From the MMRSA to the Adult Use of Marijuana Act: the Distributor License

There are two adult use cannabis legalization initiatives – proposed laws – that had been gaining supporters over the past few months in preparation for the 2016 vote. First is the Adult Use of Marijuana Act, (AUMA) which boasts backing by Sean Parker[1], former president of Facebook and current Silicon Valley billionaire, and Lieutenant Governor Gavin Newsom. Second is The Control, Regulate and Tax Cannabis Act of 2016 (CRTCA), an initiative put forth by Reform CA, backed by co-proponents Dale Sky-Jones, chancellor of Oaksterdam University, and Alice Huffman, president of the California NAACP and board member for the national sector of the organization.

ReformCA has suspended its initiative. A majority of ReformCA’s board members endorsed the AUMA after its drafters amended their initiative to bridge the gaps between it and the ReformCA initiative[2]. One of the problematic differences[3] between the two is that the AUMA provides for a three-tier structure, adding a “distributor” license to reflect the recently enacted MMRSA[4] provisions. This article’s focus will be the AUMA’s adoption of the Medical Marijuana Regulation and Safety Act’s (MMRSA) three-tier system and the public policy considerations surrounding the decision to keep it, followed by policy recommendations aimed at (1) streamlining the supply chain, (2) keeping product quality high, and (3) ensuring a fair market throughout the supply chain[5], namely among the distributor class.

Where We’ve Been

On October 9th, 2015, the California legislature passed[6] and Governor Brown signed the MMRSA as written.

Instead of maintaining the status quo ante – cultivators (farmers) selling directly to retailers (dispensaries) – the MMRSA mandates that licensed manufacturers and cultivators send their product to a licensed “distributor,”[7] who then gets to collect a fee for, essentially, recording the harvest, production, or sale. Curiously, licenses for distributors (Type 11) are not the same as licenses for transporters (Type 12). Type 11 licensees are required to also become transporters; they “shall apply for a Type 12 license, but shall not apply for any other type of state license.”[8] Type 12 licensees “may” also apply to be distributors. That is confusing because Section 19326(a) of the B& P Code mandates that the only licensees who can transport cannabis are licensed transporters, which begs the question: what is the distributor for, then?

Subsection (b) attempts an answer: “All licensees holding cultivation or manufacturing licenses shall send all medical cannabis and medical cannabis products to a distributor . . . for quality assurance and inspection.” It also requires that those goods go to a Type 8 tester before sale to a dispensary[9]. Subsection (c)(1) explains that it also falls upon the distributor to “inspect the product to ensure the identity and quantity of the product” and make sure that a sample is tested for quality. Subsection (c)(2) explains that after a product has been tested for quality, it must go back to the distributor for a “quality assurance review,” to ensure “quantity and content” of the cannabis.

It is reasonable to assume that the MMRSA established a comprehensive regulatory structure – including creating a government agency[10] – that would also be the regulatory framework when it came time to legalize cannabis for adult use[11]. Thus, the MMRSA’s provisions would likely be translated into whatever bill legalized adult use. Indeed, the licensing section of the AUMA references Chapter 3.5 of Division 8 of the Business and Professions Code, which is the MMRSA. One of the main legalization pushes – in states that are looking to legalize adult use cannabis – advocates regulating cannabis like alcohol, which is already widely regulated at the state level. That policy is appealing from the state’s perspective because of the easy transition – states already regulate liquor sales. Further, it accomplishes the government’s financial objective: collecting taxes.

However, it puts strain on smaller firms either looking to break into or expand within the distribution market. The medical cannabis industry moves a lot of money, but clearly the adult population of the ninth biggest economy in the world is a more significant market than only the Californians that have prescriptions for medical cannabis. Established distributors in other markets – alcohol, for example – already have the infrastructure, technology, and capital to fill the distributor level in states that opt to regulate cannabis like alcohol. In concrete terms, this infrastructure includes inventory and accounting resources, which translates to lower level personnel (those whose job it would be to keep tabs on inventory), accounting staff (or an outside CPA on contract), and the technology that accompanies both of those positions.

The Argument for, and Problems With, the Type 11 License

The argument for inserting the distributor level is that the cannabis industry needs a “choke point” in order to limit supply. The government has two interests here: prevent diversion of (1) either cannabis itself, or (2) taxes that should have been paid on cannabis by failing to declare the correct amount harvested and sold. Those are legitimate objectives to be sure, but the means don’t justify the end – a small number of firms dictate supply for the whole market simply by virtue of their preexistence.

This hurts consumers in several key ways. First, prices will be higher: the distributors will be charging a fee, which either consumers or cultivators (or both) will have to absorb some or all of. Every time cannabis is harvested or “manufactured” (e.g., processed into edibles or concentrate), there is another fee, which gets passed down the supply chain. Second, quality will be lower. Liquor is distilled and therefore non-perishable, but cannabis is a crop that is better fresh – quality goes down the longer it sits. Third, selection will be slimmer. Large firms[12] will lack incentives to work with the mom-and-pop cultivators; it will be the same amount of work and fee collecting for a smaller product. There are huge barriers to entry for businesses that want to become distributors – established firms already have the necessary structure in place, dominate the market and will push out competitors because it means more profit for them.

It is worth clarifying that cultivators are not required to sell their product to distributors under the MMRSA, and they are allowed to keep direct relationships with retailers. However, they must still send their harvested or manufactured products to a distributor to insure identification, weight and content. Thus, the effect is the same – all of the fees and cannabis in the state go through the few companies that have readymade operations and therefore no interest in preserving the diverse, grassroots industry that cannabis has made itself into.

