The cannabis industry is experiencing a surge in lawsuits filed against CBD companies, highlighting the fundraising risks for CBD companies associated with potentially false or misleading statements or omissions about their business and business activities.

In sum, CBD companies continued to experience a surge in class action and securities litigation throughout 2020, which began in 2018 following the passage of the Farm Bill that same year. Continuing this trend, cannabis attorneys, as well as financial experts, expect to see the number, scope, and magnitude of these types of lawsuits similarly increase throughout 2021 – especially in connection with fundraising activities of CBD companies.

I.   Introduction to Securities Lawsuits

Securities are tradable financial instruments generally “sold” to investors for the purpose of securing funding for a business. A typical plaintiff in this type of litigation is a shareholder seeking to recover his or her investment losses – including not only the monies paid but additional damages, including punitive damages for fraud and more. Securities lawsuits are not limited to publicly traded businesses but can also be leveraged in connection with private capital fundraising.

The focus of these lawsuits is usually on whether false or misleading statements or omissions were made by a company’s officers in connection with a securities offering. Ongoing litigation casts direct light on specific fundraising risks for CBD companies, including those relevant to statements and/or omissions related to financial statements, projections, operations, asset and maintenance valuations, and specific transactions.

Therefore, it is critically important that business owners, managers, and even marketing personnel are aware of these significant fundraising risks for CBD companies and conduct their business operations as well as their advertising and marketing in a way that minimizes or mitigates such risk. Below we examine three of these ongoing lawsuits, the alleged wrongful conduct, the legal issues presented, as well as the outcome or status of these potentially financially devastating lawsuits:

II.   Ongoing Securities Litigation

Ina v. CV Sciences, Inc. et al, No. 2:2018cv01602 – (D. Nev.) – Filed August 2018

  • Defendant: CV Sciences is a company focusing on CBD research and products.
  • Plaintiff: Richard Ina, plaintiff, is an investor.
  • Factual Background: In 2016, CV Sciences filed a patent application for a CBD chewing gum product intended to assist in smokeless tobacco use and addiction with the U.S. Patent and Trademark Office. Received non-final rejection in April 2017; the final rejection was received in December 2017. Despite this, the company made the following statements:
    • June 2017 – Company Press Release, Founder and then-CEO: “product ha[s] a favorable development roadmap.”
    • 2017 Q2 – 2018 Q1 – Form 10-Q and K filings, “[product is] lead drug candidate” due to “proprietary formulations, processes and technology that [CV Sciences] believe[s] are patent-protectable.”
    • August 2018 – Company Press Release, “drug development program is making steady progress in advancing [its] proprietary lead drug candidate […] which addresses the multibillion dollar smokeless tobacco use and addiction market.”
  • Claim: Defendants made materially false and misleading statement about the status of the company’s chewing gum product’s patent application. Specifically, defendants failed to disclose that the product’s patent had been rejected in its multiple public statements and disclosures.
  • Defenses: Because the patent application process regularly extends beyond a “final rejection” notice issued by the USPTO, the challenged statements are neither false nor misleading. Also argued that calling a product “proprietary” is non-actionable puffery or non-actionable forward-looking statements.
  • Primary Issue: The Court rejected the company’s argument regarding non-actionability, and found that CV Sciences represented the product was “patent-pending” or, at a minimum, “patent-protectable.” The court framed the primary issue as, Whether a reasonable investor would have believed that “a patent remain[ed] pending after a final rejection.”
  • Status: Ongoing. In October 2020, attorneys filed motions for sanctions against attorneys representing CV Sciences’ former executive, claiming they concealed a hard drive, generally stonewalled discovery requests, and raised frivolous objections.

