Federal Reserve Chairman Jerome Powell, while testifying before Congress yesterday, Tuesday, February 26, 2019, explicitly acknowledged the uncertainty and tension surrounding the access of a company engaged in marijuana or marijuana-related business to banking because of conflicting state and federal laws. When asked about the topic, the Chairman said, “I think it would be great to have clarity,” adding, “Financial institutions and their regulators and supervisors are in a difficult position with marijuana being illegal under federal law and legal under some state laws.”
Further, last week, the House Financial Services Committee made history by holding its first ever hearing on marijuana and financial services. Up for discussion at that hearing was a new draft of the Secure and Fair Enforcement (SAFE) Banking Act. Last year, Congress introduced the SAFE Act of 2017, which stalled and went nowhere. Colorado Rep. Ed Perlmutter, a prime sponsor of the bill, has been introducing a version of this bill for almost six years, but has failed to get a hearing until now. This year, not only is the bill going to be discussed, but the bill is even more robust, specifically adding protections for ancillary businesses providing products and services to marijuana-related businesses.
As Treasury Secretary Steven Mnuchin made clear while testifying before Congress last year, he too would like to see marijuana businesses able to access banking services. “I assure you that we don’t want bags of cash,” he said before a House Committee last year. “We want to find a solution to make sure that the businesses that have large access to cash have a way to get them into a depository institution for it to be safe.”
Today, while 10 states and the district of Columbia have legalized recreational marijuana, marijuana remains illegal on the federal level, listed as a Schedule 1 drug, along with heroin and LSD. And, while an increasing number of financial institutions are willing to bank marijuana and marijuana-related businesses, there still is a predominant, industry-wide reluctance to get involved, whether because of the added compliance that is required, or because of the unclear restrictions that are promulgated, by the Department of the Treasury.
The long-awaited resurgence of the Agriculture Improvement Act of 2018, colloquially referred to as the 2018 Farm Bill, became more promising yesterday as its latest iteration received overwhelming bipartisan approval as it decidedly passed through the Senate on Tuesday, by a vote of 87-to-13, and easily passed through the House of Representatives, by a vote of 369-to-47. Now, the reality of the 2018 Farm Bill awaits the hand of President Donald Trump, who is expected to sign it into law before the end of the month.
Most notable, the 2018 Farm Bill is set to legalize hemp, a plant that’s nearly identical to marijuana and is a key source of the highly popular health and wellness ingredient cannabinoid, or CBD. If signed into law, the 803-page Bill would be the most significant change to the Controlled Substances Act (the “CSA”) since 1971, which is illustrative of the federal government’s recognition that outdated federal regulations do not sufficiently distinguish between hemp, including CBD derived from hemp, and CBD derived from marijuana.
In contrast to its predecessor, the voluminous 2018 Farm Bill expressly and unambiguously provides that the definition of “marihuana” under the CSA would be amended to exclude “hemp”, which, in turn, is defined as “the plant Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis.” Succinctly, if signed into law, the 2018 Farm Bill would be the first piece of federal legislation that explicitly carves out certain permutations of CBD containing tetrahydrocannabinol (“THC”), the active ingredient that causes the psychoactive effect of marijuana, from the CSA.
Against this backdrop, financial institutions that have been reluctant to establish relationships with hemp-related business because of the inclusion of “hemp” in the CSA’s definition of “marihuana” and the February 14, 2014 guidance from the Department of the Treasury Financial Crimes Enforcement Network, may now turn a new leaf and embrace the estimated $1 billion industry.
Relatedly, and in furtherance of the federal government’s progressive initiative toward the proliferation of the rapidly increasing hemp market, the 2018 Farm Bill also places far-reaching limitations on the States’ abilities to prevent the transport of hemp across interstate commerce. Specifically, the 2018 Farm Bill states, in relevant part, that “No State or Indian Tribe shall prohibit the transportation or shipment of hemp or hemp products,” so long as such hemp or hemp products are produced in accordance with discrete guidelines set forth elsewhere in the 2018 Farm Bill.
Notwithstanding, this monumental shift in cannabis reform should not be misconstrued as a blanket legalization of hemp at the state level. Conversely, the 2018 Farm Bill provides a roadmap for states and Indian tribes to become the “primary regulators” of hemp production by submitting “a plan under which the State or Indian tribe monitors and regulates” the production of hemp within its borders. In this regard, those interested in getting involved in the hemp industry, in any capacity, are cautioned to review the applicable state law, which may carry more stringent restrictions than the 2018 Farm Bill, as well as any other pertinent federal authority.
