By: Teri Buhl
26 July 2019
A top-tier law firm, Greenberg Traurig LLP, has lent its name to secure an effective registration of a pure-play cannabis ETF on a major U.S. stock exchange.
Innovation Labs Cannabis index shares The Cannabis ETF ($THCX), launched this month, is the brain child of a seasoned ETF manager Matt Markiewicz who cut his teeth building out hundreds of ETF’s at BlackRock iShares.
The journey to find a custodial bank, fund administrator, and a law firm that was willing to sign a rigorously inspected opinion letter took Markiewicz over a year.
But given the reputations of the firms that partnered with him it could show more seasoned Wall St. firms are moving past fears of working with cannabis companies in a country where federal law still considers the plant illegal.
THCX is a passively managed index with a monthly rebalance that tracks the Innovation Labs Cannabis Index. It trades on the NYSE ARCA. Stocks picked for the index are only marijuana, hemp or CBD focused with no fillers in other vice businesses like tobacco or alcohol. Considering there is no regular growth market for cannabis companies yet Innovation Shares is counting on a monthly reset of holdings to set them apart from the typical quarterly reset. With a quarterly reset you can get stuck in a bad position and not be able to get out of it for a few months; like The Street is seeing now with CannTrust who was caught by Canadian regulators for growing tons of unregistered marijuana plant and trying to cover it up.($TRST has dropped over 60% since the news broke)
One thing THCX stays away from is Multi-State Operators that touch the plant in the U.S. known as MSOs.
This is the second ETF for the Securities and Exchange Commission to make effective. AdvisorShares Pure Cannabis ETF with a Cheech and Chong sounding ticker called YOLO launched in April with Morgan Lewis & Bockius as lawyers for the SEC registration.
Both $THCX and $YOLO were first to go through the question and answer process of its U.S. regulator who was somewhat gun shy after another ETF, ETFMG Alternative Harvest ($MJ), snuck into the market without going through regulatory approval in December 2017.
MJ was a Latin American real estate ETF who went and changed their strategy to Cannabis and raised one billion of assets under management. But its top tier custodial bank U.S. Bancorp dropped them just a few months after the switch-a-ru leaving MJ scrambling to find a custodian. ETF’s in the US have to have a custodian hold the stock as an additional lawyer of gatekeeping to protect main street retail investors. MJ ended up getting a questionable California broker-dealer, who has faced an SEC enforcement action, WedBush, to act as custodian. MJ is passively managed and resets quarterly. It traded at a high of $43 last year and is currently trading around $28 as of press time.
Matt Markiewicz has scored a few first which started with convincing Kip Meadows, CEO of a North Carolina ETF fund administrator Nottingham Investments, to agree to try their first cannabis ETF. In an interview with the Cannabis Law Report, Meadows said it was his long time professional relationship with Greenberg Traurig partner Terry Davis that helped bring the top tier law firm into the venture. Attorney Davis, who works out of the Atlanta office, said he entrusted the transaction to Tanya Cody a senior attorney he brought into the firm. It was her first experience within the cannabis space and Davis said what she accomplished ‘was no small feat’. The registration process took ten months which was longer than any of the parties had hopped for but they got side-swiped when the US congress battled over budget issues in the longest government shut down this spring. There was also the issue of the SEC requiring a third-party law firm to put their stamp of approval on the ETF.
“The legal opinion required by the SEC is unique to cannabis funds and required extensive negotiations with the SEC regarding its content including everything from what the fund thinks is legal in cannabis investing to their checks and balance process to ensure they follow investing guidelines”
Attorney Tanya Cody told Cannabis Law Report.
Attorney Cody explained to Cannabis Law Report there are no written rules set yet by the Securities and Exchange Commission regarding cannabis ETFs. The major exchanges like NYSE and NASDAQ have created their own requirements around cannabis-related companies that include that they will not list a company that produces or distributes marijuana in the U.S. because federal law prohibits such practices. These companies are known as MSOs. The major exchanges also will not list an ETF that holds these types of companies in their portfolio. Part of the legal opinion that the SEC has accepted in order to allow cannabis funds to go effective, states that the fund will only invest in companies that are listed on securities exchanges that have these requirements, such as NYSE, NASDAQ, TSX, TSX-Venture and the Australian exchange.
This means ETFs registered with the SEC can’t currently put MSO stocks in their portfolio.
“This is no rubber stamp process,” said attorney Cody and the level of scrutiny can depend on what SEC inspector you get assigned.
“Getting that approval letter from Greenberg Traurig was a big deal,” said Markiewicz.
This is the first cannabis ETF registration for Cody’s top tier law firm, Greenberg Traurig, who is working to build out an expertise in their cannabis practice from their Denver, Colorado office advising cannabis companies on private transactions.
YOLO didn’t go the same path. While they secured a global firm like Morgan Lewis to file the registration, SEC filings show the ETF went out to law firm, Fox Rothchild, to get the opinion letter. Fox Rothchild had done one other cannabis transaction.
There is speculation Morgan Lewis wouldn’t do the opinion letter. YOLO is run by a Texan, Dan Ahrens, who use to work for Ladenburg Thalmann Gaming and Casino Fund. Ladenburg was led by chairman Philip Frost who was charged with securities fraud and settled with the SEC for his role in running pump and dump schemes this year.
Dan Ahrens told Cannabis Law Report he considered Fox Rothchild an expert in the cannabis space and ‘they cost less’.
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The opinion letter is important because investment managers running mutual funds that want to invest in a Cannabis ETF could have a mandate that they won’t invest if they ETF doesn’t have top tier partners and vendors.
