The Vital Importance of Compliance in the Cannabis Industry

The Vital Importance of Compliance in the Cannabis Industry

Protection for state medical cannabis extended by federal budget amendment


Bryce Killen and Morris Sherwood

Some cannabis clients ask,is “compliance” really that big a deal,is it something they need to worry about? For those working in the cannabis industry, compliance is neither optional nor does it come naturally, rather, it is the heart and soul of a licensed operation, and as critical to the business’ continued existence as it is to its ultimate success.


Why is Compliance Important?


Understanding the nuances of operations and compliance with applicable cannabis regulations is vitally important to your business in two specific ways: it safeguards the business’ license, and hence its ability to operate; and it protects and enhances your business’ value.A robust compliance program will identify and mitigate risk factors particular to your company and its individual operations– from physical security to recordkeeping.


Safekeeping Your Ability to Operate


In California, as in all states that permit medical or recreational cannabis, only a licensed cannabis operator may cultivate, manufacture, distribute, or sell cannabis or cannabis-infused products. Further, under California’s local-control system, cannabis operators are required to obtain and maintain cannabis licenses at two separate levels – both state and local – either of which can cite your business for violations and potentially revoke your license, effectively putting you out of business overnight. Thus, keeping your licenses in good standing is critical to continued operations and preventing unnecessary downtime.


Protecting and Enhancing Your Business’ Value


A good compliance program maximizes operational procedures within the applicable regulatory constraints to ensure highly efficient operations while protecting against avoidable violations, fines, and work stoppages. Establishing standard operating procedures that meet regulatory requirements, and ensuring employees and officers follow them is critical to good compliance. But great compliance meansalso regularly reviewing those procedures, identifying inefficient or potentially non-compliant practices, implementing changes, and continually evaluating operations to stay ahead of problems. A solid compliance regime can actually enhance returns by weeding out duplicative or ineffective procedures and increasing efficiency.


In addition, great compliance can enhance the value of the company to future investors or acquiring companies. Investors and buyers with the capital to expand your business and take it to the next level want to be able to identify clear milestones showing the strength and reliability of the target company. A good compliance program provides a transparent recordkeeping system demonstrating not only compliance with current standards, but operations consistent with best practices in the industry, reassuring investors that the underlying company has a solid foundation.


Further, because cannabis licenses in California are non-transferrable, most transactions will be in the form of a corporate acquisition, rather than an asset sale. Because the corporate existence and its liabilities will transfer on to the new owners, a verifiable track record of strict compliance and best practices can enhance the acquisition value of your business compared to competitors, drawing more suitors and better offers.


What Does Great Compliance Look Like?


A great compliance program should implement a holistic approach – that is, it should examine the company as a whole, identifying all risk factors, not just regulatory issues.It should evaluate and enhance your operational framework to meetor exceed regulatory requirements and systematize operations to streamline production compliance and promote self-regulation.


A great compliance program should encompass the physical plant operations, as well as the financial and administrative operations.


Compliance in the physical plant is of course dependent upon the specific business and license type, and may include many different elements where multiple cannabis license types are held. However, any good compliance program will account for equipment installation, maintenance and operation, standard operating procedures for all regulated activities, including product handling and processing, use of pesticides, packaging, safety procedures and plant security protocols, as well as employee hiring, training and supervision.


Regardless of license type, there is one physical operations area where all cannabis businesses will need impeccable compliance systems – inventory control. Track and trace (aunique ID number which follows a cannabis product from seed to sale, tracked through a web-based State-compliance program) is required by law in California and is the heart of good regulatory compliance.But maintaining accurate inventory control requires more than just entering the figures into the state tracking system. Understanding the applicable regulations, and properly training managers and employees is critical to streamlining operations and minimizing errors and costs. Robust resource management software and refined operating procedures can ensure your business is always in compliance, always on top of its inventory, and able to avoid unnecessary work stoppages. Coupled with regular internal audits (required under California law), solid inventory management can provide greater efficiency, as well as a demonstrable track record of top notch regulatory compliance.


Compliance on the financial side of the business is just as important as inside the physical plant. Solid cash management systems, both for reporting and physical storage and transportation, are a must for all cannabis businesses. Because access to banking services for cannabis businesses is still very limited, cash is a reality of the industry, and complying with state and federal reporting requirements, as well as the cost of storing and transporting cash, can drain a company’s resources in unexpected ways. Managing cash effectively ensures both compliance with the law, as well as more efficient operation.


Additionally, managing and accurately reporting sales, use, and excises taxes can be crucial to avoiding violations and the hefty penalties that can follow. Documented compliance with IRC §280E regarding income from illicit businesses not only will protect your business from federal interference from the IRS, but also provide substantial value to the company, assuring future investors or buyers that no lingering tax liabilities are lurking behind the operation.


Developing and maintaining compliant contractual relations with other licensed and non-licensed businesses is an often overlooked, but critical, piece of your compliance puzzle. Licensed cannabis operators are restricted from sharing profits with most non-licensed vendors, and conducting business with an unlicensed party can result in a “major” violation under California regulations. Therefore, developing compliant vendor service agreements and licensing agreementscanbe crucial to maintaining a clean operating record and avoiding costly fines and suspensions.


In addition, depending upon the size and nature of a cannabis operation, many varying regulations may apply to worker compensation and labor practices, including mandatory “labor peace agreements” for cultivators with more than 20 employees. Numerous local jurisdictions apply additional “living wage” standards or other required minimum compensation and benefits as a condition to obtaining a cannabis business license, therefore, understanding and appropriately applying these standards to your employee hiring and retention practices is yet another important part of a complete compliance program.


Beyond Checklists


Checklists and standard operating procedures are an important part of any good compliance program. However, truly great compliance systems will move beyond checklists alone, and integrate those procedures into a holistic approach to overall compliance. Reviewing the use and accuracy of checklists, and updating and documenting changes to procedures is vital to ensuring those systems continue to drive compliance with changing regulations. Good recordkeeping and review protocols will help improve your systems over time, while also providing documented proof of your regulatory efforts for inspectors to review. By implementing data integration across all phases of the operations, additional efficiencies can be achieved while isolating and mitigating unforeseen risk factors. Finally, utilizing regular internal audits and periodicexternal audits to ensure that your systems are catching errors and correcting them will provide continual improvement to your compliance program while also reducing potential liability and enhancing the value of your business.

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