How Federal Prohibition on Cannabis Impacts Stock Trading

The legal cannabis industry is booming, but investors getting into the space may have a difficult time ahead of them. Although the industry was valued at $9.1 billion in 2020 and expected to grow to $70.6 billion by 2028, according to Grandview Research, the ongoing federal prohibition of cannabis presents serious obstacles to the industry’s growth and investors’ ability to take advantage of the value the industry creates. 

The federal prohibition on cannabis remains in place

Despite the move by 33 states to legalize cannabis for medical and/or adult use, the federal government maintains that cannabis is an illegal Schedule I substance under the U.S. Controlled Substances Act (CSA). Though efforts are underway in the nation’s capital toward cannabis reform and legalization, progress towards a legalized future remains sluggish. 

How federal prohibition impacts the cannabis industry

There are several key ways the federal prohibition impacts cannabis businesses, slowing the overall growth of the industry and locking investors out of the value it creates. 

“The legal cannabis industry in the U.S. has made expansive strides state by state, but the federal illegality of the industry remains an albatross around its neck,” said Dr. Sean Hall, MD, CEO of Medlab Clinical LTD. “For the industry to mature and more advanced sectors like pharmaceutical cannabis products to emerge and come into their own, a true national market is needed.”

Banking and financial challenges

Due to federal prohibition on cannabis in the U.S., many banks refuse to do business with cannabis companies — both plant-touching and ancillary B2B service businesses. Access to the banking system remains extremely limited, not only for lending opportunities but also for basic services like checking accounts and payroll. 

In an attempt to alleviate the banking challenges associated with the cannabis industry, Rep. Ed Perlmutter (D-CO) introduced the Secure and Fair Enforcement (SAFE) Banking Act, which would codify legal protections for banks and financial institutions working with state-legal cannabis businesses. That bill, however, has died in several sessions of Congress already, leaving the banking limitations in place year after year as cannabis businesses accumulate more cash and seek out basic financial services. 

In addition, credit card processing remains a rarity within the industry, which largely deals in cash transactions. Major card networks like Visa and MasterCard have refused to run cannabis transactions, opting instead to wait until the U.S. government moves on cannabis reform.

Advertising restrictions

Most cannabis businesses are limited by law in how they can advertise. Every state has its own laws, but there are some common themes throughout many, such as bans on television or radio ads (especially when the audience is reasonably expected to be composed of children). Advertising restrictions prevent many young cannabis companies from engaging in conventional branding and marketing campaigns, forcing them to get creative.

But it’s not just legal restrictions on advertising and marketing that plague cannabis businesses. In addition, the terms of use of many platforms, such as leading social media organizations, prohibit most types of advertising for cannabis. While, in many cases, cannabis businesses are able to establish a profile and develop a following, sponsored content and paid advertising are almost universally prohibited. 

Fragmented regulatory landscape

Due to the state-by-state nature of cannabis legalization in the U.S., every state has established its own regulatory system and unique set of rules governing the local cannabis market. That can make it difficult for multi-state operators (MSOs) to adjust to a new set of rules as they expand into new markets, limiting their ability to grow and provide a healthy return to their shareholders. As the industry has matured, MSOs have become more adept at moving into new markets, but it still remains a significant challenge as opposed to a unified set of federal rules from which to begin.

“Every business needs to deal with regulators, but it’s much easier when there is a clear set of rules from which to begin,” Hall said. “In the U.S., cannabis businesses contend with wide-ranging regulatory frameworks from state to state, which makes for a volatile operational environment.” 

What about cannabis stock trading?

So long as federal cannabis prohibition continues, the market will be hindered by all the factors that go along with it. Still, investors can partake in stock trading, although the space is particularly volatile. In the U.S., as a result of the challenges surrounding federal prohibition, cannabis stocks (as represented by the ETFMG Alternative Harvest ETF) have underperformed the rest of the market. According to Investopedia, the ETF has posted a negative return, shrinking by 60.4% year-over-year as of February 2022.

Is federal cannabis legalization coming?

There is some reason to be optimistic about the future of legal cannabis in the U.S. Currently, Sens. Chuck Schumer (D-NY), Cory Booker (D-NJ), and Ron Wyden (D-OR) are co-sponsoring a bill they plan to introduce in April called the Cannabis Administration and Opportunity Act (CAOA). The bill would, if passed, legalize cannabis and establish a baseline regulatory framework for the management of the industry, identifying which agencies would oversee the establishment of a national cannabis market.

However, if the struggles the SAFE Banking Act has faced are any indicator, the CAOA may have a rocky road ahead of it. If and when the bill does pass, there would still be a heavy lift to promulgate the rules for the new federal cannabis industry, as well as award licenses to applicants and allow their businesses to begin operations.

In other words, investors in cannabis businesses or the industry generally shouldn’t expect the meteoric growth to rapidly translate into massive returns on investment. Indeed, in the short run, many major cannabis stocks have lost value. However, for investors who want to get in on the ground floor of the industry and don’t mind taking on additional risk, the cannabis industry may offer immense future opportunities.

There remains another pitfall for investors in the cannabis industry as well — fraud. Recently, the U.S. Securities and Exchange Commission (SEC) won a $1 million case against a group that defrauded investors by soliciting more than $600,000 in investments from 27 investors across several states. It wasn’t the first instance of fraud in the industry — in 2021 there were several high-profile instances of investment fraud by either fake cannabis businesses or those that grossly over-represented their position. Investors should always do their due diligence, especially in a fledgling space like cannabis.

Challenges remain, but growth opportunities are on the horizon

The cannabis industry has high hopes for its future, but at the moment there remain labyrinthian legal and regulatory challenges facing businesses in the industry. For investors, the market projections may offer an enticing opportunity, but it is replete with pitfalls. To make the most of investing in the cannabis space, be sure to scrutinize each company before making any investment. While there are many strong, healthy cannabis businesses that are poised to take advantage of the industry’s massive growth and eventual legalization in the U.S., there are many more that are a house of cards, if not outright fraudulent. Investors should tread lightly when entering the cannabis space for the first time and partner with a trusted advisor to make the right choice for their portfolio.

*Medlab Clinical LTD is a client of Quantum Media Group, LLC

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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