The marijuana industry has an accounting problem, with a number of companies correcting errors in financial statements in recent years through restatements.
Restating financial results is a rare occurrence for most public companies: 2020 had the lowest number of financial restatements by public companies in the past 20 years with only 364, according to a report by Massachusetts-based Audit Analytics.
But a disproportionate number of them have come from the cannabis industry over the past few years, making it harder for investors to gauge the financial health of a company.
Restatements also can lead to potentially costly class action lawsuits.
In the case of the marijuana industry, the restatements have included high-profile companies:
- Florida-based multistate operator Jushi Holdings in September said it filed restated financial results for this year’s first quarter.
- Chicago-headquartered MSO Verano Holdings announced in July it would restate five quarters of financial results.
- KushCo Holdings, a California-based packaging company now known as Greenlane Holdings, announced in 2019 it was restating results from fiscal 2018 and 2017 to reflect accounting errors stemming from previous acquisitions.
- Canadian cultivator and processor Cronos Group, headquartered in Toronto, said in November 2021 it would restate financials for the three- and six-month periods ending June 30 of that year.
Matt Karnes, founder of New York-based cannabis financial consultancy GreenWave Advisors, attributes the problem largely to the U.S. government’s marijuana prohibition.
That has prevented major accounting firms such as the Big Four – Deloitte, EY (formerly Ernst & Young), KPMG and PricewaterhouseCoopers – from servicing the marijuana industry.
He also chalks it up to inexperienced and/or understaffed in-house accounting departments at public cannabis companies.
“Financial reporting is definitely an area that many people overlook,” he said.
Accounting for errors
Jushi announced on Sept. 9 it filed restated first-quarter 2022 results.
The company identified two errors:
- Right-of-use assets associated with finance leases, accrued expenses and other liabilities.
- Operating, investing and financing activity cash flow.
“These errors did not impact the cash balance as of March 31, 2022, and there was no net change in cash flows during the three months then ended,” according to a Jushi news release.
Verano said in July that it would be restating five quarterly financial statements dating to March 31, 2021, and that all of its disclosures and investor presentations since then “should therefore no longer be relied upon.”
Stock-based compensation had been understated, according to a news release, affecting the stated tax expenses.
“In this particular case, it seems like it was an error that was overlooked,” Karnes said, “and it seems like a very simple matter that should have been identified.
“And so it really brings home the point that I’ve been expressing for a long time now, that many cannabis companies lack the in-house accounting expertise that other industries have.”
Common pitfalls
John Pelliterri, a partner at New York-headquartered Grassi Advisors and Accountants, said the issues Verano and Jushi have grappled with are common in the marijuana industry, where accounting for the cash-based sector is particularly challenging and equity-based compensation is common.
In addition, he said common pitfalls include:
- Inventory, which moves quickly in cannabis.
- State taxes combined with issues related to Section 280E of the federal tax code, which prohibits marijuana businesses from taking traditional business deductions.
- Convoluted ownership structures.
Some management teams might choose to invest more in the company’s brand rather than key areas such as accounting.
But, Pelliterri said, with time and, perhaps, by learning the hard way, restatements will become less common.
“We’re getting there,” he said. “Once you get in a year, two years, you start to understand the nuances and then you get a handle on a lot of the issues.
“But there’s not that many people that have been doing it that long.”
Legal risks
Toronto-based Cronos Group announced in November 2021 it would restate financials for the three and six months ending June 30, 2021, after failing to report more than $220 million in impairment charges.
“As we move forward, we are committed to improving our internal controls and financial reporting practices, maintaining the highest standards of transparency and accountability, and enhancing our capabilities and resources across functions to support our strategy,” President and CEO Kurt Schmidt said in a statement this past February.
In the meantime, a number of law firms launched investigations to determine whether there were grounds for – and shareholder interest in – filing a class action lawsuit.
“Cronos stock was down more than 15% during intraday trading on Nov. 9, 2021, thereby injuring investors,” according to a November 2021 news release, issued by Philadelphia-based Kehoe Law, soliciting investors who lost more than $25,000 to contact the firm.
“The restating of a public company’s financial statements is like ringing the alarm bell for class action lawyers,” Robert Cohen, a litigation partner at the Cassels law firm in Toronto, told MJBizDaily via email.
“It doesn’t necessarily mean that a class action will ensue or be successful, but it typically means that there is smoke to be investigated, and often when there is smoke, there is fire.”
In another instance, Cronos Group restated its first-, second- and third-quarter financial statements in 2019 after reviewing sales of bulk resin and wholesale products.
That spurred one shareholder to attempt to file a class action lawsuit on behalf of other individuals, arguing that the company had “orchestrated a scheme to inflate its reported revenue figures” and that the errors had ultimately negatively affected the share price.
According to the Ontario Court Appeal’s Sept. 26 decision to allow the class action regarding the 2019 restatements to move ahead, the defendants dispute that the share price drop is attributed to the restatements but, rather, to the COVID-19 pandemic and delayed distribution of a new product in the United States.
Cronos Group did not respond to a request for comment from MJBizDaily.
The Court of Appeal’s decision shows that class actions are the most common way to take action against public companies for alleged misrepresentations that come to light from the restatement of financial statements, Cohen said.
“Starting a class action, obtaining leave of the court to proceed and getting it across the finish lines of both a trial and an appeal is rare in Canada, as many class actions settle along the way,” Cohen said.
“Having said that, just the commencement of a class action which has various badges of merit can prove to be very damaging to a public company, including to its ability to raise funds at critical times.”
Considering the risks and costs associated with restatements of financial statements, both Karnes and Pelliterri advise marijuana companies to invest in accounting and make an effort to stay on top of the latest developments. The industry is still new.
“A lot of the rules are still being written,” Pelliterri said.
“As more people get into the industry and it becomes more mainstream, a larger group will gravitate (toward cannabis) from a financial perspective.”
Kate Robertson can be reached at kate.robertson@mjbizdaily.com.
