|Posted on January 17, 2019 at 6:50 PM|
Cannabis Securities Compliance
The touchstone of what constitutes a security is whether or not it is a “passive investment.”
If the investment requires active management engagement by the investor, it is not a security.
If it is a passive investment where the investor relies on others, it is a security.
Investors often have the right to give input into management decisions but do not exercise this right. The trend in securities regulation is to look beyond the terms of the agreement to the realities. Cannabis businesses can choose to have all investors be active member-managers and draft their operating agreement accordingly. The following are guidelines to ensure that such investors are “active member-managers” rather than “passive investors.”
1. Investors have voting rights under the terms of the LLC operating agreement and exercise those rights.
2. Investors have a management role or are otherwise “actively engaged.”
3. Investors are members on committees tasked with business operations.
4. Investors had input into and negotiated terms of the LLC agreement.
5. Investors actually receive and even approve reports regularly.
6. Investors have input on key company strategic decisions – major decisions are made after consultation with investors.
If investors have an active and participatory role in management you can ignore securities issues. Accordingly, you may want to see if new investors have experience in the cannabis industry. As the number of cannabis investors grows and becomes more geographically diverse, it is more likely investors will be considered “passive.” At that point you will need rely on one or more securities exemptions and make the appropriate filings.
Cannabis businesses may utilize “management control” under recently released regulations. Regulations define as an “owner” any person who participates in the “direction, control, or management” of a business. Such individuals, having management rights, need to be vetted by state regulators in the license application process.
Both securities compliance and cannabis regulatory compliance are now very much in play. If investors lack management rights and are passive investors, securities compliance is required.