Finally, it is worth noting that nothing in the 2018 Farm Bill implicates the status quo of marijuana or CBD derived from marijuana, both of which remain illegal under federal law. And while the legal landscape remains somewhat hazy, bipartisan agreement of the 2018 Farm Bill marks a long-overdue, massive step forward for the U.S. hemp industry.
About the authors
On August 31, 2018, the California State Senate passed novel legislation, , which requires new disclosures for certain commercial financing, such as loans, factoring transactions, and, potentially, merchant cash advances (MCAs). California Governor Jerry Brown has until September 30 to sign this legislation, and it appears likely that he will. continue reading >>
In an August 2017 posting we reported that the U.S. Tax Court had held that, notwithstanding an IRS revenue ruling to the contrary, the sale by a foreign partner of his interest in a U.S. partnership was not a taxable transaction to him (assuming he was not otherwise a U.S. taxpayer), just as the sale of stock in a U.S. corporation is not a taxable transaction to a foreign shareholder. (“Tax Court: Foreign investors not taxable on sales/liquidations, of U.S. partnership interests.”)
Press Release – New York, NY – July 26, 2017 – Jodi B. Zimmerman, Esq. of Sichenzia Ross Ference Kesner LLP participated in a Q&A blog post hosted by eSignatureGuarantee Group, to share “What You Should Know About Creating A Last Will & Testament.” The Q&A outlines the reasons for planning ahead, what to be aware of, and most importantly — the impact on your family and community.
Jay Kaplowitz, Cass Sanford, Tessa Patti
On January 13, 2016 the SEC approved interim final rules implementing two provisions of the Fixing America’s Surface Transportation (FAST) Act, adopted by Congress in December, that revise financial reporting forms for emerging growth companies* and smaller reporting companies.** continue reading >>
President Obama signed the Fixing America’s Surface Transportation Act, or FAST Act, into law on December 4, 2015. The FAST Act, which is aimed at improving the country’s surface transportation infrastructure, also contains several sections that amend securities laws to ease regulatory burdens for smaller companies.
Improving Access to Capital for Emerging Growth Companies, or EGCs continue reading >>
December 9, 2015 – Sichenzia Ross Friedman Ference founding partner Gregory Sichenzia appears on Lawline, continue reading >>
November 30, 2015
Crowdfunding continues to garner more and more attention as the SEC pushes forward implementing the 2012 JOBS Act. continue reading >>
On August 6th, 2015, the SEC responded to letter a from Citizen VC, Inc. continue reading >>
August 19, 2015 — Sichenzia Ross Friedman Ference LLP Sports and Entertainment Chairman Ed Schauder, Esq. was interviewed this week by Professional Sports and the Law continue reading >>
In our last blog post covering international tax planning, we focused on the unique tax traps related to international acquisitions. In our final installment, we discuss the tax considerations for foreign businesses looking to acquire companies in the U.S.
The U.S. is still the big apple for most foreign businesses, but deciding how to get a bite of it requires careful tax planning.
This article is meant to address the commitments a Chinese entrepreneur interested in accessing the US capital markets should be prepared to make. continue reading >>
A reverse merger is a common method by which private companies go public.
Companies appreciate this method because it is generally quick, though the process is comparatively expensive to other ways of going public. continue reading >>
Why Go Public?
“There was a time a few years ago when the United States was spoken of in the plural number.
Men said ‘the United States are’ — ‘the United States have’ — ‘the United States were.’ But the war changed all that.” The Washington Post, April 24, 1887. The phrase “United States” became a singular noun after the Civil War. continue reading >>
On January 14, 2015, the House of Representatives passed H.R. 37, a bill that would continue reading >>
January 29, 2015
An issuer organized outside of the United States may seek to be classified as a foreign private issuer (“FPI”) in order to benefit from certain accommodations that may not be available to domestic issuers under Nasdaq Stock Market (“NASDAQ”) and New York Stock Exchange (“NYSE”) rules. continue reading >>
New York, NY – January 9, 2015 – Press Release – Marc J. Ross is a leading authority involving the issues surrounding the marijuana legalization debate and the developing, yet still conflicting, laws across the U.S. concerning marijuana and marijuana-related businesses. continue reading >>
Stock options are a popular method of providing executive compensation for start-up or young companies. They don’t cost the company any cash and they give the employees an incentive to make the company succeed. But stock options come in different forms, and the form you choose can have a big impact on the tax consequences to your employees. continue reading >>
December 4, 2014: In Atalese v. U.S. Legal Servs. Group, the Supreme Court of New Jersey recently held an arbitration clause unenforceable where the provision did not contain an express waiver of the consumer’s right to sue in court. The Court found that, continue reading >>
The resolution of tension between two desires of a subset of powerful investors—to sell, and to govern well—is the impetus behind the affiliate sale provisions as drafted in the amended Rule 144.
