What Could Rescheduling Mean for the Cannabis Industry?

The U.S. marijuana industry received one its biggest jolts in years this week when news leaked that the Department of Health and Human Services is on board to reschedule cannabis. If the Drug Enforcement Administration agrees, the plant would move from the most restrictive level of Schedule 1 to the middle ground of Schedule 3, a potential milestone that could result in a huge financial boost to the sector.

The biggest obvious benefit of rescheduling, several industry attorneys said, is that the federal tax provision 280E would be nullified. That would likely free up tens or even hundreds of millions of dollars in capital for operators.

“My prediction is we’re going to see a lot of money rolling into the industry. We’re going to see a lot of M&A,” said attorney Andrew Kline, who works closely with the U.S. Cannabis Council and helped author a white paper that made the case for de-scheduling.

Kline noted that many larger cannabis companies have faced federal tax bills of $60 million to $80 million. Smaller marijuana businesses also have been on the hook for millions of dollars to the IRS.

“All of a sudden, you go from an effective 80% tax rate to a normal 28% corporate rate. That’s a big deal,” Kline said.

Unanswered Questions

But there are still a host of unanswered questions, misinformation, and discontent swirling around the rescheduling proposal, particularly since the near-universal preference among marijuana activists and businesses would be for cannabis to be removed from the controlled substances list altogether.

“What we need to keep in mind is the (U.S. Food and Drug Administration) is lurking in the background,” warned Khurshid Khoja, a California-based attorney and industry advocate who authored a paper on potential rescheduling ramifications.

How the FDA will approach the legal marijuana trade if rescheduling does become a reality is still unclear, he said. For example, few if any of the current state-licensed marijuana companies would be able to qualify as makers or sellers of Schedule 3 drugs under federal law, or fully comply with the Food, Drug and Cosmetic Act.

For any given company to obtain federal permission to make and sell a Schedule 3 drug on a national level, it generally takes private pharmaceutical companies 10-12 years and as much as $1 billion to pay for research and clinical trials, in order to prove new drugs are safe for human consumption, according to Khoja’s research.

That’s not a bar that existing U.S. marijuana companies are prepared to meet, which means there will still be legal tension between federal agencies and state cannabis markets.

That same expensive and time-consuming threshold to meet Schedule 3 FDA approval, however, is also going to keep out big pharmaceutical players, argued Shane Pennington, a Washington D.C.-based cannabis attorney who has written extensively about rescheduling ins and outs. He said that fears of a Big Pharma marijuana takeover due to rescheduling are overblown for one simple fact: There’s no easy way to control who grows or sells marijuana.

The only return on investment for those companies, Pennington said, is the temporary market exclusivity they get when new drugs do get FDA approval.

“Temporary market exclusivity is only possible if there’s not already a billion-dollar market out there,” Pennington pointed out. “There’s no incentive to get a short-term monopoly on your drug … if everyone is already selling it at the state level.”

Even if the current cannabis trade doesn’t have to fear external industry forces, “It’s not entirely clear” what approach the FDA will take to industry oversight, Khoja said.

He pointed out that moving marijuana lower on the list of controlled substances shifts responsibility for federal oversight – including enforcement – from the DEA to the FDA.

“Obviously, there’s going to be a conversation between the FDA and state regulators before any massive crackdown potentially happens,” Khoja said. “I’m hopeful that the DEA rulemaking process will open up that dialogue … but we need to have that conversation.”

One possibility, said Kline and other attorneys, is that the FDA or Department of Justice – or both – could issue new policy guidance memos for states and marijuana businesses, similar to the 10-year-old Cole Memo from the Obama administration, which set the stage for recreational sales in 2014 after Colorado and Washington state voted to legalize adult-use marijuana sales.

The Cole Memo laid out clear ways that state-legal marijuana businesses could avoid being prosecuted by the DEA, such as not marketing to minors or selling across state lines. It has remained the unofficial guidance ever since, despite being revoked under the Trump administration in 2018.

And, several attorneys noted, both the FDA and DEA have always had legal authority to prosecute state-legal marijuana businesses, but they have chosen not to do so.

The federal agencies could formalize those policies again in guidance documents as part of the rescheduling process, sources said.

