines and reputational harm.
Lauren Rudick represents investors and startup organizations in all aspects of business and intellectual property law, specializing in cannabis, media and technology. Her law firm, Hiller, PC (www.hillerpc.com), is a white-shoe boutique firm with a track record for success and handling sophisticated legal matters that include business and corporate law.