There are three key takeaways to learn from the lawsuit filed on December 30, 2019 by David McNear, Individually and on behalf of all others similarly situated, v. Trulieve Cannabis Corp., Kim Rivers, and Mohan Srinivasan. Plaintiff McNear is suing Defendants Trulieve, Rivers, and Srinivasan on behalf of “persons or entities” who purchased publicly traded Trulieve securities between September 25, 2018 and December 17, 2019. (See Case 1:19-cv-07289-WFK-RER. https://uploads.strikinglycdn.com/files/51e61f34-abbb-4782-af9e-241f8e6c4f46/Trulieve-class-action.pdf?id=204628) Note that this is a complaint filed with the court; more shall be revealed in discovery in the coming months. By no means are we anywhere near a final ruling.
The obvious first lesson for cannabis executives is to maintain utmost transparency in real estate transactions. It is clear that the complaint filed in the U.S. District Court in the Eastern District of New York gives one side of the story, but frankly it is not a good one. Trulieve allegedly used “murky” entities as well as closely-held transactions to re-value and quickly sell real estate within arm’s reach of its executives at tremendous gains. Could this be a sign of growing pains of the cannabis industry, which is accustomed to setting up numerous management structures and holding companies in order to avoid 280E implications? Possibly, and of course we would like to give executives the benefit of the doubt. Nonetheless, the fact that the valuations kept spiraling up with each flip of the property looks opportunistic. Takeaway #1 for marijuana companies: the days of playing the shell game of one company owning land and another company buying it for another segment of your operation are over. Manipulation of deeds and assessments of real property may have been necessary years ago, at the dawn of the legal cannabis industry. The 2019 holding in Harborside put companies on notice that the IRS can see through such machinations, thus making them no longer relevant to the entity’s structure. A multi-million-dollar corporation that engages in these practices now just looks suspicious.
The suit alleges that Trulieve was using a grow process that amounted to little more than “low quality hoop houses”, rather than the high-yield, scalable cultivation techniques meticulously spelled out in its standard operating procedures. Takeaway #2 for marijuana companies: your product tells your story. If you fail to inform consumers or investors about changes in how your product is produced, you’ve changed your story in ways that are fundamental to the way the product is perceived. Deceptive practices are never a good look.
Perhaps most relevant to all cannabis business owners, big and small, is the fact that investors take issue with the financial reporting practices. Specifically, the complaint alleges that Trulieve “overstated its mark-up on its biological assets” and that “Trulieve’s reported gross profit was inflated.” (See Case 1:19-cv-07289-WFK-RER, Page 11, Paragraph 35). Takeaway #3 for marijuana companies: your accounting systems will make or break you. At issue is are the most fundamental concepts of accounting, which require full disclosure of material data. C-Suite Executives need to especially note that you won’t be able to use your corporate structure as a shield. Trulieve’s CEO Kim Rivers and CFO Mohan Srinivasan are named as co-defendants with their company. It is reasonable to think that damages will be shouldered by the company and by Rivers and Srinivasan.
It is clear that the entire lawsuit might have been avoided had Trulieve followed GAAP-compliant accounting policies and procedures each and every quarter. Cannabis CEOs and CFOs beware: the Trulieve case is the first of many more to come as the smoke clears from cannabis businesses and stakeholders realize that a cannabis business is still a business, and accounting (and ethics!) still apply.
--Paula Collins, EA, MBA, Esq.