Rule 144 is the main avenue open to affiliates to sell un-registered securities in the public market. An “affiliate” of an issuer is defined as a “person” who directly or indirectly controls the issuer, generally any executive officer, director or shareholder beneficially-owning 10% or more of the issued and outstanding shares. Volume limitations, reporting obligations and manner of sale provisions, as well as a definition of “person” that responds to the concept of “indirect control,” are among the measures incorporated into Rule 144, in view of the SEC’s understanding that, absent limitations, those in control of a company could be liable for significant abuses in sales of un-registered securities.
Affiliates should know who they are, and what their obligations under the rule are in order to plan efficient sales with reduced liability potential. Additional benefits may be gained at the point of negotiating director or officer compensation. Negotiators may better gauge the value of un-registered compensation shares if they understand the workings of the Rule 144 affiliate sale process.
The navigation of affiliate sale requirements begins with a substantive analysis: Is a given security-holder an “affiliate” for the purpose of Rule 144? The answer is complicated by the broad definition of “person,” which responds to the possibility of “indirect control” of an issuer.
As stated above, an affiliate is defined as a person who directly or indirectly controls the issuer. “Indirect control” is determined in courts through a facts and circumstances analysis—it is a “know-it-when-we-see-it” idea. A director’s wife, for example, may exert indirect control on a company through influence, though she holds no formal position and may not own many shares. When does an ordinary filial relationship become a control relationship with the issuer? The question becomes more involved when determining when percentage-ownership, perhaps by an otherwise ordinary public investor, translates to having “control” of a company. Courts consider 10% beneficial ownership indicative of a control relationship, but not dispositive.
Rule 144 gets in front of these questions by counting a range of people, entities and donees related to an individual security-holder as one “person.” Individuals or entities that constitute one affiliated “person” are individually subject to the affiliate sale rules, and their sales will be considered cumulatively as if they were one seller. An analysis of affiliate status can be done on a case-by-case basis where circumstances are vague or there are countervailing factors weighing against otherwise suspicious relationships. For this reason, determining whether one is an affiliate can be a rigorous point of investigation, and it must be done before sales can be planned.
Rule 144 permits sales where an affiliate did not acquire shares with the intent to profit by distributing them, possibly at the expense of the issuer or the investing public. Volume limitations, manner of sale provisions and an obligation to report sales of a certain size, are factors the SEC believes demonstrate an affiliate assumed the economic risk of investment. Assumption of economic risk cleanses an affiliate’s intent in the eyes of the authorities.
Volume limitations control the rate at which securities may be sold. Quarterly sales of shares in an exchange-listed issuer are limited to the greater of 1% of the issued and outstanding shares of the same class being sold, or the average weekly trading volume during the preceding four weeks. An affiliate in a non-exchange listed issuer (such as an OTC Bulletin Board or OTC Markets company) must use the 1% measurement. Volume limitations present a significant, though straightforward, control on affiliate sales, and affiliates should consider them when planning sales on a timeline.
Manner of sale provisions prescribe the appropriate relationship between an affiliate and a broker. They prevent sales from taking on the semblance of distributions, through commission structures or otherwise. Affiliates must sell equity securities in unsolicited broker’s transactions directly with a market maker, or in riskless principal transactions. A broker must do no more than execute an order to sell the securities as agent for the affiliate, and may receive no more than customary commission. Solicitation for buy orders is generally inappropriate. The SEC has cited the “gatekeeper” role of the broker to ensure compliance with Rule 144. By turn, affiliates should select brokers with care and construct healthy sale relationships with them in view of the manner of sale provisions.
Finally, the SEC requests to be made aware of significant public securities transfers by affiliates. Affiliates must file Form 144 with the SEC in advance of sales of more than 5,000 shares or $50,000 aggregate dollar value. The sale must take place within three months of filing the form.
Officers, directors or large shareholders of an issuer should have a firm grasp of the affiliate sale rules under Rule 144, so they may plan sales efficiently, effectively and properly. This begins with knowing whether one is an affiliate, and how to count shares using the definition of “person” described above. Once affiliate status is determined, the obligation runs to sell in compliance with volume limitations, manner of sale provisions and Form 144 reporting. At the time of sale, this insulates affiliates from liability, and allows them to cultivate reputations as responsible controlling investors. At the time of employment contract negotiation, knowledge of the affiliate sale process can help an officer or director better gauge the value of compensation shares. Most importantly, being in compliance with Rule 144 enables an affiliate perform its duties to the issuer and the investing public, while participating actively in the market.