“With all the enforcement discretion policies related to FDA, it’ll probably be very similar to what the Cole Memo looked like,” said Emily Leongini, a Los Angeles-based cannabis attorney who is also a former FDA lawyer. “Until there’s a comprehensive regulatory framework passed by Congress – and who knows when that’s going to be – you’re going to continue to see these imperfect solutions like the Cole Memo.”

Not a Quick Fix

Several attorneys, however, shot down the hope that rescheduling could throw open the doors for interstate commerce, a claim that some industry insiders made when the news broke on Wednesday.

Because of the strict rules that surround Schedule 3 drugs, interstate commerce would technically become an option, but only for those who spend years and huge sums of money obtaining FDA approval, said Jason Horst, the president of the International Cannabis Bar Association.

“For current operators, nothing really changes,” Horst said. “Schedule 3 does not open the floodgates to interstate commerce for existing operators. … The most likely response from operators in the states is to thank the federal government for the tax break and to go on about their business.”

Rescheduling also doesn’t truly solve the banking issue for cannabis companies, and the industry still needs to demand passage of the SAFE Banking Act, Kline said. He also squashed the hopes of publicly traded marijuana companies that rescheduling will lead to uplisting on stock exchanges such as the Nasdaq.

“I would put it in the bucket of wishful thinking. I’d put it in the same bucket as banking and payment processing, insurance coverage,” Kline said. “The Banks of America or the Nasdaqs of the world are still going to see this as a violation of the (Controlled Substances Act) … and it’s not going to give them enough comfort, would be my guess. I don’t think it’s going to unleash that kind of progress.”

Not a Guarantee

There’s also still an outside chance that the entire rescheduling agenda gets derailed by the DEA or through one or more lawsuits, warned Pennington.

The law enforcement agency technically could refuse to move cannabis from Schedule 1 if it wants to cite the Single Convention on Narcotic Drugs treaty that the U.S. signed in 1961, Pennington said.

“HHS’s recommendation on scheduling … is binding on DEA, and effectively determines the outcome of the process. Historically, DEA has never overridden an HHS recommendation, other than to ensure treaty compliance,” Pennington said. “If they did decide to do that, that could scuttle things.”

However, both Pennington and Kline said they doubt DEA will use that excuse, in part because Canada is also a signatory to the same treaty, and the nation hasn’t faced any major international blowback after it federally legalized marijuana in 2018.

“The answer to that question is, let’s get with the 21^st century and renegotiate these treaties,” said Kline.

The other potential wrench in the process is that DEA must hold a 30-day judicial review period after it announces whatever scheduling decision is coming. At that point, anyone unhappy with the proposed change – whether pro- or anti-cannabis – could force a court to weigh in.

“You’ll have the SAMs (Smart Approaches to Marijuana, an anti-cannabis organization) of the world and the opponents of cannabis saying everything you can think of, that it should stay in Schedule 1 or Schedule 2, this is a travesty, we have 50 years of unbroken law on this,” Pennington predicted. “Then on the other side … you’re going to have all the supposed friends of reform, saying, ‘This is an outrage, Schedule 3 is still the war on drugs, they’re trying to keep Black and brown folks in jail.’”

“It’s going to go to court, and a court will get to say if it gets to stand or fall. God forbid that we get all the way through the marathon and get across the finish line only to be sabotaged by nonsense,” he said.

Pennington also said that part of the upcoming process with the DEA is potential hearings before an administrative law judge on the question of rescheduling, at which point members of the industry and reform movement might be allowed to present their own arguments and evidence. That’s something Pennington predicted that cannabis opponents will be ready for, and said cannabis businesses should be doing the same preparations.

Kline acknowledged that there’s a heap of work left to do for industry interests that want to see rescheduling implemented in a beneficial way.

“It’s always incremental reform. We need to understand this is a huge win. This is the first win. We need to build on it. We can’t just walk away from it and say, ‘The president didn’t do enough,'” Kline said.

Pennington said he wants to see industry interests and reform activists combine their resources instead of fighting among themselves over rescheduling versus de-scheduling. The top priority for everyone who backs marijuana legalization, he said, should be to get rescheduling across the finish line.

“They should be showing up in force. They should be like the Spanish armada,” he added. “This is a massive, massive amount of work. And I’m worried … that it won’t be done well.”