Policy Recommendations

There are two areas of public policy that deserve attention with regard to the Type 11 distribution license: (1) damage to consumers, and (2) waste – namely, of consumers’ money. The stated purpose of the distributor is to, first, ensure the identity and quantity and, second, ensure the quantity and content of cannabis or cannabis products. It seems that they will function as sort of a cannabis mailroom, where everything is sent, weighed and sorted both before and after testing. It is mysterious, then, why those three[13] aspects of a cannabis harvest (or manufacture) cannot be recorded by the cultivator, the tester or the transporter.

  1. Damage to Consumers

The Type 11 license hurts consumers in two significant ways, as mentioned above: pricing and selection. The resolutions to each of those negative effects on consumers chiefly hinge on the elimination of the Type 11 license. Taking that as the general thesis of this post, the analysis continues regarding alternate ways to resolve each of those issues.

Price Increase:

If the enacted regulatory scheme includes the Type 11 distributor license, then the price increase is unavoidable[14]. A distribution fee is the only method by which Type 11 licensees can make money. However, they are not making money for ‘distributing’ – they are making money for inventory management; i.e., recording the quantity cultivated or manufactured. The requirement that a Type 11 licensee apply for a Type 12 license abates this problem slightly: the cost of transporting cannabis – which, alone, a Type 11 licensee is disallowed from doing – is easily incorporated into normal costs that a Type 12 licensee would encounter: trucks, gasoline, and records of both transactions and travel, for example. Thus, the Type 11 and Type 12 licenses can, and should, be combined in the AUMA to avoid this extra charge being passed down to consumers.

Transporters can be charged with handling records of quantity and content, as could testers. Both will already be charging a fee, and however many people it was going to take to run a distribution company – here I am speaking to the notion that Type 11 licenses are an instrument of job-creation – will be employed by either of the licensee business types (8 or 12) that absorbs it.

Selection:

Distributors are charged with handling all of the cannabis in the state, which is a considerable load. Since distributors will have a full plate, some cultivators and manufacturers will be pushed to the fringe. Most likely, those will be cultivators and manufacturers with a smaller yield of cannabis or cannabis products because they will be finishing products for distribution less frequently, which means fewer fees, which means less money. Cultivators and manufacturers can enter into contracts with individual retailers, but they can also choose to sell to other licensees – distributors or transporters, for example. Distributors will be incentivized to deal with businesses that bring them more money, which leaves smaller firms out, thereby decreasing selection for consumers. The AUMA attempts to give smaller companies a chance through the licensing scheme for cultivators, but if the distributors have their way, that provision may be in vain. Large-scale grows (those with “medium” licenses) will tend to grow a smaller variety of strains

The other possibility is that distributors will buy the yield from smaller companies and store it, which runs the risk of decreasing quality. Unlike liquor, which is distilled and can sit, cannabis flower is sensitive to improper storage.

The fix for this problem is simple: grant different levels of permits as in the cultivation provisions[15], and establish regulations to ensure freshness of products.

General Conclusion

The distribution license, as written, discourages smaller businesses from joining the market, limits selection, and increases cost to consumers. Perhaps the biggest problem with the Type 11 license is that it is wholly unnecessary. It adds another layer of paper and processing in an industry where most cultivators (and manufacturers) would prefer direct contact – while still recording sales to ensure taxes are paid and checking quality – with the people who will be selling their products, instead of having to go through a middleman. The AUMA has undergone some good amendments, but they have not gone far enough. Before Californians enact the AUMA, the drafters should make sure that the Type 11 license won’t get in the way of adult use regulations in business while protecting consumers.

 

[1] He has reportedly contributed $500,000 to the initiative; see the Secretary of State’s list of donors here.

[2] The Los Angeles Weekly published a good account of this dramatic and fascinating story.

[3] Of course, this is either a problem or… not, depending on where you’re sitting.

[4] For full text see AB 243, AB 266 and SB 643, which together comprise the Act.

[5] As it stands, the supply chain mandated by the MMRSA typically goes: Cultivator à Distributor / Tester (either can be first but cannabis or cannabis products must go through both) à Retailer.

[6] Which requires a two-thirds affirmative vote in each chamber – Assembly and Senate.

[7] See AB 266, which added Business and Professions Code Sections 19326(b), (c)(1)-(3).

[8] See AB 266 or Business and Professions Code Section 19328(a)(7).

[9] For an explanation of the other licenses see either here (for this blog’s explanation), or here (for a shorter article brought to you by NORML).

[10] The Bureau of Medical Marijuana Regulation; see e.g., Section 19302 of AB 266.

[11] Evidenced by, among other things, both ReformCA’s initiative and the AUMA relying on the Department of Consumer Affairs to regulate production and distribution, as does the MMRSA.

[12] The AUMA notably does not limit the size or number of distribution firms to mirror the antitrust provisions elsewhere in the Act.

[13] Identity, weight, and content.

[14] The price may still be lower than it is now if production efficiencies increase (which they probably will), but the MMRSA’s provisions have not gone into effect yet, so that remains to be seen.

[15] As the ReformCA initiative made space for with the language, “the office shall establish different tiers of distribution licenses based on the annual gross revenue of the cannabis distribution licensee.” See Section 26028 of the CRTCA.

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