Ahrens was able to score one big win with his vendors, which is getting the first FDIC bank to be its custodian. BNY Mellon, who has worked with AdvisorShares for years said they agreed to work with YOLO because they knew the company. This was a night and day switch because when Kip Meadows at Nottingham approached them last year for THCX he got a response that BNY Mellon was never going to work in the cannabis space.
Nottingham is also a customer of BNY Mellon. Cowen, a respected broker dealer, agreed to be THCX custodian. Meadows said in the current environment the hardest part of setting up an ETF in the cannabis industry is finding the custodian. A bank custodian’s fear is they could loose their FDIC license because of the government’s view on the legality of marijuana.
“We have always considered the needs and interests of our ETF clients across global markets as they evolve, and this is no different,” said BNY Mellon spokesman Paul Petalla. “The fund [YOLO] has been reviewed in accordance with our internal governance requirements, and has been deemed to be compliant with those requirements.”
MSO Workaround could be an issue
YOLO has come under scrutiny this week when an ETF trade publican reported the SEC and the NYSE are reviewing what’s really in YOLO’s holdings.
That’s because Ahrens has bought private party swaps in MSOs as part of YOLO’s holdings. The fund registration documents filed with the SEC do warn investors there will be investments with counter party risk and the fund will use swaps. Only 20% of the holdings are allowed to be swaps and YOLO currently has 12% in swaps. ETF.com reported these swaps aren’t on the list of holdings YOLO gave to the NYSE and its custodian bank when it had to report what kind of companies the ETF would invest in.
“YOLO runs like a hedge fund,” says Jon Najarian, the co-founder of optionMonster and CNBC contributor, who has joined Markiewicz to be an advisor to THCX. “Why do want that kind of risk in an ETF?”
Markiewicz, managing director of THCX, said in a TV interview with Bloomberg that his fund isn’t going use swaps or have exposure to MSOs and nor did his counsel feel comfortable with that in offering docs—for now at least.
“A fund could be looking at fines with MSO swap exposure,” said Najarian.
Ahrens said in an interview that a custodial bank doesn’t hold swaps so it’s not a transaction they are responsible for when asked if BNY Mellon is concerned about the use of swaps. He also told Cannabis Law Report he thinks everyone involved in launch of the fund was made ‘very aware’ of its investment strategy.
The NYSE would not comment of the swaps/MSO issue.
Matt Karnes, founder of Greenwave Advisers , a cannabis investment research firm and familiar with the new ETFs said, “Pension plans are staying clear of investing in U.S. MSO’s and because of the added counter party risk associated with these types of derivative products (Swaps) Cannabis ETFs will likely remain unappealing to institutional investors.”
Karnes also expressed concerns about the counter party risk of a swap. “The inherent risk associated with plant touching businesses keeps many on the sidelines as the federal illegality continues to raise concerns of potential business shutdowns which in a worst case scenario could destroy all valuations. And, the question remains as to whether ISDA contracts would cover Swaps linked to businesses that are federally illegal.”
THCX Future Plan
Institutional Investors like hedge funds that go long or short cannabis stocks aren’t investing in ETF’s. But with the billions in AUM they have to invest Markiewicz and Najarian will be making a play to attract their attention. Najarian’s decades of experience in options is already being put to use.
“We are currently having productive conversation with two exchanges about getting a futures product going for THCX,” Najarian told Cannabis Law Report. “I think this could be a billion dollar fund.” Options need liquidity though and robust market makers. “When THCX gets past a few hundred million in assets under management I think the market will be ready for futures.”
Two hedge funds invested in Cannabis stocks told Cannabis Law Report if THCX can get the options action going that would be huge for their hedging strategy. Right now THCX can also make money off stock lending for Hedge Funds that want to short a stock. The lending is done through their broker dealer Cowen out of stocks THCX holds. Markiewicz says they have favorable lending rates and the stock lending revenue goes to THCX bottom line.
I’m a professional financial investigative journalist who has written for the Greenwich Time, Hearst CT Newspapers, Forbes Magazine, Fortune.com, The Atlantic.com, New York Magazine, New York Post, Trader Monthly, Housingwire, ML-Implode, The business Insider, Long Island business News, Dealbreaker, New York Observer, Bitcoin Magazine, DealFlow Media, SIRF.org and more. For the last five years I have been a contributing reporter for Market Nexus Media who publishes a financial trade publication called Growth Capital Investor.
I earned my breaking/investigative news chops reporting during the financial crisis in 2008 for the Sunday edition of the New York Post. I was one of the first to report on the missteps at IndyMac that lead to government investigations and lawsuits against the banks founders. Caught hedge funds like Carrington Capital abusing investors without disclosing conflicts of interest with senior RMBS bond holders; they were sued by Wilbur Ross for Civil RICO. I exposed Bear Stearns misleading their own investors and monoline insurers on the quality of the loans in their mortgage-backed securities, which led to a fraud lawsuit against JP Morgan/Bear Stearns and the $13 billion settlement with the DOJ in 2013. Since 2010 multiple Wall Street firms, that my reporting warned about first, have been [JP Morgan, SpongeTech, Security Savings Bank, SAC Capital, Palm Beach Capital Management, New Stream Capital, NIR Group/Cory Ribotsky, Bear Stearns RMBS Traders, Mike Perry IndyMac CEO, Steven Muehler and the Nanocap MarketPlace, Barry Honig and The Frost Group] investigated or charged for financial violations by the FBI/SEC/State AG or shut down by bank regulators.
The Huffington Post named me the number three most dangerous financial journalist for being willing to challenge the establishment and inform readers best. I’m working on trade-marking “Smashmouth Journalism”
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