Unnecessary DOJ Scrutiny Cost Marijuana Companies Millions, Execs Say

The whistleblower, a senior official in the Justice Department named John Elias, testified in front of the House Judiciary Committee on Wednesday as part of a probe into whether the department has been politicized. He told the committee that Justice Department career attorneys deemed that a proposed merger between MedMen Enterprises (ticker: MMNFF) and PharmaCann needed no further antitrust review, citing the established guidelines. Instead, he said Barr called the antitrust division leadership to his office and ordered the division to proceed with a full investigation.

Elias said the MedMen merger, and nine others that followed, “were not close” to meeting established criteria for what’s known as a second request for information. A second request is akin to a subpoena and requires companies to turn over thousands of pages of documents—including cellphone records, computer hard disk images, and entire copies of mobile devices—and answer dozens of detailed questions about a broad swath of business interests.

“At one point, cannabis investigations accounted for five of the eight active merger investigations in the office that is responsible for the transportation, energy, and agriculture sectors of the American economy,” Elias said. “The investigations were so numerous that staff from other offices were pulled in to assist, including from the telecommunications, technology, and media offices.”

In 90% of mergers, there are no competition concerns, a former Justice Department antitrust trial attorney and senior fellow at the Center for Democracy & Technology Avery Gardiner told Barron’s.

During the hearing, Rep. Doug Collins (R-Ga.) referred to a memo, which Politico obtained, from the Justice Department’s Office of Professional Responsibility. The document said it was reasonable to seek more information on the industry through the second request process.

In his written testimony, Elias said that while responding to internal concerns about the investigations, Assistant Attorney General Makan Delrahim for the antitrust division “acknowledged that the investigations were motivated by the fact that the cannabis industry is unpopular ‘on the fifth floor’,” a reference to Barr’s offices in the DOJ headquarters building.

A Department of Justice spokesperson did not return Barron’s requests seeking comment about Elias’s testimony and costs associated with additional reviews.

American cannabis companies have raced one another to establish empires across the states that allow licensed sales of marijuana. As one after another of the multistate operators raised money in Canadian stock offerings in 2018, they started using their cash and stock to expand through acquisitions.

A U.S. cannabis executive tells Barron’s that a second request from the Department of Justice cost their company $10 million in legal fees and other expenses. According to that executive, 80 lawyers were required to answer the DOJ’s questions.

iAnthus Capital Holding’s (IAN.Canada) merger with MPX Bioceutical closed in February of 2019, a month before Elias says the second requests began. A second executive at another U.S. operator, who also asked not to be identified, said that second requests began appearing in disclosures on subsequent mergers: MedMen with PharmaCann, Curaleaf Holdings (CURA.Canada) with Grassroots and Cura Partners, Cresco Labs (CL.Canada) with Origin House, and several Harvest Health & Recreation (HARV.Canada) deals.

At the time the acquisitions in question were announced, the Federal Trade Commission required most deals valued at over $90 million—a threshold that has since been raised to $94 million—be reviewed by antitrust regulators in the U.S., but such review does not always include a second request. Any marijuana company that announced a deal above $90 million received additional scrutiny, according to the second cannabis executive.

A Barron’s analysis of filings in the Sentieo database found that in 2019, Curaleaf’s $22.8 million in one-time charges contributed a third of the company’s $69.8 million net loss. At Cresco Labs, $17.5 million in acquisition and non-core costs were more than 75% of its 2019 pretax loss. A material portion of these extraordinary charges were the legal bills for extended merger reviews, the companies said in their filings and conference calls.

Because marijuana is federally illegal in the U.S., the public cannabis companies that operate in the country listed shares in Canada. These companies also can’t deduct business expenses for federal tax purposes.

Stifel GMP analyst Rob Fagan told Barron’s he previously thought such federal antitrust reviews had to do with the Department of Justice seeking more information about cannabis firms. He said the added scrutiny probably didn’t lead to mergers falling through, though the delayed process likely hurt investor sentiment throughout the space. He did note that such operators needed to pass regulatory scrutiny from individual states where they operated—an onerous process on its own.

When Harvest Health announced in March 2020 that it was canceling its $850 million merger with Verano Holdings, the companies blamed delays that began with the deal’s extended antitrust review.

Fagan said that if Wednesday’s testimony leads the Department of Justice to no longer impose such strict reviews on marijuana mergers, it could heat up mergers and acquisitions. But he does point to industrywide capital shortages, especially amid Covid-19, that will still create barriers for large deals. He says that Curaleaf has the most robust balance sheet among U.S. growers to execute mergers and acquisitions.

For other pot companies, the window of opportunity may have closed.

Write to Connor Smith at connor.smith@barrons.com, Bill Alpert at william.alpert@barrons.com and Max A. Cherney at max.cherney@barrons.com