Tchatchou v. India Globalization Capital, Inc. et al, No. 8:2018cv03396 – Document 37 (D. Md.) – Filed November 2018

  • Defendant: India Globalization Capital, Inc. engages in CBD research, as well as builds farming facilities for lease.
  • Plaintiffs: Investor class action
  • Factual Background: In September 2018, India Globalization Capital announced it would produce a CBD-infused beverage called “Nitro-G” and that it had executed a distribution agreement with a manufacturing partner located in Malaysia without disclosing that in Malaysia, cannabis is illegal and publishable by death. A subsequent secondary stock offering raised $30 million.
  • Claims: Defendants made materially false and misleading statement related to the quality of the manufacturer. Specifically, defendants made the following false statements and/or omissions:
    • Falsely or misleadingly describing the manufacturing partner as an “experienced manufacturer” when in reality, it was a “recently-created distributor entity” controlled by India Globalization Capital;
    • Failing to disclose to investors that cannabis was illegal – and punishable by death – in Malaysia.
  • Defense: The disclosures contain no false statements because they did not represent that the CBD-infused version of Nitro-G would be manufactured in Malaysia. IGC was not required to disclose that it exercised substantial control over the distributor. Further, even if the statements are false, they are not material.
  • Status: Ongoing. Motion to dismiss is pending: fully briefed, no hearing yet held.

Note on “Material”: For an alleged false statement to be actionable, the statement must be material to an investor’s decision to buy or sell stock. That is, a plaintiff must show there is “‘a substantial likelihood that a reasonable purchaser or seller of a security (1) would consider the fact important in deciding whether to buy or sell the security or (2) would have viewed the total mix of information made available to be significantly altered by disclosure of the fact.’” Ottman, 353 F.3d at 343 (quoting Longman, 197 F.3d at 682-83). For purposes of this analysis, “a ‘reasonable investor’ is neither an ostrich hiding her head in the sand from relevant information, nor a child, unable to understand facts and risks of investing.” Greenhouse, 392 F.3d at 656 (citing Hillson Partners, 42 F.3d at 213).

In re Curaleaf Holdings, Inc. Securities Litigation (1:19-cv-04486), New York Eastern District Court – Filed August 2019

  • Defendant: Curaleaf is a Massachusetts-based cannabis producer and distributor.
  • Plaintiffs: Investor class action
  • Factual Background: In November 2018, Curaleaf announced it would launch its own CBD products and marketed them as potentially able to provide relief for ailments like chronic pain, anxiety, depression, Parkinson’s and Alzheimer’s disease, and more. In June 2019, the FDA issued a public warning letter. The next month, Curaleaf issued a public statement that it removed the challenged statements from its website, discontinued several products designed to provide the challenged health benefits, and denied its conduct was in violation of Federal Law. In August 2019, Curaleaf’s then-CFO characterized the situation as having a “tremendous amount of ambiguity.”
  • Claim: Defendants made materially false and misleading statement about the company’s expansion because the company’s products were not FDA-approved and the regulatory scheme is complex.
  • Defenses:
    • Curaleaf’s public statements could not have misled investors in light of their other disclosures. Specifically, the Company’s securities filings repeatedly put investors on notice of the fact that its products were not FDA-approved and were thus subject to potential FDA regulation, the Company was not required to repeat the same information in every press release. (Materiality argument)
    • The relevant information (“the risk of FDA regulation”) was a matter of readily accessible public record. Specifically, reasonable investors would have been aware of the FDA’s own persistent statements that it could potentially take regulatory action against unapproved cannabis-derived products and that it had not yet decided whether and how to approve them.
    • Statements were promotional – and “conveyed no information – and are therefore not actionable.
  • Status: Ongoing. Motion to dismiss is pending: fully briefed, no hearing yet held.

Note on SEC Actions: The SEC is friendly to defrauded investors, but investors are not always compensated even if an SEC lawsuit is successful.

III.   CBD and Cannabis Companies Urged to be Cautious

Stay abreast of these issues regarding fundraising risks for CBD companies. It is critical you work with an attorney who is well-advised in ongoing cannabis litigation in order to leverage this insider knowledge to effectively see around corners and avoid issues before they even arise.

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