The information in this blog post is for general, educational purposes only and should not be taken as specific legal advice.
Written by Jennifer R. Rodriguez, Esq.
Entrepreneurs often choose limited liability companies to incubate their businesses. An LLC offers a simple entity structure, it lets the members claim start-up losses on their own tax returns, and it eliminates the double tax imposed on a corporate structure once the venture turns profitable.
But an LLC has a tax defect that its owners frequently don’t understand until it’s too late: because it is not a corporation an LLC cannot participate in a tax-free corporate reorganization. So when the owners sell their LLC interests to another company for stock, the transaction is a taxable event to them but they don’t get cash to pay the tax on any gain.
If the stock trades publicly the owners can sell some of it to raise cash for the taxes. But they may not want to do that, and there may be SEC- or deal-driven lockups that prohibit them from selling before the tax is due. If the stock doesn’t trade publicly, they may need to find cash somewhere else.
The buyer may have a number of reasons for wanting to acquire membership interests of an LLC using its stock as currency: it may not have the cash itself, or want to use it, or it may want the sellers to continue to have an equity interest in the company and be motivated to help it succeed. The buyer may propose a stock-for-stock exchange, a stock-for-assets exchange, or a merger. All of these transactions could be tax-free to the sellers who own the target – but only if the target is a corporation.
There are solutions to this problem, but each solution carries tax risks. The sellers can incorporate their LLC (or elect to have it treated as a corporation for tax purposes) before the acquisition and then exchange their stock in the new corporation for stock in the buyer. But this approach will usually generate a so-called “step-transaction” analysis: if the IRS decides that the conversion of the LLC into a “C” corporation and the subsequent stock exchange were all part of the same transaction, and that there was no non-tax reason for the conversion, it will disregard the first step – the conversion – and treat the transaction as a taxable sale of the LLC interests. The closer the conversion occurs to the acquisition, the more likely the step-transaction doctrine will be applied.
Another solution is to structure the exchange as a tax-free “Section 351 transfer”. Section 351 transfers can involve property (as opposed to just stock). In a section 351 transfer the seller contributes his LLC interests (or the LLC’s assets) to a new corporation, and the buyer contributes stock (or other property) to the new corporation, and if together the seller and the buyer control more than 80% of the new corporation, then the transfer is tax-free.
But this solution has its drawbacks, as well. For one thing the stock that the seller now owns is not stock in the buyer but in a corporation that is a subsidiary of the buyer. That stock probably won’t be sellable. After a decent interval (which could be as long as a year) the parties could liquidate the subsidiary into the buyer and distribute stock in the buyer, but if they do that too soon then — you guessed it — the step-transaction analysis is applied once again. And if the buyer uses treasury stock to capitalize the subsidiary, there is an unsettled legal question as to whether the transfer is still tax free to the seller. In any event, the section 351 transfer forces the buyer to hold the target’s business in a subsidiary company, something it may not wish to do.
There are also non-tax solutions: the deal might require the buyer to provide enough cash consideration for the seller to pay the tax, but then the amount of cash becomes a negotiating point and chances are the seller gives up something in return for it.
The best solution to the LLC problem is to plan ahead. Way ahead. Do you need an LLC in the first place – will the tax benefits of the losses justify the potential tax problem on a sale for stock? Would an S corporation serve as an alternative to an LLC? (It’s not an alternative if there are foreign, corporate or (in some cases) trust owners, more than 100 owners, or more than one class of equity.) If you plan to sell the business before it turns a profit (and then there would be no benefit to the tax flow-through) should you just start with a corporation in the first place? There are no boiler-plate answers to these questions; the alternatives need to be analyzed in the context of the business and the exit strategy.
If you already have an LLC and plan to sell, the best solution is still to plan ahead. If today you foresee a sale of your company in a year or so, now may be the time to convert it to a corporation. The further in advance of the sale that you do so, the more likely you are to avoid the step-transaction doctrine. (LLCs can usually be converted to corporations tax-free.) Again, there is no one-solution-fits-all, but you will have more options if you address the problem well in advance of the sale.
The corporate tax-free exchange rules of the tax laws are among the most complicated in the Internal Revenue Code, but people have been dealing with them for decades and a solution is often available, as long as you leave yourself enough time and flexibility to find it.
Written by Michael Savage, Esq.
The information in this article is for general, educational purposes only and should not be taken as specific legal advice.