Investing in Cannabis: Key Takeaways from the CSA’s recent staff notice on disclosure expectations for cannabis issuers

On October 10, 2018, the Canadian Securities Administrators (“CSA”) published Staff Notice 51-357 Staff Review of Reporting Issuers in the Cannabis Industry, which detailed a long list of issues with the disclosure of reporting issuers operating in the cannabis industry.

Provincial securities regulators in Alberta, British Columbia, Ontario and Quebec conducted a review of the disclosure of 70 publicly-listed cannabis companies with varying levels of involvement in the industry and with operations in different countries. The most significant takeaways relate to licensed cannabis producers (or “LPs”).

Source: CSA Staff Notice 51-357 Staff Review of Reporting Issuers in the Cannabis Industry

There are two key takeaways from the recent CSA staff notice:

All of the LPs needed to improve their fair value and fair value related disclosure
71% of LPs did not separately disclose all fair value amounts included in the profit and loss statement

Companies involved in agricultural activities (such as LPs) are required under IAS 41 to measure living plants, or biological assets, at their fair value. As a result, LPs place a value on their crop while it’s still growing or waiting to be sold, reporting the unrealized, non-cash change gains (or losses).

Since cannabis production is currently growing at a faster rate than sales, and the fair value of those plants is being recognized long before any sales take place, LPs can end up reporting massive gross profit margins. Canopy Growth Corp., the world’s largest cannabis company, reported a gross profit margin of 97% (according to IAS 41 reporting standards) for 2017.[1] By way of comparison, Apple Inc. reported a gross margin of 38% in 2017.[2]

In addition to the complexity faced by investors in deciphering fair value generally, the CSA found that fair value adjustments were often embedded in costs of goods sold rather than being broken out into a separate line item. The CSA found that unrealized (and realized) gains/losses resulting from fair value changes should be disclosed separately so that investors can understand the actual cost of sales, excluding any impact from fair value adjustments.

Even with perfect disclosure, ordinary investors will likely struggle to understand the financials of LPs. Since the CSA found that all LPs need to improve their disclosure relating to fair value adjustments, investors are being placed at a significant disadvantage.

Sotos LLP is at the forefront of this budding industry, working with emerging and established retailers and franchisors to help them grow their brands. If you are considering entry into the cannabis industry, start by retaining qualified and experienced legal counsel to assist you in navigating the landscape.

[1] Without accounting for fair value changes, Canopy Growth Corp.’s gross margin would have been 66%. https://www.newswire.ca/news-releases/canopy-growth-corporation-reports-fourth-quarter-and-fiscal-year-2018-financial-results-driving-readiness-for-the-canadian-recreational-cannabis-market-686663871.html

[2] https://www.apple.com/newsroom/pdfs/fy17-q4/Q4FY17ConsolidatedFinancialStatements.pdf