The North American cannabis industry is booming amid increased legalization, with merger and acquisition activity soaring and new deals being announced almost daily. While the industry is clearly still in its growth stage, more legalization of cannabis foretells increased competition followed by industry consolidation, shakeout and a movement toward industry maturity—as is the case with most every consumer product industry.

As the industry continues to progress through its growth stage, cannabis-related companies will increasingly seek additional capital through public transactions, in response to competitive forces and persisting investor demand. Many self-appointed investment gurus feel that the industry is currently a once-in-a-lifetime growth opportunity, and every investor seems to want a piece of the action. But, despite all the recent success stories stemming from expanding cannabis legalization in Canada and the United States, why does it feel as though investment options are still very limited? The answer lies in the current U.S. federal law and banking regulations, which severely limit opportunities for cannabis investment on major stock exchanges.

The past year saw numerous groundbreaking legal developments in the North American cannabis industry. Canada legalized adult-use cannabis in October 2018 with passage of the Cannabis Act (S.C. 2018, c. 16). The United States legalized the production of hemp and hemp-derived products, such as cannabidiol or "CBD," in December 2018 with passage of the Agricultural Improvement Act of 2018 (Pub. L. 115-334). The U.S. Food and Drug Administration approved its first cannabis-derived drug, Epidiolex, a purified form of CBD for the treatment of certain epileptic seizure disorders, in June 2018. In Utah and Missouri, voters chose to legalize medical cannabis, and Michigan became the tenth state to legalize adult-use cannabis. In total, over the course of 2018, 21 states considered bills to legalize adult-use cannabis, including the Garden State and our neighbors New York, Pennsylvania, Delaware and Connecticut. While cannabis-based investment used to be a taboo subject among sophisticated investors, even Wall Street firms are now compelled to take notice of the investment opportunities arriving in the wake of this new wave of legalization.

Until the recent legalization developments of 2018, cannabis companies were categorically restricted from listing their stock on the two most prominent exchanges in the United States, the New York Stock Exchange and NASDAQ, which both prohibit companies that operate in violation of federal law. Instead, many North American cannabis companies interested in raising capital elected to go public on foreign (primarily Canadian) exchanges, or by listing on the U.S. over-the-counter (OTC) market—also called the "pink sheets" market. Although these alternative exchanges were the most viable option for cannabis companies seeking early exposure to public investment, their status as lower-tier alternatives to the major U.S. stock exchanges limited the investment potential and trading liquidity.

As a general matter, companies that have listed their stock on the OTC market or other smaller exchanges do not attract the attention of many U.S.-based institutional investors, who usually avoid investing on these exchanges due to their weaker listing standards, unfamiliar reporting requirements, and lower overall trading volume. The New York Stock Exchange remains the gold standard for attracting institutional investment in the United States. Retail investors are similarly hard to come by for companies trading on smaller exchanges, as most investors are not as familiar with investing on smaller exchanges as they are with major exchanges because of a shortage of high-quality analyst coverage and broker limitations. While some very successful and investment-worthy brands such as Samsung, Nestle, BMW and Nintendo voluntarily choose to list their corporate stock on the OTC market and/or other foreign exchanges to avoid Securities and Exchange Commission reporting requirements or for other strategic reasons, investors typically associate the pink sheets with risk.

Despite the increased legalization of cannabis across North America and the fact that, as of the date of this publication, a majority of states have legalized cannabis in some capacity, both the NYSE and NASDAQ continue to hold firm on their stance that companies that operate in violation of federal law are prohibited from listing. Therefore, cannabis producers and other plant-touching companies in the United States are still relegated to the pink sheets. However, the most recent round of cannabis legalization has resulted in some changes at the NYSE and NASDAQ that benefit foreign cannabis companies and cannabis-related companies seeking to list there.

In February 2018, Canadian-based Cronos Group became the first cannabis producer and distributor to trade on the NASDAQ exchange (NASDAQ:CRON). Shortly thereafter, in May 2018, Canadian-based Canopy Growth Corp. became the first cannabis producer to list on the NYSE (NYSE:CGC). Both companies are leaders in the cultivation, production and distribution of cannabis and operate on an international level. However, it is important to note that both companies have refrained from entering the U.S. cannabis market and are therefore not operating in violation of federal law. Since these companies are in compliance with the laws of every jurisdiction in which they operate (including Canada, Israel, Australia, Germany and Poland), their stock is now readily purchased on major U.S. exchanges by American investors.  However, U.S.-based cannabis producers that operate under state legalization are still relegated to the pink sheets.

While it is true that some U.S.-based, cannabis-related companies now trade on the NYSE and NASDAQ, the list is limited to companies operating in federally legal secondary or related markets. For instance, Greenlane Holdings, a leading distributor of vape products, smoking accessories and hemp-derived CBD in the U.S. and Canada, was recently listed on the NASDAQ exchange in April (NASDAQ:GNLN). Greenlane is based in Boca-Raton, Fla., and is not a plant-touching company, meaning that it is operating legally under federal law. Its products do not violate federal drug paraphernalia laws, and its distribution chain is not in violation of federal drug trafficking or racketeering laws. Other U.S.-based, cannabis-related companies that are listed on major exchanges include Innovative Industrial Properties (NYSE:IIPR), a medical-use cannabis real estate investment trust with headquarters in California, and Turning Point Brands (NYSE:TPB), a Kentucky-based, smoking-accessories company that owns the Zig-Zag rolling papers brand.

Established foreign cannabis producers eyeing an expansion into the U.S. market are faced with a difficult choice at the moment. If these companies intend to pursue listing their stock on a major U.S. exchange, they must continue to stay out of the U.S. marketplace. Despite their existing production capabilities, they will be forced to forgo mouthwatering opportunities to leverage their competencies in relatively untapped U.S. marketplaces with high levels of demand and low levels of supply. These emerging opportunities will be increasingly difficult for foreign producers to resist as more and more states across the U.S. legalize cannabis. If the temptation is too great, and these companies do decide to enter the U.S. market, they will be excluded from the major exchanges and their access to investment capital will therefore be limited.

Without federal reform, it appears that cannabis producers and other plant-touching companies that operate openly and successfully in the U.S. under state legalization will continue to be relegated to the pink sheets and excluded from the major exchanges. As a result, their access to investment capital will continue to be limited compared with that of their foreign counterparts. We therefore expect that the majority of U.S. public investment in the cannabis industry in the immediate future will be directed toward foreign plant-touching companies or cannabis-related companies listed on the major exchanges.

Evan P. Zimmerman, an associate with Giordano, Halleran & Ciesla in Red Bank, represents clients in complex land development projects, regulatory issues and cannabis law matters. Paul T. Colella, co-managing shareholder at the firm, concentrates on business law, mergers and acquisitions, corporate finance and cannabis law. Patrick S. Convery, a shareholder, focuses on mergers and acquisitions, corporate law, business transactions, financing issues and cannabis law.